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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10–Q

For the Quarterly Period Ended September 30, 2003

OR

For the Transition Period from             to

Commission file number 000-26679

ART TECHNOLOGY GROUP, INC.

25 First Street, Cambridge, Massachusetts
(Address of principal executive offices)

02141
(Zip Code)

(617) 386-1000
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2 of the Exchange Act). Yes o No x

     As of November 7, 2003 there were 72,672,743 shares of the Registrant’s common stock outstanding.

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ART TECHNOLOGY GROUP, INC.
INDEX TO FORM 10-Q

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ART TECHNOLOGY GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ART TECHNOLOGY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ART TECHNOLOGY GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(UNAUDITED)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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ART TECHNOLOGY GROUP, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) OPERATIONS AND BASIS OF PRESENTATION

     Art Technology Group, Inc. (ATG or the Company) is a Delaware company incorporated on December 31, 1991. ATG offers an integrated suite of Internet online marketing, sales and self-service applications, as well as related application development, integration and support services.

     ATG develops and markets software that enables consumer, retail and financial services companies to dynamically market, sell and provide services to their customers online. The Company offers proven, flexible online marketing, sales, and self-service software applications for consumer facing e-commerce sites. ATG also offers its clients related professional services including support, education and implementation services.

     The accompanying unaudited condensed consolidated financial statements of the Company have been prepared pursuant to the rules of the Securities and Exchange Commission for quarterly reports on Form 10-Q. The disclosures do not include all of the information and footnotes required by accounting principles generally accepted in the United States and while the Company believes that the disclosures presented are adequate to make information not misleading, these financial statements should be read in conjunction with the audited financial statements and related notes included in the Company’s 2002 Annual Report on Form 10-K. In the opinion of management, the accompanying unaudited condensed consolidated financial statements and notes contain all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation of the Company’s financial position, results of operations and cash flows at the dates and for the periods indicated. The operating results for the three and nine months ended September 30, 2003 are not necessarily indicative of the results to be expected for the full year ending December 31, 2003.

     The accompanying consolidated financial statements include the accounts of ATG and its wholly owned subsidiaries. All significant intercompany balances have been eliminated in consolidation.

(2) STOCKHOLDERS’ EQUITY

     Stock-Based Compensation

     ATG grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. ATG accounts for stock-based compensation for employees in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations, and follows the disclosure-only alternative under Statement of Financial Accounting Standards (FAS) 123, Accounting for Stock Based Compensation (FAS 123).

     Had compensation expense for ATG’s Stock Plans been recorded consistent with the fair value method under FAS 123, the pro forma net loss and net loss per share would have been as follows (in thousands, except per share amounts):

     Increase in Shares Available Under Option Plans

     During the second quarter of 2003, the Company’s stockholders approved resolutions that increased the number of shares of common stock available for future issuances under the 1999 Outside Director Stock Option Plan and the 1999 Employee Stock Purchase Plan to 800,000 shares from 300,000 shares, and to 5,000,000 shares from 3,000,000 shares, respectively.

     Decrease in Authorized Shares of Common Stock

     During the second quarter of 2003, the Company’s stockholders approved a resolution to decrease the number of shares of common stock authorized to 200,000,000 from 500,000,000.

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     Option Exchange Program

     On August 1, 2002, the Company offered all full-time and part-time employees, other than the officers as defined in Rule 16a-1(f) of the Securities Exchange Act of 1934, and directors, the opportunity to participate in a stock option exchange program. The voluntary program gave employees the opportunity to exchange options with exercise prices of $15.00 or more per share that were granted under the Amended and Restated 1996 Stock Option Plan. However, if an employee elected to cancel any awards, all options granted after January 26, 2002 were also required to be canceled and the employee could not be granted any additional shares of stock before March 3, 2003. The new options were exercisable for one share of ATG’s common stock for every three shares of the Company’s common stock issuable upon exercise of a surrendered option to be granted at least six months and one day after the old options were cancelled. Approximately 3,000,495 options were eligible for exchange under this program.

     On August 29, 2002, 1,997,819 options were cancelled under the stock option exchange program. On March 3, 2003, 479,447 replacement options were granted to employees of ATG in accordance with the option exchange program, at a grant price of $0.99 per share. Twenty-five percent of each new option vested immediately on the date of grant. The remaining seventy-five percent will vest in three equal installments in six-month intervals.

(3) NET INCOME (LOSS) PER SHARE

     Net income (loss) per share is computed in accordance with FAS 128, Earnings Per Share (FAS 128). Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding, plus the dilutive effect of common stock equivalents using the treasury stock method. Common stock equivalents consist of stock options.

     The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share amounts):

(4) REVENUE RECOGNITION

     ATG recognizes product license revenue from licensing the rights to use its software to end-users. ATG also generates service revenues from integrating its software with its customers’ operating environments, the sale of maintenance services and the sale of certain other consulting and development services. ATG generally executes separate agreements with its customers, which govern the terms and conditions of its software license, consulting and support and maintenance services. These separate agreements, along with ATG’s price list and business practices of selling services separately, provide the basis for establishing vendor-specific objective evidence of fair value. This allows ATG to appropriately allocate fair value among the multiple elements in an arrangement and apply the residual method under Statement of Position (SOP) No. 97-2, Software Revenue Recognition (SOP 97-2) and SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions (SOP 98-9).

     ATG recognizes revenue in accordance with SOP 97-2 and SOP 98-9. Revenues from software product license agreements are recognized upon execution of a license agreement and delivery of the software, provided that the fee is fixed or determinable and deemed collectible by management. If conditions for acceptance are required subsequent to delivery, revenues are recognized upon customer acceptance if such acceptance is not deemed to be perfunctory. In multiple element arrangements, ATG uses the residual value method in accordance with SOP 97-2 and SOP 98-9. Revenue earned on software arrangements involving multiple elements which qualify for separate element accounting treatment is allocated to each undelivered element using the relative fair values of those elements based on vendor specific objective evidence with the remaining value assigned to the delivered element, the software license. Typically, the Company’s software licenses do not include significant post-delivery obligations to be fulfilled by the Company and payments are due within a three-month period from the date of delivery. Consequently, license fee revenue is generally recognized when the product is shipped. Revenues from software maintenance agreements are recognized ratably over the term of the maintenance period, which is typically one year. ATG enters into reseller arrangements that typically provide for sublicense fees payable to ATG based upon a percentage of ATG’s list price. Revenues are recognized under reseller agreements as earned for guaranteed minimum royalties, or based upon actual sales by the resellers. ATG does not grant its resellers the right of return or price protection.

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     Revenues from professional service arrangements are recognized on either a time-and-materials or percentage-of-completion basis as the services are performed, provided that amounts due from customers are fixed or determinable and deemed collectible by management. Unbilled services represent service revenues that have been earned by ATG in advance of billings. Amounts collected or billed prior to satisfying the above revenue recognition criteria are reflected as deferred revenue. Deferred revenue primarily consists of advance payments related to support and maintenance and service agreements.

(5) CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

     ATG accounts for investments in marketable securities under FAS 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115). Under FAS 115, investments for which ATG has the positive intent and the ability to hold to maturity, consisting of cash equivalents and marketable securities, are reported at amortized cost, which approximates fair market value. Cash equivalents are highly liquid investments with maturities at the date of acquisition of less than 90 days. Marketable securities are investment grade debt securities with maturities at the date of acquisition of greater than ninety days. At September 30, 2003 and December 31, 2002, all of ATG’s marketable securities were held in commercial paper and corporate bonds, classified as held-to-maturity, and had maturities of less than one year. The average maturity of ATG’s marketable securities was approximately 5.91 months and 3.6 months at September 30, 2003 and December 31, 2002, respectively. At September 30, 2003, and December 31, 2002, the difference between the amortized cost and market value of ATG’s marketable securities was approximately $(9,800) and $(21,000), respectively. At September 30, 2003 and December 31, 2002, ATG’s cash, cash equivalents and marketable securities consisted of the following (in thousands):

(6) COMPREHENSIVE INCOME (LOSS)

     FAS 130, Reporting Comprehensive Income, requires that a full set of general purpose financial statements be expanded to include the reporting of comprehensive income (loss). Comprehensive income (loss) is comprised of two components, net income (loss) and other comprehensive income (loss). The following are the components of ATG’s comprehensive income (loss) (in thousands):

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(7) DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE

     FAS 131, Disclosures About Segments of an Enterprise and Related Information, establishes standards for reporting information regarding operating segments in annual financial statements and requires selected information for those segments to be presented in interim financial reports issued to stockholders. FAS 131 also establishes standards for related disclosures about products and services and geographic areas. Operating segments are identified as components of an enterprise for which separate discrete financial information is available for evaluation by the chief operating decision-maker, or decision-making group, to assess performance and allocate resources. ATG’s chief operating decision-makers, as defined under FAS 131, are the members of its executive management team. To date, the Company has viewed its operations and manages its business as principally one segment with two major offerings: software licenses and services. ATG evaluates these product offerings based on their respective gross margins. As a result, the financial information disclosed herein represents all of the material financial information related to the Company’s principal operating segment.

     Revenues from sources outside of the United States were approximately $4.7 million and $7.5 million for the three months ended September 30, 2003 and 2002, respectively, and $19.5 million and $22.9 million for the nine months ended September 30, 2003 and 2002, respectively. ATG’s revenue from international sources was primarily generated from customers located in Europe and Asia/Pacific. All of ATG’s software licenses for the three and nine months ended September 30, 2003 and 2002 were delivered from its headquarters located in the United States.

     The following table represents the percentage of total revenues by geographic region from customers for the three and nine months ended September 30, 2003 and 2002:

(8) LONG-TERM OBLIGATIONS

     Credit Facility

     Effective June 13, 2002, ATG entered into a $15 million revolving line of credit with Silicon Valley Bank (the Bank) which provided for borrowings of up to the lesser of $15 million or 80% of eligible accounts receivable. The line of credit bore interest at the Bank’s prime rate. The line of credit was secured by all of the Company’s tangible and intangible intellectual and personal property and is subject to financial covenants including liquidity coverage and profitability. As a result of this agreement, ATG was no longer required to fully cash secure letters of credit (LC’s) the Company had issued to secure obligations under its facility leases. However, the Company was required to maintain $18 million of unrestricted cash with the Bank at all times during the term of the line of credit. As a result of this requirement, this revolving line of credit did not increase the amount of net cash available to the Company during the term of the agreement.

     In December 2002, ATG increased its eligible line of credit to $20 million from $15 million. While there were no outstanding borrowings under the facility at September 30, 2003, ATG had issued letters of credit (LC’s) totaling $12.2 million, which are supported by this facility. The line of credit bears interest at the Bank’s prime rate (4.00% at September 30, 2003). As of September 30, 2003 approximately $7.8 million was available for future borrowings. The line of credit is secured by all of ATG’s tangible and intangible intellectual and personal property and is subject to financial covenants including liquidity coverage and profitability. The liquidity covenant mandates ATG maintain $40 million in cash and marketable securities at the end of each month throughout the duration of the facility. The profitability covenant allowed for net losses not to exceed $1.0 million for the third and fourth quarters of 2003. The Bank has granted the Company a waiver of the profitability covenant for the third quarter of 2003 as the Company’s reported net loss exceeded the amount originally allowed for in the covenant. The Company was in compliance with all other covenants. The Bank has granted additional provisions, to be used if necessary, for a maximum $25 million in restructuring charges for the duration of the facility. Of the $25 million, a maximum of $7.5 million may be taken as a cash expense during the term of the facility; a second provision is made for a maximum of $12.0 million in cash to be paid toward real estate buy-outs. ATG is required to maintain $27 million in unrestricted cash and marketable securities with the Bank at all times, and in the event the balance should decrease, ATG will be required to pay fees and expenses to compensate the Bank for lost income. As of September 30, 2003, the Company is in compliance with all other related financial covenants. In the event that ATG does not comply with any of the covenants within the line of credit without having received a waiver from the Bank or defaults on any of its provisions, the Bank’s significant remedies include, 1) declaring all obligations immediately due and payable; 2) ceasing to advance money or extend credit for the Company’s benefit; 3) applying to the obligations any balances and deposits held by the Company or any amount held by the Bank owing to or for the credit or the account of ATG; and, 4) putting a hold on any deposit account held as collateral. If the agreement expires, or is not extended, the Bank will require outstanding LC’s at that time to be cash secured on terms acceptable to the Bank. The revolving line of credit expires on December 23, 2003.

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(9) COMMITMENTS AND CONTINGENCIES

     Leases

     ATG has offices, primarily for sales and support personnel, in nine domestic locations as well as eight foreign countries. At September 30, 2003, ATG had issued $12.2 million of LC’s under its line of credit in favor of various landlords to secure obligations under its facility leases, which expire from 2003 through 2009.

     The approximate future minimum payments of ATG’s facility leases and certain operating equipment leases as of September 30, 2003, were as follows (in thousands):

     Of the $36.3 million in future minimum lease payments, $25.9 million was included in the Company’s 2001, 2002 and 2003 restructuring charges. The $25.9 million has been reduced to a $21.4 million restructuring accrual after taking into consideration estimated sublease income, vacancy periods and operating costs until the various properties are sub-leased (see Note 10). Rent expense included in the accompanying statements of operations was $1.3 million and $2.4 million for the three months ended September 30, 2003 and 2002, respectively. Rent expense included in the accompanying statements of operations was $4.2 million and $7.2 million for the nine months ended September 30, 2003 and 2002, respectively.

     Indemnifications

     The Company frequently has agreed to indemnification provisions in software license agreements with customers and in its real estate leases in the ordinary course of its business.

     With respect to software license agreements, these indemnifications generally include provisions indemnifying the customer against losses, expenses, and liabilities from damages that may be awarded against the customer in the event the Company’s software is found to infringe upon a patent or copyright of a third party. The software license agreements generally limit the scope of and remedies for such indemnification obligations in a variety of industry-standard respects, including but not limited to certain geography-based scope limitations, the right to replace or modify an infringing product, and the right to terminate the license and refund a portion of the original license fee if a remedy is not commercially practical. The Company believes its internal development processes and other policies and practices limit its exposure related to the indemnification provisions of the software license agreements. In addition, the Company requires its employees to sign a proprietary information and inventions agreement, which assigns the rights to its employees’ development work to the Company. To date, the Company has not had to reimburse any of its customers for any losses related to these indemnification provisions and no material claims are outstanding as of September 30, 2003.

     With respect to real estate lease agreements or settlement agreements with landlords, these indemnifications typically apply to claims asserted against the landlord relating to personal injury and property damage at the leased premises or to certain breaches of the Company’s contractual obligations or representations and warranties included in the settlement agreements. These indemnification provisions generally survive the termination of the agreement, although the provision has the most relevance during the contract term and for a short period of time thereafter. The maximum potential amount of future payments that the Company could be required to make under these indemnification provisions is unlimited. The Company has purchased insurance that reduces its monetary exposure for landlord indemnifications. The Company has never paid any amounts to defend lawsuits or settle claims related to these indemnification provisions. Accordingly, the Company believes the estimated fair value of these indemnification arrangements is minimal.

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(10) RESTRUCTURING

     As a result of a global slowdown in information technology spending, during the first nine months of 2003, and the years ended 2002 and 2001, the Company recorded restructuring charges/(benefits) of $(5.3) million, $19.0 million and $76.9 million, respectively, pertaining to the closure and consolidation of excess facilities, impairment of assets, employee severance benefits, and settling of certain contractual obligations. The 2003 charges were recorded in accordance with FAS 146, Accounting for Costs Associated with Exit or Disposal Activities, FAS 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits (FAS 88) and Staff Accounting Bulletin (SAB) 100, Restructuring and Impairment Charges. The 2002 and 2001 charges were recorded in accordance with Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring), FAS 88 and SAB 100.

2001 Actions

     Actions taken by ATG in 2001 included: consolidation and closure of excess facilities, a worldwide workforce reduction, the write-off of certain unrealizable assets and settling certain obligations that had no future benefit. In the second quarter of 2001, ATG recorded a restructuring charge of $44.2 million, and in the fourth quarter of 2001, ATG recorded a restructuring charge of $32.7 million. Total restructuring charges for 2001 totaled $76.9 million.

     The facilities-related charge was $38.1 million and $22.8 million in the second and fourth quarters, respectively, consisting of excess rental space for offices worldwide, net of estimates for the vacancy period and sublease income based on the then-current real estate market data, and related write-offs of abandoned leasehold improvements and fixed assets of $7.7 million and $2.2 million, respectively. In the second and fourth quarters of 2002, the Company increased the facilities-related portion of the 2001 charge by an additional $447,000 and $907,000, respectively for changes to sub-lease and vacancy assumptions, which was offset by a benefit of $536,000 due to an unanticipated vendor refund associated with a written off prepaid cost. The employee severance cost component of the restructuring charge was $4.7 million and $3.2 million in the second and fourth quarters, respectively. ATG terminated the employment of 530 employees, or 46% of ATG’s workforce, none of whom remained employed at June 30, 2002. Approximately 47% of these employees were from sales and marketing, 22% from services, 19% from general and administrative and 12% from research and development. In addition, ATG settled 11,762 exchangeable shares with a certain employee and recorded $1.3 million as a charge to restructuring for this settlement. Also included in the 2001 charge was the write-off of approximately $4.0 million of goodwill related to acquisitions from 2000, approximately $1.4 million of purchased software that was deemed impaired due to ATG’s revised product development strategy, and $1.1 million of prepaid costs, and legal and accounting expenses.

     At September 30, 2003, there was $11.0 million from the 2001 actions remaining in the restructuring accrual comprising $10.8 million of facilities-related costs and $229,000 of severance and related costs.

     The 2003 activity related to the 2001 actions was as follows (in thousands):

     Of the $5.3 million net benefit that the Company recorded in the second quarter of 2003, the Company recognized a net benefit of $8.1 million related to adjustments to the 2001 actions. The $8.1 million benefit comprised a $10.4 million benefit from settlements of lease obligations in San Francisco and Cambridge, offset by additional facilities related charges of $2.1 million and $229,000 related to additional employee severance and related costs.

     During the quarter ending September 30, 2003 the Company recognized a net benefit of $771,000 related to adjustments to the 2001 actions. The $771,000 benefit was a result of a settlement of a lease obligation in Germany.

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2002 Action

     Actions taken by ATG in 2002 included: consolidation and closure of excess facilities, a worldwide workforce reduction and, the write-off of certain idle assets. In the second quarter of 2002, ATG recorded a restructuring credit of $89,000, due to a change in the 2001 restructuring charge, and in the fourth quarter of 2002, ATG recorded an aggregate restructuring charge of $19.1 million comprising $18.2 million of 2002 actions and a $907,000 adjustment to the facilities-related portion of the 2001 restructuring charge.

     The facilities-related charge associated with the 2002 fourth quarter action was $13.5 million comprising $12.0 million for operating leases related to idle office space and $1.5 million of leasehold improvements and furniture and fixtures associated with these facilities, which were written down to their fair value. The amount of the operating lease charge was based on assumptions from current real estate market data for sub-lease income and vacancy rates at the location. The Company also recorded a charge of $3.6 million for severance and benefit costs related to cost reduction actions taken across the worldwide employee base. The severance and benefit costs were for 125 employees, or 23% of the Company’s workforce, all of whom were terminated as of June 30, 2003. Of the 125 employees, 53 of the employees were from sales and marketing, 45 from services, 19 from general and administrative and 8 from research and development. The Company also wrote-off $1.1 million in computer equipment and software and furniture and fixtures that it had abandoned.

     At September 30, 2003, there was $9.9 million from the 2002 action remaining in the restructuring accrual comprising $9.8 million of facilities-related costs and $115,000 of severance and related costs.

     The 2003 activity related to the 2002 action was as follows (in thousands):

     In the second quarter of 2003, ATG recorded a net restructuring charge of $637,000 for changes in assumptions and estimates to charges recorded in 2002 for excess lease obligations and employee severance and related costs. The charge was comprised of a benefit of $1.1 million resulting from settlements of lease obligations in San Francisco and Toronto, offset by additional facilities related charges of $1.4 million primarily related to changes in estimates of vacancy and sub-lease income in an idle facility and additional employee severance and related costs of $327,000.

2003 Actions

     As a result of several reorganization decisions ATG undertook plans to restructure operations in the second and third quarters of 2003. Actions taken by ATG included: closure of an excess facility, a worldwide workforce reduction, and the write-off of certain idle assets.

     The significant components of the 2003 restructuring charge were as follows (in thousands):

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June 30, 2003 Action

     During the second quarter of 2003, the Company recorded a net restructuring benefit of $5.3 million which consisted of benefits from lease settlements of $11.5 million and additional charges of $4.0 million for changes in estimates related to the 2001 and 2002 actions, as well as new 2003 actions totaling $2.2 million. During the second quarter of 2003, the Company settled $38.2 million of future lease obligations for one-time cash payments totaling $9.7 million, resulting in a benefit, net of sub-lease and vacancy assumptions, of $11.5 million. This benefit was primarily recorded against the charges recorded under the 2001 actions.

     The second quarter 2003 action included a facilities-related charge of $1.1 million comprising $866,000 for an operating lease related to idle office space, $144,000 of assets written down to their fair value, and $61,000 for various office equipment leases. The lease charge was for office space the Company vacated and intends to sub-lease. The amount of the operating lease charge was based on assumptions from current real estate market data for sub-lease income rates and vacancy rates at the location. In accordance with FAS 146, the Company has recorded the present value of the net lease obligation. The Company also recorded a charge of $927,000 for severance and benefit costs related to cost reduction actions taken across the worldwide employee base. The severance and benefit costs were for 32 employees, or 7.4% of the Company’s workforce, consisting of 11 employees from sales and marketing, three from services, three from general and administrative and 15 from research and development. The Company accrued employee benefits pursuant to ongoing benefit plans for domestic locations and under statutory minimum requirements in foreign locations. In addition, the Company accrued additional amounts for its foreign locations based on its best estimate of the final payments for severance. All employees were notified of their termination as of June 30, 2003. The termination process is expected to be completed during the fourth quarter of 2003. As a result of a reduction of employees as well as the closure of a certain office location, the Company wrote off leasehold improvements related to the facilities it is attempting to sub-lease as the estimated cash flows to be generated from that location would not have been sufficient to recover the carrying value of the assets. In addition, computer and office equipment were written down to their fair value based on the expected cash flows they would generate over their remaining economic life. Due to the short remaining economic life and current market conditions for such assets, the fair value of these assets was estimated as zero. The Company also recorded a charge of $169,000 to reduce the carrying value of third-party software embedded in its products that the Company will discontinue selling, to its net realizable value based on management’s best estimate of future net cash flows to be generated from the sale of the software to customers.

September 30, 2003 Action

     During the third quarter of 2003, the Company undertook actions resulting in a benefit of $771,000 from lease settlements which was offset by new actions totaling approximately $771,000. The benefit from the lease settlements resulted from a one-time cash payment of $6.4 million for the settlement of $11.8 million of future lease obligations, which had been accrued as part of the 2001 action. The third quarter action comprised $227,000 for an operating lease related to idle office space and $166,000 of assets written down to their fair value. The lease charges were for office space the Company vacated and intends to sub-lease. The amount of the operating lease charges was based on assumptions from current real estate market data for sub-lease income rates and vacancy rates at the location. In accordance with FAS 146, the Company has recorded the present value of the net lease obligation. In the third quarter of 2003 the Company also recorded a charge of $378,000 for severance and benefit costs related to cost reduction actions taken across the worldwide employee base. The severance and benefit costs were for 16 employees consisting of seven employees from sales and marketing, four from services and five from research and development. The Company accrued employee benefits pursuant to ongoing benefit plans. In addition, the Company accrued additional amounts for the second quarter action related to its foreign locations based on its best estimate of the final payments for severance. All employees were notified of their termination as of September 30, 2003. The termination process is expected to be completed during the fourth quarter of 2003.

     As of September 30, 2003, the Company had an accrued restructuring liability of $22.5 million, of which $11.0 million related to 2001 restructuring charges, $9.9 million relates to 2002 restructuring charges, and $1.6 million related to 2003 restructuring charges. The long-term portion of the accrued restructuring liability was $13.2 million.

(11) LITIGATION

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     The Company and certain officers have been named defendants in seven purported class action suits currently pending in the United States District Court for the District of Massachusetts. Each of these cases alleges that the Company and certain officers have violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, which generally may subject issuers of securities and persons controlling those issuers to civil liabilities for fraudulent actions or defects in the public disclosure required by securities laws. Four of the cases were filed on various dates in October 2001 in the U.S. District Court for the District of Massachusetts. Three of the cases were initially filed in the Central District of California (the “California actions”) on various dates in August and September 2001. The California actions were consolidated and transferred to the District of Massachusetts on or about November 27, 2001. On December 13, 2001, the Court issued an Order of Consolidation in which it consolidated all actions filed against us and appointed certain individuals as Lead Plaintiffs in the consolidated action. It also appointed two law firms as Co-Lead Counsel, and a third law firm as Liaison Counsel. Counsel for the plaintiffs has filed a Consolidated Amended Complaint applicable to all of the consolidated actions. On April 19, 2002, the Company filed a motion to dismiss the case. On September 4, 2003 the court issued a ruling dismissing all but one of the Plaintiff’s allegations. The remaining allegation is based on the veracity of a public statement made by an officer of the Company. While management believes the remaining claim against the Company is without merit, and intends to defend the action vigorously, the litigation is still in the preliminary stage.

     A breach of contract claim was filed in Germany by DIFA Deutsche Immobilien Fonds AG against Art Technology Group GMBH, a subsidiary of the Company, on July 18, 2002. The suit alleges that ATG GmbH failed to pay rent on office space leased by the plaintiff and failed to deliver a bank guarantee, thereby breaching its lease obligations to plaintiff. The German court returned a ruling on January 22, 2003 adverse to ATG and found in favor of the plaintiff in the approximate amount of 1.4 million euros plus 8% interest and the delivery of a security deposit in the form of a bank guarantee in the amount of approximately 675,000 euros. ATG filed an appeal to the suit on February 6, 2003. On August 18, 2003, ATG and DIFA settled the lawsuit and all remaining lease obligations for 5.75 million euros (approximately $6.4 million on August 18, 2003) plus 16% VAT (approximately $1.0 million on August 18, 2003 which was recovered in October 2003) in exchange for dismissal of the lawsuit and a complete release from all liability related to the claim. These amounts had been accrued as part of the restructuring accrual in prior periods.

     The Company is also subject to various other claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on the Company’s business, financial condition or results of operations.

(12) FOREIGN CURRENCY TRANSLATION

     The financial statements of the Company’s foreign subsidiaries are translated in accordance with FAS 52, Foreign Currency Translation. The Company has determined that the functional currency of its foreign subsidiaries is the local currency. As a result, the Company translates the assets and liabilities of its foreign subsidiaries at the exchange rates in effect at the period-end. Prior to translation, the Company re-measures foreign currency denominated assets and liabilities into the functional currency of the respective Company entity, resulting in unrealized gains or losses recorded in Interest and Other Income, Net in the accompanying Condensed Consolidated Statements of Operations. Revenues and expenses are translated using average exchange rates in effect during the respective period. Gains and losses from foreign currency translation are credited or charged to Accumulated Other Comprehensive Loss included in Stockholders’ Equity in the accompanying Condensed Consolidated Balance Sheets. During the three months ended September 30, 2003 and 2002, the Company recorded losses of $191,000 and $237,000, respectively, from transactional gains and losses and re-measurement gains and losses. During the nine months ended September 30, 2003 and 2002, the Company recorded gains of $262,000 and $666,000, respectively, from transaction gains and losses and re-measurement gains and losses.

(13) HEDGING ACTIVITIES

     A portion of the Company’s revenues, earnings and cash flows are exposed to changes in foreign exchange rates. The Company’s foreign currency-hedging program, seeks to manage the foreign exchange risk through the use of foreign currency forward-exchange contracts. ATG may use these contracts to offset the potential earnings and cash flow effects from short-term foreign currency assets and liabilities that arise from operations. FAS 133, Accounting for Derivative Instruments and Hedging Activities requires that all derivative contracts and hedging activities be recorded at fair value in the financial statements. Such contracts are marked to market in each reporting period with the resulting change in fair value recognized immediately in Other Income in the Condensed Consolidated Statement of Operations as unrealized gains and losses up through their maturity, at which time the gains or losses become realized. These gains and losses offset the changes in fair value of the asset or liability being hedged. Realized and unrealized gains and losses were not material in the three or nine month periods ended September 30, 2003 and 2002.

(14) RECENT ACCOUNTING PRONOUNCEMENTS

     In January 2003, the FASB issued Interpretation No. 46 Consolidation of Variable Interest Entities (FIN 46), which is an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Statements. FIN 46 addresses consolidation by business enterprises of variable interest entities and requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. Variable interest entities that effectively disperse risks are not consolidated unless a single party holds an interest or combination of interests that effectively recombines risks that were previously dispersed. FIN 46 applies immediately to variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003, if certain criteria are met. FIN 46 applies to public enterprises as of the beginning of the applicable interim or annual period. The adoption of FIN 46 as it relates to variable interest entities created after February 1, 2003 did not have a material effect on our financial position or results of operations. The adoption of FIN 46 as it relates to variable interest entities created before February 1, 2003 is not expected to have a material effect on our financial position or results of operations.

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     In April 2003, the FASB released FAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (FAS 149). FAS 149 clarifies the accounting for derivatives, amending FAS 133, Accounting for Derivative Instruments and Hedging Activities. FAS 149 clarifies under what circumstances a contract with an initial net investment meets the characteristics of a derivative, amends the definition of an underlying contract, and clarifies when a derivative contains a financing component in order to increase the comparability of accounting practices under FAS 133. FAS 149 is effective for contracts entered into or modified after September 30, 2003. The adoption of FAS 149 is not expected to have a material impact on the Company’s financial position or results of operations.

     In May 2003 the FASB issued FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (FAS 150). FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. FAS 150 applies specifically to a number of financial instruments that companies have historically presented within their financial statements either as equity or between the liabilities section and the equity section, rather than as liabilities. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of FAS 150 did not have a material impact on the Company’s financial position or results of operations.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes contained in Item 1 of this Quarterly Report on Form 10-Q. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors including those set forth elsewhere in this report.

Overview

     We were founded in December 1991. From 1991 through 1995, we devoted our efforts principally to building, marketing and selling our professional services capabilities and to research and development activities related to our software products. Beginning in 1996, we began to focus on selling our software products. To date, we have enhanced and released several versions of our products. We market and sell our products worldwide through our direct sales force, systems integrators, technology alliances, value added resellers and original equipment manufacturers.

     We derive our revenues from the sale of software product licenses and related services. Product license revenues are derived from the sale of software licenses of our products. Our software licenses are priced based on either the number of licenses implemented or site license terms. Services revenues are derived from fees for professional services, training and software maintenance and support. Professional services include implementation, custom application development and project and technical consulting. We bill professional service fees primarily on a time and materials basis or in some cases, on a fixed-price schedule defined specifically in our contracts. Software maintenance and support arrangements are priced based on the level of services provided. Generally, customers are entitled to receive software updates, maintenance releases and on-line and telephone technical support for an annual maintenance fee, which is calculated as a certain percentage of the list price of the licensed product, or on a net purchase price for site licenses. Training is billed as services are provided.

     As of September 30, 2003 we had active offices in England, France, Germany, Italy, Japan, Spain, Sweden, and the United States. Revenues from customers outside the United States accounted for 30% of our total revenues for the three months ended September 30, 2003 and 2002, respectively, and 30% and 34% for the nine months ended September 30, 2003 and 2002, respectively.

Critical Accounting Policies and Estimates

     This management’s discussion of financial condition and results of operations analyzes our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.

     We believe the following critical accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates and judgments, including those related to revenue recognition, the allowance for doubtful accounts, research and development costs, restructuring expenses, the impairment of long-lived assets and income taxes. Management bases its estimates and judgments on historical experience, known trends or events and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Revenue Recognition

     Not only is revenue recognition a key component of our results of operations, the timing of our revenue recognition also determines the timing of certain expenses, such as commissions. In measuring revenues, we follow the specific guidelines of Statement of Position, or SOP, 97-2, Software Revenue Recognition and SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, with Respect to Certain Transactions. SOP 97-2 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists via a signed license agreement; (2) physical or electronic delivery has occurred including the availability of license keys or services rendered; (3) the fee is fixed or determinable representing amounts that are due unconditionally with no future obligations under customary payment terms; and (4) collectibility is probable. In addition, revenue results are difficult to predict and any shortfall or delay in recognizing revenue could cause our operational results to vary significantly from quarter to quarter and could result in future operating losses.

     In accordance with SOP 97-2 and SOP 98-9, revenues from software product license agreements are recognized upon execution of a license agreement and delivery of the software, provided that the fee is fixed or determinable and deemed collectible by management. If conditions for acceptance are required subsequent to delivery, revenues are recognized upon customer acceptance if such acceptance is not deemed to be perfunctory. In multiple element arrangements, we use the residual value method in accordance with SOP 97-2 and SOP 98-9. Revenue earned on software arrangements involving multiple elements which qualify for separate element accounting treatment is allocated to each undelivered element using the relative fair values of those elements based on vendor specific objective evidence with the remaining value assigned to the delivered element, the software license. Typically our software licenses do not include significant post-delivery obligations to be fulfilled by us and payments are due within a three-month period from the date of delivery. Consequently, license fee revenue is generally recognized when the product is shipped. Revenues from software maintenance agreements are recognized ratably over the term of the maintenance period, which is typically one year. We enter into reseller arrangements that typically provide for sublicense fees payable to us based upon a percentage of our list price. Revenues are recognized under reseller agreements as earned for guaranteed minimum royalties, or based upon actual sales by the resellers. We do not grant our resellers the right of return or price protection.

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Revenues from professional service arrangements are recognized on either a time-and-materials or percentage-of-completion basis as the services are performed, provided that amounts due from customers are fixed or determinable and deemed collectible by management. Amounts collected prior to satisfying the above revenue recognition criteria are reflected as deferred revenue. Unbilled services represent service revenues that have been earned by us in advance of billings. Deferred revenue primarily consists of advance payments related to support and maintenance and service agreements.

Accounts Receivable and Bad Debt

     We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We continuously monitor collections and payments from our customers and determine the allowance for doubtful accounts based upon historical experience and specific customer collection issues. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required.

Research and Development Costs

     We account for research and development costs in accordance with Statement of Financial Accounting Standard, or FAS, 2, Accounting for Research and Development Costs, and FAS 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, which specify that costs incurred internally to develop computer software products should be charged to expense as incurred until technological feasibility is reached for the product. Once technological feasibility is reached, all software costs should be capitalized until the product is made available for general release to customers. Judgment is required in determining when technological feasibility is established. We believe that the time period from reaching technological feasibility until the time of general product release is very short. Costs incurred after technological feasibility is reached are not material, and accordingly, all such costs are charged to research and development expense as incurred.

Restructuring Expenses

     During the nine months ended September 30, 2003 and the years ended December 31, 2002 and 2001, we recorded restructuring charges (benefits) of $(5.3) million, $19.0 million and $76.9 million, respectively, pertaining to the closure and consolidation of excess facilities, impairment of assets as discussed below, employee severance benefits, and settling of certain contractual obligations. The 2003 charges were recorded in accordance with FAS 146, Accounting for Costs Associated with Exit or Disposal Activities, FAS 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits and, Staff Accounting Bulletin, or SAB, 100, Restructuring and Impairment Charges. The 2002 and 2001 charges were recorded in accordance with Emerging Issues Task Force, or EITF, Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), FAS 88, and SAB 100. In determining the charges to record, we made certain estimates and judgments surrounding the amounts ultimately to be paid for the actions we have taken. At September 30, 2003, there are various accruals recorded for the costs to exit certain facilities and lease obligations, which may be adjusted periodically for either resolution of certain contractual commitments or changes in estimates of sub-lease income or the period of time the facilities will be vacant and sub-leased. Although we do not anticipate significant changes to our restructuring accruals, the actual costs may differ from those recorded in the event that the subleasing assumptions require adjustment due to changes in economic conditions surrounding the real estate market or we are successful in terminating our lease obligations prior to the scheduled termination date. Such changes could have a material impact to our operating results.

Impairment or Disposal of Long Lived Assets

     We review our long-lived assets whenever events or changes in circumstances indicate that the carrying amount of such an asset may not be recoverable. Recoverability of these assets is measured by comparison of their carrying amount to future undiscounted cash flows the assets are expected to generate. If such assets are considered impaired, the impairment to be recognized is equal to the amount by which the carrying value of the assets exceeds the fair market value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique. In assessing recoverability, we must make assumptions regarding estimated future cash flows and discount factors. If these estimates or related assumptions change in the future, we may be required to record impairment charges.

     As a result of our restructuring activities in 2003, 2002 and 2001, we evaluated the realizability of our long-lived assets including fixed assets and leasehold improvements related to our restructured facility leases and intangible assets consisting primarily of unamortized goodwill. In 2003, we determined that $613,000 of leasehold improvements, computer and office equipment and software were impaired as a result of our decision to restructure operations and discontinue sale of a certain product. In 2002, we determined that $1.7 million of furniture and fixtures, computer equipment and software were impaired as a result of our decision to abandon the assets because of the termination of employees and related closures of offices in our 2002 and 2001 restructuring plans. These assets were no longer being used or will not be used in the future upon completion of the restructuring plans, which had been substantially completed by September 30, 2003. In addition, in 2002, $909,000 of leasehold improvements were deemed to be impaired due to exiting certain office locations and the estimated sub-lease income was not sufficient to recover the carrying value of the assets. In 2001, we determined that $7.7 million of leasehold improvements and $2.2 million of furniture, fixtures and equipment were impaired as a result of these restructured operating leases. In addition we determined that $1.4 million of purchased software was impaired due to our revised product development strategy. Lastly we wrote off the remaining unamortized goodwill of $4.0 million due to the closure and abandonment of two professional service acquisitions completed in 2000.

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Accounting for Income Taxes

     We account for income taxes in accordance with FAS 109 Accounting for Income Taxes which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. FAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. We evaluate quarterly the realizability of our deferred tax assets by assessing our valuation allowance and by adjusting the amount of such allowance, if necessary.

     At September 30, 2003 and December, 31, 2002, we have provided a full valuation allowance against our deferred tax assets due to the uncertainty of their realizability.

     In addition, we have provided for potential amounts due in various foreign tax jurisdictions. Judgment is required in determining our worldwide income tax expense provision. In the ordinary course of global business, there are many transactions and calculations where the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of cost reimbursement arrangements among related entities. Although we believe our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. Such differences could have a material impact on our income tax provision and operating results in the period in which such determination is made.

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Results of Operations

     The following table sets forth statement of operations data as percentages of total revenues for the periods indicated: