This quarterly report on Form 10-Q and the documents incorporated into this quarterly report by reference contain forward-looking statements and information relating to the Company within the safe harbor provisions of the Private Securities Litigation Reform Act. These statements include statements with respect to our financial condition, results of operations and business. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "estimates," "intends" or similar terminology identify forward-looking statements. Forward-looking statements may include projections of our revenue, expenses, capital expenditures, earnings per share, product development projects, future economic performance or management objectives. These statements are based on the beliefs of management as well as assumptions made using information currently available to management. Because these statements reflect the current views of management concerning future events, they involve risks, uncertainties and assumptions. Therefore, actual results may differ significantly from the results discussed in the forward-looking statements. Except as required by law, we undertake no obligation to update publicly any forward-looking statement for any reason, even if new information becomes available.
When we use the terms "S1 Corporation", "S1", "Company", "we", "us" and "our," we mean S1 Corporation, a Delaware corporation, and its subsidiaries. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes appearing elsewhere herein and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008. You are urged to read the risk factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008, as supplemented by the risk factors in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2009, each as filed with the Securities and Exchange Commission ("SEC"). Executive Overview
S1 Corporation is a global provider of customer interaction software solutions for financial and payment services. We sell our solutions primarily to traditional financial services providers, such as banks, credit unions and insurance companies, as well as to transaction processors and retailers. We operate and manage S1 in two business segments: Enterprise and Postilion.
The Enterprise segment targets large financial institutions worldwide, providing software solutions and related services that financial institutions use to interact with their customers including (i) self-service banking solutions such as Internet personal, small business, corporate banking and trade finance, and mobile banking, and (ii) full-service banking solutions such as teller, branch, sales and service, and call center. We primarily offer our Enterprise products on a perpetual license basis. With the focus on selling perpetual licenses for our Enterprise products, license revenue may fluctuate in any given period depending on the amount, timing and nature of customer licensing activity. The Enterprise segment also provides software, custom software development, hosting and other services to State Farm.
The Postilion segment provides payments processing and card management solutions targeting organizations of all sizes globally, and banking solutions targeting community and regional banks and credit unions in North America. Postilion's payments processing and card management solutions provide transaction switching, device driving, and secure card issuance and life cycle management for credit, debit and prepaid cards for financial institutions and other ATM owners and deployers, retailers, merchant acquirers, and card issuers. These solutions are primarily licensed on a perpetual basis. Postilion's banking solutions include software and related services that financial institutions use to interact with their customers including (i) self-service banking solutions such as Internet personal and business banking, voice banking and mobile banking, and (ii) full-service banking solutions such as teller, branch, sales and service, call center and lending. We license Postilion's self-service banking applications primarily on a subscription basis and its full-service banking applications primarily on a perpetual basis.
We derive a significant portion of our revenue from licensing our solutions and providing professional services. We generate recurring revenue from support and maintenance, hosting applications in our data center, and from electronic bill payment services. We also generate recurring revenue by charging our customers a periodic fee for term licenses including the right-to-use the software and receive maintenance and support for a specified period of time. For certain customers, this fee includes the right to receive hosting services. In discussions with our customers and investors, we use the word "subscription" as being synonymous with a term license. Subscription license revenue is recognized evenly over the term of the contract which is typically between three to five years, whereas perpetual license revenue is generally recognized upon execution of the contract and delivery or on a percentage of completion basis over the implementation period.

Our revenue was $60.3 million for the three months ended September 30, 2009 which is an increase of $1.7 million or 3% as compared to the same period in 2008. Our revenue was $179.5 million for the nine months ended September 30, 2009 which is an increase of $9.7 million or 6% as compared to the same period in 2008. Our revenue has increased as compared to 2008 due primarily to the demand for Postilion's payments solutions and Enterprise's personal, business and corporate Internet banking solutions offset by a decline in projects with our largest customer, State Farm. In 2009, revenue was unfavorably impacted from foreign currency exchange rates when compared to 2008 by $840 thousand for the three months ended September 30 and $5.4 million for the nine months ended September 30. For the three months ended September 30, 2009 and 2008, our net income was $6.9 million and $6.2 million, respectively. For the nine months ended September 30, 2009 and 2008, our net income was $20.5 million and $16.5 million, respectively. Our net income increased during each of these periods in 2009 as compared to the same periods in 2008 primarily due to growth in our revenue and lower stock-based compensation expense partially offset as we continued to build out product functionality and invest in customer satisfaction initiatives during 2009.
Revenue from Significant Customers
Revenue from State Farm was 16% and 19% of our total revenue and 29% and 34% of our Enterprise segment revenue during the three months ended September 30, 2009 and 2008, respectively. Revenue from State Farm was 16% and 20% of our total revenue and 30% and 35% of our Enterprise segment revenue during the nine months ended September 30, 2009 and 2008, respectively. In 2008, we announced that we expected our relationship with State Farm to conclude by the end of 2011. We expect approximately $80 million in revenue from State Farm from 2009 until our work for them concludes by the end of 2011. We expect approximately $36 - $38 million in revenue in 2009 and approximately $25 - $26 million in revenue in 2010 from State Farm. Additional information about our business segments, geographic disclosures and major customer is presented in Note 10 to our unaudited condensed consolidated financial statements contained elsewhere in this report.
Recent Accounting Pronouncements
For a complete list of recent accounting pronouncements, please refer to Note 2 in the unaudited condensed consolidated financial statements contained elsewhere in this report.
Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reported period. Generally, we base our estimates on historical experience and on various other assumptions in accordance with U.S. GAAP that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under other assumptions or conditions.
Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. During the nine months ended September 30, 2009, there were no significant changes in our critical accounting policies and estimates but we have included summary information and data below for a better understanding of our revenue and stock-based compensation expense. You should refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended December 31, 2008 for a more complete discussion of our critical accounting policies and estimates. Our critical accounting policies and estimates include those related to:
• revenue recognition;

• estimation of our allowance for doubtful accounts and billing adjustments;

• valuation and recoverability of long-lived assets, including goodwill;

• determination of technological feasibility and capitalization of software development costs;

• determination of the fair value of employee stock options and stock appreciation rights awards;

• recognition of costs in connection with restructuring plans;

• reserves for contingencies; and

• income taxes.

Revenue recognition. Our Software licenses revenue includes subscription, or term based arrangements, which allow our customers the right to use our software during a specified period, typically three to five years. Generally, the amount of subscription fees is based on the number of end-users accessing the licensed system, subject in certain circumstances to minimum user levels. Subscription revenue is generally recognized ratably over the term of the arrangement and includes the rights to receive support services and unspecified upgrades and enhancements during the term. For certain customers, the subscription also entitles the customer to receive hosting services. Subscription agreements typically contain renewal terms that automatically extend the term of the arrangement for one year or more unless a timely notice of termination is provided. As the number of customers on subscription arrangements increases, revenue for our support and maintenance, data center, and software licenses will be impacted. This transition reflects the acceptance of the Postilion segment's self-service banking products on a subscription basis. Postilion's payments solutions are primarily sold on a perpetual license model. The Enterprise segment currently sells licenses on a perpetual basis, but has sold subscription licenses in the past. Our Software licenses revenue includes subscription revenue as follows (in thousands):

                                                        Three Months Ended September 30,                  Nine Months Ended September 30,
                                                         2009                      2008                    2009                      2008

Subscription revenue:
Enterprise                                         $            861          $            751        $           2,335          $         1,980
Postilion                                                     3,273                     2,407                    9,370                    6,569

Total Company                                      $          4,134          $          3,158        $          11,705          $         8,549

Since the sales cycle for large financial institutions and retailers can last from six to 18 months, Software licenses and Professional services revenue can be impacted by one or two large customer agreements. Accordingly, Professional services and Software licenses revenue can increase or decrease based on progress towards completion of projects, including project delays. Software licenses revenue may also fluctuate depending on the amount, timing and nature of customer licensing activity. When professional services are considered essential to the functionality of the software, we record revenue for the perpetual license and professional services over the implementation period using the contract accounting method on a contract by contract basis, typically measured by the percentage of cost incurred to date to estimated total costs to complete the contract. We typically use labor hours to estimate contract costs. Contract costs generally include direct labor, contractor costs and indirect costs identifiable with or allocable to the contract. Otherwise, perpetual license revenue is recognized upon delivery of the software provided that all other revenue recognition criteria are met.
From time to time, we enter into software arrangements that include software license, maintenance, and professional services which are considered essential to the functionality of the software. In these instances, we recognize revenue for the three revenue streams (software license, maintenance and professional services) under three units of accounting, which are the (i) software license,
(ii) professional services, and (iii) support and maintenance. For purposes of displaying revenues and costs, we present applicable license fees, maintenance and professional services revenues in our statement of operations using vendor-specific objective evidence of fair value (or if unavailable, other objective evidence of fair value) for the undelivered elements and assigning the remainder of the arrangement fee to the license. Stock-based compensation. Our stock-based compensation expense relates to our stock options, restricted stock and cash-settled SARs. The SARs expense is recalculated each quarter based on our updated valuation which includes, among other factors, our closing stock price for the period. Therefore, changes in our stock price during a period will cause our SARs liability to change thus impacting our stock-based compensation (benefit) expense until the SARs are settled. Our stock price decreased 11% during the third quarter of 2009 causing a lower SARs expense in third quarter of 2009. Our stock price decreased 22% during the nine months ended September 30, 2009 causing a lower SARs expense for nine months ended September 30, 2009. Our stock-based compensation expenses included in operating expenses and by grant type were as follows (in thousands):

                                                  Three Months Ended                Nine Months Ended
                                                    September 30,                     September 30,
                                                 2009             2008             2009            2008

Operating expenses:
Cost of professional services, support
and maintenance                               $        6        $     31        $       67            104
Cost of data center                                   35              29                78             76
Selling and marketing                               (364 )            (5 )            (437 )        1,601
Product development                                   36              15               142            599
General and administrative                           148             342               571          2,225

Total stock-based compensation
(benefit) expense                             $     (139 )      $    412        $      421        $ 4,605


Grant type:
Stock options                                 $      607        $  1,239        $    1,821        $ 3,185
Restricted stock                                     607             267             1,169            702
Stock appreciation rights                         (1,353 )        (1,094 )          (2,569 )          718

Total stock-based compensation
(benefit) expense                             $     (139 )      $    412        $      421        $ 4,605

Effects of Foreign Currencies
Our revenue and net income were impacted by foreign exchange rate fluctuations mainly for transactions in the British Pound, South African Rand, Indian Rupee and European Euro. Generally, expenses are denominated in the same currency as our revenue and the exposure to rate changes is naturally hedged for transactions in the British Pound and European Euro which minimizes the impact to net income. However, our development centers in India and South Africa are not naturally hedged as their costs are in the local currency but are funded in U.S. Dollars and British Pounds. We did not enter into material financial derivatives to hedge our currency risks in the nine months ended September 30, 2009 or 2008. Please refer to Item 7A of Part II, "Quantitative and Qualitative Disclosures about our Market Risk" of our Annual Report on Form 10-K for our fiscal year ended December 31, 2008 for a further discussion of potential foreign currency risks.
The estimated effect on our consolidated statements of operations from changes in exchange rates versus the U.S. Dollar is as follows (in thousands, except per share data):

                                              Three Months Ended September 30, 2009                                Nine Months Ended September 30, 2009
                                   At Prior Year                                                        At Prior Year
                                      Exchange               Exchange                                      Exchange               Exchange
                                     Rates (1)              Rate Effect            As reported            Rates (1)             Rate Effect           As reported
Revenue                            $       61,177          $        (840 )        $      60,337         $      184,822          $     (5,355 )       $     179,467
Operating expenses                         52,269                   (995 )               51,274                161,162                (6,490 )             154,672

Operating income                            8,908                    155                  9,063                 23,660                 1,135                24,795
Net income                                  6,445                    465                  6,910                 18,890                 1,595                20,485
Basic earnings per share           $         0.12          $        0.01          $        0.13         $         0.35          $       0.03         $        0.38
Diluted earnings per share         $         0.12          $           -          $        0.12         $         0.34          $       0.03         $        0.37

(1) Current year results translated into U.S. Dollars using prior year's period average exchange rates.

Comparison of the Three Months Ended September 30, 2009 and 2008 Revenue. The following table sets forth our revenue data for the three months ended September 30, 2009 and 2008. The table provides the percentage change of each revenue type for the periods presented (dollars in thousands):

                                                          Three Months Ended September 30,
                              Enterprise                              Postilion                                Total
                     2009          2008         Chg         2009          2008         Chg         2009          2008         Chg
Revenue:
Software
licenses           $  2,478      $  1,696         46 %    $  7,747      $  7,512          3 %    $ 10,225      $  9,208         11 %
Support and
maintenance           4,792         4,200         14 %       8,680         8,059          8 %      13,472        12,259         10 %
Professional
services             18,850        19,741         -5 %       6,937         5,198         33 %      25,787        24,939          3 %
Data center           6,957         7,269         -4 %       3,896         4,974        -22 %      10,853        12,243        -11 %


Total revenue      $ 33,077      $ 32,906          1 %    $ 27,260      $ 25,743          6 %    $ 60,337      $ 58,649          3 %

Total revenue increased by $1.7 million, or 3%, for the three months ended September 30, 2009 compared to the same period in 2008 mainly due to the growth in Software licenses and Support and maintenance revenue in both segments and Professional services revenue for the Postilion segment. For the three months ended September 30, 2009, revenue was unfavorably impacted from foreign currency exchange rates for operations in Europe by approximately $840 thousand when compared to the same period in 2008.
Our Enterprise segment revenue increased $200 thousand, or 1%, for the three months ended September 30, 2009 compared to the same period in 2008 which includes approximately $370 thousand of unfavorable impact from foreign currency exchange rates for operations in Europe. Software licenses revenue for our Enterprise segment increased 46% from the prior year's quarter primarily due to increased licensing activity of our corporate Internet banking solution. Support and maintenance revenue for our Enterprise segment grew 14% from the prior year's quarter primarily due to increased licensing activity of our personal, business and corporate Internet banking solutions. Professional services revenue for our Enterprise segment declined 5% from the prior year's quarter as work with our largest customer decreased $1.6 million partially offset by growth in the number of projects for our personal and business Internet banking solutions and work related to an implementation for a large international bank. Professional services revenue in any one quarter can be impacted by the number and size of customer projects and therefore can increase or decrease significantly based on project activity. Data center revenue for our Enterprise segment declined 4% primarily due to an unfavorable foreign exchange impact for our customers in Europe.
Our Postilion segment revenue increased $1.5 million, or 6%, for the three months ended September 30, 2009 compared to the same period in 2008 which includes approximately $470 thousand of unfavorable impact from foreign currency exchange rates for operations in Europe. Software licenses revenue for our Postilion segment increased 3% from the prior year's quarter due primarily to the conversion of self-service banking customers in North America from annual support and maintenance agreements to long-term subscription agreements, which in some cases included hosting services. Support and maintenance revenue grew 8% from the prior year's quarter primarily due to licensing activity for our payments and full service banking solutions which more than offset the effect of converting self-service banking customers to subscription agreements. Professional services revenue for the Postilion segment increased 33% from the prior year's quarter due to the growth in projects for our payments solutions. Professional services revenue in any one quarter can be impacted by the number and size of customer projects and therefore can increase or decrease significantly based on project activity. Data center revenue for our Postilion segment decreased 22% from the prior year's quarter due in part to the conversion of hosted customers to long-term subscription agreements and the impact of customer attrition that occurred primarily during 2008.

Operating direct costs. The following table sets forth our operating direct costs for the three months ended September 30, 2009 and 2008. The table provides each operating direct cost type as a percentage of the applicable revenue type for the periods presented (dollars in thousands):

                                                                        Three Months Ended September 30,
                                   Enterprise                                      Postilion                                         Total
                     2009         %          2008         %          2009         %          2008         %          2009         %          2008         %
Operating
direct costs:
Cost of
software
licenses           $    150         6 %    $    236        14 %    $    473         6 %    $    702         9 %    $    623         6 %    $    938        10 %
Cost of
professional
services,
support and
maintenance          10,446        44 %      11,714        49 %       8,754        56 %       7,708        58 %      19,200        49 %      19,422        52 %
Cost of data
center                3,995        57 %       4,015        55 %       3,084        79 %       2,728        55 %       7,079        65 %       6,743        55 %


Total operating
direct costs       $ 14,591        44 %    $ 15,965        49 %    $ 12,311        45 %    $ 11,138        43 %    $ 26,902        45 %    $ 27,103        46 %

Total operating direct costs decreased $200 thousand for the three months ended September 30, 2009 compared to the same period in 2008. As a percentage of revenue, total operating direct costs were 45% and 46% for the three months ended September 30, 2009 and 2008, respectively. Total operating direct costs exclude charges for depreciation of property and equipment. For the three months ended September 30, 2009, total operating direct costs were favorably impacted from foreign currency exchange rates for operations in Europe and India by approximately $340 thousand when compared to the same period in 2008.
Cost of software licenses. Cost of software licenses for our products sold includes the cost of software components that we license from third parties as well as the amortization of acquired technology. In general, the Cost of software licenses for our products is minimal because we internally develop most of the software components, the cost of which is reflected in product development expense as incurred. The Cost of software licenses could increase in future periods if we license and install more of our products that include third party products. Acquired technology amortization was $400 thousand and $700 thousand for the three months ended September 30, 2009 and 2008, respectively. Overall, the Cost of software licenses was 6% and 10% of Software licenses revenue for the three months ended September 30, 2009 and 2008, respectively.
Cost of professional services, support and maintenance. Cost of professional services, support and maintenance consists primarily of personnel and related infrastructure costs and excludes charges for depreciation of property and equipment. Operating direct costs associated with professional services, support and maintenance decreased 1% for the three months ended September 30, 2009 . . .