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 our subsidiaries and us 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 updated risk factors discussed under Item 1A of Part II of this Form 10-Q and the risk factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 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 and 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) through our FSB Solutions brand, 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 product brands, solutions and related markets are summarized below:

                                        Enterprise        Postilion
                                       S1 Enterprise   Postilion   FSB

                Self Service Banking
                Online Banking
                Personal Banking          Global          US        -
                Business Banking          Global          US        -
                Bill pay services           US            US        -
                Corporate Banking         Global           -        -
                Trade Finance             Global           -        -
                Mobile Banking            Global        Global      -
                Voice Banking             Global          US        -

                Full Service Banking
                Teller                    Global           -       US
                Sales and Service         Global           -       US
                Call Center               Global           -       US
                Lending                      -             -       US

                Payments                     -          Global      -

                Insurance                   US             -        -

Revenue from Significant Customers
Revenue from State Farm was 16% and 20% of our total revenue and 31% and 36% of our Enterprise segment revenue during the three months ended June 30, 2009 and 2008, respectively. Revenue from State Farm was 16% and 20% of our total revenue and 30% and 36% of our Enterprise segment revenue during the six months ended June 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, of which we expect approximately $36 - $38 million in revenue in 2009. 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.
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 six months ended June 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. 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 June 30,           Six Months Ended June 30,
                            2009                2008              2009               2008
Subscription revenue:
Enterprise              $         778       $         682     $      1,474       $      1,229
Postilion                       3,059               2,129            6,097              4,160

Total Company           $       3,837       $       2,811     $      7,571       $      5,389

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.

Stock-based compensation. Our stock-based compensation expense relates to our stock options, restricted stock and cash-settled stock appreciation rights ("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 expense to change thus impacting our stock based compensation expense until the SARs are settled. Our stock price increased 34% during the second quarter of 2009 as compared to an increase of 6% in the same period of 2008 causing a higher SARs expense in second quarter of 2009 as compared to same period in 2008. Our stock price decreased 12% during the six months ended June 30, 2009 as compared to an increase of 4% in the same period of 2008 causing a lower SARs expense for six months ended June 30, 2009 as compared to the same period in 2008. Our stock-based compensation expense included in expenses and by grant type is as follows (in thousands):

                                           Three Months Ended              Six Months Ended
                                                June 30,                       June 30,
                                          2009            2008            2009           2008
Operating expenses:
Cost of professional services,
support and maintenance                $      213       $      27      $       61      $      73
Cost of data center                            23              22              43             47
Selling and marketing                       1,147             882             (73 )        1,606
Product development                           236             262             106            584
General and administrative                  1,472           1,112             423          1,883

Total stock-based compensation
expense                                $    3,091       $   2,305      $      560      $   4,193


Grant type:
Stock options                          $      620       $     982      $    1,214      $   1,946
Restricted stock                              349             261             562            435
Stock appreciation rights                   2,122           1,062          (1,216 )        1,812

Total stock-based compensation
expense                                $    3,091       $   2,305      $      560      $   4,193

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.
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 the 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 six months ended June 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 on 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 June 30, 2009                         Six Months Ended June 30, 2009
                               At Prior                                               At Prior
                                 Year                                                   Year
                               Exchange           Exchange                            Exchange           Exchange
                               Rates (1)        Rate Effect        As reported        Rates (1)         Rate Effect        As reported

Revenue                       $    62,517       $     (1,675 )    $      60,842      $   123,645       $      (4,515 )    $     119,130
Operating expenses                 57,403             (2,160 )           55,243          108,893              (5,495 )          103,398

Operating income                    5,114                485              5,599           14,752                 980             15,732
Net income                          3,861                770              4,631           12,445               1,130             13,575
Basic earnings per share      $      0.07       $       0.02      $        0.09      $      0.23       $        0.02      $        0.25
Diluted earnings per share    $      0.07       $       0.01      $        0.08      $      0.23       $        0.02      $        0.25

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

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

                                                             Three Months Ended June 30,
                              Enterprise                              Postilion                                Total
                     2009          2008         Chg         2009          2008         Chg         2009          2008         Chg
Revenue:
Software
licenses           $  1,683      $  2,437        -31 %    $ 10,628      $  5,680         87 %    $ 12,311      $  8,117         52 %
Support and
maintenance           5,002         4,499         11 %       8,610         8,096          6 %      13,612        12,595          8 %
Professional
services             17,741        18,104         -2 %       6,349         5,632         13 %      24,090        23,736          1 %
Data center           6,986         7,032         -1 %       3,843         5,008        -23 %      10,829        12,040        -10 %


Total revenue      $ 31,412      $ 32,072         -2 %    $ 29,430      $ 24,416         21 %    $ 60,842      $ 56,488          8 %

Total revenue increased by $4.4 million, or 8%, for the three months ended June 30, 2009 compared to the same period in 2008 mainly due to the Postilion segment's growth in Software licenses. For the three months ended June 30, 2009, revenue was unfavorably impacted from foreign currency exchange rates for operations in Europe and South Africa by approximately $1.7 million when compared to the same period in 2008.
Our Enterprise segment revenue decreased $700 thousand, or 2%, for the three months ended June 30, 2009 compared to the same period in 2008 which includes a $700 thousand unfavorable impact from foreign currency exchange rates for operations in Europe. Software licenses revenue for our Enterprise segment would have been unchanged from the prior year's quarter excluding a $600 thousand settlement in the second quarter of 2008 with an international customer of an amount previously thought to be uncollectible. Support and maintenance revenue for our Enterprise segment grew 11% primarily due to increased licensing activity of our personal, business and corporate Internet banking solutions. Professional services revenue for our Enterprise segment included an increase in work related to a multi-channel implementation for a large international bank and growth in the number of projects for our personal, business and corporate Internet banking solutions offset by a $1.8 million decline in projects with our largest customer and an unfavorable foreign exchange impact. Professional services revenue in any one quarter can be impacted by one or two large customer projects and therefore, can increase or decrease significantly based on the projects. Data center revenue for our Enterprise segment was relatively unchanged as an increase in customer transactions was offset by an unfavorable foreign exchange impact.
Our Postilion segment revenue increased $5.0 million, or 21%, for the three months ended June 30, 2009 compared to the same period in 2008 which includes a $1.0 million unfavorable impact from foreign currency exchange rates for operations in Europe and South Africa. Software licenses revenue for our Postilion segment increased 87% due primarily to high demand for our payments solutions. Licensing activity for our full-service banking solutions and 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, also contributed to the increase in Software licenses revenue. Support and maintenance revenue grew 6% primarily due to licensing activity for our payments solutions in 2008 and 2009 which more than offset the effect of converting self-service banking customers to subscription agreements. Professional services revenue for the Postilion segment increased 13% due to the growth in projects for our payments solutions. Professional services revenue in any one quarter can be impacted by customer projects and therefore, can increase or decrease significantly based on the projects. Data center revenue for our Postilion segment decreased 23% 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 June 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 June 30,
                                   Enterprise                                      Postilion                                         Total
                     2009         %          2008         %          2009         %          2008         %          2009         %          2008         %
Operating
direct costs:
Cost of
software
licenses           $    203        12 %    $    418        17 %    $  1,069        10 %    $    727        13 %    $  1,272        10 %    $  1,145        14 %
Cost of
professional
services,
support and
maintenance          10,730        47 %      10,999        49 %       7,807        52 %       7,034        51 %      18,537        49 %      18,033        50 %
Cost of data
center                4,041        58 %       3,735        53 %       3,077        80 %       2,666        53 %       7,118        66 %       6,401        53 %


Total operating
direct costs       $ 14,974        48 %    $ 15,152        47 %    $ 11,953        41 %    $ 10,427        43 %    $ 26,927        44 %    $ 25,579        45 %

Operating direct costs increased $1.3 million for the three months ended June 30, 2009 compared to the same period in 2008, mainly due to increases in the Postilion segment. As a percentage of revenue, operating direct costs were 44% and 45% for the three months ended June 30, 2009 and 2008, respectively. Operating direct costs exclude charges for depreciation of property and equipment. For the three months ended June 30, 2009, operating direct costs were favorably impacted from foreign currency exchange rates for operations in Europe, South Africa and India by approximately $800 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 $500 thousand and $700 thousand for the three months ended June 30, 2009 and 2008, respectively. Overall, the Cost of software licenses was 10% and 14% of Software licenses revenue for the three months ended June 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 increased 3% for the three months ended June 30, 2009 compared to the same period in 2008 due primarily to increased customer support and project growth, partially offset by a $700 thousand favorable impact from foreign currency exchange rates for operations in Europe, South Africa and India. As a percentage of revenue, Cost of professional services, support and maintenance was 49% and 50% of Support and maintenance and Professional services revenue for the three months ended June 30, 2009 and 2008, respectively. Cost of data center. Cost of data center consists primarily of personnel costs, facility costs and related infrastructure costs to support our data center business and excludes charges for depreciation of property and equipment. Cost of data center increased 11% for the three months ended June 30, 2009 compared to the same period in 2008 due primarily to higher costs as we increased resources to support our customers. Additionally, the conversion of self -service banking customers to subscription agreements in Postilion's self-service banking business has unfavorably increased the Cost of data center as a percentage of Data center revenue. As a percentage of Data center revenue, Cost of data center was 66% and 53% for the three months ended June 30, 2009 and 2008, respectively.

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