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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
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                                   FORM 10-KSB

                [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

     For  the  fiscal  year  ended  December  31,  2004

                                       OR

              [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                           Commission File No. 0-30152

                           PAYMENT DATA SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

                NEVADA                              98-0190072
     (State  or  other  jurisdiction  of        (I.R.S.  Employer
     incorporation  or  organization)         Identification  No.)

              12500 SAN PEDRO, SUITE 120, SAN ANTONIO, TEXAS 78216
           (Address of principal executive offices, including Zip Code)

                                 (210) 249-4100
                           (Issuer's telephone number)

        Securities registered pursuant to section 12(b) of the Act:  None

           Securities registered pursuant to section 12(g) of the Act:

                     Common Stock, par value $.001 per share

Check  whether  the issuer (1) filed all reports required to be filed by section
13  or  15(d) of the Exchange Act during the past 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 [  ]

Check  if there is no disclosure of delinquent filers in response to item 405 of
Regulation  S-B  is  not  contained  in  this  form,  and  no disclosure will be
contained,  to  the  best  of  registrant's  knowledge,  in  definitive proxy or
information statements incorporated by reference in part III of this Form 10-KSB
or  any  amendment  to  this  Form  10-KSB.  [  ]

The issuer's revenues for the fiscal year ended December 31, 2004 were $357,566.

The  aggregate market value of common stock held by non-affiliates of the issuer
as  of  March 9, 2005, was $6,739,536. As of March 9, 2005, 24,732,241 shares of
the  issuer's  common  stock  were  issued  and  outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions  of the Definitive Proxy Statement for the issuer's 2005 Annual Meeting
of  Stockholders  to  be  filed within 120 days after the end of the fiscal year
covered by this report are incorporated by reference in Part III of this report.

Transitional  Small  Business  Disclosure  Format  (Check  one):  Yes;    No   X
                                                                      ----  ----

                                        1

                           PAYMENT DATA SYSTEMS, INC.

                                   FORM 10-KSB
                      FOR THE YEAR ENDED DECEMBER 31, 2004

                                      INDEX

                                                                            Page
                                                                            ----
                                     PART I

Item  1.     Description  of  Business                                         3
Item  2.     Description  of  Property                                         6
Item  3.     Legal  Proceedings                                                7
Item  4.     Submission  of  Matters  to  a  Vote  of  Security  Holders       7

                                     PART II

Item  5.     Market  for  Common  Equity  and  Related  Stockholder  Matters   8
Item  6.     Management's  Discussion  and  Analysis  or  Plan  of  Operation  9
Item  7.     Financial  Statements                                            18
Item  8.     Changes  In  and  Disagreements  With Accountants on
             Accounting and Financial  Disclosure                             34
Item  8A.    Controls  and  Procedures                                        34
Item  8B.    Other  Information                                               34

                                    PART III

Item  9.     Directors,  Executive  Officers,  Promoters  and  Control
             Persons; Compliance  With Section  16  (a)  of  the
             Exchange  Act                                                    35
Item  10.    Executive  Compensation                                          35
Item  11.    Security  Ownership of Certain Beneficial Owners and
             Management  and  Related  Stockholder  Matters                   35
Item  12.    Certain  Relationships  and  Related  Transactions               35
Item  13.    Exhibits                                                         35
Item  14.    Principal  Accountant  Fees  and  Services                       36

                     FACTORS THAT MAY AFFECT FUTURE RESULTS

This  Annual  Report  on  Form  10-KSB  and the documents incorporated herein by
reference  contain  certain forward-looking statements within the meaning of the
Federal  Securities  Laws. Specifically, all statements other than statements of
historical  facts  included  in  this Annual Report on Form 10-KSB regarding our
financial  performance, business strategy and plans and objectives of management
for  future  operations  are forward-looking statements and based on our beliefs
and  assumptions.  If  used  in  this report, the words "anticipate," "believe,"
"estimate",  "expect,"  "intend,"  and  words  or  phrases of similar import are
intended  to  identify  forward-looking  statements. Such statements reflect our
current  view  with  respect  to future events and are subject to certain risks,
uncertainties,  and  assumptions, including, but without limitation, those risks
and  uncertainties contained in the Risk Factors section of Item 6, Management's
Discussion  and  Analysis,  of  this  Annual  Report on Form 10-KSB. Although we
believe that our expectations are reasonable, we can give no assurance that such
expectations  will  prove to be correct. Based upon changing conditions, any one
or  more  of  these events described herein as anticipated, believed, estimated,
expected  or  intended  may not occur. All prior and subsequent written and oral
forward-looking  statements attributable to the Company or persons acting on its
behalf  are  expressly qualified in their entirety by this cautionary statement.

                                        2

                                     PART I


ITEM  1.  DESCRIPTION  OF  BUSINESS.

Introduction

Payment  Data  Systems, Inc. was founded in July 1998 and is incorporated in the
State  of  Nevada.  On July 25, 2003, we sold substantially all of our assets to
Harbor Payments, Inc., formerly known as CyberStarts, Inc. The aggregate selling
price  for  the  asset group sold was $4,100,000, plus the assumption of certain
liabilities  by  Harbor  Payments.  The  assets sold represented our proprietary
technology  infrastructure,  certain third party software and hardware platforms
and  certain  furniture  and  fixtures  that  supported  our  Electronic  Bill
Presentment and Payment service offerings. The assets sold represented virtually
all  of  our  assets,  which we used to produce substantially all of our revenue
through  the  date  we sold these assets. Therefore, we discontinued our primary
operations and began to concentrate on building our electronic payments business
using  the  assets  that  we  retained after this sale. Before the sale of these
assets,  our  primary operations consisted of hosting the electronic presentment
of bills on the Internet for other companies and managing the related electronic
payments  from their consumers through third party payment processors. After the
sale  of  these  assets,  our  primary  operations  consist  of functioning as a
processor  of  electronic  payments  for  other  companies. We also continued to
operate  our  bills.com  consumer bill payment web site through which we process
online  payments  by  consumers.

Continuing  Operations

General

We  provide  integrated  electronic payment processing services to merchants and
businesses, including all types of Automated Clearinghouse processing and credit
and debit card-based processing services. The Automated Clearinghouse Network is
a  nationwide  electronic funds transfer system that is regulated by the Federal
Reserve  and  provides  for  the  clearing  of  electronic  payments  between
participating  financial  institutions.  Our  Automated Clearinghouse processing
services  enable  merchants  or  businesses  to  both  disburse or collect funds
electronically  using  e-checks  to  transfer funds instead of traditional paper
checks.  An  e-check  is  an electronic debit to a bank checking account that is
initiated  at  the  point-of-sale,  on the Internet, over the telephone or via a
bill  payment  sent  through  the  mail  and  is  processed  using the Automated
Clearinghouse  network.  Our  card-based processing services enable merchants to
process  both  traditional  card-present,  or  "swipe," transactions, as well as
card-not-present  transactions.  A  traditional  card-present transaction occurs
whenever  a  cardholder physically presents a credit or debit card to a merchant
at  the  point-of-sale.  A  card-not-present  transaction  occurs  whenever  the
customer does not physically present a payment card at the point-of-sale and may
occur  over  the  Internet,  mail,  fax  or  telephone.  Our  electronic payment
processing may take place in a variety of forms and situations. For example, our
capabilities  allow  merchants to convert a paper check to an e-check or receive
card  authorization  at  the  point-of-sale,  have  their  customer  service
representatives take e-check or card payments from their consumers by telephone,
and enable their consumers to make e-check or card payments directly through the
use  of a web site or by calling an Interactive Voice Response telephone system.
We  also  operate  an  online payment processing service for consumers under the
domain  name  www.bills.com  through  which  consumers  can  pay  anyone.

We  generate  revenues by charging fees for the electronic processing of payment
transactions  and  related  services.  We  charge  certain  merchants  for these
processing services at a bundled rate based on a percentage of the dollar amount
of each transaction and, in some instances, additional fees are charged for each
transaction.  We charge other merchant customers a flat fee per transaction, and
may also charge miscellaneous fees to our customers, including fees for returns,
monthly minimums, and other miscellaneous services. We charge consumers that use
our bills.com online payment service a flat monthly fee that allows them to make
a  certain  number  of  payments  in  a month. We also charge these consumers an
additional fee for each payment that exceeds the allowed number of payments in a
given  month.  We  operate  solely  in  the  United States as a single operating
segment  and  do  not  currently  have  any  foreign  operations.

Industry  Background

The  use  of non-paper based forms of payment by consumers in the United States,
such  as  credit  and  debit cards, has steadily increased over the past several
years.  According  to  the  2004  Federal  Reserve Payments Study, the number of
electronic payment transactions totaled 44.5 billion in 2003 while the number of
checks  paid  totaled  36.7  billion. This marked the first time that electronic
payment  transactions  in  the  U.S.  exceeded check payments. If current growth
rates  are  sustained,  payments  made by credit cards and debit cards will each
exceed  the number of paid checks by 2010. The growth of electronic commerce has
made  the  acceptance  of  card-based  and  other  electronic forms of payment a
necessity  for businesses, both large and small, in order to remain competitive.

We  believe  that  the  electronic  payment processing industry will continue to
benefit  from  the  following  trends:

                                        3

Favorable  Demographics

As  consumers  age,  we  expect  that  they  will  continue  to  use the payment
technology  to which they have grown accustomed. More consumers are beginning to
use  card-based and other electronic payment methods for purchases at an earlier
age.  According  to  the  Federal  Reserve  Survey  of  Consumer  Finances,  the
percentage  of  households  with consumers under the age of 30 years using debit
cards  increased  from  24.5%  in  1995  to 60.6% in 2001. As consumers who have
witnessed  the  wide  adoption  of  card  products, technology, and the Internet
comprise  a greater percentage of the population and increasingly enter the work
force,  we  expect that purchases using electronic payment methods will comprise
an  increasing  percentage of total consumer spending. Because of the Internet's
increasing  adoption  rate,  businesses  have  a  growing opportunity to conduct
commerce  with  their  consumers  and  business  partners  over  the  Internet.

Increased  Electronic  Payment  Acceptance  by  Small  Businesses

Small  businesses  are a vital component of the U.S. economy and are expected to
contribute  to the increased use of electronic payment methods. According to the
U.S.  Small  Business Administration, small businesses generate more than 50% of
the nonfarm private gross domestic product in the United States. The lower costs
associated  with  electronic  payment  methods  are  making  these services more
affordable  to  a  larger  segment of the small business market. In addition, we
believe  these  businesses  are  experiencing  increased  pressure  to  accept
electronic  payment  methods in order to remain competitive and to meet consumer
expectations.  As  a  result, many of these small businesses are seeking, and we
expect  many  new  small  businesses  will  seek,  to provide customers with the
ability  to  pay  for merchandise and services using electronic payment methods,
including those in industries that have historically accepted cash and checks as
the  only  forms  of  payment  for  their  merchandise  and  services.

Growth  in  Online  Transactions

Market  researchers  expect dramatic growth in card-not-present transactions due
to  the  rapid  growth of the Internet and electronic commerce. According to the
U.S.  Census  Bureau,  retail  e-commerce  sales for 2004 were $69.2 billion, an
increase of 24% from $56.0 billion in 2003. The prevalence of the Internet makes
having  an  online presence a basic consideration for those operating a business
today.  To  remain  competitive,  many  companies  are  seeking  to leverage the
Internet  to  provide operational efficiencies, create new revenue opportunities
and  maximize  the  longevity and profitability of their customer relationships.

Products  and  Services

Our  service  offerings  are  supported  by  our  systems  infrastructure  that
integrates  certain proprietary components with processing systems outsourced to
third  party  providers  to  offer  our  customers a flexible and secure payment
process.  We  utilize a secure sockets layer so that connections and information
are  secure  from  outside inspection and 128-bit encryption to make information
unreadable  as  it passes over the Internet for all electronic transactions that
we  process.  Our systems infrastructure allows us to work with our customers to
build  a  customized  electronic  payment  service  offering  tailored  to their
specific  needs. We have designed and implemented our integrated payment systems
to  function  as  gateways  between our customers and our third party processing
providers.  Our  systems provide for interfaces with our customers through which
payment  data is captured electronically and transferred through the connections
we  have  with  our  processing  providers.  Our  systems  also  provide  a data
warehousing capability so that all of a customer's payment data can be stored in
one  place to facilitate efficient data retrieval and analysis. We outsource our
Automated  Clearinghouse  transaction  processing  and  card-based  transaction
processing to third party providers. Our card-based processing system is capable
of  connecting with all of the major card-based processors in the United States.
We  also  outsource the processing of the payments initiated by consumers online
at  our  bills.com  web  site.

The  components  of  our  service  offering  include  all  forms  of  Automated
Clearinghouse  transaction  processing,  such as Re-presented Check , which is a
consumer  non-sufficient  funds  check  that  is  re-presented  for  payment
electronically  rather  than  through  the  paper  check  collection system, and
Accounts  Receivable  Check  Conversion, which is a consumer paper check payment
that  is  converted  into  an  e-check.  Our  customers  can  initiate Automated
Clearinghouse  transactions directly using an online terminal accessible through
a  web  site  or  we  can initiate Automated Clearinghouse transactions on their
behalf.  Our  service  offering  also includes merchant account services for the
processing  of card-based transactions through the VISA and MasterCard networks,
including  online  terminal  services  accessed  through  a  web  site or retail
services  accessed  via  a  physical  terminal. We offer a proprietary web-based
customer service application that combines both Automated Clearinghouse and card
processing  capabilities  and allows companies to process one-time and recurring
payments  via  e-checks  or  credit  cards at the request of their consumers. In
addition,  we  offer an Interactive Voice Response telephone system to companies
that  accepts payments directly from consumers over the telephone using e-checks
or  credit  cards.

We  also  operate a consumer web site focused on providing bill payment services
under  the domain name www.bills.com. Consumers subscribe to the payment service
and  are  allowed  to  make  a  limited number of payments each month for a flat
monthly fee. The bills.com strategy is to provide the consumer with an efficient
and  secure  interface  for  paying and managing bills via the Internet. We also
market  this  portal  service  to online financial services providers looking to
provide  online  bill  payment capabilities as part of their service offering to
consumers.

                                        4

Relationships  with  Sponsors  and  Processors

We  have agreements with several processors to provide to us, on a non-exclusive
basis,  transaction  processing  and  transmittal, transaction authorization and
data capture, and access to various reporting tools. In order to provide payment
processing services for Automated Clearinghouse transactions, we must maintain a
relationship  with  an  Originating  Depository  Financial  Institution  in  the
Automated  Clearinghouse  Network  because  we  are not a bank and therefore not
eligible  to be an Originating Depository Financial Institution. The third party
provider  that  handles  our  Automated  Clearinghouse  processing  maintains  a
relationship  with  several Originating Depository Financial Institutions on our
behalf.  Similarly, in order to provide payment processing services for Visa and
MasterCard transactions, we must be sponsored by a financial institution that is
a  principal  member  of  the  Visa  and  MasterCard  card associations. We have
agreements  with  Network 1 Financial, Inc. and TriSource Solutions, LLC through
which  their  member  banks sponsor us for membership in the Visa and MasterCard
card  associations  and  settle  card  transactions  for  our  merchants.  These
agreements  may  be  terminated  by  the  processors if we materially breach the
agreement  and  we  do  not  cure  the  breach  within  30  days, or if we enter
bankruptcy  or  file  for  bankruptcy.

Under  our  processing  agreements  with  Network  1  Financial  and  TriSource
Solutions,  we  are  financially  liable  for  all  fees, chargebacks and losses
related  to  our  card  processing  merchant customers. If, due to insolvency or
bankruptcy  of our merchant customers, or for another reason, we are not able to
collect from them amounts that have been refunded to the cardholders because the
cardholders  properly  initiated  a chargeback transaction to reverse the credit
card charges, we must bear the credit risk for the full amount of the cardholder
transaction.  We  utilize  a  number  of  systems and procedures to evaluate and
manage  merchant  risk, such as obtaining approval of prospective merchants from
our  processor  and  sponsor  bank,  setting  transaction  limits and monitoring
account  activity.  We  may  also  require  cash  deposits  and  other  types of
collateral  from  certain  merchants  to  mitigate  any such risk. We maintain a
reserve  for  losses  resulting from card processing and related chargebacks. We
estimate  our potential loss for chargebacks by performing a historical analysis
of  our  chargeback loss experience with similar merchants and considering other
factors  that  could  affect that experience in the future, such as the types of
card  transactions  processed and nature of the merchant relationship with their
consumers.

We also maintain a separate allowance for doubtful accounts for estimated losses
resulting  from  the  inability  or  failure  of  our merchant customers to make
required  payments  for  fees  charged  by us. Amounts due from customers may be
deemed  uncollectible  because  of  merchant  disputes,  fraud,  insolvency  or
bankruptcy.  We  determine  the  allowance  for  doubtful  accounts  based on an
account-by-account  review, taking into consideration such factors as the age of
the  outstanding  receivable,  historical  pattern  of collections and financial
condition  of  the  customer. We closely monitor extensions of credit and if the
financial  condition  of  our  customers  were  to  deteriorate, resulting in an
impairment  of their ability to make contractual payments, additional allowances
may  be  required.

Sales  and  Marketing

We market and sell our products and services through direct contact by our sales
personnel,  as  well  as through non-exclusive resellers that act as an external
sales  force,  with  minimal  direct  investment  in  sales  infrastructure  and
management.  Our  direct  sales  effort  is coordinated by a sales executive and
supported  by  other  employees  who  function  in sales capacities. Our primary
market  focus  is  on  companies  generating  high volumes of electronic payment
transactions.  We  tailor  our  sales  efforts  to  reach  this  market by using
resellers  that have access to or existing relationships with such companies and
by  pre-qualifying  prospective  sales  leads  through  direct contact or market
research.  Our  sales  personnel  typically  initiate  contact  with prospective
customers  that  we  identify as meeting our target profile. We will continue to
analyze  our sales and marketing efforts in order to control costs, increase the
effectiveness  of  our  sales  force,  and  broaden  our  reach through reseller
initiatives  and  advantageous  alliances.

Customers

Nearly  all  of  our customers are consumers geographically dispersed throughout
the  United  States  utilizing  our bills.com Internet bill payment service on a
recurring monthly basis to pay household bills. The service relationship between
our  bills.com customers and us is not contractual and the fee we charge for the
service is not negotiable. We seek to retain customers by providing high service
levels.  Customers  are  also more likely than not to continue using the service
once  activated  due  to their investment of time in setting up the service with
their  personal  banking  and payment information. The monthly average number of
bills.com  customers  using  our  online payment service increased from 2,020 in
2003  to  2,190  in  2004.

Our  other  customers  are  merchants  and  businesses  that  use  our Automated
Clearinghouse  and/or  card-based  processing services in order to provide their
consumers  with  the ability to pay for goods and services without having to use
cash  or  a paper check. These merchant customers operate in a variety of retail
industries  and  are under contract with us to exclusively use the services that
we  provide  to  them.  Most  of  our  merchant  customers have signed long-term
contracts,  with  generally  three-year  terms,  that  provide  for volume-based
transaction  fees.  We  provided  services  to  51  and  8 merchant customers at
December  31,  2004  and  2003,  respectively.  We  first  offered  Automated
Clearinghouse  processing  services  in the third quarter of 2003 and card-based
processing  services  in the fourth quarter of 2003. Services provided to Credit
Payment Services, Inc. accounted for approximately 13% of our total consolidated
revenues for the year ended December 31, 2004. Revenue generated by our merchant

                                        5

customers  represented  approximately  55%  of our total revenues in 2004 and we
believe  that this percentage will increase as we anticipate adding new merchant
customers and experiencing growth in transaction volumes as a result. We believe
that  our  merchant  business  provides us with the best opportunity for revenue
growth and will continue to comprise the majority of our business in the future.

Competition

The  payment  processing  industry  is  highly competitive. Many small and large
companies  compete  with us in providing payment processing services and related
services  to  a wide range of merchants. There are a number of large transaction
processors,  including  First  Data  Merchant Services Corporation, Concord EFS,
Inc.,  National  Processing, Inc., and Global Payments, Inc., that serve a broad
market  spectrum  from  large  to small merchants and provide banking, automatic
teller  machine,  and  other payment-related services and systems in addition to
card-based  payment  processing.  There  are  also  a  large  number  of smaller
transaction  processors  that provide various services to small and medium-sized
merchants.  Many of our competitors have substantially greater capital resources
than  us  and  operate  as  subsidiaries of financial or bank holding companies,
which  may  allow them on a consolidated basis to own and conduct depository and
other  banking activities that we do not have the regulatory authority to own or
conduct.  We  believe  that  the  principal  competitive  factors  in our market
include:

-     quality  of  service;
-     reliability  of  service;
-     ability  to  evaluate,  undertake  and  manage  risk;
-     speed  in  implementing  payment  processes;
-     price  and  other  financial  terms;  and
-     multi-channel  payment  capability.

We  believe  that  our specific focus on providing integrated payment processing
solutions  to merchants, in addition to our understanding of the needs and risks
associated with providing payment processing services electronically, gives us a
competitive  advantage  over  other  competitors,  which  have a narrower market
perspective, and over competitors of a similar or smaller size that may lack our
experience  in  the  electronic  payments  industry.  Furthermore, we believe we
present  a competitive distinction through the use of our internal technology to
provide  a  single  integrated  payment  storage or warehouse that consolidates,
processes,  tracks  and  reports  all  payments  regardless of payment source or
channel.

Trademarks

We  own federally registered trademarks on the marks bills.com and bills.com and
design. We have applied for trademarks on Payment Data Systems, Inc. and Payment
Data  Systems,  Inc.  and  design  with  the  United States Patent and Trademark
Office.  We  have  also  secured  domain  name  registrations  for  bills.com,
paymentdatasystems.com,  paymentdata.org  and  paymentdata.com.  We  rely  on  a
combination  of  copyright,  trademark and trade secret laws, employee and third
party  nondisclosure  agreements,  and  other  intellectual  property protection
methods  to  protect  our  services  and  related  products.

Discontinued  Operations

Prior  to  the sale of substantially all of our assets in July 2003, we provided
Electronic  Bill  Presentment and Payment and related services to companies that
generate recurring paper-based bills. Electronic Bill Presentment and Payment is
the  process  of  sending  bills  to consumers securely through the Internet and
processing  Internet payment of bills utilizing an electronic transfer of funds.
During  the  year  ended  December  31, 2003, the discontinued operations of the
asset  group  sold  provided  revenue  of  $2,155,000.

Employees

As  of  December  31,  2004,  we  had  8  employees.  We  are not a party to any
collective  bargaining  agreements.  We  believe  that  our  relations  with our
employees  are  good.

ITEM  2.  DESCRIPTION  OF  PROPERTY.

As  of  December  31,  2004,  our  headquarters  and  operations  were housed in
approximately  4,500  square  feet of leased office space in San Antonio, Texas.
The  office  lease  has a three-year term that expires in October 2006 and has a
renewal  option  for  an  additional  three-year  term. The Company believes its
existing  facilities  will  be  adequate  to  meet its anticipated needs for the
foreseeable  future.

                                        6

ITEM  3.  LEGAL  PROCEEDINGS.

Beginning  in December 2000, we pledged as loan guarantees certain funds held as
money market funds and certificates of deposit to collateralize margin loans for
the  following  executive  officers:  (1)  Michael R. Long, then Chairman of the
Board  of  Directors  and  Chief  Executive  Officer;  (2)  Louis  A. Hoch, then
President  and Chief Operating Officer; (3) Marshall N. Millard, then Secretary,
Senior  Vice  President,  and  General  Counsel;  and  (4)  David S. Jones, then
Executive  Vice  President.  Mr. Millard and Mr. Jones are no longer employed by
us.  The margin loans were obtained in March 1999 from institutional lenders and
were  secured by shares of our common stock owned by these officers. The pledged
funds  were  held  in our name in accounts with the lenders that held the margin
loans  of  the  officers. Our purpose in collateralizing the margin loans was to
prevent  the  sale  of  our  common  stock owned by these officers while we were
pursuing  efforts to raise additional capital through private equity placements.
The  sale  of that common stock could have hindered our ability to raise capital
in  such  a  manner  and compromised its continuing efforts to secure additional
financing.  The  highest  total  amount  of  funds  pledged for the margin loans
guaranteed  by  us  was  approximately  $2.0 million. At the time the funds were
pledged,  we  believed  we would have access to them because (a) the stock price
was  substantial  and  the  stock  pledged by the officers, if liquidated, would
produce funds in excess of the loans payable, and (b) with respect to one of the
institutional  lenders  (who was also assisting us as a financial advisor at the
time),  even  if  the  stock  price  fell,  we had received assurances from that
institutional  lender  that the pledged funds would be made available as needed.
During the fourth quarter of 2002, we requested partial release of the funds for
operating purposes, which request was denied by an institutional lender. At that
time,  the  stock  price  had  fallen  as  well,  and  it became clear that both
institutional  lenders  would  not  release the pledged funds. In light of these
circumstances,  we  recognized  a  loss  on  the guarantees of $1,278,138 in the
fourth  quarter of 2002 and recorded a corresponding payable under related party
guarantees  on our balance sheet at December 31, 2002 because it became probable
at  that  point that we would be unable to recover our pledged funds. During the
quarter  ended  March 31, 2003, the lenders applied the pledged funds to satisfy
the  outstanding  balances  of  the loans. The total balance of the margin loans
guaranteed  by  us was zero at December 31, 2004. We may institute litigation or
arbitration  in collection of the outstanding repayment obligations of Mr. Long,
Mr.  Hoch,  Mr.  Millard,  and  Mr.  Jones,  which  currently  total $1,278,138.
Presently,  we have refrained from initiating action to recover these funds from
Mr. Long, Mr. Hoch, and Mr. Millard because they may have offsetting claims that
total $1,445,500 collectively by virtue of the change of control clause in their
respective  employment  agreements  based  on  our  preliminary  analysis.  We
understand  that  these  individuals may assert such claims based on our sale of
substantially  all  of  our assets to Harbor Payments, Inc. on July 25, 2003. We
have  not  initiated  any  formal settlement negotiations with these individuals
because they have been under an extended employment contract with us or have not
been  amenable  to  such  an action. On July 25, 2004, our employment agreements
with  Michael  Long,  Chief  Executive  Officer and Chief Financial Officer, and
Louis  Hoch,  President and Chief Operating Officer, expired. We intend to enter
into  new employment agreements with both of these individuals and are currently
negotiating  the  terms  of such agreements. We have not pursued the outstanding
repayment  obligation of Mr. Jones because we do not consider a recovery attempt
to  be  cost  beneficial.  In  order  to  attempt  a recovery from Mr. Jones, we
estimate  that we would incur a minimum of $20,000 in estimated legal costs with
no  reasonable  assurance of success in recovering his outstanding obligation of
approximately  $38,000. Because of the limited amount of the obligation, we also
anticipate  difficulty  in  retaining  counsel  on a contingency basis to pursue
collection  of  this  obligation.  The  ultimate  outcome  of this matter cannot
presently  be  determined.

On  July  25,  2003,  certain of our stockholders (those stockholders being Mike
Procacci,  Jr.,  Mark and Stefanie McMahon, Anthony and Lois Tedeschi, Donna and
James  Knoll, John E. Hamilton, III, William T. Hagan, Samuel A. Fruscione, Dana
Fruscione-Penzone,  Gia  Fruscione,  Alicia  Fruscione, Joseph Fruscione, Robert
Evans,  John Arangio, Gary and JoAnne Gardner, Lee and Margaret Getson, G. Harry
Bonham,  Jr.,  Gary Brewer, Bob Lastowski, Robert Filipe, Mitchell D. Hovendick,
Dr.  John  Diephold,  Joseph  Maressa, Jr., and Charles Brennan) commenced legal
action  against  us,  Ernst  & Young, LLP, and certain of our current and former
directors  (including  the executive officers named above) in the District Court
of  the  45th Judicial District, Bexar County, Texas. With respect to us and the
current  and  former directors named in the suit, the plaintiffs allege that we,
acting  through  such  directors,  misstated in our 2000 and 2001 Form 10-Ks our
ability to use for operational purposes the funds pledged as security for margin
loans  of  certain of our executive officers, as discussed above. The plaintiffs
allege  and seek resulting economic and exemplary damages, rescission, interest,
attorneys'  fees  and  costs of court. We believe this suit is without merit and
intend  to vigorously defend the company and the directors named in the suit. As
of the date of this report, there have been no material developments in the suit
other  than  the  case  being  set  for trial in late 2005. The results of legal
proceedings  cannot  be  predicted with certainty. If we fail to prevail in this
legal  matter,  our  financial  position,  results of operations, and cash flows
could  be  materially  adversely  affected.

ITEM  4.  SUBMISSION  OF  MATTERS  TO  A  VOTE  OF  SECURITY  HOLDERS.

There  were no matters submitted to a vote of our stockholders during the fourth
quarter  of  fiscal  year  2004.

                                        7

                                     PART II


ITEM  5.  MARKET  FOR  COMMON  EQUITY  AND  RELATED  STOCKHOLDER  MATTERS.

Market  Information

Our  common  stock  was traded on the National Association of Securities Dealers
Over  the Counter Bulletin Board through March 13, 2000 at which time our common
stock was approved for trading on the NASDAQ Small Cap Market. Subsequently, our
stock  was  approved  for trading on the NASDAQ National Market on July 31, 2000
under  the symbol BLLS. On February 4, 2003, the NASDAQ National Market delisted
our  common stock because we did not meet the requirements for continued listing
on  the  NASDAQ National Market. Our common shares were immediately eligible for
quotation  on  the  Over  the  Counter  Bulletin  Board  effective at opening of
business  on February 4, 2003. Our common stock began trading under a new ticker
symbol,  PYDS,  on  the  Over  the  Counter  Bulletin  Board on August 20, 2003.

The  following table sets forth for the quarterly periods indicated the range of
high  and  low  closing  prices  of our common stock as reported on the Over the
Counter  Bulletin  Board:


<TABLE>
<CAPTION>



<S>             <C>    <C>

                High   Low
                -----  -----
    2004
-------------
First Quarter   $0.46  $0.15
Second Quarter  $0.43  $0.21
Third Quarter   $0.26  $0.16
Fourth Quarter  $0.34  $0.21

    2003
--------------
First Quarter   $0.23  $0.07
Second Quarter  $0.14  $0.08
Third Quarter   $0.35  $0.09
Fourth Quarter  $0.32  $0.14
</TABLE>

Holders

As  of  March  9,  2005,  24,732,241  shares  of our common stock are issued and
outstanding. As of March 9, 2005, there were approximately 4,865 stockholders of
record  of  our  common  stock.

Dividend  Policy

We  have never declared or paid cash or stock dividends and have no present plan
to  pay  any  such  dividends  in  the foreseeable future, instead, we intend to
reinvest  our  earnings,  if  any.

                                        8

ITEM  6.  MANAGEMENT'S  DISCUSSION  AND  ANALYSIS  OR  PLAN  OF  OPERATION.

The  following  discussion  and  analysis should be read in conjunction with the
Consolidated  Financial  Statements  and  Notes  thereto,  and  other  financial
information  included  elsewhere  in  this  Form  10-KSB.  This  report contains
forward-looking  statements that involve risks and uncertainties. Actual results
in  future periods may differ materially from those expressed or implied in such
forward-looking  statements  as  a result of a number of factors, including, but
not  limited  to,  the  risks  discussed  under  the  heading "Risk Factors" and
elsewhere  in  this  Form  10-KSB.

Overview

On  July  25,  2003, we sold substantially all of our assets to Harbor Payments,
Inc.,  formerly  known  as CyberStarts, Inc. The aggregate selling price for the
asset  group  was  $4,100,000, plus the assumption by Harbor Payments of certain
liabilities.  The sale of the asset group was approved by our Board of Directors
and  a majority of our stockholders at a Special Meeting of Shareholders held on
July  14,  2003.  The  assets  sold  represented  our  proprietary  technology
infrastructure  along  with  certain third party software and hardware platforms
and  certain  furniture  and  fixtures  that  supported  our  Electronic  Bill
Presentment  and  Payment  service  offerings.  Electronic  Bill Presentment and
Payment  is  the  process  of  sending  bills  to consumers securely through the
Internet  and  processing  Internet  payment  of  bills  utilizing an electronic
transfer  of  funds.  The  carrying  value  of  these  non-current  assets  was
approximately  $1,068,000 at July 25, 2003. Harbor Payments also assumed certain
of  our  current and non-current liabilities with carrying values of $83,000 and
$30,000,  respectively,  at July 25, 2003. The assets sold represented virtually
all  of  our  assets,  which  we  used  to  produce  nearly  all of our revenue;
therefore,  we ceased our Electronic Bill Presentment and Payment operations and
continued to operate our bills.com consumer bill payment portal and concentrated
on  building our electronic payments business. The results of operations for the
asset  group  disposed  of  have been reported as discontinued operations in the
accompanying  statements  of operations. We retained the accounts receivable and
related  deferred  revenue  associated  with  the  customers of the discontinued
operations,  as well as certain accounts payable and accrued liabilities related
to the discontinued operations. At December 31, 2003, our balance sheet included
approximately  $38,000  of net accounts receivable and approximately $277,000 of
current  liabilities  that  related  to  the  discontinued  operations.

We  provide  integrated  electronic payment services, including credit and debit
card-based  processing  services  and  transaction  processing via the Automated
Clearinghouse  Network,  and  continue to operate an Internet electronic payment
processing  service  for  consumers  under  the domain name www.bills.com. Since
inception,  we  have  incurred operating losses each quarter, and as of December
31,  2004,  we  have  an  accumulated deficit of $48.2 million. Our prospects to
continue  as  a going concern must be considered in light of the risks, expenses
and  difficulties  frequently  encountered by companies in their early stages of
growth,  particularly  companies  in  new  and  rapidly evolving markets such as
electronic commerce. Such risks include, but are not limited to, an evolving and
unpredictable  business model and our ability to continue as a going concern. To
address these risks, we must, among other things, grow and maintain our customer
base,  implement  a  successful  marketing  strategy,  continue  to maintain and
upgrade  our  technology  and  transaction-processing  systems, provide superior
customer  service,  respond  to  competitive  developments,  attract, retain and
motivate  qualified  personnel,  and respond to unforeseen industry developments
and other factors. We cannot assure you that we will be successful in addressing
such risks, and the failure to do so could have a material adverse effect on our
business,  prospects,  financial  condition  and  results  of  operations.

We  believe  that  our  success  will depend in large part on our ability to (a)
manage our operating expenses, (b) add quality customers to our client base, (c)
meet evolving customer requirements and (d) adapt to technological changes in an
emerging  market.  Accordingly,  we  intend  to  focus  on  customer acquisition
activities  and  outsource  some  of our processing services to third parties to
allow  us  to  maintain  an  efficient  operating  infrastructure and expand our
operations  without  significantly  increasing  our  fixed  operating  expenses.

As  a  result  of  our  limited operating history and the emerging nature of the
markets  in  which we compete, we are unable to precisely forecast our revenues.
Our  current and future expense levels are based largely on our investment plans
and  estimates  of future revenues. Revenue and operating results will depend on
the  volume of payment transactions processed and related services rendered. The
timing of such services and transactions and our ability to fulfill a customer's
demands are difficult to forecast. Although we systematically budget for planned
outlays  and  maintain  tight  controls on our expenditures, we may be unable to
adjust  spending  in  a  timely  manner to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall in revenues in relation to our
planned  expenditures  could  have  a  material  adverse effect on our business,
prospects,  financial  condition and results of operations. Further, we may make
certain  pricing,  service, marketing or acquisition decisions that could have a
material  adverse  effect  on  each  or  all  of  these  areas.

Critical  Accounting  Policies

General

Management's  discussion  and analysis of its financial condition and results of
operations  is based upon our consolidated financial statements, which have been
prepared  in  accordance with U.S. generally accepted accounting principles. The

                                        9

preparation  of  these  financial  statements  requires us to make estimates and
judgments  that  affect the reported amounts of assets, liabilities, revenue and
expenses,  and  related  disclosure  of contingent assets and liabilities. On an
on-going  basis,  we  evaluate  our  estimates,  including  those related to the
reported  amounts  of  revenues  and expenses, bad debt, investments, intangible
assets, income taxes, and contingencies and litigation. We base our estimates on
historical  experience  and  on  various other assumptions that we believe 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 could differ from these
estimates  under  different  assumptions  or  conditions.

Reserve  for  Losses  on  Card  Processing

If,  due  to insolvency or bankruptcy of the merchant, or for another reason, we
are not able to collect amounts from our card processing merchant customers that
have  been  properly  "charged back" by the cardholders, we must bear the credit
risk  for  the  full  amount  of the cardholder transaction. We may require cash
deposits  and  other  types of collateral from certain merchants to minimize any
such  risk. In addition, we utilize a number of systems and procedures to manage
merchant  risk.  Card merchant processing loss reserves are primarily determined
by  performing  a  historical  analysis  of  our  chargeback loss experience and
considering  other factors that could affect that experience in the future. This
reserve  amount  is  subject  to risk that actual losses may be greater than our
estimates.  At  December  31,  2004, the balance of our card merchant processing
loss  reserve  was  $4,341.

Bad  Debt

We  maintain  an  allowance for doubtful accounts for estimated losses resulting
from the inability or failure of our customers to make required payments. We did
not  record any bad debt expense or bad debt write-offs in 2004. We recorded bad
debt  expense  of  $10,700  and  recorded  bad debt write-offs of $54,742 to our
allowance for doubtful accounts in 2003. At both December 31, 2004 and 2003, the
balance  of  the  allowance  for  doubtful accounts was $3,155. If the financial
condition  of  our  customers were to deteriorate, resulting in an impairment of
their  ability  to  make  contractual  payments,  additional  allowances  may be
required.

Valuation  of  Long-Lived  and  Intangible  Assets

We  assess the impairment of long-lived and intangible assets at least annually,
and whenever events or changes in circumstances indicate that the carrying value
may  not  be  recoverable.  Factors considered important, which could trigger an
impairment  review, include the following: significant underperformance relative
to  historical or projected future cash flows; significant changes in the manner
of  use  of  the assets or the strategy of the overall business; and significant
negative  industry  trends.  When  we  determine  that  the  carrying  value  of
long-lived  and  intangible assets may not be recoverable, we measure impairment
as  the  excess  of the assets' carrying value over the estimated fair value. No
impairment  losses  were  recorded  in  2004. Impairment losses of $217,000 were
recorded  in  2003 and are included in discontinued operations in the statements
of  operations  except  for  $17,000  that is included in continuing operations.

Income  Taxes

Deferred tax assets and liabilities are recorded based on the difference between
the  tax bases of assets and liabilities and their carrying amount for financial
reporting  purposes,  as measured by the enacted tax rates and laws that will be
in  effect when the differences are expected to reverse. Deferred tax assets are
computed  with  the  presumption  that they will be realizable in future periods
when  pre-taxable  income  is generated. Predicting the ability to realize these
assets  in  future  periods  requires  a great deal of judgment by us. It is our
judgment  that we cannot predict with reasonable certainty that the deferred tax
assets  as  of  December  31,  2004  will  be  fully realized in future periods.
Accordingly,  a valuation allowance has been provided to reduce the net deferred
tax  assets  to  $0.  At December 31, 2004, we have available net operating loss
carryforwards of approximately $36.1 million, which expire beginning in the year
2020.

Results  of  Operations

Total  revenues  for 2004 increased 200% to $357,566 from $119,297 for 2003. The
increase  from  the  prior  year  was  primarily attributable to the addition of
revenues  generated  from  card-based  and  Automated  Clearinghouse  processing
services  that  we  began  providing  during  2003.  We  processed our first ACH
transactions during the third quarter of 2003 and processed our first card-based
transactions  during  the  fourth  quarter  of 2003, but the related transaction
volumes  for  2003  were  not  significant  so the only component of our service
offering  that  generated significant revenue for 2003 was the bills.com payment
service.  The  prior  year  increase was also attributable to an increase in the
average  number of consumers subscribing to the bills.com payment service and an
increase  in  the  monthly  fee  paid  by  certain  consumers subscribing to the
bills.com  payment  service  because  these  consumers were converted from a per
payment  pricing  plan  to  a  flat  monthly  fee pricing plan during the second
quarter  of  2004.  The  monthly  average  number  of consumers using our online
payment  service  increased  to  2,190  in  2004  from  2,020  in  2003.

The number of transactions generated by bills.com customers is not indicative of
revenue growth because the majority of these customers pay a flat monthly fee to
process  up  to  a  certain  number of payments each month and do not exceed the

                                       10

maximum  number  of  payments  allowed. We expect our revenues to increase as we
anticipate  continued growth in the number of bills.com customers and additional
merchant  customers.  Revenue  generated  by  our merchant customers represented
approximately  55%  of  our total revenues for the year ended December 31, 2004,
and  we  believe  that this percentage will increase as we anticipate adding new
merchant  customers  and  experiencing growth in transaction volumes. We believe
that  our  merchant  business  provides us with the best opportunity for revenue
growth  and  that  revenues from card-based processing services will continue to
grow  and  will  make  up  the  majority  of  our  revenues  in  future periods.

Cost  of  services  includes the cost of personnel dedicated to the creation and
maintenance  of  connections  to third party payment processors and fees paid to
such  third  party providers for electronic payment processing services. Through
our  contractual  relationships  with  our  payment  processors,  we are able to
process  Automated Clearinghouse and debit or credit card transactions on behalf
of  our  customers  and  their consumers. We pay volume-based fees for debit and
credit  transactions  initiated through these processors, and pay fees for other
transactions  such  as  returns,  notices  of  change  to bank accounts and file
transmission.  Cost  of  services  was  $327,474 and $138,009 for 2004 and 2003,
respectively.  The  increase from the prior year is due to fees incurred in 2004
for  Automated  Clearinghouse  and  card-based  processing  services.

Selling,  general  and  administrative  expenses decreased to $1,374,779 in 2004
from $1,726,028 for 2003. The decrease from the prior year is principally due to
lower  corporate  insurance,  legal and accounting expenses and lower salary and
benefit  costs  due  to  the  reduction  of  personnel  during  2003.

Depreciation  and  amortization  was  $95,190  and  $130,671  for 2004 and 2003,
respectively.  The  decrease  from  the prior year was due to lower depreciation
expense  related to certain assets that became fully depreciated during 2004. We
purchased  $5,000 of computer equipment during 2004 and do not anticipate making
significant  capital  expenditures  in  2005.

Net  other  expense was $74,654 in 2004 compared to net other income of $101,112
in  2003.  The change from 2003 to 2004 is primarily attributable to $165,000 of
consulting  fees  recognized  in  other  income in the third quarter of 2003 for
transitional  Electronic  Bill  Presentment  and  Payment  consulting  services
provided  to  our  former  equal  partner  in an Electronic Bill Presentment and
Payment  joint venture in Australia. The joint venture was dissolved as a result
of the sale of substantially all of our assets during the third quarter of 2003.

Loss  from  continuing operations improved to $1,514,531 in 2004 from $1,774,299
in  2003,  primarily  as  a  result  of  the  decrease  in  selling, general and
administrative  expenses.

Liquidity  and  Capital  Resources

At  December 31, 2004, we had $154,000 of cash and cash equivalents, compared to
$528,000  of  cash  and  cash equivalents at December 31, 2003. We have incurred
substantial  losses  since inception, which has led to a significant decrease in
our cash position and a deficit in working capital. We sold substantially all of
our  assets in July 2003 and reduced expenditures for operating requirements. We
believe  that  our  current  available  cash  and  cash  equivalents  along with
anticipated  revenues may be insufficient to meet our anticipated cash needs for
the foreseeable future. Consequently, our ability to continue as a going concern
may be contingent on us receiving additional funds in the form of equity or debt
financing.  We  are  currently  aggressively  pursuing  strategic  alternatives.

In  February  2004,  we  executed an agreement for an equity line of credit with
Dutchess  Private  Equities  Fund,  LP. Under the terms of the agreement, we may
elect  to receive as much as $10 million from Dutchess in common stock purchases
over  three  years  at  our  option.  We  agreed to file with the Securities and
Exchange  Commission,  and  have  declared  effective  before any funds could be
received under the agreement, a registration statement registering the resale of
the shares of our common stock to be issued to Dutchess. On August 13, 2004, the
Securities and Exchange Commission declared an amended registration statement we
filed  on  Form SB-2 to register the resale of the shares to be issued under the
equity  line  of  credit  with  Dutchess  to be effective. During the year ended
December  31, 2004, we sold 1,459,435 shares of our common stock pursuant to the
equity  line  of  credit  and received total proceeds, net of issuance costs, of
$321,486.  Pursuant  to  the  terms  of  a promissory note with Dutchess, we are
obligated  to use a portion of the proceeds from the equity line to pay back the
promissory  note.

On August 24, 2004, we entered into a promissory note with Dutchess. Pursuant to
terms  of the promissory note, we received $260,000 and promised to pay Dutchess
$284,000  with a maturity date of December 24, 2004. We repaid this note in full
on the maturity date. We also issued 75,000 shares of restricted common stock to
Dutchess  as  an  incentive for the investment and agreed to register the common
stock  issued pursuant to the promissory note on the next registration statement
that  we  file.

                                       11

On  December  10,  2004,  we entered into another promissory note with Dutchess.
Pursuant  to  terms of the promissory note, we received $260,000 and promised to
pay  Dutchess  $284,000  with  a maturity date of April 10, 2005. We also issued
75,000  shares  of  restricted  common stock to Dutchess as an incentive for the
investment  and  agreed  to  register  the  common  stock issued pursuant to the
promissory  note  on  the  next  registration  statement  that  we  file.

Payments  on  the  promissory note are to be made from the equity line of credit
that  we  previously  entered  into  with  Dutchess. We will pay to Dutchess the
lesser  of  $71,000  or 50% of each put, until the face amount of the promissory
note  is  paid in full. The first payment is due at the closing of the first put
30  days  after  the issuance of the promissory note and all subsequent payments
are  due  at  the  closing  of  every  put  to Dutchess. We issued as collateral
twenty-five  put  notices  to  Dutchess for the full amount applicable under the
terms  of the equity line of credit and agreed to do so at the maximum frequency
allowed  under the equity line agreement, until such time as the note is paid in
full.

In  the  event that on the maturity date, there are any remaining amounts unpaid
on this note, Dutchess can exercise its right to increase the residual amount by
2.5%  per month paid as liquated damages. In the event that we default, Dutchess
has  the  right,  but  not  the  obligation,  to switch the residual amount to a
three-year,  10%  interest bearing convertible debenture at a conversion rate at
the  lesser of (i) 75% of the average of the lowest closing bid price during the
fifteen trading immediately preceding the convertible maturity date or (ii) 100%
of  the  average of the lowest bid price for the twenty trading days immediately
preceding  the  convertible  maturity  date.  If Dutchess chooses to convert the
residual  amount  to a convertible debenture, we shall have twenty business days
after  notice of the same to file a registration statement covering an amount of
shares  equal  to  300% of the residual amount. In the event we do not file such
registration statement within twenty business days of Dutchess' request, or such
registration statement is not declared by the Securities and Exchange Commission
to  be  effective  within  the  time period described above, the residual amount
shall  increase  by  $1,000  per  day.

The  satisfactory  completion of an additional investment or growth of cash flow
from  operations  is essential or we have no other alternative that will provide
sufficient  cash  flows  to  meet  current  operating  requirements. The sale of
additional  equity  or  convertible  debt  securities would result in additional
dilution  to  our  stockholders,  and  debt financing, if available, may involve
restrictive  covenants which could restrict operations or finances. There can be
no  assurance that financing will be available in amounts or on terms acceptable
to  us,  if  at  all.  If we cannot raise funds, on acceptable terms, or achieve
positive cash flow, we may not be able to continue to exist, conduct operations,
grow  market  share,  take  advantage  of  future  opportunities  or  respond to
competitive  pressures  or  unanticipated  requirements,  any  of  which  would
negatively  impact  our  business,  operating  results  and financial condition.

Beginning  in December 2000, we pledged as loan guarantees certain funds held as
money market funds and certificates of deposit to collateralize margin loans for
the  following  executive  officers:  (1)  Michael R. Long, then Chairman of the
Board  of  Directors  and  Chief  Executive  Officer;  (2)  Louis  A. Hoch, then
President  and Chief Operating Officer; (3) Marshall N. Millard, then Secretary,
Senior  Vice  President,  and  General  Counsel;  and  (4)  David S. Jones, then
Executive  Vice  President.  Mr. Millard and Mr. Jones are no longer employed by
us.  The margin loans were obtained in March 1999 from institutional lenders and
were  secured by shares of our common stock owned by these officers. The pledged
funds  were  held  in our name in accounts with the lenders that held the margin
loans  of  the  officers. Our purpose in collateralizing the margin loans was to
prevent  the  sale  of  our  common  stock owned by these officers while we were
pursuing  efforts to raise additional capital through private equity placements.
The  sale  of that common stock could have hindered our ability to raise capital
in  such  a  manner  and compromised its continuing efforts to secure additional
financing.  The  highest  total  amount  of  funds  pledged for the margin loans
guaranteed  by  us  was  approximately  $2.0 million. At the time the funds were
pledged,  we  believed  we would have access to them because (a) the stock price
was  substantial  and  the  stock  pledged by the officers, if liquidated, would
produce funds in excess of the loans payable, and (b) with respect to one of the
institutional  lenders  (who was also assisting us as a financial advisor at the
time),  even  if  the  stock  price  fell,  we had received assurances from that
institutional  lender  that the pledged funds would be made available as needed.
During the fourth quarter of 2002, we requested partial release of the funds for
operating purposes, which request was denied by an institutional lender. At that
time,  the  stock  price  had  fallen  as  well,  and  it became clear that both
institutional  lenders  would  not  release the pledged funds. In light of these
circumstances,  we  recognized  a  loss  on  the guarantees of $1,278,138 in the
fourth  quarter of 2002 and recorded a corresponding payable under related party
guarantees  on our balance sheet at December 31, 2002 because it became probable
at  that  point that we would be unable to recover our pledged funds. During the
quarter  ended  March 31, 2003, the lenders applied the pledged funds to satisfy
the  outstanding  balances  of  the loans. The total balance of the margin loans
guaranteed  by  us was zero at December 31, 2004. We may institute litigation or
arbitration  in collection of the outstanding repayment obligations of Mr. Long,
Mr.  Hoch,  Mr.  Millard,  and  Mr.  Jones,  which  currently  total $1,278,138.
Presently,  we have refrained from initiating action to recover these funds from
Mr. Long, Mr. Hoch, and Mr. Millard because they may have offsetting claims that
total $1,445,500 collectively by virtue of the change of control clause in their
respective  employment  agreements  based  on  our  preliminary  analysis.  We
understand  that  these  individuals may assert such claims based on our sale of
substantially  all  of  our assets to Harbor Payments, Inc. on July 25, 2003. We
have  not  initiated  any  formal settlement negotiations with these individuals
because they have been under an extended employment contract with us or have not
been  amenable  to  such  an action. On July 25, 2004, our employment agreements
with  Michael  Long,  Chief  Executive  Officer and Chief Financial Officer, and
Louis  Hoch,  President and Chief Operating Officer, expired. We intend to enter
into  new employment agreements with both of these individuals and are currently
negotiating  the  terms  of such agreements. We have not pursued the outstanding
repayment  obligation of Mr. Jones because we do not consider a recovery attempt
to  be  cost  beneficial.  In  order  to  attempt  a recovery from Mr. Jones, we
estimate  that we would incur a minimum of $20,000 in estimated legal costs with
no  reasonable  assurance of success in recovering his outstanding obligation of
approximately  $38,000. Because of the limited amount of the obligation, we also
anticipate  difficulty  in  retaining  counsel  on a contingency basis to pursue
collection  of  this  obligation.  The  ultimate  outcome  of this matter cannot
presently  be  determined.

                                       12

Net cash used in operating activities was $941,000 and $2.2 million for 2004 and
2003,  respectively.  Net  cash  used  in  operating  activities  was  primarily
attributable  to operating net losses generated by early growth stage activities
and  overhead costs. We plan to focus on expending our resources prudently given
our  current  state of liquidity and do not expect to achieve positive cash flow
from  operations  for  2005.

Net  cash  provided by investing activities was $2,000 in 2004 and reflected the
return  of  $7,000  of  deposits  that had been used to secure the lease for our
corporate  office  offset  by  capital  expenditures  of  $5,000  for  computer
equipment.  Net  cash  provided  by investing activities of $4.1 million in 2003
reflected  proceeds  of  $4.2  million from the sale of substantially all of our
assets  in  July  2003  offset  by  capital expenditures of $66,000 for computer
equipment  and  software.  We  do  not  anticipate  making  significant  capital
expenditures  during  2005.

Net  cash  provided  by  financing  activities  of  $565,000  for  2004 resulted
primarily from proceeds, net of issuance costs, of $329,000 from the issuance of
common  stock as well as $236,000 of net borrowings under short-term agreements.
Net  cash  used  in  financing  activities  of  $1.7  million for 2003 primarily
resulted  from  the payment of $1.8 million under our convertible debt agreement
in  July  2003.

OFF-BALANCE  SHEET  ARRANGEMENTS

We  currently have no off-balance sheet arrangements that have or are reasonably
likely  to  have a current or future material effect on our financial condition,
changes  in  financial  condition,  revenues or expenses, results of operations,
liquidity,  capital  expenditures  or  capital  resources.

EFFECT  OF  NEW  ACCOUNTING  PRONOUNCEMENTS

On  May  15,  2003,  the  FASB issued Statement No. 150, "Accounting for Certain
Financial  Instruments with Characteristics of both Liabilities and Equity". FAS
150  establishes  standards for classifying and measuring as liabilities certain
freestanding  financial  instruments  that  embody obligations of the issuer and
have  characteristics  of  both liabilities and equity. The statement defines an
obligation as "a conditional or unconditional duty or responsibility on the part
of  the  issuer  to  transfer  assets or to issue its equity shares." FAS 150 is
effective  for all financial instruments created or modified after May 31, 2003,
and  otherwise  effective at the beginning of the first interim period beginning
after  June  15, 2003. The adoption of this statement did not have a significant
impact  on  our  results  of  operations  or  financial  position.

In  January  2003,  the  FASB  issued  Interpretation  No. 46, "Consolidation of
Variable  Interest  Entities",  and  in  December  2003  issued  a  revised
interpretation,  FIN  46R.  FIN  46  and FIN 46R address the accounting for, and
disclosure  of, investments in variable interest entities. We adopted FIN 46 and
FIN  46R,  which  did  not  have  a material impact on our financial position or
results  of  operations.

In  December  2004,  the  FASB issued Statement No. 123R, "Share-Based Payment,"
which  requires  all  companies to measure compensation cost for all share-based
payments  (including employee stock options) at fair value, effective for public
companies  for  interim  or  annual  periods  beginning after June 15, 2005. The
adoption  of  this  statement  is  not expected to have a material impact on our
results  of  operations  or  financial  position.

RISK  FACTORS

There  are  many  factors  that  affect  our  business  and  the  results of its
operations, some of which are beyond our control. The following is a description
of  some  of  the  important  factors  that  may cause the actual results of our
operations  in future periods to differ materially from those currently expected
or  desired.

                          RISKS RELATED TO OUR BUSINESS

Our independent accountants have issued a going concern opinion and if we cannot
obtain  additional  financing,  we  may  have  to  curtail  operations  and  may
ultimately  cease  to  exist.

Our  independent  accountants  have  issued  a  going  concern  opinion.  Due to
continuing  operating  losses,  our  current available cash and cash equivalents
along  with  anticipated  revenues  are  likely  to  be insufficient to meet our
anticipated  cash  needs  for  the  near  future.  Consequently,  our ability to
continue  as  a  going  concern  is likely contingent on us receiving additional
funds  in  the  form  of equity or debt financing. We currently plan to meet our
capital  requirements primarily through the issuance of equity securities or new
borrowing  arrangements.  Accordingly,  we  are  aggressively pursuing strategic
alternatives.  However,  financing  may  not be available in amounts or on terms
acceptable  to  us,  if  at all. If we cannot raise funds on acceptable terms or
achieve  positive  cash  flow,  we  may  be  forced to curtail operations or may
ultimately  cease  to  exist.

                                       13

We have generated significant losses and expect to generate operating losses for
the  foreseeable  future,  therefore  we  may  not  become  profitable.

We  organized  in  1998  and  began  operations  as  a public company in 1999 by
offering  electronic  billing services to other companies. After the sale of our
primary  business  in July 2003, we have concentrated on building our electronic
payments services operations. We have not been profitable since inception and we
may  never  become  profitable. As of December 31, 2004, our accumulated deficit
was  $48.2  million.

If  our  security  applications  are  not  sufficient to address changing market
conditions  and  customer  concerns,  we  may  not be able to sell our services.

Our  use  of  applications  designed  for premium data security and integrity to
process electronic transactions may not be sufficient to address changing market
conditions  or  the  security  and  privacy  concerns  of existing and potential
customers.  Adverse  publicity  raising  concerns about the safety or privacy of
electronic  transactions,  or  widely  reported  breaches  of  our  or  another
provider's  security, have the potential to undermine consumer confidence in the
technology  and  could  have  a  materially  adverse  effect  on  our  business.

If the trend of an increasing percentage of payments cleared electronically does
not  continue,  we  may  not  be  able  to  grow  our  business.

Our  future  financial performance will be materially affected by the percentage
of  payments that can be cleared electronically. Based on reports by the Federal
Reserve,  paper  check  use as a percentage of retail non-cash payments declined
from  77.1%  in  1995  to  59.5% in 2000. Accordingly, a reversal of the current
trend  toward  a  smaller  proportion  of  paper-based  payments would limit the
potential  growth  of  our  business.

If  we  do  not  adapt  to  rapid  technological  change, our business may fail.

Our  success  depends  on  our ability to develop new and enhanced services, and
related products that meet changing customer needs. The market for our services,
however,  is  characterized  by  rapidly  changing technology, evolving industry
standards,  emerging competition and frequent new and enhanced software, service
and  related  product introductions. In addition, the software market is subject
to  rapid  and  substantial  technological change. To remain successful, we must
respond  to new developments in hardware and semiconductor technology, operating
systems,  programming  technology  and computer capabilities. In many instances,
new  and enhanced services, products and technologies are in the emerging stages
of  development  and  marketing,  and  are  subject to the risks inherent in the
development  and  marketing  of  new software, services and products. We may not
successfully  identify  new service opportunities, and develop and bring new and
enhanced  services and related products to market in a timely manner. Even if we
do  bring such services, products or technologies to market, they may not become
commercially  successful.  Additionally,  services,  products  or  technologies
developed  by others may render our services and related products noncompetitive
or  obsolete.  If  we are unable, for technological or other reasons, to develop
and  introduce  new  services  and  products  in  a timely manner in response to
changing  market  conditions  or  customer  requirements, our business may fail.

We  rely on our relationship with the Automated Clearinghouse Network and if the
Federal  Reserve rules were to change, our business could be adversely affected.

We  have a contractual relationship with a third party provider, which maintains
a  relationship  with  multiple Originating Depository Financial Institutions in
the  Automated  Clearinghouse  Network. The Automated Clearinghouse Network is a
nationwide batch-oriented electronic funds transfer system that provides for the
interbank  clearing  of  electronic  payments  for  participating  financial
institutions. An Originating Depository Financial Institution is a participating
financial  institution  that  must  abide  by  the  provisions  of the Automated
Clearinghouse Operating Rules and Guidelines. Through our relationship with this
third  party  provider, we are able to process payment transactions on behalf of
our  customers  and  their  consumers  by  submitting  payment instructions in a
prescribed Automated Clearinghouse format. We pay volume-based fees to the third
party  provider  for debit and credit transactions processed each month, and pay
fees  for  other  transactions  such  as  returns  and notices of change to bank
accounts.  These  fees  are  part  of our cost structure. If the Federal Reserve
rules were to change to introduce restrictions or modify access to the Automated
Clearinghouse,  our  business  could  be  materially  adversely  affected.

If our third party card processing providers or our bank sponsors fail to comply
with  the  applicable  requirements  of  Visa  and  MasterCard  credit  card
associations,  we  may have to find a new third party processing provider, which
could  increase  our  costs.

Substantially  all  of  the  card-based  transactions we process involve Visa or
MasterCard.  If  our third party processing providers, Network 1 Financial, Inc.
and  TriSource  Solutions,  LLC,  or  our  bank sponsors, Harris Bank and DuTrac
Community  Credit  Union, fail to comply with the applicable requirements of the
Visa  and  MasterCard credit card associations, Visa or MasterCard could suspend
or  terminate their registration. Also, our contract with these third parties is

                                       14

subject to cancellation upon limited notice by either party. The cancellation of
our  contract,  termination  of their registration or any changes in the Visa or
MasterCard  rules  that would impair their registration could require us to stop
providing  such  payment  processing services if we are unable to obtain another
provider  or  sponsor  at similar costs. Additionally, changing our bank sponsor
could  adversely  affect  our relationship with our merchants if the new sponsor
provides  inferior  service  or  charges  higher  costs.

We  depend  on Michael R. Long and Louis A. Hoch and if these officers ceased to
be  active  in  our  management,  our  business  may  not  be  successful.

Our  success depends to a significant degree upon the continued contributions of
our  key  management,  marketing,  service  and  related product development and
operational personnel, including our Chairman, Chief Executive Officer and Chief
Financial  Officer,  Michael  R.  Long  and  our  President  and Chief Operating
Officer,  Louis A. Hoch. We had employment agreements with Mr. Long and Mr. Hoch
that  expired  in  July  2004  and  prohibited them from competing with us for a
period  of  two  years  upon termination of their employment. We intend to enter
into  similar  new  employment agreements with both of these individuals and are
currently  negotiating  the  terms  of  such agreements. Our business may not be
successful  if,  for any reason, either of these officers ceased to be active in
our  management.

If our software fails, and we need to repair or replace it, or we become subject
to  warranty  claims,  our  costs  could  increase.

Our software products could contain errors or "bugs" that could adversely affect
the  performance  of  services  or damage a user's data. We attempt to limit our
potential  liability  for  warranty  claims  through  technical  audits  and
limitation-of-liability  provisions  in  our customer agreements. However, these
measures  may  not  be effective in limiting our exposure to warranty claims. We
have  not  experienced  a  significant  increase  in software errors or warranty
claims.  Despite  the  existence  of  various security precautions, our computer
infrastructure  may also be vulnerable to viruses or similar disruptive problems
caused  by  our  customers  or  third  parties  gaining access to our processing
system. If our software fails, and we need to replace or repair it, or we become
subject  to  warranty  claims,  our  costs  could  increase.

Our  business strategy includes identifying new businesses to acquire, and if we
cannot  integrate  acquisitions into our company successfully, we may not become
profitable.

Our  success  partially  depends  upon  our  ability  to  identify  and  acquire
undervalued  businesses  within our industry. Although we believe that there are
companies  available  for  potential  acquisition that are undervalued and might
offer  attractive  business  opportunities,  we  may  not  be  able  to make any
acquisitions,  and  if we do make acquisitions, they may not be profitable. As a
result,  our  business  may  not  grow  and  we  may  not  achieve  or  sustain
profitability.

If  we  do  not  manage our growth, we may not achieve or sustain profitability.

We may experience a period of rapid growth that could place a significant strain
on  our  resources.  In order to manage our growth successfully, we will have to
continue to improve our operational, management and financial systems and expand
our  work force. A significant increase in our customer base may necessitate the
hiring of a significant number of additional personnel, qualified candidates for
which,  at  the  time needed, may be in short supply. In addition, the expansion
and  adaptation  of  our computer and administrative infrastructure will require
substantial operational, management and financial resources. Although we believe
that  our  current infrastructure is adequate to meet the needs of our customers
in  the  foreseeable  future,  we  may  not  be  able  to  expand  and adapt our
infrastructure  to  meet  additional demand on a timely basis, at a commercially
reasonable  cost,  or  at  all.  If  our  management  is unable to manage growth
effectively, hire needed personnel, expand and adapt our computer infrastructure
and  improve our operational, management, and financial systems and controls, we
may  not  attain  or  sustain  profitability.

If  we  do  not manage our credit risks related to our merchant accounts, we may
incur  significant  losses.

We  rely  on the Federal Reserve's Automated Clearinghouse system for electronic
fund  transfers  and  the  Visa  and  MasterCard  associations for settlement of
payments by credit or debit card on behalf of our merchant customers. In our use
of  these  established  payment  clearance systems, we generally bear the credit
risks  arising  from  returned  transactions  caused by insufficient funds, stop
payment  orders,  closed  accounts, frozen accounts, unauthorized use, disputes,
customer charge backs theft or fraud. Consequently, we assume the credit risk of
merchant  disputes,  fraud,  insolvency or bankruptcy in the event we attempt to
recover  funds  related  to  such  transactions  from our customers. We have not
experienced  a  significant  increase  in  the  rate of returned transactions or
incurred  any  losses  with respect to such transactions. We utilize a number of
systems  and  procedures  to manage and limit credit risks, but if these actions
are  not  successful  in  managing  such risks, we may incur significant losses.

                                       15

                          RISKS RELATED TO OUR INDUSTRY

The electronic commerce market is relatively new and if it does not grow, we may
not  be  able  to  sell  sufficient  services  to  make  our  business  viable.

The electronic commerce market is a relatively new and growing service industry.
If  the  electronic  commerce  market  fails  to  grow  or  grows  slower  than
anticipated,  or  if  we,  despite  an  investment of significant resources, are
unable  to adapt to meet changing customer requirements or technological changes
in this emerging market, or if our services and related products do not maintain
a  proportionate  degree  of acceptance in this growing market, our business may
not grow and could even fail. Additionally, the security and privacy concerns of
existing  and  potential  customers  may  inhibit  the  growth of the electronic
commerce  market  in general, and our customer base and revenues, in particular.
Similar  to  the  emergence  of  the  credit  card  and automatic teller machine
industries,  we  and  other organizations serving the electronic commerce market
must  educate  users  that electronic transactions use encryption technology and
other electronic security measures that make electronic transactions more secure
than  paper-based  transactions.

Changes  in  regulation  of  electronic  commerce and related financial services
industries  could  increase  our  costs  and  limit  our business opportunities.

We  believe  that  we  are  not  required  to  be  licensed by the Office of the
Comptroller  of  the  Currency,  the  Federal Reserve Board, or other federal or
state  agencies  that  regulate  or monitor banks or other types of providers of
electronic commerce services. It is possible that a federal or state agency will
attempt  to  regulate  providers  of  electronic  commerce services, which could
impede  our  ability  to  do  business  in  the regulator's jurisdiction. We are
subject  to  various  laws  and regulations relating to commercial transactions,
such  as the Uniform Commercial Code, and may be subject to the electronic funds
transfer  rules  embodied  in  Regulation  E, promulgated by the Federal Reserve
Board.  Given  the  expansion  of  the  electronic  commerce market, the Federal
Reserve  Board might revise Regulation E or adopt new rules for electronic funds
transfer  affecting  users  other  than  consumers.  Because  of  growth  in the
electronic  commerce  market,  Congress has held hearings on whether to regulate
providers  of services and transactions in the electronic commerce market. It is
possible  that  Congress  or  individual  states could enact laws regulating the
electronic  commerce  market. If enacted, such laws, rules and regulations could
be  imposed  on  our business and industry and could increase our costs or limit
our  business  opportunities.

If  we  cannot  compete successfully in our industry, we could lose market share
and  our  costs  could  increase.

Portions  of  the  electronic  commerce  market  are  becoming  increasingly
competitive.  We  expect  to  face  growing  competition  in  all  areas  of the
electronic payment processing market. New companies could emerge and compete for
merchants  of all sizes. We expect competition to increase from both established
and  emerging  companies  and  that  such  increased competition could lower our
market  share  and  increase  our  costs.  Moreover,  our  current and potential
competitors, many of whom have greater financial, technical, marketing and other
resources  than  us,  may  respond  more  quickly  than  us  to  new or emerging
technologies or could expand to compete directly against us in any or all of our
target  markets.  Accordingly,  it  is  possible  that  current  or  potential
competitors  could  rapidly  acquire market share. We may not be able to compete
against  current  or  future competitors successfully. Additionally, competitive
pressures  may  increase  our  costs,  which  could  lower our earnings, if any.

                        RISKS RELATED TO OUR COMMON STOCK

Our  stock  price  is  volatile and you may not be able to sell your shares at a
price  higher  than  what  you  paid.

The  market  for our common stock is highly volatile. In 2004, our closing stock
price  fluctuated between $0.15 and $0.46. The trading price of our common stock
could  be  subject  to  wide  fluctuations  in  response to, among other things,
quarterly  variations  in  operating  and  financial  results,  announcements of
technological  innovations  or new products by our competitors or us, changes in
prices  of  our products and services or our competitors' products and services,
changes  in  product  mix,  or  changes in our revenue and revenue growth rates.

Existing  stockholders  may  experience  significant  dilution  from the sale of
securities  pursuant  to our investment agreement with Dutchess Private Equities
Fund.

The  sale  of  shares pursuant to our Investment Agreement with Dutchess Private
Equities  Fund  may have a dilutive impact on our stockholders. As a result, our
net  income  per  share could decrease in future periods and the market price of
our common stock could decline. In addition, the lower our stock price is at the
time  we  exercise  our  put  option,  the  more shares we will have to issue to
Dutchess  Private  Equities  Fund  to  draw  down  on  the full equity line with
Dutchess  Private Equities Fund. If our stock price decreases, then our existing
stockholders  would  experience  greater  dilution. At a stock price of $0.26 or
less, we would have to issue all 40,000,000 shares currently registered in order
to  draw  down  on  the  full  equity  line.

                                       16

Dutchess  Private  Equities  Fund  will pay less than the then-prevailing market
price  of  our  common stock, which could cause the price of our common stock to
decline.

Our common stock to be issued under our agreement with Dutchess Private Equities
Fund  will  be  purchased  at a 5% discount to the lowest closing best bid price
during  the  five  days  immediately  following  our  notice to Dutchess Private
Equities  Fund  of  our  election  to  exercise  our put right. Dutchess Private
Equities  Fund  has  a  financial incentive to sell our common stock immediately
upon receiving the shares to realize the profit between the discounted price and
the  market price. If Dutchess Private Equities Fund sells our shares, the price
of  our  stock  could  decrease.  If our stock price decreases, Dutchess Private
Equities  Fund  may  have  a  further incentive to sell the shares of our common
stock  that  it  holds.  The  discounted sales under our agreement with Dutchess
Private  Equities  Fund  could  cause  the price of our common stock to decline.

We  must comply with penny stock regulations that could effect the liquidity and
price  of  our  stock.

The  SEC  has  adopted rules that regulate broker-dealer practices in connection
with  transactions  in  "penny  stocks."  Penny  stocks  generally  are  equity
securities  with a price of less than $5.00, other than securities registered on
certain national securities exchanges or quoted on NASDAQ, provided that current
price  and volume information with respect to transactions in such securities is
provided  by  the exchange or system. Prior to a transaction in a penny stock, a
broker-dealer  is  required  to:

-  deliver  a  standardized  risk  disclosure  document  prepared  by  the  SEC;

-  provide  the  customer  with  current  bid and offer quotations for the penny
stock;

-  explain  the  compensation  of  the  broker-dealer and its salesperson in the
transaction;

-  provide  monthly  account  statements  showing the market value of each penny
stock  held  in  the  customer's  account;

-  make  a  special  written  determination  that  the penny stock is a suitable
investment  for  the  purchaser  and  receive  the  purchaser's  executed
acknowledgement  of  the  same;  and

-  provide  a  written  agreement  to  the  transaction.

These requirements may have the effect of reducing the level of trading activity
in  the  secondary  market  for our stock. Because our shares are subject to the
penny  stock  rules,  you  may  find  it  more  difficult  to  sell your shares.

We  have  adopted  certain  measures that may make it more difficult for a third
party  to  acquire  control  of  our  company.

Our  Board  of  Directors  is classified into three classes of directors serving
staggered  three-year  terms.  Such  classification  of  the  Board of Directors
expands  the  time required to change the composition of a majority of directors
and  may  tend  to  discourage  a  proxy  contest  or other takeover bid for our
company.

                                       17

ITEM  7.  FINANCIAL  STATEMENTS.


INDEX  TO  CONSOLIDATED  FINANCIAL  STATEMENTS


Report  of  Independent  Registered  Public  Accounting  Firm                 19

Consolidated  Balance  Sheets  as  of  December  31,  2004  and  2003         20

Consolidated  Statements  of  Operations  for  the  years  ended
  December  31,  2004  and  2003                                              21

Consolidated  Statement  of  Changes  in  Stockholders' Equity (Deficit) for
  the years  ended  December  31,  2004  and  2003                            22

Consolidated  Statements  of  Cash  Flows  for  the  years  ended
  December  31,  2004  and  2003                                              23

Notes  to  Consolidated  Financial  Statements                                24

                                       18

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


The  Board  of  Directors  and  Stockholders
Payment  Data  Systems,  Inc.  and  Subsidiaries
San  Antonio,  Texas

We  have  audited  the  accompanying consolidated balance sheets of Payment Data
Systems,  Inc.,  formerly known as Billserv, Inc, and subsidiaries (collectively
referred  to as "the Company") as of December 31, 2004 and 2003, and the related
consolidated  statements of operations, changes in stockholders' equity and cash
flows for the years ended December 31, 2004 and 2003. These financial statements
are  the  responsibility  of  the Company's management. Our responsibility is to
express  an  opinion  on  these  financial  statements  based  on  our  audits.

We  conducted  our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements  are free of material misstatement. An audit includes examining, on a
test  basis,  evidence  supporting  the amounts and disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made  by  management,  as well as evaluating the overall
financial  statement  presentation.  We  believe  that  our  audits  provide  a
reasonable  basis  for  our  opinion.

In  our  opinion,  the financial statements referred to above present fairly, in
all  material  respects,  the  consolidated financial position of the Company at
December  31,  2004 and 2003, and the consolidated results of its operations and
cash  flows for the years then ended, in conformity with U.S. generally accepted
accounting  principles.

The  accompanying  financial  statements  of  Payment  Data  Systems,  Inc.  and
subsidiaries  have  been  prepared  assuming that the Company will continue as a
going  concern.  As  more  fully  described  in Note 1, the Company has incurred
substantial  losses  since inception, which has led to a significant decrease in
its  cash  position and a deficit in working capital. In addition, in July 2003,
substantially all operations were sold. These conditions raise substantial doubt
about  the  Company's  ability  to  continue  as  a going concern. The financial
statements  of  Payment  Data  Systems, Inc. and subsidiaries do not include any
adjustments  to  reflect  the  possible future effects on the recoverability and
classification  of  assets or the amounts and classification of liabilities that
may  result  from  the  outcome  of  this  uncertainty.



/s/  Akin,  Doherty,  Klein  &  Feuge,  P.C.
AKIN,  DOHERTY,  KLEIN  &  FEUGE,  P.C.
San  Antonio,  Texas
February  18,  2005,  except  for  Note  15,
to  which  the  date  is  March  11,  2005

                                       19

<TABLE>
<CAPTION>


                                   PAYMENT DATA SYSTEMS, INC.
                                  CONSOLIDATED BALANCE SHEETS


<S>                                                             <C>             <C>
                                                                December 31,    December 31,
                                                                   2004            2003
Assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . .  $     153,966   $     528,119
Accounts receivable, net . . . . . . . . . . . . . . . . . . .         57,788          43,693
Prepaid expenses and other . . . . . . . . . . . . . . . . . .         47,833         113,650
                                                                --------------  --------------
Total current assets . . . . . . . . . . . . . . . . . . . . .        259,587         685,462

Property and equipment, net. . . . . . . . . . . . . . . . . .        132,064         215,156
Other assets . . . . . . . . . . . . . . . . . . . . . . . . .         23,589          37,782
                                                                --------------  --------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . .  $     415,240   $     938,400
                                                                ==============  ==============


Liabilities and stockholders' equity (deficit):
Current liabilities:
  Accounts payable . . . . . . . . . . . . . . . . . . . . . .  $     482,788   $     501,488
  Accrued expenses . . . . . . . . . . . . . . . . . . . . . .        392,515         224,180
  Short-term borrowings. . . . . . . . . . . . . . . . . . . .        264,165               -
                                                                --------------  --------------
Total current liabilities. . . . . . . . . . . . . . . . . . .      1,139,468         725,668

Stockholders' equity (deficit):
Common stock, $.001 par value, 200,000,000 shares authorized;
  23,569,180 and 20,987,956 issued and outstanding . . . . . .         23,569          20,988
Additional paid-in capital . . . . . . . . . . . . . . . . . .     47,417,898      46,842,908
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . .    (48,165,695)    (46,651,164)
                                                                --------------  --------------
Total stockholders' equity (deficit) . . . . . . . . . . . . .       (724,228)        212,732
                                                                --------------  --------------
Total liabilities and stockholders' equity (deficit) . . . . .  $     415,240   $     938,400
                                                                ==============  ==============

See notes to consolidated financial statements.
</TABLE>

                                       20

<TABLE>
<CAPTION>


                                        PAYMENT DATA SYSTEMS, INC.
                                  CONSOLIDATED STATEMENTS OF OPERATIONS


<S>                                                                        <C>             <C>
                                                                           Year ended      Year ended
                                                                           December 31,    December 31,
                                                                              2004            2003

Revenues. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  $     357,566   $     119,297

Operating expenses:
Cost of services. . . . . . . . . . . . . . . . . . . . . . . . . . . . .        327,474         138,009
Selling, general and administrative . . . . . . . . . . . . . . . . . . .      1,374,779       1,726,028
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . .         95,190         130,671
                                                                           --------------  --------------
Total operating expenses. . . . . . . . . . . . . . . . . . . . . . . . .      1,797,443       1,994,708
                                                                           --------------  --------------

Operating loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .     (1,439,877)     (1,875,411)

Other income (expense), net:
Interest income . . . . . . . . . . . . . . . . . . . . . . . . . . . . .            712           5,122
Interest expense. . . . . . . . . . . . . . . . . . . . . . . . . . . . .        (46,111)        (61,432)
Other income (expense). . . . . . . . . . . . . . . . . . . . . . . . . .        (29,255)        157,422
                                                                           --------------  --------------
Total other income (expense), net . . . . . . . . . . . . . . . . . . . .        (74,654)        101,112
                                                                           --------------  --------------

Loss from continuing operations before income taxes . . . . . . . . . . .     (1,514,531)     (1,774,299)
Income taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              -               -
                                                                           --------------  --------------
Loss from continuing operations . . . . . . . . . . . . . . . . . . . . .     (1,514,531)     (1,774,299)

Discontinued operations:
Loss from discontinued operations, net of no income taxes . . . . . . . .              -        (477,846)

Gain on disposition of discontinued operations, net of no income taxes. .              -       2,737,041
                                                                           --------------  --------------
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . .  $  (1,514,531)  $     484,896
                                                                           ==============  ==============

Loss from continuing operations per common share - basic and diluted. . .  $       (0.07)  $       (0.09)

Income from discontinued operations per common share - basic and diluted.              -            0.11
                                                                           --------------  --------------
Net income (loss) per common share - basic and diluted. . . . . . . . . .  $       (0.07)  $        0.02
                                                                           ==============  ==============
Weighted average common shares
 outstanding - basic and diluted. . . . . . . . . . . . . . . . . . . . .     21,813,979      20,883,218

See notes to consolidated financial statements.
</TABLE>

                                       21

<TABLE>
<CAPTION>
                                                 PAYMENT DATA SYSTEMS, INC.
                             CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
<S>                                              <C>           <C>          <C>           <C>              <C>

                                                        Common Stock        Additional                     Total
                                                 -------------------------  Paid - In     Accumulated      Shareholders'
                                                 Shares        Amount       Capital       Deficit          Equity (Deficit)
                                                 ------------  -----------  ------------  ---------------  -----------------
Balance at December 31, 2002. . . . . . . . . .    20,603,799  $    20,604  $ 46,770,186  $  (47,136,060)  $       (345,270)

Issuance of common stock. . . . . . . . . . . .       118,857          119        22,841               -             22,960
Exercise of stock options . . . . . . . . . . .       265,300          265        49,881               -             50,146
Net loss for the year . . . . . . . . . . . . .             -            -             -         484,896            484,896
                                                 ------------  -----------  ------------  ---------------  -----------------

Balance at December 31, 2003. . . . . . . . . .    20,987,956       20,988    46,842,908     (46,651,164)           212,732

Issuance of common stock - equity line of
  credit. . . . . . . . . . . . . . . . . . . .     1,459,435        1,459       320,026               -            321,485
Issuance of common stock - other. . . . . . . .     1,070,789        1,071       218,215               -            219,286
Exercise of stock options . . . . . . . . . . .        51,000           51         7,074               -              7,125
Issuance of common stock warrants . . . . . . .             -            -        29,675               -             29,675
Net loss for the year . . . . . . . . . . . . .             -            -             -      (1,514,531)        (1,514,531)
                                                 ------------  -----------  ------------  ---------------  -----------------
Balance at December 31, 2004. . . . . . . . . .    23,569,180  $    23,569  $ 47,417,898  $  (48,165,695)  $       (724,228)
                                                 ============  ===========  ============  ===============  =================
See notes to consolidated financial statements.
</TABLE>

                                       22

<TABLE>
<CAPTION>
                             PAYMENT DATA SYSTEMS, INC.
                        CONSOLIDATED STATEMENTS OF CASH FLOWS
<S>                                                       <C>           <C>

                                                             2004          2003
                                                        -------------  -------------
Operating activities:
Loss from continuing operations. . . . . . . . . . . . .  $(1,514,531)  $(1,774,299)
Adjustments to reconcile loss from continuing
  operations to net cash used in operating activities:
Depreciation . . . . . . . . . . . . . . . . . . . . . .       87,690       115,671
Amortization . . . . . . . . . . . . . . . . . . . . . .        7,500        15,000
Impairment of assets . . . . . . . . . . . . . . . . . .            -        17,000
Non-cash issuance of common stock. . . . . . . . . . . .      215,710             -
Non-cash issuance of common stock warrants . . . . . . .       29,675             -
Amortization of debt discount. . . . . . . . . . . . . .       28,165             -
Changes in current assets and current liabilities:
  Accounts receivable. . . . . . . . . . . . . . . . . .      (14,095)      615,381
  Prepaid expenses and other . . . . . . . . . . . . . .       65,817       144,160
  Accounts payable and accrued expenses. . . . . . . . .      153,210      (763,034)
  Deferred revenue . . . . . . . . . . . . . . . . . . .            -      (400,960)
                                                          ------------  ------------
Net cash used in continuing operations . . . . . . . . .     (940,859)   (2,031,081)
Net cash used in discontinued operations . . . . . . . .            -      (145,038)
                                                          ------------  ------------
Net cash used in operating activities. . . . . . . . . .     (940,859)   (2,176,119)

Investing activities:
Purchases of property and equipment. . . . . . . . . . .       (4,598)      (66,395)
Proceeds from sale of assets . . . . . . . . . . . . . .            -     4,224,108
Long-term deposits, net. . . . . . . . . . . . . . . . .        6,693       (30,282)
                                                          ------------  ------------
Net cash provided by investing activities. . . . . . . .        2,095     4,127,431

Financing activities:
Proceeds from notes payable. . . . . . . . . . . . . . .      520,000             -
Principal payments for notes payable . . . . . . . . . .     (284,000)   (1,800,000)
Cash pledged as collateral for related party obligations            -     1,311,984
Payments for related party obligations . . . . . . . . .            -    (1,278,138)
Issuance of common stock, net of issuance costs. . . . .      328,611        56,856
                                                          ------------  ------------
Net cash provided by (used in) financing activities. . .      564,611    (1,709,298)
                                                          ------------  ------------

Change in cash and cash equivalents. . . . . . . . . . .     (374,153)      242,014
Cash and cash equivalents, beginning of year . . . . . .      528,119       286,105
                                                          ------------  ------------
Cash and cash equivalents, end of year . . . . . . . . .  $   153,966   $   528,119
                                                          ============  ============

Supplemental information:
  Cash paid for interest . . . . . . . . . . . . . . . .  $    24,000   $    41,623
  Cash paid for federal income taxes . . . . . . . . . .            -             -

See notes to consolidated financial statements.
</TABLE>

                                       23

                           PAYMENT DATA SYSTEMS, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2004 AND 2003


NOTE  1.  DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Going  Concern

The  Company has incurred substantial losses since inception, which has led to a
significant  decrease in its cash position and a deficit in working capital. The
Company  sold  substantially  all  of  its assets in July 2003 (see Note 14) and
reduced  expenditures  for  operating  requirements.  Despite these actions, the
Company believes that its current available cash along with anticipated revenues
may  be  insufficient  to  meet  its  anticipated cash needs for the foreseeable
future.  Accordingly,  the  Company is currently aggressively pursuing strategic
alternatives,  including  investment in the Company via an equity line of credit
(See  Note  2).  The  satisfactory completion of an additional investment in the
Company  or  growth of cash flow from operations is essential or the Company has
no  other  alternative  that  will  provide  sufficient  funds  to  meet current
operating  requirements.  The  sale  of  additional  equity  or convertible debt
securities  would  result  in additional dilution to the Company's stockholders,
and  debt financing, if available, may involve restrictive covenants which could
restrict  operations  or finances. There can be no assurance that financing will
be available in amounts or on terms acceptable to the Company, if at all. If the
Company  cannot raise funds, on acceptable terms, or achieve positive cash flow,
it  may not be able to continue to exist, conduct operations, grow market share,
take  advantage  of  future opportunities or respond to competitive pressures or
unanticipated  requirements,  any of which would negatively impact its business,
operating  results  and  financial  condition.

Description  of  Business

Payment  Data  Systems,  Inc.,  formerly  known  as  Billserv,  Inc.,  and  its
subsidiaries  (collectively  referred  to  as "the Company"), provide integrated
electronic  payment  services,  including credit and debit card-based processing
services  and  transaction  processing  via  the automated clearinghouse ("ACH")
network  to billers and retailers. In addition, the Company operates an Internet
electronic  payment  processing  service  for  consumers  under  the domain name
www.bills.com.  Prior  to  selling substantially all of its assets in July 2003,
the  Company  provided electronic bill presentment and payment ("EBPP") services
to  companies  generating  recurring  bills, primarily in the United States. The
Company  also  provided related EBPP consulting and Internet-based customer care
interaction  services.  In  accordance  with  Statement  of Financial Accounting
Standards  No.  144,  "Accounting  for  the Impairment or Disposal of Long-Lived
Assets"  ("FAS  144"), the results of operations for the asset group disposed of
have  been  classified  as  discontinued  operations.

Principles  of  Consolidation  and  Basis  of  Presentation

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

The  accompanying  financial statements have been presented assuming the Company
will  continue  as  a  going  concern.

Use  of  Estimates

The  preparation  of  financial  statements  in  conformity  with U.S. generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect  the  reported  amounts  of assets and liabilities and
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.  Actual  results  could  differ  from  those  estimates.

Cash  and  Cash  Equivalents

The  Company  considers all highly liquid investments purchased with an original
maturity  of  three  months  or  less  to  be  cash  equivalents.

Accounts  Receivable

Accounts  receivable  are  reported at outstanding principal net of an allowance
for doubtful accounts of $3,155 at December 31, 2004 and 2003, respectively. The
Company  normally does not charge interest on accounts receivable. The allowance
for  doubtful  accounts  is  generally determined based on an account-by-account
review.  Accounts  are  charged  off when collection efforts have failed and the
account  is  deemed  uncollectible.

                                       24

Concentration  of  Credit  Risk

Financial instruments that potentially expose the Company to credit risk consist
of  cash  and cash equivalents, investments and accounts receivable. The Company
is  exposed  to credit risk on its cash, cash equivalents and investments in the
event  of  default  by  the  financial  institutions  or  the  issuers  of these
investments to the extent of the amounts recorded on the balance sheet in excess
of  amounts  that are insured by the FDIC. Trade receivables potentially subject
the  Company  to  concentrations  of  credit  risk.  The Company's customer base
operates  in  a  variety of industries and is geographically dispersed, however,
the relatively small number of customers increases the risk. The Company closely
monitors  extensions  of  credit and credit losses have been provided for in the
consolidated  financial  statements  and  have  been  within  management's
expectations.  No bad debt expense or bad debt write-offs were recorded in 2004.
The  Company recorded bad debt expense of $10,700 for 2003 and recorded bad debt
write-offs  of  $54,742  to its allowance for doubtful accounts in 2003. For the
year  ended December 31, 2004, 13% of total revenues were from sales to a single
customer.  No  single  customer  accounted  for more than 5% of total continuing
operating  revenues  for  the  year  ended  December  31,  2003.

Fair  Value  of  Financial  Instruments

Cash  and  cash  equivalents,  accounts  receivable,  accounts  payable, accrued
liabilities  and  short-term  borrowings  are  reflected  in  the  accompanying
consolidated financial statements at cost, which approximates fair value because
of  the  short-term  maturity  of  these  instruments.

Property  and  Equipment

Property  and  equipment  are  stated at cost. Depreciation and amortization are
computed  on  a  straight-line  method  over  the  estimated useful lives of the
related  assets,  ranging  from three to seven years. Leasehold improvements are
amortized  over  the  lesser  of  the  estimated useful lives or remaining lease
period.  Expenditures  for  maintenance  and  repairs  are charged to expense as
incurred.

Impairment  of  Long-Lived  Assets

The  Company  periodically  reviews,  on  at least an annual basis, the carrying
value  of  its  long-lived  assets,  including  property,  plant  and equipment,
whenever events or changes in circumstances indicate that the carrying value may
not  be  recoverable. To the extent fair value of a long-lived asset, determined
based  upon  the  estimated  future cash inflows attributable to the asset, less
estimated future cash outflows, are less than the carrying amount, an impairment
loss  is  recognized.

Revenue  Recognition

Revenue  consists  primarily of fees generated through the electronic processing
of  payment  transactions and related services, and are recognized as revenue in
the  period  the  transactions  are  processed  or when the related services are
performed.  Merchants  may be charged for these processing services at a bundled
rate based on a percentage of the dollar amount of each transaction and, in some
instances,  additional  fees  are charged for each transaction. Certain merchant
customers  are  charged  a  flat  fee  per transaction, while others may also be
charged  miscellaneous  fees, including fees for chargebacks or returns, monthly
minimums,  and  other  miscellaneous  services. Revenues derived from electronic
processing  of  credit  and  debit  card  transactions  that  are authorized and
captured  through  third  party  networks  are reported gross of amounts paid to
sponsor  banks  as  well  as  interchange  and  assessments  paid to credit card
associations  (MasterCard and Visa). Revenue also includes any up-front fees for
the  work  involved  in implementing the basic functionality required to provide
electronic  payment  processing  services  to  a  customer.  Revenue  from  such
implementation fees is recognized over the term of the related service contract.

Reserve  for  Losses  on  Merchant  Accounts

Disputes  between a cardholder and a merchant periodically arise as a result of,
among  other  things,  cardholder  dissatisfaction  with  merchandise quality or
merchant services. Such disputes may not be resolved in the merchant's favor. In
these  cases, the transaction is "charged back" to the merchant and the purchase
price  is  refunded  to  the customer through the merchant's acquiring bank, and
charged  to the merchant. If the merchant has inadequate funds, the Company must
bear  the  credit  risk  for  the  full  amount  of the transaction. The Company
evaluates  its  risk  for such transactions and estimates its potential loss for
chargebacks based primarily on historical experience and other relevant factors.

Advertising  Costs

The  cost  of  advertising  is  expensed  as  incurred. The Company's continuing
operations  did not incur any advertising costs for the years ended December 31,
2004  or  2003.

                                       25

Income  Taxes

Deferred  tax  assets  and liabilities are recorded based on differences between
financial  reporting  and  tax  bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are  expected  to  reverse.

Stock-Based  Compensation

The  Company  applies  the  intrinsic  value  method  under  the recognition and
measurement  provisions  of  APB  No.  25,  "Accounting  for  Stock  Issued  to
Employees",  in  accounting  for  its  stock  option  and  stock purchase plans.
Accordingly,  no  stock-based  employee compensation expense has been recognized
for  options  granted  with  an  exercise price equal to the market value of the
underlying  common stock on the date of grant or in connection with the employee
stock  purchase  plan.  The following table illustrates the effect on net income
and  earnings  per  share  if the Company had applied the fair value recognition
provisions  of  Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("FAS 123"), to stock-based employee compensation.


<TABLE>
<CAPTION>

<S>                                                <C>              <C>
                                                       2004          2003
                                                    ------------  ----------

Net income (loss), as reported                      $(1,514,531)  $ 484,896

Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects                 (141,751)   (573,186)
                                                    ------------  ----------

Pro forma net loss                                  $(1,656,282)  $ (88,290)
                                                    ============  ==========

Net income (loss) per common share:
Basic and diluted, as reported                      $     (0.07)  $    0.02

Basic and diluted, pro forma                        $     (0.08)  $       -
</TABLE>


Net  Loss  Per  Share

Basic and diluted losses per common share are calculated by dividing net loss by
the  weighted  average  number  of  common shares outstanding during the period.
Common  stock  equivalents,  which consist of stock options and warrants and the
convertible  debt,  were  excluded  from the computation of the weighted average
number of common shares outstanding for purposes of calculating diluted loss per
common  share  because  their  effect  was antidilutive. See Notes 10 and 11 for
disclosure  of  securities that could potentially dilute basic EPS in the future
that  were not included in the computation of diluted EPS because to do so would
have  been  antidilutive  for  the  periods  presented.

Recent  Accounting  Pronouncements

On  May  15,  2003,  the  Financial  Accounting  Standards Board ("FASB") issued
Statement  No.  150,  "Accounting  for  Certain  Financial  Instruments  with
Characteristics of both Liabilities and Equity" ("FAS 150"). FAS 150 establishes
standards  for  classifying  and  measuring  as liabilities certain freestanding
financial  instruments  that  embody  obligations  of  the  issuer  and  have
characteristics  of  both  liabilities  and  equity.  The  statement  defines an
obligation as "a conditional or unconditional duty or responsibility on the part
of  the  issuer  to  transfer  assets or to issue its equity shares." FAS 150 is
effective  for all financial instruments created or modified after May 31, 2003,
and  otherwise  effective at the beginning of the first interim period beginning
after  June  15, 2003. The adoption of this statement did not have a significant
impact  on  the  Company's  results  of  operations  or  financial  position.

In  January  2003,  the  FASB  issued  Interpretation  No. 46, "Consolidation of
Variable  Interest  Entities"  ("FIN 46"), and in December 2003 issued a revised
interpretation  ("FIN  46R"). FIN 46 and FIN 46R address the accounting for, and
disclosure  of,  investments  in variable interest entities. The Company adopted
FIN  46  and  FIN  46R,  which  did  not have a material impact on the Company's
financial  position  or  results  of  operations.

In  December  2004,  the  FASB issued Statement No. 123R, "Share-Based Payment,"
which  requires  all  companies to measure compensation cost for all share-based
payments  (including employee stock options) at fair value, effective for public
companies  for  interim  or  annual  periods  beginning after June 15, 2005. The
adoption  of  this  statement  is  not expected to have a material impact on the
Company's  results  of  operations  or  financial  position.

                                       26

NOTE  2.  ISSUANCE  OF  COMMON  STOCK

In February 2004, the Company executed an agreement for an equity line of credit
with  Dutchess  Private  Equities  Fund, LP ("Dutchess"). Under the terms of the
agreement, the Company may elect to receive as much as $10 million from Dutchess
in  common  stock  purchases  over  the  next  three  years at the option of the
Company. On August 11, 2004, the Company filed an amended registration statement
on  Form SB-2 with the Securities and Exchange Commission to register the resale
of the shares to be issued under the equity line of credit with Dutchess Private
Equities  Fund, LP. The Securities and Exchange Commission declared this amended
registration statement to be effective on August 13, 2004. During the year ended
December  31,  2004,  the  Company  sold  1,459,435  shares  of its common stock
pursuant  to  the  equity  line  of  credit  and received total proceeds, net of
issuance  costs,  of  $321,486.  Pursuant to the terms of a promissory note with
Dutchess  Private  Equities  Fund,  II,  LP.,  the Company is obligated to use a
portion  of  the  proceeds  from the equity line to pay back the promissory note
(see  Note  7).

In  February  2004,  the  Company issued 55,000 shares of common stock under the
terms of its Comprehensive Employee Stock Plan to a former employee for services
provided  while  employed by the Company in 2003. During the year ended December
31,  2004,  the  Company  also  issued a total of 943,564 shares of common stock
under  the  terms  of  its  Comprehensive  Employee  Stock  Plan  to independent
contractors  providing  consulting services to the Company and recorded $202,960
of  related  expense.

During  the  year  ended  December 31, 2004, the Company issued 51,000 shares of
common  stock  and  received  cash proceeds of $7,125 related to the exercise of
stock  options granted under the terms of its Comprehensive Employee Stock Plan.
There  were  no  stock  options  exercised  in  2003.

During the years ended December 31, 2004 and 2003, the Company issued 72,225 and
75,000  shares of common stock, respectively, to certain independent contractors
performing services for the Company. Such shares were issued pursuant to Section
506  of Regulation D of the Securities and Exchange Act of 1933, as amended. The
Company  recorded $11,375 and $16,250 of expense related to the issuance of this
stock  in  2004  and  2003,  respectively. The average closing price was used to
value  the  stock  given  as  consideration  because  the  related  independent
contractor  agreements  called  for  the contractors to earn a certain number of
shares  of  common  stock  for each month (prorated for any partial month) spent
working  on  behalf  of  the  Company  with  no  specified  term. In effect, the
contractors earned the same fixed number of shares for each day that they worked
for  the  Company  so the performance commitment was met by the contractors on a
daily  basis and valued as such in accordance with the measurement date guidance
provided  by  EITF  96-18.

NOTE  3.  PROPERTY  AND  EQUIPMENT

The  following  is  a  summary  of  property  and  equipment  at  December  31:

<TABLE>
<CAPTION>

<S>                                              <C>         <C>
                                                      2004        2003
                                                 ----------  ----------

Furniture and fixtures. . . . . . . . . . . . .  $ 175,856   $ 175,856
Equipment . . . . . . . . . . . . . . . . . . .    428,420     424,901
Software. . . . . . . . . . . . . . . . . . . .    175,819     174,740
Leasehold improvements. . . . . . . . . . . . .      8,434       8,434
                                                 ----------  ----------
                                                   788,529     783,931
Less: accumulated depreciation and amortization   (656,465)   (568,775)
                                                 ----------  ----------
Total property and equipment, net . . . . . . .  $ 132,064   $ 215,156
                                                 ==========  ==========
</TABLE>

NOTE  4.  IMPAIRMENT  OF  ASSETS

During  the  second  quarter of 2003, the Company performed an impairment review
because  the  Company  expected to sell the asset group comprising the Business.
The Company determined that the asset group to be sold was impaired and recorded
a  non-cash charge of $200,000, which is included as a component of discontinued
operations  in the accompanying consolidated statement of operations. Fair value
was  based  on  the expected selling price of the asset group. During the fourth
quarter  of 2003, the Company performed an impairment review because the Company
expected  to  sell  certain  assets  not  currently  being utilized. The Company
determined  that  the  assets  expected  to be sold were impaired and recorded a
non-cash charge of $17,000, which is included as a component of selling, general
and  administrative  expense  in  the  accompanying  consolidated  statement  of
operations.  Fair  value  was  based  on  the  selling  price of similar assets.


                                       27

NOTE  5.  ACCRUED  EXPENSES

Accrued  expenses  consist  of  the  following  balances:
<TABLE>
<CAPTION>



<S>                        <C>            <C>
                           December 31,   December 31,
                                2004           2003
                           --------------  ------------
Accrued salaries. . . . .  $     289,709   $     11,325
Accrued sales taxes . . .         12,266        101,696
Accrued professional fees         32,875        100,515
Other accrued expenses. .         57,665         10,644
                           --------------  ------------
Total . . . . . . . . . .  $     392,515   $    224,180
                           ==============  ============
</TABLE>



NOTE  6.  OPERATING  LEASES

In  August  2003,  the Company signed a three-year lease for approximately 4,500
square feet that serves as the Company's headquarters. Additionally, the Company
leases  office  equipment  under non-cancelable operating leases. Rental expense
under  operating  leases  for continuing operations for the years ended December
31,  2004  and 2003, was $85,000 and $59,000, respectively. Future minimum lease
payments  required  under  operating leases consist of the following at December
31,  2004:
<TABLE>
<CAPTION>



<S>                           <C>
Year ending December 31,

         2005. . . . . . . .  $ 83,199
         2006. . . . . . . .    67,605
                              --------

Total minimum lease payments  $150,804
                              ========
</TABLE>



NOTE  7.  DEBT

On  August  24,  2004,  the Company entered into a zero-discount promissory note
with Dutchess Private Equities Fund, II, LP. Pursuant to terms of the promissory
note, the Company received $260,000 and promised to pay Dutchess $284,000 with a
maturity  date  of  December  24,  2004,  which  represents  an effective annual
interest rate of 28%. The Company repaid this note in full on the maturity date.
The  Company also issued 75,000 shares of restricted common stock to Dutchess as
an  incentive  for the investment and agreed to register the common stock issued
pursuant  to the promissory note on the next registration statement filed by the
Company.

On  December 10, 2004, the Company entered into another zero-discount promissory
note  with  Dutchess  Private  Equities  Fund,  II, LP. Pursuant to terms of the
promissory  note,  the  Company  received  $260,000 and promised to pay Dutchess
$284,000  with  a maturity date of April 10, 2005, which represents an effective
annual interest rate of 28%. The Company also issued 75,000 shares of restricted
common  stock  to  Dutchess  as  an  incentive  for the investment and agreed to
register  the  common  stock  issued pursuant to the promissory note on the next
registration  statement  filed  by  the  Company.

Payments  on  the  promissory note are to be made from the equity line of credit
that the Company previously entered into with Dutchess (see Note 2). The Company
will  pay  to  Dutchess the lesser of $71,000 or 50% of each put, until the face
amount  of  the promissory note is paid in full. The first payment is due at the
closing  of  the first put 30 days after the issuance of the promissory note and
all  subsequent  payments  are  due at the closing of every put to Dutchess. The
Company  issued  as  collateral twenty-five put notices to Dutchess for the full
amount  applicable under the terms of the equity line of credit and agreed to do
so  at the maximum frequency allowed under the equity line agreement, until such
time  as  the  note  is  paid  in  full.




                                       28

In  the  event  that on the maturity date, the Company has any remaining amounts
unpaid  on  this  note, Dutchess can exercise its right to increase the residual
amount by 2.5% per month paid as liquated damages. In the event that the Company
defaults, Dutchess has the right, but not the obligation, to switch the residual
amount  to  a  three-year,  10%  interest  bearing  convertible  debenture  at a
conversion  rate  at  the lesser of (i) 75% of the average of the lowest closing
bid  price  during  the  fifteen  trading  immediately preceding the convertible
maturity date or (ii) 100% of the average of the lowest bid price for the twenty
trading  days  immediately  preceding the convertible maturity date. If Dutchess
chooses  to  convert the residual amount to a convertible debenture, the Company
shall  have twenty business days after notice of the same to file a registration
statement  covering an amount of shares equal to 300% of the residual amount. In
the  event  the  Company does not file such registration statement within twenty
business  days  of  Dutchess'  request,  or  such  registration statement is not
declared  by  the  Securities and Exchange Commission to be effective within the
time  period  described  above, the residual amount shall increase by $1,000 per
day.

On  July 24, 2002, the Company executed a financing agreement with Laurus Master
Fund,  Ltd.  ("Laurus")  in exchange for a $1.5 million convertible note bearing
interest  at  7%  annually and a four-year warrant to purchase 300,000 shares of
the  Company's  common  stock at exercise prices of $0.936 for the first 150,000
shares,  $0.975  for the next 50,000 shares, and $1.17 for the remaining 100,000
shares. In connection with the sale of substantially all of its assets (see Note
14),  the  Company paid the outstanding balance of the convertible note in cash,
including  accrued  penalties  and interest, in full settlement of all claims by
Laurus  during July 2003. In addition, the four-year warrant to purchase 300,000
shares of the Company's common stock initially granted to Laurus was canceled as
part  of  the  settlement.

NOTE  8.  RELATED  PARTY  TRANSACTIONS  AND  GUARANTEES

Beginning in December 2000, the Company pledged as loan guarantees certain funds
held  as  money market funds and certificates of deposit to collateralize margin
loans  for the following executive officers of the Company: (1) Michael R. Long,
then  Chairman  of the Board of Directors and Chief Executive Officer; (2) Louis
A.  Hoch,  then  President and Chief Operating Officer; (3) Marshall N. Millard,
then  Secretary,  Senior  Vice  President, and General Counsel; and (4) David S.
Jones,  then  Executive  Vice President. Mr. Millard and Mr. Jones no longer are
employees  of  the  Company.  The  margin loans were obtained in March 1999 from
institutional  lenders  and were secured by shares of the Company's common stock
owned  by  these  officers. The pledged funds were held in the Company's name in
accounts  with  the  lenders  that  held  the  margin loans of the officers. The
Company's purpose in collateralizing the margin loans was to prevent the sale of
its  common stock owned by these officers while it was pursuing efforts to raise
additional  capital  through  private equity placements. The sale of that common
stock  could  have  hindered  the  Company's  ability to raise capital in such a
manner  and  compromised  its continuing efforts to secure additional financing.
The highest total amount of funds pledged for the margin loans guaranteed by the
Company  was approximately $2.0 million. At the time the funds were pledged, the
Company  believed  they  would have access to them because (a) their stock price
was  substantial  and  the  stock  pledged by the officers, if liquidated, would
produce funds in excess of the loans payable, and (b) with respect to one of the
institutional lenders (who was also assisting the Company as a financial advisor
at  the  time),  even if the stock price fell, they had received assurances from
that  institutional  lender  that  the  pledged funds would be made available as
needed. During the fourth quarter of 2002, the Company requested partial release
of  the  funds  for  operating  purposes,  which  request  was  denied  by  an
institutional lender. At that time, their stock price had fallen as well, and it
became  clear  that  both  institutional  lenders  would not release the pledged
funds.  In  light  of  these circumstances, the Company recognized a loss on the
guarantees  of  $1,278,138  in  the  fourth  quarter  of  2002  and  recorded  a
corresponding  payable  under  related  party guarantees on its balance sheet at
December  31,  2002  because  it  became probable at that point that it would be
unable  to  recover  its pledged funds. During the quarter ended March 31, 2003,
the lenders applied the pledged funds to satisfy the outstanding balances of the
loans.  The total balance of the margin loans guaranteed by the Company was zero
at  December  31,  2004.  The Company may institute litigation or arbitration in
collection  of  the outstanding repayment obligations of Mr. Long, Mr. Hoch, Mr.
Millard, and Mr. Jones, which currently total $1,278,138. Presently, the Company
has  refrained  from initiating action to recover these funds from Mr. Long, Mr.
Hoch,  and  Mr.  Millard  because  they  may  have  offsetting claims that total
$1,445,500  collectively  by  virtue  of  the  change of control clause in their
respective  employment agreements based on our preliminary analysis. The Company
understands that these individuals may assert such claims based on the Company's
sale  of  substantially  all  of its assets to Harbor Payments, Inc. on July 25,
2003.  The  Company  has  not  initiated any formal settlement negotiations with
these  individuals  because they have been under an extended employment contract
with  us  or  have  not  been  amenable to such an action. On July 25, 2004, the
Company's  employment  agreements with Michael Long, Chief Executive Officer and
Chief  Financial Officer, and Louis Hoch, President and Chief Operating Officer,
expired.  The  Company intends to enter into new employment agreements with both
of  these individuals and is currently negotiating the terms of such agreements.
The  Company  has  not pursued the outstanding repayment obligation of Mr. Jones
because  the Company does not consider a recovery attempt to be cost beneficial.
In  order  to  attempt  a recovery from Mr. Jones, the Company estimates that it
would  incur  a  minimum  of $20,000 in estimated legal costs with no reasonable
assurance  of  success in recovering his outstanding obligation of approximately
$38,000.  Because  of  the  limited  amount  of the obligation, the Company also
anticipates  difficulty  in  retaining  counsel on a contingency basis to pursue
collection  of  this  obligation.  The  ultimate  outcome  of this matter cannot
presently  be  determined.

                                       29

NOTE  9.  INCOME  TAXES

Deferred  income  taxes  reflect  the  net  tax  effect of temporary differences
between  the  carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the  Company's  deferred  tax  assets  and  liabilities as of December 31 are as
follows:
<TABLE>
<CAPTION>



<S>                                 <C>            <C>
                                            2004           2003
                                    =============  =============
Deferred Tax Assets:
----------------------------------
Warrant expense. . . . . . . . . .  $  3,177,082   $  3,166,992
Loss on related party guarantees .       434,567        434,567
Net operating loss carryforwards .    12,266,021     11,759,182
Other items. . . . . . . . . . . .        77,419         91,019
                                    -------------  -------------
                                      15,955,089     15,451,760
Valuation allowance. . . . . . . .   (15,914,425)   (15,400,069)
                                    -------------  -------------
Total Deferred Tax Asset . . . . .        40,664         51,691

Deferred Tax Liabilities:
----------------------------------
Depreciation and other items . . .        40,664         51,691
                                    -------------  -------------
Net Deferred Tax Asset (Liability)  $          -   $          -
                                    =============  =============
</TABLE>



For  the  period  from  inception (July 30, 1998) through December 31, 2004, the
Company  has  net operating loss carryforwards for tax purposes of approximately
$36.1  million  that  begin  to  expire  in  the year 2020. In October 1999, the
Company  issued  common  stock  pursuant  to  a private placement offering. As a
result,  an  ownership  change  occurred  under  Section  382  that  limits  the
utilization  of  pre-change net operating loss carryforwards. Approximately $3.5
million  of  the  total  net  operating  loss  is  subject  to  the  Section 382
limitations.

The  reconciliation  of  income  tax  computed at the U.S. federal statutory tax
rates  to  income  tax  expense  is  as  follows:
<TABLE>
<CAPTION>



<S>                                     <C>         <C>
                                             2004        2003
                                        ----------  ----------
Tax (benefit) at statutory rate -- 34%  $(514,941)  $ 164,865
Change in valuation allowance. . . . .    514,356    (521,398)
Permanent and other differences. . . .        585     356,533
                                        ----------  ----------
Income tax expense . . . . . . . . . .  $       -   $       -
                                        ==========  ==========
</TABLE>



NOTE  10.  EMPLOYMENT  BENEFIT  PLANS

Stock  Option  Plans

The Board of Directors and stockholders approved the 1999 Employee Comprehensive
Stock  Plan  ("Employee  Plan")  to  provide  qualified  incentive stock options
("ISOs")  and  non-qualified stock options ("NQSOs") as well as restricted stock
grants  to  key  employees.  Under  the terms of the Employee Plan, the exercise
price  of  ISOs  must  be  equal to 100% of the fair market value on the date of
grant  (or  110%  of  fair  market  value in the case of an ISO granted to a 10%
stockholder/grantee).  There  is no price requirement for NQSOs, other than that
the  option price must exceed the par value of the common stock. The Company has
reserved  10,000,000  shares  of  its  common stock for issuance pursuant to the
Employee  Plan. On December 29, 2003, the Employee Plan was amended and restated
by  the  Board of Directors to add provisions 1) allowing for stock awards to be
made to consultants as provided in Rule 405 promulgated under the Securities Act
of  1933,  as amended from time to time, and other applicable law, 2) increasing
the  amount of shares of common stock of the Company exercisable per fiscal year
from  stock  options,  whether  ISOs  or  NQSOs, from 350,000 to 500,000, and 3)
removing  minimum  holding periods on "Restricted Stock" as such term is defined
in  the  Employee  Plan.

The  1999 Non-Employee Director Plan ("Director Plan") was approved by the Board
of  Directors  and  stockholders  in 1999. Under the Director Plan, non-employee
directors  may  be granted options to purchase shares of common stock at 100% of
fair  market  value  on  the  date  of grant. The Company has reserved 1,500,000
shares  of  its  common  stock  for  issuance  pursuant  to  the  Director Plan.

                                       30

Option  activity  under  the  Employee  Plan  and  Director  Plan is as follows:
<TABLE>
<CAPTION>



<S>                             <C>                <C>
                                Number of Shares   Weighted Average Exercise Price
                                -----------------  --------------------------------
Outstanding, December 31, 2002         5,761,649   $                           0.99
   Granted . . . . . . . . . .         1,755,000                               0.13
   Canceled. . . . . . . . . .        (2,699,579)                              0.87
   Exercised . . . . . . . . .          (265,300)                              0.19
                               -----------------
Outstanding, December 31, 2003         4,551,770                               0.78
   Granted . . . . . . . . . .            30,000                               0.20
   Canceled. . . . . . . . . .          (296,000)                              0.86
   Exercised . . . . . . . . .           (51,000)                              0.14
                               -----------------
Outstanding, December 31, 2004         4,234,770   $                           0.78
                               =================
</TABLE>



There  was  an  aggregate  of  5,866,441  and  971,230  options  to purchase the
Company's  common  stock  available  for  future  grants  under the Employee and
Director  Plans  at  December 31, 2004 and 2003, respectively. Exercisable stock
options amounted to 4,079,770 at a weighted average price of $0.81 and 3,171,770
at  a  weighted  average  price  of  $1.06  at  December  31,  2004  and  2003,
respectively.

Summarized  information  about stock options outstanding at December 31, 2004 is
as  follows:

<TABLE>
<CAPTION>



<S>                 <C>                  <C>                  <C>                <C>        <C>

                                                 Options Outstanding                  Options Exercisable
                                           -----------------------------------   ---------------------------
                                         Weighted Average     Weighted                      Weighted
Range of Exercise   Options              Remaining            Average Exercise   Number of  Average Exercise
 Prices             Outstanding          Contractual Life     Price              Options    Price
------------------  -------------------  -------------------  -----------------  ---------  -----------------
0.09 - $0.14                 1,670,000            8.9 years  $            0.13  1,545,000  $            0.13
0.18 - $0.26                 1,104,100            6.5 years  $            0.19  1,074,100  $            0.19
0.86 - $0.88                   711,668            6.4 years  $            0.86    711,668  $            0.86
1.88 - $2.07                   334,001            6.0 years  $            2.06    334,001  $            2.06
2.81 - $11.25                  415,001            4.2 years  $            3.85    415,001  $            3.85
                    -------------------                                         ----------
                             4,234,770            7.2 years  $            0.78  4,079,770  $            0.81
                    ===================                                         ==========
</TABLE>

The  weighted average fair value of stock options at date of grant was $0.13 and
$0.10  per  option  for  options  granted  during  fiscal  years  2004 and 2003,
respectively.  The  fair  value  of  each option granted was estimated using the
Black-Scholes  option-pricing  model,  utilizing  the  following  assumptions:

<TABLE>
<CAPTION>

<S>                      <C>    <C>

                         2004   2003
                         -----  -----

Dividend yield. . . . .  None   None
Expected volatility . .   143%   142%
Risk-free interest rate  2.50%  1.80%
Expected life . . . . .  2.00   2.45

</TABLE>



Employee  Stock  Purchase  Plan

The Company established the 1999 Employee Stock Purchase Plan ("ESPP") under the
requirements  of  Section 423 of the Internal Revenue Code (the "Code") to allow
eligible  employees to purchase the Company's common stock at regular intervals.
Participating  employees  may  purchase  common  stock through voluntary payroll
deductions  at the end of each participation period at a purchase price equal to
85%  of  the lower of the fair market value of the common stock at the beginning
or  the  end  of  the  participation  period.  Common  stock reserved for future
employee  purchases  under  the  plan  aggregated 755,828 shares at December 31,
2004.  A total of 43,857 shares were issued under the ESPP in 2003 at a price of
$0.15  per  share.  There  were  no  shares  issued  under  the  ESPP  in  2004.

                                       31

401(k)  Plan

In May 1999, the Company adopted a defined contribution plan (the "401(k) Plan")
pursuant  to  Section  401(k)  of  the  Code.  All  eligible  full and part-time
employees  of  the  Company who meet certain age requirements may participate in
the 401(k) Plan. Participants may contribute between 1% and 15% of their pre-tax
compensation,  but  not  in  excess of the maximum allowable under the Code. The
401(k)  Plan allows for discretionary and matching contributions by the Company.
The  Company  made  no  contributions  during  2004  or  2003.

NOTE  11.  STOCK  WARRANTS

On  September 30, 2004, the Company signed a performance-based warrant agreement
with  Kubra  Data Transfer, Ltd., a provider of enterprise information solutions
servicing EBPP customers, as consideration for entering into a customer referral
agreement  with  the  Company  for  a  three-year  term.  Under the terms of the
referral agreement, the Company will become Kubra's preferred provider of credit
and  debit card payment processing. The incentive warrant agreement provides for
both  an initial vested warrant for 250,000 shares of restricted common stock at
$0.24 per share and contingent warrants to be earned based on the achievement of
annual  or  quarterly goals for delivery of gross revenue to the Company through
the  referral  or  transfer  of  profitable  payment  processing  customers. The
contingent  warrants will also be for restricted common stock and will be priced
at  120%  of  the  market  price  for  the  common  stock  when  earned.

At  December  31, 2004, the outstanding vested warrants to purchase common stock
were  as  follows:

<TABLE>
<CAPTION>



<S>          <C>        <C>          <C>

 Shares of              Aggregate
 Common      Exercise   Exercise     Expiration
 Stock       Price      Price        Date
-----------  ---------  -----------  ----------


  2,179,121  $   11.38  $24,798,397  06/02/2010
    250,000       0.24       60,000  09/30/2009
  2,000,000       1.80    3,600,000  11/27/2006
-----------             -----------
  4,429,121             $28,458,397
===========             ===========
</TABLE>


NOTE  12.  COMMON  STOCK  LISTING

The  Company's common stock began trading on the Over the Counter Bulletin Board
("OTCBB") operated by the National Association of Securities Dealers ("NASD") on
December  3,  1998.  The  NASD adopted eligibility rules in 1999, which required
clearance  of  comments  by  the  SEC  on all SEC filings. The Company filed its
initial  filing  on  Form 10 with the SEC on June 10, 1999 but, as of October 7,
1999, the SEC had not cleared its comment period. In accordance with the OTCBB's
phase-in  schedule  for  the new eligibility rules, the listing on the OTCBB was
terminated.  The  Company's  common  stock  was quoted in the National Quotation
Board's  Electronic Pink Sheets until December 7, 1999, when the SEC cleared the
comment  period and the stock was relisted and traded on the OTCBB through March
13,  2000  at  which time the stock was approved for trading on the NASDAQ Small
Cap  Market.  Subsequently  the  stock  was  approved  for trading on the NASDAQ
National  Market  ("NNM") on July 31, 2000, under the symbol "BLLS." On February
4, 2003, the NNM delisted the Company's common stock because the Company did not
meet  the  requirements  for  continued listing on the NNM. The Company's common
shares were immediately eligible for quotation on the OTCBB effective at opening
of  business  on  February  4,  2003.  On July 29, 2003, the Company amended its
Articles  of  Incorporation to change its name to Payment Data Systems, Inc. and
began  trading  on  the  OTCBB  under  a  new  symbol, PYDS, on August 20, 2003.

                                       32

NOTE  13.  LEGAL  PROCEEDINGS

On  July  25,  2003,  certain of our stockholders (those stockholders being Mike
Procacci,  Jr.,  Mark and Stefanie McMahon, Anthony and Lois Tedeschi, Donna and
James  Knoll, John E. Hamilton, III, William T. Hagan, Samuel A. Fruscione, Dana
Fruscione-Penzone,  Gia  Fruscione,  Alicia  Fruscione, Joseph Fruscione, Robert
Evans,  John Arangio, Gary and JoAnne Gardner, Lee and Margaret Getson, G. Harry
Bonham,  Jr.,  Gary Brewer, Bob Lastowski, Robert Filipe, Mitchell D. Hovendick,
Dr.  John  Diephold,  Joseph  Maressa, Jr., and Charles Brennan) commenced legal
action  against  us,  Ernst  & Young, LLP, and certain of our current and former
directors  (including  the executive officers named above) in the District Court
of  the  45th Judicial District, Bexar County, Texas. With respect to us and the
current  and  former directors named in the suit, the plaintiffs allege that we,
acting  through  such  directors,  misstated in our 2000 and 2001 Form 10-Ks our
ability to use for operational purposes the funds pledged as security for margin
loans  of  certain of our executive officers, as discussed above. The plaintiffs
allege  and seek resulting economic and exemplary damages, rescission, interest,
attorneys'  fees  and  costs of court. We believe this suit is without merit and
intend  to vigorously defend the company and the directors named in the suit. As
of the date of this report, there have been no material developments in the suit
other  than  the  case  being  set  for trial in late 2005. The results of legal
proceedings  cannot  be  predicted with certainty. If we fail to prevail in this
legal  matter,  our  financial  position,  results of operations, and cash flows
could  be  materially  adversely  affected.

NOTE  14.  DISCONTINUED  OPERATIONS

On  July  25,  2003  (the  "Closing")  the Company sold substantially all of its
assets  (the  "Business")  to  Harbor Payments, Inc. (the "Purchaser"), formerly
known  as  CyberStarts,  Inc.  (the "Sale"). The aggregate selling price for the
Business  was  $4,800,000  (the "Purchase Price"), including $700,000 subject to
certain  earnout  provisions,  plus  the  Purchaser's  assumption  of  certain
liabilities  of the Company. The Purchase Price was determined through extensive
negotiations  between  the  Purchaser and the Company. The Board of Directors of
the  Company,  in  its reasonable business judgment, approved the Purchase Price
based upon the following factors: 1) the extensive search for a purchaser of the
Business; 2) the number of offers made by potential purchasers for the Business;
3)  the  Company's  ability  to  raise  other  sources of capital to operate the
Business;  and 4) the future trends in the industry of the Business. The sale of
the  Business was approved by a majority of the stockholders of the Company at a
Special  Meeting  of  Shareholders  held  on  July  14,  2003.  The  assets sold
represented  the  Company's  proprietary  technology  infrastructure  along with
certain  third  party  software and hardware platforms and certain furniture and
fixtures  that  supported  its  service  offerings,  including  its  eServ  and
eConsulting  products.  The  carrying  value  of  these  non-current  assets was
approximately  $1,068,000  at  July 25, 2003. The Purchaser also assumed certain
current and non-current liabilities with carrying values of $83,000 and $30,000,
respectively, at July 25, 2003. The assets sold represented virtually all of the
Company's assets, which it used to produce nearly all of its revenue; therefore,
the  Company  has ceased its primary operations and will continue to operate its
bills.com  consumer  bill  payment  portal  and  concentrate  on  building  its
electronic  payments  business.  The  results  of operations for the asset group
disposed  of  have  been reported as discontinued operations in the accompanying
statements  of  operations.  During  the  year  ended  December  31, 2003, these
discontinued operations provided revenue of $2,155,000. The Company retained its
accounts  receivable  and related deferred revenue associated with the customers
of  the  Business,  as  well as certain accounts payable and accrued liabilities
related  to  the  Business.  At  December  31, 2003, the Company's balance sheet
included  approximately  $38,000  of  net  accounts receivable and approximately
$277,000  of current liabilities that related to the operations of the Business.

At  Closing,  the Purchaser paid the Company $4,100,000 in cash. The Company did
not  earn  any  of the additional $700,000 subject to certain earnout provisions
based  upon  subsequent gross revenues of the Business. The Sale of the Business
qualifies  as  a  change  of  control  under  the employee agreements of certain
officers  of  the  Company, which may result in the assertion of claims by these
officers  under  their  employee agreements. The ultimate outcome of this matter
cannot  presently  be  determined.  Subsequent  to the Sale, the Company settled
claims  made  under employee agreements by the Chief Financial Officer and Chief
Marketing  Officer  for  cash  consideration  of  $182,000  in the aggregate and
terminated  their  respective  employee  agreements.

NOTE  15.  SUBSEQUENT  EVENTS

In  January  2005,  the  Company's  Chief  Executive Officer and Chief Financial
Officer;  President  and  Chief  Operating Officer, and all other employees owed
unpaid wages elected to receive common stock from the Company in lieu of a total
of  $179,000  in  accumulated  unpaid  salary.  The Company's Board of Directors
granted  a  total  of  859,743 shares of common stock in exchange for the unpaid
salaries.  All shares are to be issued under the terms of the Company's Employee
Comprehensive  Stock  Plan.

Subsequent  to  December  31, 2004 and through March 11, 2005, the Company sold
455,125  shares  of  unregistered common stock to Dutchess Private Equities Fund
pursuant  to the equity line of credit (see Note 2) and received total proceeds,
net  of  issuance  costs,  of  $265,666.

Subsequent  to  December  31, 2004 and through March 11, 2005, the Company also
issued  a  total  of  169,367  shares  of  common  stock  under the terms of its
Comprehensive  Employee  Stock  Plan  to  independent  contractors  providing
consulting  services  to  the  Company  for which it recorded $50,140 of related
expense.

                                       33

ITEM  8.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING AND
     FINANCIAL  DISCLOSURE.

None.

ITEM  8A.  CONTROLS  AND  PROCEDURES.

As  of  the  end  of the period covered by this Annual Report on Form 10-KSB, an
evaluation was performed under the supervision and with the participation of our
management,  including  the Chief Executive Officer and Chief Financial Officer,
of  the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rules 13a-14 and 15d-14 of the Securities Exchange Act
of  1934).  Based  on  that  evaluation,  our  Chief Executive Officer and Chief
Financial  Officer  concluded  that  our disclosure controls and procedures were
effective  in  ensuring that material information relating to us with respect to
the  period  covered  by  this  report was made known to them. Since the date of
their  evaluation,  there  have  been  no  significant  changes  in our internal
controls  or  in  other  factors that could significantly affect these controls,
including  any  corrective  actions  with regard to significant deficiencies and
material  weaknesses.

ITEM  8B.  OTHER  INFORMATION.

None.

                                       34

PART  III

We  omitted certain information required by Part III from this Report because we
will  file  our  definitive  Proxy  Statement  for  our  2005  Annual Meeting of
Stockholders  pursuant  to  Regulation 14A of the Securities and Exchange Act of
1934  not  later  than 120 days after the end of the fiscal year covered by this
Report.  Certain  information  included  in  the Proxy Statement is incorporated
herein  by  reference.

ITEM  9.  DIRECTORS  ,  EXECUTIVE  OFFICERS,  PROMOTERS  AND  CONTROL  PERSONS;
COMPLIANCE WITH  SECTION  16(A)  OF  THE  EXCHANGE  ACT.

There  is  incorporated  in  this  Item  9,  by  reference,  that portion of our
definitive  Proxy  Statement  for the 2005 Annual Meeting of Stockholders, which
appears  therein  under  the captions "Election of Director," "Committees of the
Board  of  Directors  and  Meetings"  and  "Section  16(a)  Beneficial Ownership
Reporting  Compliance."

ITEM  10.  EXECUTIVE  COMPENSATION.

There  is  incorporated  in  this  Item  10,  by  reference, that portion of our
definitive  Proxy  Statement  for the 2005 Annual Meeting of Stockholders, which
appears  under  the  caption  "Executive  Compensation."

ITEM  11.  SECURITY  OWNERSHIP  OF  CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER  MATTERS.

There  is  incorporated  in  this  Item  11,  by  reference, that portion of our
definitive  Proxy  Statement  for the 2005 Annual Meeting of Stockholders, which
appears  under  the caption "Security Ownership of Certain Beneficial Owners and
Management."

<TABLE>
<CAPTION>

<S>                                   <C>                         <C>                   <C>
                                     Equity Compensation Plan Information

                                                                  Weighted-average      Number of securities
                                      Number of securities to be  exercise price        remaining available for
                                      issued upon exercise of     of outstanding        future issuance under
                                      outstanding options           options             compensation plan
                                      --------------------------  --------------------  -----------------------
Employee Comprehensive Stock
Plan approved by stockholders. . . .                   3,701,767  $               0.63                4,899,444

Non-Employee Director
Plan approved by stockholders. . . .                     533,003  $               1.88                  966,997

</TABLE>


ITEM  12.  CERTAIN  RELATIONSHIPS  AND  RELATED  TRANSACTIONS.

There  are  no  reportable  relationships  or  transactions.

ITEM  13.  EXHIBITS.

The  exhibits  listed below are filed as part of or incorporated by reference in
this  Report.

Exhibit     Description
-------     -----------

3.1  Articles  of  Incorporation,  as amended (incorporated by reference to such
     exhibit  in  the Registrant's Quarterly Report on Form 10-Q, filed November
     14,  2003)

3.2  By-laws,  as  amended  (incorporated  by  reference  to such exhibit in the
     Registrant's  Registration Statement on Form SB-2, filed December 29, 1999)

4.1  Rights  Agreement, dated October 4, 2000 (incorporated by reference to such
     exhibit  in  the  Registrant's  Registration  Statement  on Form 8-A, filed
     October  11,  2000)

10.1 Asset  Purchase  Agreement between the Company and Saro, Inc. dated May 15,
     2003  (incorporated  by  reference  to  Appendix  A  in  the  Registrant's
     Definitive  Proxy  Statement,  filed  June  19,  2003)

10.2 First  Amendment  to  Asset  Purchase  Agreement  dated  July  25,  2003
     (incorporated  by  reference  to such exhibit in the Registrant's Quarterly
     Report  on  Form  10-Q,  filed  November  14,  2003)

                                       35

10.3 Standard  Office Lease between the Company and Frost National Bank, Trustee
     for a Designated Trust, dated August 22, 2003 (incorporated by reference to
     such  exhibit  in  the  Registrant's  Quarterly  Report on Form 10-Q, filed
     November  14,  2003)

10.4 1999  Employee  Comprehensive  Stock  Plan,  as  amended  (incorporated  by
     reference  to  such  exhibit  in the Registrant's Registration Statement on
     Form  S-8,  filed  January  26,  2005)

10.5 1999  Non-Employee  Director Plan, as amended (incorporated by reference to
     such  exhibit in the Registrant's Registration Statement on Form S-8, filed
     January  26,  2005)

10.6 1999  Employee  Stock  Purchase  Plan  (incorporated  by  reference to such
     exhibit  in  the  Registrant's  Registration  Statement  on Form S-8, filed
     February  23,  2000)

10.7 Form  of Employment Agreement between the Company and Executive Officers of
     the  Company, dated May 31, 2001 (incorporated by reference to such exhibit
     in  the  Registrant's  Annual  Report  on  Form  10-K, filed April 1, 2002)

10.8 Investment  Agreement  between  the  Company  and Dutchess Private Equities
     Fund,  LP, dated June 6, 2004 (incorporated by reference to such exhibit in
     the  Registrant's Registration Statement on Form SB-2, filed June 18, 2004)

10.9 Registration  Rights  Agreement  between  the  Company and Dutchess Private
     Equities  Fund,  LP  dated  June 6, 2004 (incorporated by reference to such
     exhibit in the Registrant's Registration Statement on Form SB-2, filed June
     18,  2004)

10.10  Placement  Agent  Agreement  between the Company, Clayton Dunning and Co,
     Inc.  and  Dutchess  Private  Equities  Fund,  LP,  dated  June  4,  2004
     (incorporated by reference to such exhibit in the Registrant's Registration
     Statement  on  Form  SB-2,  filed  July  23,  2004)

10.11  Affiliate  Office  Agreement between the Company and Network 1 Financial,
     Inc.,  dated  October 7, 2003 (incorporated by reference to such exhibit in
     the Registrant's Registration Statement on Form SB-2, filed April 28, 2004)

10.12  Promissory  Note  between the Company and Dutchess Private Equities Fund,
     II, LP, dated August 24, 2004 (incorporated by reference to such exhibit in
     the  Registrant's  Report  on  Form  8-K,  filed  September  2,  2004)

10.13  Warrant  Agreement between the Company and Kubra Data Transfer LTD, dated
     as  of September 30, 2004 (incorporated by reference to such exhibit in the
     Registrant's  Report  on  Form  8-K,  filed  October  6,  2004)

10.14  Promissory  Note  between the Company and Dutchess Private Equities Fund,
     II,  LP, dated December 10, 2004 (incorporated by reference to such exhibit
     in  the  Registrant's  Report  on  Form  8-K,  filed  December  16,  2004)

16.1 Letter  from  Ernst and Young LLP to the Securities and Exchange Commission
     dated  February  10, 2004 (incorporated by reference to such exhibit in the
     Registrant's  Current  Report  on  Form  8-K,  filed  February  11,  2004)

21.1 Subsidiaries  of  the Registrant (incorporated by reference to such exhibit
     in  the  Registrant's  Annual  Report  on  Form  10-K, filed April 1, 2002)

23.1 Consent  of  Akin  Doherty Klein & Feuge, P.C., Independent Auditors (filed
     herewith)

31.1 Certification  pursuant  to  Rule  13a-14(a)  or Rule 15d-14(a), as adopted
     pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith)

32.1 Certification  pursuant  to  18 U.S.C. Section 1350, as adopted pursuant to
     Section  906  of  the  Sarbanes-Oxley  Act  of  2002  (filed  herewith)

ITEM  14.  PRINCIPAL  ACCOUNTANT  FEES  AND  SERVICES.

There  is  incorporated  in  this  Item  14,  by  reference, that portion of our
definitive  Proxy  Statement  for the 2005 Annual Meeting of Stockholders, which
appears  under  the  caption  "Fees  Paid  to  the  Independent  Accountant."

                                       36

                                   SIGNATURES

In  accordance  with  Section  13  or  15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

     PAYMENT  DATA  SYSTEMS,  INC.

     By:  /s/  Michael  R.  Long
        ------------------------
     Michael  R.  Long
     Chairman  of  the  Board,  Chief  Executive  Officer,  and
     Chief  Financial  Officer
     Date:  March  30,  2005

In  accordance  with  the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated on
March  30,  2005.


                                   By:  /s/  Michael  R.  Long
                                        ----------------------
                                   Michael  R.  Long
                                   Chairman  of  the  Board,  Chief  Executive
                                   Officer,  and  Chief  Financial  Officer
                                   (principal  executive  officer  and principal
                                   financial  and  accounting  officer)


                                    By:  /s/  Louis  A.  Hoch
                                         --------------------
                                    Louis  A.  Hoch
                                    President,  Chief  Operating  Officer,  and
                                    Director


                                    By:  /s/  Peter  G.  Kirby
                                         ---------------------
                                    Peter  G.  Kirby
                                    Director

                                       37