**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549





**FORM
      10-QSB**





[
      X ]
      QUARTERLY REPORT UNDER SECTION 13 OR 15(d)


OF
      THE
      SECURITIES EXCHANGE ACT OF 1934





For
      the
      quarterly period ended September 30, 2006





OR





[
      ]
      TRANSITION REPORT UNDER SECTION 13 OR 15(d)


OF
      THE
      EXCHANGE ACT





For
      the
      transition period from ____ to ____





Commission
      file number 000- 30152








**Payment
      Data Systems, Inc.**


(Exact
      name of small business issuer as specified in its charter)











**Nevada**
            **98-0190072**(State
                or other jurisdiction of
            (IRS
                Employerincorporation
                or organization)
            Identification
                No.)








**12500
      San Pedro, Suite 120**


**San
      Antonio, TX 78216**


(Address
      of principal executive offices)





**(210)
      249-4100**


(Issuer’s
      telephone number)








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 requirement for the past 90 days. Yes X No
      ___





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act). Yes ___ No X





As
      of
      November 1, 2006, 44,504,810 shares of the issuer’s common stock, $0.001 par
      value, were outstanding.





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





-1-


**PAYMENT
      DATA SYSTEMS, INC.**





**INDEX**














PagePART I -FINANCIAL INFORMATIONItem
                1.Financial
                Statements (Unaudited)Consolidated
                Balance Sheets as of September 30, 2006and
                December 31, 2005
            3Consolidated
                Statements of Operations for the three and nine monthsended
                September 30, 2006 and 2005
            4Consolidated
                Statements of Cash Flows for the nine monthsended
                September 30, 2006 and 2005
            5Notes
                to Consolidated Financial Statements
            6Item 2.Management’s
              Discussion and Analysis or Plan of Operation
            10Item
              3.Controls
              and Procedures
            15PART
                II-OTHER INFORMATIONItem
              1.Legal
              Proceedings
            16Item 2.Unregistered
              Sales of Equity Securities and Use of Proceeds
            16Item 3.Defaults
              Upon Senior Securities
            17Item 4.Submission
              of Matters to a Vote of Security Holders
            17Item 5.Other
              Information
            17Item 6.Exhibits
              and Reports on Form 8-K
            17


-2-


**PART
      I** - **FINANCIAL INFORMATION**





**Item
      1.** **FINANCIAL
      STATEMENTS**





**PAYMENT
      DATA SYSTEMS, INC.**


**CONSOLIDATED
      BALANCE SHEETS**











September
                30, 2006
            
            December
                31, 2005(Unaudited)Assets:Current
                assets:Cash
                and cash equivalents
            
            $
            400,673
            
            $
            378,098Accounts
                receivable, net
            
            
            151,115
            
            
            59,558Prepaid
                expenses and other
            
            
            313,605
            
            
            51,962Total
                current assets
            
            
            865,393
            
            
            489,618Property
                and equipment, net
            
            
            170,326
            
            
            162,600Other
                assets
            
            
            156,338
            
            
            20,833Total
                assets
            
            $
            1,192,057
            
            $
            673,051Liabilities
                and stockholders’ equity (deficit):Current
                liabilities:Accounts
                payable
            
            $
            514,228
            
            $
            524,520Accrued
                expenses
            
            
            448,885
            
            
            776,595Note
                payable
            
            
            470,648
            
            
            -Deferred
                revenue
            
            
            43,259
            
            
            44,038Total
                current liabilities
            
            
            1,477,020
            
            
            1,345,153Stockholders’
                equity (deficit):Common
                stock, $0.001 par value, 200,000,000 shares authorized; 44,504,810
                and
                32,827,056 issued and outstanding
            
            
            44,505
            
            
            32,827Additional
                paid-in capital
            
            
            50,696,770
            
            
            49,486,143Deferred
                compensation
            
            
            (649,003
            )
            
            (829,687
            )Accumulated
                deficit
            
            
            (50,377,235
            )
            
            (49,361,385
            )Total
                stockholders’ equity (deficit)
            
            
            (284,963
            )
            
            (672,102
            )Total
                liabilities and stockholders’ equity (deficit)
            
            $
            1,192,057
            
            $
            673,051





See
      notes
      to interim consolidated financial statements.


-3-





**PAYMENT
      DATA SYSTEMS, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**(UNAUDITED)**





Three
                Months Ended September 30,
            
            Nine
                Months Ended September 30,2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            884,269
            
            $
            318,206
            
            $
            1,771,894
            
            $
            876,094Operating
                expenses:Cost
                of services
            
            
            707,035
            
            
            275,242
            
            
            1,410,373
            
            
            771,082Selling,
                general and administrative
            
            
            377,298
            
            
            429,469
            
            
            1,254,739
            
            
            1,290,458Depreciation
                and amortization
            
            
            19,589
            
            
            24,583
            
            
            61,947
            
            
            62,694Total
                operating expenses
            
            
            1,103,922
            
            
            729,294
            
            
            2,727,059
            
            
            2,124,234Operating
                loss
            
            
            (219,653
            )
            
            (411,088
            )
            
            (955,165
            )
            
            (1,248,140
            )Other
                income (expense):Interest
                income
            
            
            -
            
            
            441
            
            
            243
            
            
            707Interest
                expense
            
            
            (25,724
            )
            
            (59,897
            )
            
            (44,565
            )
            
            (125,734
            )Other
                income (expense)
            
            
            (16,363
            )
            
            (201,622
            )
            
            (16,363
            )
            
            (251,510
            )Total
                other income (expense)
            
            
            (42,087
            )
            
            (261,078
            )
            
            (60,685
            )
            
            (376,537
            )Loss
                from operations before income taxes
            
            
            (261,740
            )
            
            (672,166
            )
            
            (1,015,850
            )
            
            (1,624,677
            )Income
                taxes
            
            
            -
            
            
            -
            
            
            -
            
            
            -Net
                loss
            
            $
            (261,740
            )
            $
            (672,166
            )
            $
            (1,015,850
            )
            $
            (1,624,677
            )Basic
                and diluted net loss per common share:
            
            $
            (0.01
            )
            $
            (0.02
            )
            $
            (0.03
            )
            $
            (0.06
            )Weighted
                average common sharesoutstanding
            
            
            43,582,923
            
            
            31,264,161
            
            
            40,503,429
            
            
            28,120,758








See
      notes
      to interim consolidated financial statements.





-4-


**PAYMENT
      DATA SYSTEMS, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(UNAUDITED)**








Nine
                Months Ended September 30,2006
            
            
            
            2005Operating
                activities:Net
                loss
            
            $
            (1,015,850
            )
            
            
            $
            (1,624,677
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            61,947
            
            
            
            
            62,694Non-cash
                issuance of common stock
            
            
            169,848
            
            
            
            
            426,547Deferred
                compensation
            
            
            180,684
            
            
            
            
            98,562Amortization
                of debt discount
            
            
            22,731
            
            
            
            
            95,374Non-cash
                issuance of common stock warrants
            
            
            -
            
            
            
            
            151,309Bad
                debts
            
            
            -
            
            
            
            
            10,000Changes
                in current assets and current liabilities:Accounts
                receivable
            
            
            (91,557
            )
            
            
            
            (31,206
            )Prepaid
                expenses and other
            
            
            (138,650
            )
            
            
            
            93,506Deferred
                revenue
            
            
            (779
            )
            
            
            
            (8,648
            )Accounts
                payable and accrued expenses
            
            
            54,512
            
            
            
            
            98,085Net
                cash used in operating activities
            
            
            (757,114
            )
            
            
            
            (628,454
            )Investing
                activities:Deposits,
                net
            
            
            14,970
            
            
            
            
            6,896Purchases
                of property and equipment
            
            
            (69,673
            )
            
            
            
            (93,773
            )Net
                cash used in investing activities
            
            
            (54,703
            )
            
            
            
            (86,877
            )Financing
                activities:Proceeds
                from notes payable
            
            
            500,000
            
            
            
            
            600,000Principal
                payments for notes payable
            
            
            (52,083
            )
            
            
            
            (431,875
            )Financing
                costs
            
            
            (50,000
            )
            
            
            
            (20,000
            )Issuance
                of common stock, net of issuance costs
            
            
            436,475
            
            
            
            
            667,430Net
                cash provided by financing activities
            
            
            834,392
            
            
            
            
            815,555Change
                in cash and cash equivalents
            
            
            22,575
            
            
            
            
            100,224Cash
                and cash equivalents, beginning of period
            
            
            378,098
            
            
            
            
            153,966Cash
                and cash equivalents, end of period
            
            $
            400,673
            
            
            
            $
            254,190





See
      notes
      to interim consolidated financial statements.


-5-


**PAYMENT
      DATA SYSTEMS, INC.**





**NOTES
      TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**


**(UNAUDITED)**





**Note
      1. Basis of Presentation**





Payment
      Data Systems, Inc. and subsidiaries (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 believes that its current
      available cash along with anticipated revenues may be insufficient to meet
      its
      anticipated cash needs for the foreseeable future. **Consequently,
      the Company’s ability to continue as a going concern is likely contingent on the
      Company receiving additional funds in the form of equity or debt financing.** The
      Company is currently aggressively pursuing strategic alternatives (see Note
      5).
      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 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. The accompanying unaudited consolidated financial
      statements of the Company 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.





The
      accompanying unaudited consolidated financial statements of the Company have
      been prepared without audit, pursuant to the rules and regulations of the
      Securities and Exchange Commission. Certain information and footnote disclosures
      normally included in financial statements prepared in accordance with U.S.
      generally accepted accounting principles have been condensed or omitted pursuant
      to such rules and regulations. In the opinion of management, the accompanying
      consolidated financial statements reflect all adjustments of a normal recurring
      nature considered necessary to present fairly the Company's financial position,
      results of operations and cash flows for such periods. The accompanying interim
      consolidated financial statements should be read in conjunction with the
      consolidated financial statements and the notes thereto included in the
      Company's Annual Report on Form 10-KSB for the year ended December 31, 2005.
      Results of operations for interim periods are not necessarily indicative of
      results that may be expected for any other interim periods or the full fiscal
      year. Certain prior year amounts have been reclassified to conform to the
      current year presentation.




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.





**Note
      2. Stock-Based Compensation**





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. Statement No. 123R eliminates
      the ability to account for stock-based compensation using APB No. 25,
“ Accounting
      for Stock Issued to Employees, ”
and
      requires that these transactions be recognized as compensation cost in the
      income statement based on their fair values on the date of grant. The transition
      provisions require the "modified prospective method" be applied to all new
      or
      modified awards and the remaining expense for unvested options. The Company
      adopted Statement No. 123R as of January 1, 2006, but the impact to the current
      period was immaterial, as substantially all outstanding options completed their
      vesting during 2005, and no new options have been granted in 2006.





The
      Company previously applied the intrinsic value method under the recognition
      and
      measurement provisions of APB No. 25 in accounting for its stock option and
      stock purchase plans. Accordingly, no stock-based employee compensation expense
      has been recognized in prior periods for options granted with an exercise price
      equal to the


-6-


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 No. 123R, “ Accounting
      for Stock-Based Compensation,” to
      stock-based employee compensation in the prior period.














Three
                Months Ended
            
            Nine
                Months EndedSeptember
                30, 2005
            
            September
                30, 2005Net loss, as reported
            
            $
            (672,166)
            
            $
            (1,624,677)Less:
                Total stock-based employeecompensation
                expense determinedunder
                fair value based method forall
                awards, net of related tax effects
            
            
            (275)
            
            
            (1,865)Pro forma net loss
            
            $
            (672,441)
            
            $
            (1,626,542)Net
                loss per common share-
                basic and diluted, as reported
            
            $
            (0.02)
            
            $
            (0.06)Net
                loss per common share-
                basic and diluted, pro forma
            
            $
            (0.02)
            
            $
            (0.06)





**Note
      3. Related Party Transactions**





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 are no longer 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. The total balance of the margin loans guaranteed
      by
      the Company was approximately $1.3 million at December 31, 2002. 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 their balance sheet
      at
      December 31, 2002 because it became probable at that point that they would
      be
      unable to recover their 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 September 30, 2006. 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 a change of control clause in their
      respective employment agreements based on our preliminary analysis.
      The


-7-


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. While Mr. Long and Mr. Hoch agreed, in connection with such sale, to
      forego any affirmative recovery of their compensation by virtue of a change
      of
      control, they have maintained the right to claim an offset of that amount in
      the
      event the Company seeks recovery of the loan balances. 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.





**Note
      4. Note Payable**





On
      August
      21, 2006, the Company entered into a zero-discount promissory note with Dutchess
      Private Equities Fund II, L.P. ("Dutchess"). Pursuant to terms of the promissory
      note, the Company borrowed $500,000 and promised to pay Dutchess $625,000 with
      a
      maturity date of August 21, 2007, which represents an effective nominal annual
      interest rate of 41% based on the minimum repayment terms of the Promissory
      Note. The Company also issued 1,042,000 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. The Company will make payments
      to
      Dutchess of 100% of each put, until $52,083 has been paid during a full calendar
      month, after which 50% of the put amounts for that month will be paid to
      Dutchess until the face amount of the promissory note is paid in full, with
      a
      minimum monthly amount of $52,083 due to Dutchess by the last business day
      of
      each month. The payments are due at the closing of every put to Dutchess and
      after the cumulative amount of financing the Company receives from any source,
      including puts, during the term of the note exceeds $500,000, the Company will
      make a prepayment of 100% of any financing proceeds over $500,000 that the
      Company receives within one business day of receipt until the face amount is
      paid in full. The Company issued
      as collateral thirty put notices to Dutchess for the maximum amount applicable
      under the terms of the Investment Agreement and agreed to issue puts at the
      maximum frequency allowed under the Investment 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 face amount by 10% as
      an
      initial penalty and 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 five-year, 14% interest bearing convertible debenture
      at a conversion rate at the
      lesser of (i)
      75%
      of the lowest closing bid price during the fifteen trading days immediately
      preceding the notice of conversion or (ii)
      100% of the average of the lowest bid price for the twenty trading days
      immediately preceding the convertible closing date .
      If
      Dutchess chooses to convert the residual amount to a convertible debenture,
      the
      Company shall have twenty business days after notice of default 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, the residual amount shall increase
      by $1,000 per day.





-8-


**Note
      5. Equity Line of Credit**





In
      February 2004, the Company executed an agreement for an equity line of credit
      with Dutchess Private Equities Fund, LP. 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. During
      the nine months ended September 30, 2006, the Company sold 3,688,383 shares
      of
      its common stock pursuant to the equity line of credit and received total
      proceeds, net of issuance costs, of $414,640.





**Note
      6. Issuance of Capital Stock**





During
      the quarter ended March 31, 2006, the Company issued a total of 4,439,024 shares
      of common stock granted to employees on December 29, 2005 as a long-term
      incentive for which it recorded $364,000 of deferred compensation. The common
      stock is restricted and vests in ten years on the anniversary date of the grant.
      The Company also issued a total of 270,000 shares granted to independent
      contractors on December 29, 2005 as a long-term incentive for which it recorded
      $22,140 of deferred compensation. The common stock is restricted and vests
      one-third annually on the anniversary date of the grant.





During
      the quarter ended March 31, 2006, the Company issued 735,295 shares of
      restricted common stock to Carmen Electra under the terms of a license agreement
      with her and recorded $125,000 of prepaid expense, which will be amortized
      over
      the remaining term of the license agreement.





During
      the nine months ended September 30, 2006, the Company issued a total of
      1,503,052 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 $176,222 of related expense.





**Note
      7. Subsequent Events**





Subsequent
      to September 30, 2006 and through November 9, 2006, the Company sold 60,000
      shares of its common stock pursuant to the equity line of credit (see Note
      5)
      and received total proceeds, net of issuance costs, of $7,128.





Subsequent
      to September 30, 2006 and through November 9, 2006, the Company issued a total
      of 7,530 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 $640 of related expense.





-9-


**Item
      2.**  **MANAGEMENT’S
      DISCUSSION AND ANALYSIS** **OR PLAN OF OPERATION**





**FORWARD-LOOKING
      STATEMENTS DISCLAIMER**





Except
      for the historical information contained herein, the matters discussed in this
      Form 10-QSB include certain forward-looking statements that involve risks and
      uncertainties, which are intended to be covered by safe harbors. Those
      statements include, but are not limited to, all statements regarding our and
      management’s intent, belief and expectations, such as statements concerning our
      future and our operating and growth strategy. We generally use words such as
      "believe," "may," "could," "will," "intend," "expect," "anticipate," "plan,"
      and
      similar expressions to identify forward-looking statements. You should not
      place
      undue reliance on these forward-looking statements. Our actual results could
      differ materially from those anticipated in the forward-looking statements
      for
      many reasons including our ability to implement our business plan, our ability
      to raise additional funds and manage our substantial debts, consumer acceptance
      of our products, our ability to broaden our customer base, our ability to
      maintain a satisfactory relationship with our suppliers and other risks
      described in our reports filed with the Securities and Exchange Commission.
      Although we believe the expectations reflected in the forward-looking statements
      are reasonable, they relate only to events as of the date on which the
      statements are made, and our future results, levels of activity, performance
      or
      achievements may not meet these expectations. Investors are cautioned that
      all
      forward-looking statements involve risks and uncertainties including, without
      limitation, the factors set forth under the Risk Factors section of Item 6,
      Management’s Discussion and Analysis of Financial Condition and Results of
      Operations, of the Annual Report on Form 10-KSB for the year ended December
      31,
      2005 and other factors detailed from time to time in our filings with the
      Securities and Exchange Commission. In light of the significant uncertainties
      inherent in the forward-looking statements included herein, the inclusion of
      such information should not be regarded as a representation by us or any other
      person that our objectives and plans will be achieved. All forward-looking
      statements made in this Form 10-QSB are based on information presently available
      to our management. We do not intend to update any of the forward-looking
      statements after the date of this document to conform these statements to actual
      results or to changes in our expectations, except as required by
      law.





This
      discussion and analysis should be read in conjunction with the unaudited interim
      consolidated financial statements and the notes thereto included in this report,
      and our Annual Report on Form 10-KSB for the year ended December 31, 2005.





**Overview**





We
      provide integrated electronic payment processing services to merchants and
      businesses, including credit and debit card-based processing services and
      transaction processing via the Automated Clearinghouse Network. We also operate
      an online payment processing service for consumers under the domain name
      www.billx.com through which consumers can pay anyone. Since inception, we have
      incurred operating losses each quarter, and as of September 30, 2006, we have
      an
      accumulated deficit of $50.4 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 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, manage our debt, 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 described in our filings with the Securities and Exchange Commission
      from time to time including our Annual Report on Form 10-KSB. We may not 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. 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.





-10-


**Critical
      Accounting Policies**





General





Management's
      Discussion and Analysis or Plan of Operation is based upon our consolidated
      financial statements, which have been prepared in accordance with U.S. generally
      accepted accounting principles. The 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 are believed to be reasonable under the circumstances, the
      results of which form the basis for making judgments about the carrying values
      of assets and liabilities that are not readily apparent from other sources.
      Actual results could differ from these estimates under different assumptions
      or
      conditions. We consider the following accounting policies to be critical because
      the nature of the estimates or assumptions is material due to the levels of
      subjectivity and judgment necessary to account for highly uncertain matters
      or
      the susceptibility of such matters to change or because the impact of the
      estimates and assumptions on financial condition or operating performance is
      material.





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,
      such
      as the types of card transactions processed and nature of the merchant
      relationship with their consumers. This reserve amount is subject to risk that
      actual losses may be greater than our estimates. At September 30, 2006, our
      card
      merchant processing loss reserve was $76,538. We have not incurred any
      chargeback losses to date. Our estimate for chargeback losses is likely to
      increase in the future as our volume of card-based transactions processed
      increases.





Bad
      Debts





We
      maintain an allowance for doubtful accounts for estimated losses resulting
      from
      the inability or failure of our customers to make required payments. 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
      balance, historical pattern of collections and financial condition of the
      customer. Past losses incurred by us due to bad debts have been within our
      expectations. We charged bad debt expense of $10,000 and recorded bad debt
      write-offs of $936 against our allowance for doubtful accounts in 2005. We
      charged bad debt expense of $15,000 and did not record any bad debt write-offs
      against our allowance for doubtful accounts in the nine months ended September
      30, 2006. At September 30, 2006, the balance of the allowance for doubtful
      accounts was $27,219. 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. Our estimate for bad debt
      losses is likely to increase in the future as our volume of transactions
      processed increases.





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 management determines that the carrying value
      of
      long-lived and intangible assets may not be recoverable, impairment is measured
      as the excess of the assets’ carrying value over the estimated fair value. No
      impairment losses were recorded in 2005 or in the nine months ended September
      30, 2006.


-11-


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 management. It
      is
      our judgment that we cannot predict with reasonable certainty that the deferred
      tax assets as of September 30, 2006 will be realized in future periods.
      Accordingly, a valuation allowance has been provided to reduce the net deferred
      tax assets to $0. At December 31, 2005, we had available net operating loss
      carryforwards of approximately $36.1 million, which expire beginning in the
      year
      2020.





**Results
      of Operations**





Our
      revenues are principally derived from providing integrated electronic payment
      services to merchants and businesses, including credit and debit card-based
      processing services and transaction processing via the Automated Clearinghouse
      Network. We also operate an online payment processing service for consumers
      under the domain name www.billx.com and sell
      this service as a private-label application to resellers. Revenues for the
      quarter ended September 30, 2006 increased 178% to $884,269 from $318,206 for
      the quarter ended September 30, 2005. Revenues for the nine months ended
      September 30, 2006 increased 102% to $1,771,894 from $876,094 for the nine
      months ended September 30, 2005. The increases from the prior year periods
      were
      primarily attributable to the increase in revenues generated from card-based
      processing services due to increased transaction volume. The number of
      transactions generated by billx.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 maximum
      number of payments allowed. Revenues generated by our billx.com payment service
      for the third quarter and first nine months of 2006 decreased from the prior
      year periods due to a decrease in the average number of consumers subscribing
      to
      our online payment service. The monthly average number of such consumers
      decreased to 1,344 in the first nine months of 2006 from 2,598 in the first
      nine
      months of 2005.




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 $707,035 and $275,242 for the quarters ended
      September 30, 2006 and 2005, respectively, and $1,410,373 and $771,082 for
      the
      nine months ended September 30, 2006 and 2005, respectively. The increase from
      the prior year quarter was due primarily to the increase in fees related to
      processing the increased card-based transaction volume.


Selling,
        general and administrative expenses decreased to $377,298 for the quarter
        ended
        September 30, 2006, from $429,469 for the third quarter of 2005. Selling,
        general and administrative expenses for the nine months ended September 30,
        2006
        decreased to $1,254,739 from $1,290,458 for the nine months ended September
        30,
        2005. The decreases from the prior year quarter and period were principally
        due
        to lower consulting expenses and legal fees. We expect our selling, general
        and
        administrative expenses to increase in the fourth quarter of 2006 as we incur
        marketing costs related to the promotion of our new debit card product, the
        Carmen Electra Prepaid MasterCard â .
 
 Depreciation
        and amortization decreased to $19,589 for the quarter ended September 30,
        2006
        from $24,583 for the third quarter of 2005. Depreciation and amortization
        for
        the nine months ended September 30, 2006 decreased to $61,947 from $62,694
        for
        the nine months ended September 30, 2005. These decreases were primarily
        due to
        lower depreciation related to certain assets that became fully depreciated
        during 2006. We capitalized $69,673 of computer hardware and software purchased
        during the nine months ended September 30, 2006 and anticipate making additional
        capital expenditures of approximately $20,000 over the remaining three months
        of
        2006.
 -12-
 Net
        other
        expense decreased to $42,087 for the quarter ended September 30, 2006 from
        $261,078 for the third quarter of 2005, and decreased to $60,685 for the
        nine
        months ended September 30, 2006 from $376,537 for the nine months ended
        September 30, 2005. The decreases from the prior year periods were attributable
        to $110,210 and $225,935 of interest expense and financing costs incurred
        in the
        quarter and nine months ended September 30, 2005, respectively, related to
        a
        note payable to Dutchess. The decreases were also attributable to $151,309
        of
        non-cash expense recorded during the third quarter of 2005 related to the
        settlement of the shareholder suit.
 
 Net
        loss
        decreased to $261,740 for the quarter ended September 30, 2006 from $672,166
        for
        the prior year quarter and decreased to $1,015,850 for the nine months ended
        September 30, 2006 from $1,624,677 for the prior year comparable period.
        Net
        loss decreased from the prior year periods primarily as a result of the decrease
        in net other expense and increase in gross margin as discussed.
 
 **Liquidity
        and Capital Resources**
 
 At
        September 30, 2006, we had $400,673 of cash and cash equivalents, compared
        to
        $378,098 of cash and cash equivalents at December 31, 2005. We have incurred
        substantial losses since inception and have a deficit in net working capital.
        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 to raise capital.
 
 In
        June
        2004, we executed an agreement for an equity line of credit with Dutchess
        Private Equities Fund, LP. Under the terms of the agreement, at our option
        we
        may elect to receive as much as $10 million from Dutchess in common stock
        purchases over three years. Through September 30, 2006, we have sold a total
        of
        8,327,662 shares of our common stock pursuant to the equity line of credit
        and
        received total proceeds, net of issuance costs, of $1,333,287.
 
 On
        August
        21, 2006, we entered into a zero-discount promissory note with Dutchess Private
        Equities Fund, II, LP. Pursuant to terms of the promissory note, we borrowed
        $500,000 and promised to pay Dutchess $625,000 with a maturity date of August
        21, 2007, which represents an effective nominal annual interest rate of 41%
        based on the minimum repayment terms of the promissory note. We also issued
        1,042,000 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 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 make payments to Dutchess
        of 100%
        of each put, until $52,083 has been paid during a full calendar month, after
        which 50% of the put amounts for that month will be paid to Dutchess until
        the
        face amount of the Promissory Note is paid in full, with a minimum monthly
        amount of $52,083 due to Dutchess by the last business day of each month.
        The
        payments are due at the closing of every put to Dutchess and after the
        cumulative amount of financing we receive from any source, including puts,
        during the term of the note exceeds $500,000, we will make a prepayment of
        100%
        of any financing proceeds over $500,000 that we receive within one business
        day
        of receipt until the face amount is paid in full. We issued
        as collateral thirty put notices to Dutchess for the maximum amount applicable
        under the terms of the Investment Agreement and agreed to issue puts at the
        maximum frequency allowed under the Investment 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 face amount by 10%
        as an
        initial penalty and 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 five-year, 14% interest bearing convertible debenture
        at a
        conversion rate at the
        lesser of (i)
        75%
        of the lowest closing bid price during the fifteen trading days immediately
        preceding the notice of conversion or (ii)
        100% of the average of the lowest bid price for the twenty trading days
        immediately preceding the convertible closing date .
        If
        Dutchess chooses to convert the residual amount to a convertible debenture, we
        shall have twenty business days after notice of default 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, the residual amount shall increase by $1,000 per day.
 
 The
        satisfactory completion of an additional investment, adequate sales of stock
        under our equity line of credit, 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 and debt service 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. Our ability
        to raise financing could be limited by the terms of a promissory note we
        entered
        into with Dutchess which requires us to pay to Dutchess the proceeds of any
        debt
        or equity financing over $500,000 to the extent we have funds due under the
        promissory note. 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 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.
 -13-
 Net
        cash
        used in operating activities was $757,114 and $628,454 for the nine months
        ended
        September 30, 2006 and 2005, respectively. Net cash used in operating activities
        was primarily attributable to operating net losses generated by growth stage
        activities and overhead costs. We plan to focus on expending our resources
        prudently given our current state of liquidity.


Net
      cash
      used in investing activities was $54,703 and $86,877 for the nine months ended
      September 30, 2006 and 2005, respectively, and primarily reflected capital
      expenditures for computer hardware and software. We anticipate making capital
      expenditures of approximately $20,000 during the remaining three months of
      2006.





Net
      cash
      provided by financing activities of $834,392 for the nine months ended September
      30, 2006 represented proceeds of $436,475 from the issuance of common stock
      under our equity line of credit, and $397,917 in net proceeds under our note
      payable. Net cash provided by financing activities of $815,555 for the nine
      months ended September 30, 2005 resulted from receiving $667,430 in proceeds
      from the issuance of common stock, primarily under our equity line of credit,
      and receiving $168,125 in net proceeds under notes payable.


**Material
          Trends and Uncertainties**
  Revenue
            generated by our merchant customers represented approximately 95% of
            our total
            revenues in the nine months ended September 30, 2006. We are uncertain
            if
            revenues from card-based merchant processing services will continue to
            grow in
            the fourth quarter of 2006 due to a recent interruption in processing
            for one of
            our merchant customers. On November 1, 2006, the credit card association
            bank
            sponsor we utilize to provide merchant processing services to Online
            Supplier,
            one of our merchant processing customers, notified us that they would
            cease
            processing credit card transactions for Online Supplier. This action
            will not
            have any affect on our agreement with the sponsoring bank or our ability
            to
            provide merchant processing services to our other customers. As of November
            14,
            2006, we secured a relationship with a new sponsoring bank that agreed
            to accept
            Online Supplier’s credit card volume on terms acceptable to both Online Supplier
            and us, pending completion of the bank’s standard underwriting procedures. We
            anticipate that we will resume processing for Online Supplier by the
            end of
            November with our revenue loss limited to the time that processing was
            interrupted, currently estimated to be approximately 4 weeks. If we are
            unable
            to resume processing Online Supplier’s credit card volume for any reason, we
            could lose Online Supplier as a merchant processing customer and their
            related
            processing revenue. During the quarter and nine months ended September
            30, 2006,
            Online Supplier generated credit card processing revenues of $411,048
            and
            $482,078, respectively, which represented 46% and 27% of our total revenues
            for
            the quarter and nine months ended September 30, 2006, respectively. We
            did not
            have any credit card processing revenues from Online Supplier in 2005,
            but we
            did have $18,645 and $3,600 in unrelated ACH processing revenues from
            Online
            Supplier in 2005 and the nine months ended September 30, 2006, respectively.
            The
            ultimate outcome of this material uncertainty cannot presently be
            determined.
  **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.


-14-


**Item
      3.**  **CONTROLS
      AND PROCEDURES** ****





As
      of the
      end of the period covered by this Quarterly Report on Form 10-QSB, an evaluation
      was performed under the supervision and with the participation of our
      management, including the individual serving as both our 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 are effective to ensure that information we are required
      to disclose in reports that we file or submit under the Securities Exchange
      Act
      of 1934 (i) is recorded, processed, summarized and reported within the time
      periods specified in Securities and Exchange Commission rules and forms, and
      (ii) is accumulated and communicated to our management, including our Chief
      Executive Officer and Chief Financial Officer, as appropriate, to allow timely
      decisions regarding required disclosure. Our disclosure controls and procedures
      are designed to provide reasonable assurance that such information is
      accumulated and communicated to our management. Our disclosure controls and
      procedures include components of our internal control over financial reporting.
      Management's assessment of the effectiveness of our internal control over
      financial reporting is expressed at the level of reasonable assurance that
      the
      control system, no matter how well designed and operated, can provide only
      reasonable, but not absolute, assurance that the control system's objectives
      will be met.





There
      was
      no change in our internal controls, which are included within disclosure
      controls and procedures, during our most recently completed fiscal quarter
      that
      has materially affected, or is reasonably likely to materially affect, our
      internal controls.


-15-


**PART
      II - OTHER INFORMATION**




**I** **tem
      1.** **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 our employees. 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 our 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. The total balance of the margin loans guaranteed
      by
      us was approximately $1.3 million at December 31, 2002. At the time the funds
      were pledged, we believed we would have access to them because (a) our 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, our 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 September 30, 2006. 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 a 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.
      While
      Mr. Long and Mr. Hoch agreed, in connection with such sale, to forego any
      affirmative recovery of their compensation by virtue of a change of control,
      they have maintained the right to claim an offset of that amount in the event
      we
      seek recovery of the loan balances. 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. 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.





**Item
      2.** **UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**





During
      the quarter ended September 30, 2006, we sold 694,498 shares of our common
      stock
      to Dutchess Private Equities Fund, LP, an accredited investor, pursuant to
      an
      equity line of credit and received total proceeds, net of issuance costs, of
      $56,998.




On
        August
        21, 2006, we issued 1,042,000 shares of restricted common stock to Dutchess Private
        Equities Fund, II, LP as an incentive for purchasing a promissory note. The
        shares were valued at $98,469.


The
      shares were sold in accordance with Rule 506 of Regulation D under the
      Securities Act of 1933 (as amended) in that:




·
            the
                sales were made to a sophisticated or accredited investors, as defined
                in
                Rule 502;




-16-


·
            we
                gave each purchaser the opportunity to ask questions and receive
                answers
                concerning the terms and conditions of the offering and to obtain
                any
                additional information which we possessed or could acquire without
                unreasonable effort or expense that is necessary to verify the accuracy
                of
                information furnished;




·
            at
                a reasonable time prior to the sale of securities, we advised each
                purchaser of the limitations on resale in the manner contained in
                Rule 502(d)2;




·
            neither
                we nor any person acting on our behalf sold the securities by any
                form of
                general solicitation or general advertising; and




·
            we
                exercised reasonable care to assure that each purchaser of the securities
                is not an underwriter within the meaning of Section 2(11) of the
                Securities Act of 1933 in compliance with
                Rule 502(d).




**Item
      3.** **DEFAULTS
      UPON SENIOR SECURITIES**





Not
      Applicable.





**Item
      4.** **SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS**





Not
      Applicable.





**Item
      5.** **OTHER
      INFORMATION**





Not
      Applicable.





**Item
      6.** **EXHIBITS
      AND REPORTS ON FORM 8-K**





(a)  Exhibits:





Exhibit


Number  Description





3.1
            Amended
                and Restated Articles of Incorporation (included as exhibit 3.1 to
                the
                Form 10-KSB filed March 31, 2006, and incorporated herein by
                reference).





3.2
            Amended
                and Restated By-laws (included as exhibit 3.2 to the Form 10-KSB
                filed
                March 31, 2006, and incorporated herein by reference).





4.1
            Amended
                and Restated 1999 Employee Comprehensive Stock Plan (included as
                exhibit
                4.1 to the Form S-8 filed May 25, 2006, and incorporated herein by
                reference).





4.2
            Amended
                and Restated 1999 Non-Employee Director Plan (included as exhibit
                10.2 to
                the Form 8-K filed January 3, 2006, and incorporated herein by
                reference).





4.3
            Employee
                Stock Purchase Plan (included as exhibit 4.3 to the Form S-8 filed
                February 23, 2000, and incorporated herein by
                reference).





4.4
            Registration
                Rights Agreement between the Company and Dutchess Private Equities
                Fund,
                LP, dated June 6, 2004 (included as exhibit 10.9 to the Form SB-2
                filed
                June 18, 2004, and incorporated herein by
                reference).





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4.5
            Rights
                Agreement between the Company and American Stock Transfer & Trust
                Company, dated May 2, 2005 (included as exhibit 4.1 to the Form 8-A
                filed
                May 5, 2005, and incorporated herein by
                reference).


10.1
            Asset
                Purchase Agreement between the Company and Saro, Inc., dated May
                19, 2003
                (included as Appendix A to the Definitive Proxy Statement on Form
                DEF 14A
                filed June 19, 2003, and incorporated herein by
                reference).





10.2
            First
                Amendment to Asset Purchase Agreement between the Company and Saro,
                Inc.,
                dated July 25, 2003 (included as exhibit 10.2 to the Form 10-Q filed
                November 14, 2003, and incorporated herein by
                reference).





10.3
            Lease
                Agreement between the Company and Frost National Bank, Trustee for
                a
                Designated Trust, dated August 2003 (included as exhibit 10.3 to
                the Form
                10-Q filed November 14, 2003, and incorporated herein by
                reference).





10.4
            Employment
                Agreement Form between the Company and Executive Officers, dated
                May 31,
                2001 (included as exhibit 10.4 to the Form 10-K filed April 1, 2002,
                and
                incorporated herein by reference).





10.5
            Investment
                Agreement between the Company and Dutchess Private Equities Fund,
                LP,
                dated June 4, 2004 (included as exhibit 10.8 to the Form SB-2 filed
                June
                18, 2004, and incorporated herein by
                reference).





10.6
            Placement
                Agent Agreement between the Company, Charleston Capital Corporation,
                and
                Dutchess Private Equities Fund, LP, dated June 4, 2004 (included
                as
                exhibit 10.10 to the Form SB-2 filed June 18, 2004, and incorporated
                herein by reference).





10.7
            Affiliate
                Office Agreement between the Company and Network 1 Financial, Inc.
                (included as exhibit 10.11 to the Form SB-2 filed April 28, 2004,
                and
                incorporated herein by reference).





10.8
            Promissory
                Note between the Company and Dutchess Private Equities Fund, II,
                LP, dated
                August 24, 2004 (included as exhibit 10.1 to the Form 8-K filed September
                2, 2004, and incorporated herein by
                reference).





10.9
            Warrant
                Agreement between the Company and Kubra Data Transfer LTD, dated
                as of
                September 30, 2004 (included as exhibit 10.1 to the Form 8-K filed
                October
                6, 2004, and incorporated herein by
                reference).





10.10
            Promissory
                Note between the Company and Dutchess Private Equities Fund, II,
                LP, dated
                December 10, 2004 (included as exhibit 10.1 to the Form 8-K filed
                December
                16, 2004, and incorporated herein by
                reference).





10.11
            Promissory
                Note between the Company and Dutchess Private Equities Fund, II,
                LP, dated
                May 12, 2005 (included as exhibit 10.11 to the Form 10-QSB filed
                May 16, 2005, and incorporated herein by
                reference).





10.12
            Corporate
                Consulting Agreement between the Company and Theodore Smith, dated
                April
                26, 2005 (included as exhibit 10.1 to the Form S-8 filed June 3,
                2005, and
                incorporated herein by reference).





10.13
            Trademark
                and Domain Name Purchase Agreement between the Company and Alivio
                Holdings, LLC, dated November 14, 2005 (included as exhibit 10.1
                to the
                Form 8-K filed November 17, 2005, and incorporated herein by
                reference).





10.14
            Promissory
                Note between the Company and Dutchess Private Equities Fund, II,
                LP, dated
                August 21, 2006 (included as exhibit 10.1 to the Form 8-K filed August
                25,
                2006, and incorporated herein by
                reference).





31.1
            Certificationof
                the Chief Executive Officer/Chief Financial Officerpursuant
                to Section 302 of the Sarbanes-Oxley Act of 2002.





32.1
            Certificationof
                Officers pursuant to 18 U.S.C. Section 1350, as adopted pursuant
                to
                Section 906 of the Sarbanes-Oxley Act of
                2002.





(b)
            Reports
                on Form 8-K:





On
      August
      25, 2006, the Company filed a report on Form 8-K to disclose that the Company
      borrowed $500,000 under a promissory note and subsequently filed a Form
      8-K/A on August 29, 2006 to amend the previous related disclosure..


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**SIGNATURE**





In
      accordance with the requirements 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** **.**








Date:
      November 14, 2006




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)




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