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, 2005

                                       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 Employer
      incorporation 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 8, 2005, 32,644,561 shares of the issuer's common stock, $0.001
par  value,  were  outstanding.

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

                                        1

<TABLE>
<CAPTION>

<S>                                                                  <C>
PAYMENT DATA SYSTEMS, INC.

                                      INDEX

PART I - FINANCIAL INFORMATION                                                        Page
                                                                                      ----

Item 1.  Financial Statements (Unaudited)

          Consolidated Balance Sheets as of September 30, 2005
           and December 31, 2004 . . . . . . . . . . . . . . . . . . . . . . .           3

          Consolidated Statements of Operations for the three and nine months
           ended September 30, 2005 and 2004 . . . . . . . . . . . . . . . . .           4

          Consolidated Statements of Cash Flows for the nine months
           ended September 30, 2005 and 2004 . . . . . . . . . . . . . . . . .           5

          Notes to Consolidated Financial Statements. . . . . . . . . . . . .            6

Item 2    Management's Discussion and Analysis or Plan of Operation . . . . .           11

Item 3    Controls and Procedures

PART II - OTHER INFORMATION

Item 1    Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . .           18

Item 2    Unregistered Sales of Equity Securities and Use of Proceeds . . . .           19

Item 3    Defaults Upon Senior Securities . . . . . . . . . . . . . . . . . .           20

Item 4    Submission of Matters to a Vote of Security Holders . . . . . . . .           20

Item 5    Other Information

Item 6    Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . .           20

</TABLE>

                                        2

                         PART I - FINANCIAL INFORMATION

Item  1.  FINANCIAL  STATEMENTS

<TABLE>
<CAPTION>

                           PAYMENT DATA SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS

<S>                                                                                   <C>                   <C>

                                                                                      September 30, 2005    December 31, 2004
                                                                                     --------------------  -------------------
                                                                                          (Unaudited)
Assets:
Current assets:
 Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . .   $           254,190   $          153,966
 Accounts receivable, net. . . . . . . . . . . . . . . . . . . . . . . . . . . . .                78,994               57,788
 Prepaid expenses and other. . . . . . . . . . . . . . . . . . . . . . . . . . . .               126,152               47,833
                                                                                     --------------------  -------------------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               459,336              259,587

Property and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . . .               173,143              132,064
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                21,868               23,589
                                                                                     --------------------  -------------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   $           654,347   $          415,240
                                                                                     ====================  ===================

Liabilities and stockholders' equity (deficit):
Current liabilities:
 Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   $           558,565   $          482,788
 Accrued expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               400,331              392,515
 Note payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               527,664              264,165
                                                                                     --------------------  -------------------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . .             1,486,560            1,139,468

Stockholders' equity (deficit):


Common stock, $0.001 par value, 200,000,000 shares authorized;
32,313,667 and 23,569,180 issued and outstanding . . . . . . . . . . . . . . . . .                32,313               23,569
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . .            49,418,674           47,417,898
Deferred compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              (492,828)                   -
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .           (49,790,372)         (48,165,695)
                                                                                     --------------------  -------------------
Total stockholders' equity (deficit) . . . . . . . . . . . . . . . . . . . . . . .              (832,213)            (724,228)
                                                                                     --------------------  -------------------
Total liabilities and stockholders' equity (deficit) . . . . . . . . . . . . . . .   $           654,347   $          415,240
                                                                                     ====================  ===================
<FN>
See  notes  to  interim  consolidated  financial  statements.
</TABLE>

                                        3

<TABLE>
<CAPTION>

                           PAYMENT DATA SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

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

                                                 Three Months Ended September 30,    Nine Months Ended September 30,
                                                 --------------------------------    --------------------------------
                                                        2005            2004               2005             2004
                                                 ----------------  --------------    ----------------  --------------

Revenues. . . . . . . . . . . . . . . . . . . .  $       318,206   $      69,201     $       876,094   $     188,600

Operating expenses:
  Cost of services. . . . . . . . . . . . . . .          275,242          61,974             771,082         191,333
  Selling, general and administrative . . . . .          429,469         353,352           1,290,458         986,055
  Depreciation and amortization . . . . . . . .           24,583          20,988              62,694          74,023
                                                 ----------------  --------------    ----------------  --------------
Total operating expenses. . . . . . . . . . .            729,294         436,314           2,124,234       1,251,411
                                                 ----------------  --------------    ----------------  --------------

Operating loss. . . . . . . . . . . . . . . .           (411,088)       (367,113)         (1,248,140)     (1,062,811)

Other income (expense), net:
  Interest income . . . . . . . . . . . . . . .              441              57                 707             700
  Interest expense. . . . . . . . . . . . . . .          (59,897)         (9,261)           (125,734)         (9,261)
  Other income (expense). . . . . . . . . . . .         (201,622)        (12,750)           (251,510)        (21,360)
                                                 ----------------  --------------    ----------------  --------------
Total other income (expense), net . . . . . .           (261,078)        (21,954)           (376,537)        (29,921)
                                                 ----------------  --------------    ----------------  --------------

Loss from operations before income taxes. . .           (672,166)       (389,067)         (1,624,677)     (1,092,732)
Income taxes. . . . . . . . . . . . . . . . .                  -               -                   -               -
                                                 ----------------  --------------    ----------------  --------------
Net loss. . . . . . . . . . . . . . . . . . .    $      (672,166)  $    (389,067)    $    (1,624,677)  $  (1,092,732)
                                                 ================  ==============    ================  ==============

Basic and diluted net loss per common share:.    $         (0.02)  $       (0.02)    $         (0.06)  $       (0.05)
Weighted average common shares
 outstanding. . . . . . . . . . . . . . . . .         31,264,161      21,695,525          28,120,758      21,459,825

<FN>

See  notes  to  interim  consolidated  financial  statements.
</TABLE>

                                        4

<TABLE>
<CAPTION>

                           PAYMENT DATA SYSTEMS, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)

<S>                                                                          <C>               <C>
                                                                             Nine Months Ended September 30,
                                                                             ----------------------------------

                                                                                    2005             2004
                                                                             ----------------  ----------------

Operating activities:
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  $    (1,624,677)  $    (1,092,732)
Adjustments to reconcile net loss to net cash used in operating activities:
 Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . .           62,694            74,023
 Non-cash issuance of common stock. . . . . . . . . . . . . . . . . . . . .          426,547           120,910
 Non-cash issuance of common stock warrants . . . . . . . . . . . . . . . .          151,309            29,675
 Deferred compensation. . . . . . . . . . . . . . . . . . . . . . . . . . .           98,562                 -
 Amortization of debt discount. . . . . . . . . . . . . . . . . . . . . . .           95,374             6,000
 Changes in current assets and current liabilities:
 Accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . .          (21,206)              951
 Prepaid expenses and other . . . . . . . . . . . . . . . . . . . . . . . .           93,506            43,176
 Accounts payable and accrued expenses. . . . . . . . . . . . . . . . . . .           89,437           200,444
                                                                             ----------------  ----------------
Net cash used in operating activities . . . . . . . . . . . . . . . . . . .         (628,454)         (617,553)

Investing activities:
Purchases of property and equipment . . . . . . . . . . . . . . . . . . . .          (93,773)           (4,598)
Long-term deposits, net . . . . . . . . . . . . . . . . . . . . . . . . . .            6,896             6,693
                                                                             ----------------  ----------------
Net cash provided by (used in) investing activities . . . . . . . . . . . .          (86,877)            2,095

Financing activities:
Proceeds from notes payable . . . . . . . . . . . . . . . . . . . . . . . .          600,000           260,000
Principal payments for notes payable. . . . . . . . . . . . . . . . . . . .         (431,875)          (10,571)
Financing costs, net. . . . . . . . . . . . . . . . . . . . . . . . . . . .          (20,000)                -
Issuance of common stock, net of issuance costs . . . . . . . . . . . . . .          667,430            32,787
                                                                             ----------------  ----------------
Net cash provided by financing activities . . . . . . . . . . . . . . . . .          815,555           282,216
                                                                             ----------------  ----------------
Change in cash and cash equivalents . . . . . . . . . . . . . . . . . . . .          100,224          (333,242)

Cash and cash equivalents, beginning of period. . . . . . . . . . . . . . .          153,966           528,119
                                                                             ----------------  ----------------
Cash and cash equivalents, end of period. . . . . . . . . . . . . . . . . .  $       254,190   $       194,877
                                                                             ================  ================
<FN>
See  notes  to  interim  consolidated  financial  statements.
</TABLE>

                                        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, 2004.
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.

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

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,"  to  stock-based  employee  compensation.

                                        6

<TABLE>
<CAPTION>

<S>                                              <C>                <C>              <C>               <C>
                                                 Three Months Ended September 30,    Nine Months Ended September 30,
                                                 --------------------------------    --------------------------------
                                                        2005            2004               2005             2004
                                                 ----------------  --------------    ----------------  --------------

Net loss, as reported                            $      (672,166)  $    (389,067)    $    (1,624,677)  $  (1,092,732)

Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects                      (275)         (3,198)             (1,865)       (138,708)
                                                 ----------------  --------------    ----------------  --------------

Pro forma net loss                               $      (672,441)  $    (392,265)    $    (1,626,542)  $  (1,231,440)
                                                 ================  ==============    ================  ==============

Net loss per common share
- basic and diluted, as reported                 $         (0.02)  $       (0.02)    $         (0.06)  $       (0.05)

Net loss per common share
- basic and diluted, pro forma                   $         (0.02)  $       (0.02)    $         (0.06)  $       (0.06)

</TABLE>

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, 2005. 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.  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.

                                        7

Note  4.  Note  Payable

On  December  10, 2004, the Company entered into a zero-discount promissory note
with  Dutchess  Private Equities Fund, II, LP ("Dutchess"). 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. The Company defaulted on final
payment  of  this  promissory  note  to  Dutchess  on  its  maturity  date.

On  May  12, 2005, the Company entered into a zero-discount promissory note with
Dutchess.  Pursuant  to  terms  of  the  promissory  note,  the Company received
$600,000  and promised to pay Dutchess $720,000 with a maturity date of December
22, 2005, which represents an effective annual interest rate of 33%. The Company
also  issued  500,000  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.  The Company used a portion of the proceeds from this note to repay the
balance  of the note due April 10, 2005 to Dutchess in full, including a penalty
of  $5,116  for  late  payment.

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 5). The Company
will  make payments to Dutchess in the amount of 50% of each put, until the face
amount  of  the  promissory  note  is  paid in full. The payments are due at the
closing of every put to Dutchess and the payment amount as a percentage of a put
escalates  to  75%  after the cumulative amount of financing we receive from any
source  during  the  term  of the note exceeds $250,000. The payment amount as a
percentage  of  a  put increases to 80% after the cumulative amount of financing
exceeds  $600,000 and reaches a maximum of 100% once the Company has raised over
$700,000  in financing. 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.

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
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, 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.

                                        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 ("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.  During  the  nine  months  ended  September 30, 2005, the Company sold
3,019,884  shares  of its common stock pursuant to the equity line of credit and
received  total  proceeds,  net  of issuance costs, of $575,795. 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  4).

Note  6.  Issuance  of  Capital  Stock

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  were  issued  under  the terms of the Company's Employee
Comprehensive  Stock  Plan.

On March 28, 2005, the Company's Board of Directors granted a total of 2,956,950
shares  of  common  stock  to  employees  as  a long-term incentive and recorded
$591,390  of  deferred  compensation.  The  common stock is restricted and vests
equally  over  three  years  on the anniversary date of the grant. The Company's
Board  of Directors also granted a total of 50,000 shares of unrestricted common
stock  under  the  terms  of  the Company's Employee Comprehensive Stock Plan to
certain  employees  and  recorded  $10,000  of  compensation  expense.

In  April  2005,  the Company issued 250,000 shares of common stock and received
cash proceeds of $60,000 related to the exercise of stock warrants granted under
the  terms  of  a  warrant  agreement  with  Kubra  Data  Transfer,  Ltd.

During  the  nine months ended September 30, 2005, the Company issued a total of
792,950  shares  of  common  stock under the terms of its Comprehensive Employee
Stock  Plan  to  independent  contractors  providing  consulting services to the
Company  and  recorded  $164,468  of  related  expense.

During  the  nine  months  ended  September  30, 2005, the Company issued 15,000
shares  of  common  stock  and  received  cash proceeds of $1,275 related to the
exercise  of stock options granted under the terms of its Comprehensive Employee
Stock  Plan.

Note  7.  Shareholder  Rights  Plan

On  April  22, 2005, the Company's Board of Directors declared a dividend of one
right  for  each  outstanding  share  of common stock. The rights were issued to
shareholders  of  record  on  April  29, 2005 and will expire on April 29, 2009.
Until  the  rights  become exercisable, the rights will trade automatically with
the common stock and separate rights certificates will not be issued. The rights
will  be  exercisable  only  if  a  person  or group acquires 15% or more of the
Company's  common  stock,  whether  through  open market or private purchases or
consummation  of  a  tender  or  exchange  offer,  or  announces  an  offer  the
consummation of which would result in such person or group owning 15% or more of
the Company's common stock. When the rights first become exercisable, each right
will entitle the holder to purchase one share of common stock for $0.23, subject
to  adjustment.  If  the  Company  is  involved  in  a  merger or other business
combination  after  a  person  or  group  has acquired 15% or more of its common
stock,  each  right  will  entitle  its  holder  to  purchase,  at  the  right's
then-current exercise price, a number of the acquiring company's shares having a
market  value  of  twice  the exercise price of each right. If a person or group
acquires  15% or more of the Company's common stock, each right will entitle its
holder to purchase a number of additional shares of common stock having a market
value  of  twice  the  exercise  price  of  each  right.

                                        9

Note  8.  Subsequent  Events

Subsequent  to  September  30,  2005  and  through  the date of this report, the
Company  sold  160,000 shares of its common stock pursuant to the equity line of
credit  (see  Note  5)  and  received  total proceeds, net of issuance costs, of
$21,367.

Subsequent  to  September  30,  2005  and  through  the date of this report, the
Company  issued a total of 170,894 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 $24,480 of related
expense.

In  October  2005, the Company signed a non-binding letter of intent to sell its
bills.com  domain name and related trademark to Alivio Holdings, LLC and provide
related  online payment processing services for total consideration of $964,500.
The  Company  plans  to  continue  offering  online  payment processing services
directly to consumers under a new domain name, www.billx.com, as well as through
resellers,  including  Alivio.  The  Company's  existing customer base currently
using bills.com for online payment services will be retained and transitioned to
the  new  billx.com  domain  name.

On  November  9,  2005, the Company entered into a settlement agreement with all
the  plaintiffs  named in the stockholder suit filed on July 23, 2005. Under the
terms  of  the  settlement,  the plaintiffs will dismiss the pending litigation,
with  prejudice,  and  release  all  claims against the Company, its current and
former  officers  and  directors,  and  our former auditors, Ernst & Young, LLP.
Additionally, the Company will reset the exercise price of 1,912,400 warrants to
purchase  our  common stock held by the plaintiffs from $1.80 per share to a new
exercise  price  of $0.20 per share. The Company will also extend the expiration
date  of  the  warrants from November 27, 2006 to November 27, 2007. The Company
recorded  a non-cash expense of $151,309 in the quarter ended September 30, 2005
as  a result of the modification of the warrant terms. The Company is not paying
any  other  economic  consideration  to  fund  this  settlement.

                                       10

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,
2004  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,
2004.

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.bills.com  through  which consumers can pay anyone. Since inception, we have
incurred operating losses each quarter, and as of September 30, 2005, we have an
accumulated  deficit  of  $49.8  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.

                                       11

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, 2005, our card
merchant  processing  loss  reserve  was  $22,091.  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  did not record any bad debt expense or bad debt write-offs in
2004.  At September 30, 2005, the balance of the allowance for doubtful accounts
was  $12,820.  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  2004  or  during  the  nine months ended
September  30,  2005.

                                       12

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,  2005  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, 2004, 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.bills.com. Revenues for the quarter ended
September 30, 2005 increased 360% to $318,206 from $69,201 for the quarter ended
September  30,  2004.  Revenues  for  the  nine  months ended September 30, 2005
increased 365% to $876,094 from $188,600 for the nine months ended September 30,
2004.  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  increase  in revenue from the nine months ended September 30, 2004 was also
due  to  an  increase  in  the  average  number  of consumers subscribing to the
bills.com  payment  service.  The  monthly average number of consumers using our
online  payment service increased to 2,598 in the first nine months of 2005 from
2,035  in the first nine months of 2004. 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 maximum number of payments allowed.
Revenues  generated  by  our  bills.com payment service for the third quarter of
2005  decreased  from  the  prior  year quarter due to a decrease in the average
number  of  consumers  subscribing  to  the  bills.com  payment  service  as  we
transitioned  to  processing  the  online  payments  ourselves  during the third
quarter  of  2005.  The  monthly  average  number  of consumers using our online
payment  service  decreased  to 1,936 in the third quarter of 2005 from 2,026 in
the  third  quarter of 2004. We had previously been using a third party provider
to  process  the  payments,  but  are  now  able  to  market  the  service  as a
private-label  application  to  prospective  resellers.

In  October 2005, we signed a non-binding letter of intent to sell our bills.com
domain  name  and  trademark  to Alivio Holdings, LLC and provide related online
payment  processing  services.  We also anticipate signing additional agreements
with Alivio to provide merchant processing and other payment services. We expect
to  continue  offering  online payment processing services directly to consumers
under  a new domain name, www.billx.com, as well as through resellers, including
Alivio.  We will retain our existing customer base currently using bills.com for
online  payment  services  and  expect  to  seamlessly  transition  this current
customer  base  to  our  new  billx.com  domain  name.

We  expect  our  total revenues to increase as we anticipate continued growth in
the  volume  of  card  transactions  and  additional merchant customers. Revenue
generated  by  our merchant customers represented approximately 89% of our total
revenues  in the three months ended September 30, 2005, 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
that  revenues  from  card-based  processing  services  will continue to grow 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 $275,242 and $61,974 for the quarters ended
September  30,  2005  and  2004, respectively, and $771,082 and $191,333 for the
nine  months ended September 30, 2005 and 2004, respectively. The increases from
the  prior  year  periods were due primarily to the increases in fees related to
processing  the  increased  card-based  transaction  volume.

                                       13

Selling,  general  and  administrative  expenses  increased  to $429,469 for the
quarter  ended  September 30, 2005, from $353,352 for the third quarter of 2004.
The  increase  from  the  prior  year  quarter  was  principally due to non-cash
amortization  of  deferred compensation of $46,731 related to employee incentive
stock  grants  and  an  increase  in  other  personnel  expenses and legal fees.
Selling, general and administrative expenses for the nine months ended September
30,  2005  increased  to  $1,290,458  from  $986,055  for  the nine months ended
September 30, 2004. The increase from the prior year period was primarily due to
non-cash  deferred  compensation  expense  of $93,462 recorded in the second and
third  quarters  of  2005 and an increase in consulting expenses related to debt
and equity financing efforts of approximately $69,000. In addition, higher sales
personnel  costs  and legal fees also contributed to the increase from the prior
year  period.

Depreciation  and  amortization  increased  to  $24,583  for  the  quarter ended
September  30,  2005, as compared to $20,988 for the third quarter of 2004. This
increase  was  due  to depreciation related to certain asset additions that were
put  into  production  during  the  third  quarter  of  2005.  Depreciation  and
amortization  for  the nine months ended September 30, 2005 decreased to $62,694
from $74,023 for the nine months ended September 30, 2004. This decrease was due
to  lower  depreciation  related to certain assets that became fully depreciated
during  2004. We capitalized $93,773 of computer hardware and software purchased
during the nine months ended September 30, 2005 and anticipate making additional
capital expenditures of approximately $25,000 over the remaining three months of
2005.

Net  other  expense  was  $261,078  for  the  quarter  ended September 30, 2005,
compared  to  $21,954  for  the  third  quarter  of  2004. Net other expense was
$376,537  for  the nine months ended September 30, 2005, compared to $29,921 for
the  nine  months  ended  September  30, 2004. The increases from the prior year
periods were partially 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 our notes payable to Dutchess. The increases 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. Under the
terms  of  the  settlement,  we  modified  the terms of the warrants held by the
plaintiffs  and  gave  no  other  economic  consideration.

Net  loss  increased  to  $672,166 for the quarter ended September 30, 2005 from
$389,067  for  the  prior  year quarter and increased to $1,624,677 for the nine
months  ended  September  30, 2005 from $1,092,732 for the prior year comparable
period. Net loss increased from both the prior year quarter and period primarily
as a result of the increases in selling, general and administrative expenses and
net  other  expense  as  discussed.

Liquidity  and  Capital  Resources

At September 30, 2005, we had $254,190 of cash and cash equivalents, compared to
$153,966  of  cash  and  cash equivalents at December 31, 2004. 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 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.

On  May  12,  2005,  we  entered  into  a  promissory note with Dutchess Private
Equities  Fund,  II,  LP.  Pursuant to terms of the promissory note, we received
$600,000  and promised to pay Dutchess $720,000 with a maturity date of December
22,  2005.  We also issued 500,000 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.  We used a portion of the proceeds from this note to repay the balance
of  the  note  due  April  10,  2005 to Dutchess in full, including a penalty of
$5,116  for  late  payment. We had previously defaulted on final payment of this
promissory  note  to  Dutchess  on  its  maturity  date.

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
in  the  amount of 50% of each put, until the face amount of the promissory note
is  paid  in  full. The payments are due at the closing of every put to Dutchess
and  the  payment  amount  as  a  percentage of a put escalates to 75% after the
cumulative amount of financing we receive from any source during the term of the
note  exceeds $250,000. The payment amount as a percentage of a put increases to
80%  after  the  cumulative  amount  of financing exceeds $600,000 and reaches a
maximum of 100% once we have raised over $700,000 in financing. We will issue as
collateral  twenty-five  put  notices to Dutchess for the full amount applicable
under  the  terms  of  the  equity line of credit and shall do so at the maximum
frequency  allowed  under the equity line agreement, until such time as the note
is  paid  in full. As of September 30, 2005, the balance of the note payable due
to  Dutchess  was  $527,664.

                                       14

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
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, 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.

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, we may
elect  to receive as much as $10 million from Dutchess in common stock purchases
over three years at our option. Through September 30, 2005, we have sold a total
of  4,479,279  shares  of our common stock pursuant to the equity line of credit
and received total proceeds, net of issuance costs, of $897,281. 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.

In  October 2005, we signed a non-binding letter of intent to sell our bills.com
domain  name  and  related trademark to Alivio Holdings, LLC and provide related
services  for total consideration of $964,500. We expect to use a portion of the
proceeds  received  from  this  sale to pay back the note payable to Dutchess by
December  22,  2005.

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 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.

Net  cash  used  in  operating activities was $628,454 and $617,553 for the nine
months  ended  September  30,  2005  and  2004,  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 and do
not  expect  to  achieve  positive  cash  flow  from  operations  for  2005.

Net  cash  used  in  investing  activities was $86,877 for the nine months ended
September  30,  2005  and  primarily reflected capital expenditures for computer
hardware  and software. Net cash provided by investing activities was $2,095 for
the nine months ended September 30, 2004 and reflected the return of $6,693 of a
long-term  lease deposit, which was partially offset by capital expenditures for
computer  hardware  and  software.  We anticipate making capital expenditures of
approximately  $25,000  during  the  remaining  three  months  of  2005.

Net  cash provided by financing activities of $815,555 for the nine months ended
September  30,  2005  resulted  from receiving $667,430 in net proceeds from the
issuance  of  common  stock,  primarily  under  our  equity  line of credit, and
receiving $168,125 in net proceeds under our notes payable. Net cash provided by
financing  activities  of  $282,216 for the nine months ended September 30, 2004
resulted  primarily  from  borrowing $260,000 under a note payable and receiving
$32,787  from  the  issuance  of  common  stock.

                                       15

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  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 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, 2005. 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.  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. 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.

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.

                                       16

Item  3.     CONTROLS  AND  PROCEDURES

Our  management  evaluated,  with  the  participation  of  our  Chief  Executive
Officer/Chief  Financial  Officer,  the effectiveness of our disclosure controls
and  procedures  as of the end of the period covered by this Quarterly Report on
Form  10-QSB.  Based  on  this  evaluation,  our  Chief  Executive Officer/Chief
Financial  Officer has 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/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  control over financial reporting that
occurred  during  our last fiscal quarter covered by this report that materially
affected,  or  is  reasonably  likely to materially affect, our internal control
over  financial  reporting.

                                       17

                           PART II - OTHER INFORMATION

Item  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  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 our
employees.  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. We were also trying to accommodate the requests of
the  named  executive  officers,  who  were  seeking to preserve their financial
liquidity.  We  believe  this  action  served  our  purpose  of  assuring stable
management  and  leadership  for  our  future. The margin loans were obtained in
March  1999  from institutional lenders and were secured by shares of our common
stock  owned  by these officers. Each of the officers used the proceeds of their
respective  margin  loans for investment purposes and usual and customary living
expenses.

None  of the margin loans were recourse with respect to the officers and none of
the  loan  guarantees  were recourse with respect to us because at the times the
margin  loans  were  made  and  the funds pledged, the value of the common stock
collateralizing  the  margin loans exceeded the loan amounts. Under the original
terms  of  the  arrangement,  we  charged  each  of  the officers, pro rata, the
difference  between the rate of return earned by us before the collateralization
of  the margin loans on the funds that were to be the pledged funds and the rate
of  return earned on the pledged funds after the collateralization of the margin
loans.  We  offset  such  amounts  due  from Mr. Long, Mr. Hoch, and Mr. Millard
against  their  respective  salaries  from the date the funds were pledged until
November  of  2002,  when  we underwent significant downsizing and Mr. Long, Mr.
Hoch, and Mr. Millard began deferring their salaries. We offset such amounts due
from Mr. Jones against his salary from the date the funds were pledged until the
date  of  his  departure  in  August  2001.

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, 2005.

The  pledged  funds  were classified as cash and cash equivalents on our balance
sheet  and  disclosed in the accompanying footnotes in our Annual Report on Form
10-K  for  each of the years ended December 31, 2000 and 2001, respectively. The
pledged  funds were classified as cash and cash equivalents on our balance sheet
and disclosed in the accompanying footnotes in our Quarterly Report on Form 10-Q
for the quarters ended March 31, 2002 and June 30, 2002, respectively. Under the
terms  of  the related guaranty agreements, we could, at any time, terminate our
obligations  and the lenders' rights under the guaranty agreements, but we would
remain  liable  for  any  losses  incurred  by  the  lenders  in liquidating the
guaranteed accounts by selling the common stock held as collateral in the margin
loan  accounts  in  order  to  pay off the margin loan balances in full during a
reasonable time subsequent to the receipt of our termination notice. On June 30,
2003, we filed an amended Annual Report on Form 10-K for the year ended December
31, 2001 and amended Quarterly Reports on Form 10-Q for the quarters ended March
31,  2002  and  June  30,  2002. These amended reports included restated balance
sheets  that  classified  the  pledged  funds  as cash pledged as collateral for
related party obligations beginning at December 31, 2000 as a result of comments
received  from  the  Securities and Exchange Commission in connection with their
review  of  our  registration  statement on Form S-3 that we originally filed on
August  9,  2002.

                                       18

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. 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. We have not
initiated any formal settlement negotiations with these individuals because they
were  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.

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 alleged 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
alleged  and  sought  resulting  economic  and  exemplary  damages,  rescission,
interest,  attorneys'  fees  and  court  costs.

On  November  9,  2005,  we  entered  into  a  settlement agreement with all the
plaintiffs  named  above. Under the terms of the settlement, the plaintiffs will
dismiss  the  pending litigation, with prejudice, and release all claims against
the  Company,  its  current  and  former  officers and directors, and our former
auditors,  Ernst & Young, LLP. Additionally, we will reset the exercise price of
1,912,400  warrants  to  purchase  our  common stock held by the plaintiffs from
$1.80  per share to a new exercise price of $0.20 per share. We will also extend
the  expiration  date  of  the  warrants from November 27, 2006, to November 27,
2007. We recorded a non-cash expense of $151,309 in the third quarter of 2005 as
a  result  of the modification of the warrant terms. We are not paying any other
economic consideration to fund this settlement. On balance, we believe the terms
of this settlement to be fair and equitable to the Company and its shareholders.
We  will  no  longer  incur  significant expenses associated with defense of the
litigation  and  the uncertainly inherent in any litigation is now resolved at a
reasonable  cost.

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

During  the  quarter  ended  September 30, 2005, we sold 1,284,486 shares of our
common  stock  to  Dutchess  Private Equities Fund pursuant to an equity line of
credit  and  received  total  proceeds,  net  of  issuance  costs,  of $201,325.

                                       19

Item  3.  DEFAULTS  UPON  SENIOR  SECURITIES

On April 10, 2005, we defaulted on payment of a note payable to Dutchess Private
Equities Fund, II, LP in the amount of $194,900, including principal and accrued
interest.  As  of  the  date  of  this  report, there was no amount in arrearage
because  we  repaid  the  full  balance  of  the  note plus accrued interest and
penalties using a portion of the proceeds from a promissory note we entered into
with  Dutchess  dated  May  12,  2005.

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     Articles  of  Incorporation,  as amended (included as exhibit 3.1 to the
Form  10-Q  filed  November  14,  2003,  and  incorporated herein by reference).

3.2     By-laws,  as  amended  (included  as  exhibit 3.2 to the Form SB-2 filed
December  29,  1999,  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 January 26, 2005, and incorporated herein by
reference).

4.2     Amended  and  Restated  1999  Non-Employee  Director  Plan  (included as
exhibit  4.2  to the Form S-8 filed January 26, 2005, 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).

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).

                                       20

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).

21.1     Subsidiaries  of the Company (included as exhibit 21.1 to the Form 10-K
filed  April  1,  2002,  and  incorporated  herein  by  reference).

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

32.1     Certification  of  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:

The  Company  did not file any reports on Form 8-K during the three months ended
September  30,  2005.

                                       21

                                    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,  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)

                                       22