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 June 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 ___
                                                                      --

As of August 8, 2005, 31,110,577 shares of the issuer's common stock, $0.001 par
value,  were  outstanding.

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

<TABLE>
<CAPTION>




PAYMENT DATA SYSTEMS, INC.

INDEX

<S>                                                                 <C>
PART I - FINANCIAL INFORMATION . . . . . . . . . . . . . . . . . .  Page
------------------------------

Item 1. Financial Statements (Unaudited)

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

Consolidated Statements of Operations for the three and six months
ended June 30, 2005 and 2004                                           4

Consolidated Statements of Cash Flows for the six months
ended June 30, 2005 and 2004                                           5

Notes to Consolidated Financial Statements                             6

Item 2 Management's Discussion and Analysis or Plan of Operation      10

Item 3 Controls and Procedures                                        15

PART II - OTHER INFORMATION

Item 1 Legal Proceedings                                              16

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds    17

Item 3 Defaults Upon Senior Securities                                17

Item 4 Submission of Matters to a Vote of Security Holders            18

Item 5 Other Information                                              18

Item 6 Exhibits and Reports on Form 8-K                               18

</TABLE>

                         PART I - FINANCIAL INFORMATION

Item  1.  FINANCIAL  STATEMENTS

<TABLE>
<CAPTION>

                           PAYMENT DATA SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS


<S>                                                  <C>               <C>
                                                     June 30, 2005     December 31, 2004
                                                       (Unaudited)
                                                   ---------------      ---------------
Assets:
Current assets:
 Cash and cash equivalents . . . . . . . . . . .   $      463,162       $      153,966
 Accounts receivable, net. . . . . . . . . . . .           74,207               57,788
 Prepaid expenses and other. . . . . . . . . . .          159,930               47,833
                                                   ---------------      --------------
Total current assets . . . . . . . . . . . . . .          697,299              259,587

Property and equipment, net. . . . . . . . . . .          175,700              132,064
Other assets . . . . . . . . . . . . . . . . . .           23,589               23,589
                                                   ---------------      --------------
Total assets . . . . . . . . . . . . . . . . . .   $      896,588       $      415,240
                                                   ===============      ==============

Liabilities and stockholders' equity (deficit):
Current liabilities:
 Accounts payable. . . . . . . . . . . . . . . .   $      562,367       $      482,788
 Accrued expenses. . . . . . . . . . . . . . . .          397,896              392,515
 Note payable. . . . . . . . . . . . . . . . . .          579,376              264,165
                                                   ---------------      --------------
Total current liabilities. . . . . . . . . . . .        1,539,639            1,139,468

Stockholders' equity (deficit):

 Common stock, $0.001 par value, 200,000,000 shares
  authorized; 30,600,078 and 23,569,180 issued and
  outstanding . . . . . . . . . . . . . . . . . .          30,600               23,569
 Additional paid-in capital . . . . . . . . . . .      48,986,664           47,417,898
 Deferred compensation. . . . . . . . . . . . . .        (542,109)                   -
 Accumulated deficit. . . . . . . . . . . . . . .     (49,118,206)         (48,165,695)
                                                   ---------------      --------------
Total stockholders' equity (deficit)  . . . . . .        (643,051)            (724,228)
                                                   ---------------      --------------
Total liabilities and stockholders' equity (deficit)$     896,588       $      415,240
                                                   ===============      ==============
<FN>
See  notes  to  interim  consolidated  financial  statements.


</TABLE>

<TABLE>
<CAPTION>

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

<S>                                            <C>                            <C>                          <C>          <C>
                                               Three Months Ended June 30,        Six Months Ended June 30,
                                                  2005        2004                   2005         2004
                                               ----------  ----------             -----------  ----------

Revenues. . . . . . . . . . . . . . . . . . .  $ 314,926   $  64,202              $  557,888   $ 119,399

Operating expenses:
Cost of services. . . . . . . . . . . . . . .    271,211      65,719                 495,840     129,359
Selling, general and administrative . . . . .    449,886     272,884                 860,989     632,703
Depreciation and amortization . . . . . . . .     17,718      25,353                  38,111      53,035
                                               ----------  ----------             -----------  ----------
Total operating expenses. . . . . . . . . . .    738,815     363,956               1,394,940     815,097
                                               ----------  ----------             -----------  ----------

Operating loss. . . . . . . . . . . . . . . .   (423,889)   (299,754)               (837,052)   (695,698)

Other income (expense), net:
Interest income . . . . . . . . . . . . . . .        264         245                     266         643
Interest expense. . . . . . . . . . . . . . .    (68,544)          -                (110,609)          -
Other income (expense). . . . . . . . . . . .     (4,362)     (3,440)                 (5,116)     (8,610)
                                               ----------  ----------             -----------  ----------
Total other income (expense), net . . . . . .    (72,642)     (3,195)               (115,459)     (7,967)
                                               ----------  ----------             -----------  ----------

Loss from operations before income taxes. . .   (496,531)   (302,949)               (952,511)   (703,665)
Income taxes. . . . . . . . . . . . . . . . .          -           -                       -           -
                                               ----------  ----------             -----------  ----------

Net loss. . . . . . . . . . . . . . . . . . .  $(496,531)  $(302,949)             $ (952,511)  $(703,665)
                                               ==========  ==========             ===========  ==========

Basic and diluted net loss per common share:   $   (0.02)  $   (0.01)             $    (0.04)  $   (0.03)
Weighted average common shares outstanding    28,596,016  21,491,884              26,523,006  21,340,681
<FN>
See  notes  to  interim  consolidated  financial  statements.


</TABLE>

<TABLE>
<CAPTION>

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

<S>                                                                          <C>                          <C>
                                                                            Six Months Ended June 30,
                                                                                2005        2004
                                                                             ----------  ----------

Operating activities:
Net loss. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .  $(952,511)  $(703,665)
Adjustments to reconcile net loss to net cash used in operating activities:
 Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . .     38,111      53,035
 Non-cash issuance of common stock. . . . . . . . . . . . . . . . . . . . .    353,667      69,200
 Deferred compensation. . . . . . . . . . . . . . . . . . . . . . . . . . .     49,281           -
 Amortization of debt discount. . . . . . . . . . . . . . . . . . . . . . .     46,086           -
 Changes in current assets and current liabilities:
 Accounts receivable. . . . . . . . . . . . . . . . . . . . . . . . . . . .    (16,419)     17,027
 Prepaid expenses and other . . . . . . . . . . . . . . . . . . . . . . . .     64,903      54,372
 Accounts payable and accrued expenses. . . . . . . . . . . . . . . . . . .     93,204      62,058
                                                                             ----------  ----------
Net cash used in operating activities . . . . . . . . . . . . . . . . . . .   (323,678)   (447,973)

Investing activities:
Purchases of property and equipment . . . . . . . . . . . . . . . . . . . .    (71,747)     (1,079)
                                                                             ----------  ----------
Net cash used in investing activities . . . . . . . . . . . . . . . . . . .    (71,747)     (1,079)

Financing activities:
Proceeds from notes payable . . . . . . . . . . . . . . . . . . . . . . . .    600,000           -
Principal payments for notes payable. . . . . . . . . . . . . . . . . . . .   (330,875)          -
Financing costs, net. . . . . . . . . . . . . . . . . . . . . . . . . . . .    (20,000)          -
Issuance of common stock, net of issuance costs . . . . . . . . . . . . . .    455,496       3,345
                                                                             ----------  ----------
Net cash provided by financing activities . . . . . . . . . . . . . . . . .    704,621       3,345
                                                                             ----------  ----------
Change in cash and cash equivalents . . . . . . . . . . . . . . . . . . . .    309,196    (445,707)

Cash and cash equivalents, beginning of period. . . . . . . . . . . . . . .    153,966     528,119
                                                                             ----------  ----------
Cash and cash equivalents, end of period. . . . . . . . . . . . . . . . . .  $ 463,162   $  82,412
                                                                             ==========  ==========
<FN>
See  notes  to  interim  consolidated  financial  statements.


</TABLE>

                           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.

<TABLE>
<CAPTION>



<S>                                     <C>                            <C>                          <C>         <C>
                                      Three Months Ended June 30,    Six Months Ended June 30,
                                      ---------------------------    -------------------------
                                           2005        2004               2005        2004
                                        ----------  ----------         ----------  ----------

Net loss, as reported. . . . . . . . .  $(496,531)  $(302,949)         $(952,511)  $(703,665)

Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects       (275)    (67,755)            (1,590)   (135,510)
                                        ----------  ----------         ----------  ----------

Pro forma net loss . . . . . . . . . .  $(496,806)  $(370,074)         $(954,101)  $(839,175)
                                        ==========  ==========         ==========  ==========

Net loss per common share
- basic and diluted, as reported . . .  $   (0.02)  $   (0.01)             (0.04)  $   (0.03)

Net loss per common share
- basic and diluted, pro forma . . . .  $   (0.02)  $   (0.02)         $   (0.04)  $   (0.04)

</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  June  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.  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  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.

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 six months ended June 30, 2005, the Company sold 1,735,358
shares  of  its  common stock pursuant to the equity line of credit and received
total  proceeds,  net of issuance costs, of $374,470. 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 six months ended June 30, 2005, the Company issued a total of 363,847
shares  of common stock under the terms of its Comprehensive Employee Stock Plan
to  independent  contractors  providing  consulting  services to the Company and
recorded  $93,988  of  related  expense.

During  the  six months ended June 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.

Note  8.  Subsequent  Events

Subsequent  to  June  30,  2005 and through the date of this report, the Company
sold  534,503  shares  of its common stock pursuant to the equity line of credit
(see  Note  5)  and  received total proceeds, net of issuance costs, of $92,700.

Subsequent  to  June  30,  2005 and through the date of this report, the Company
issued  a  total  of  52,019  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 $10,240 of related
expense.

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

The  following  discussion  and  analysis  of financial condition and results of
operations  contains  forward-looking  statements that involve a number of risks
and  uncertainties.  Actual results in future periods may differ materially from
those  expressed  or implied in such forward-looking statements. 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 June 30, 2005, we have an
accumulated  deficit  of  $49.1  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.

Critical  Accounting  Policies

General

Management's  Discussion  and Analysis of Our Financial Condition and Results of
Operations  is based upon our consolidated financial statements, which have been
prepared  in  accordance with U.S. generally accepted accounting principles. The
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 June 30, 2005, our card
merchant  processing  loss  reserve  was  $15,017.  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  June 30, 2005, the balance of the allowance for doubtful accounts was
$10,207.  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 six months ended June 30,
2005.

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 June 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
June 30, 2005 increased 391% to $314,926 from $64,202 for the quarter ended June
30,  2004.  Revenues  for  the  six months ended June 30, 2005 increased 367% to
$557,888  from  $119,399  for  the six months ended June 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 was also due to an increase in the
average  number of consumers subscribing to the bills.com payment service and an
increase  in  the  monthly  fee  paid  by  certain  consumers subscribing to the
bills.com  payment  service  because  these  consumers were converted from a per
payment  pricing  plan  to  a  flat  monthly  fee pricing plan during the second
quarter  of  2004.  The  monthly  average  number  of consumers using our online
payment service increased to 2,892 and 2,929 in the first quarter and six months
of  2005  from  1,986  and  2,039  in  the first quarter and six months of 2004,
respectively.


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. We expect that revenues generated by our
bills.com  payment  service  will  decrease  as  we transition to processing the
online  payments  ourselves  during the third quarter of 2005. We had previously
been  using a third party provider to process the payments, but will now be able
to  market  the service as a private-label application to prospective resellers.
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 85% of our total
revenues  in  the  three  months  ended  June 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 $271,211 and $65,719 for the quarters ended
June  30,  2005  and  2004,  respectively, and $495,840 and $129,359 for the six
months  ended June 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.

Selling,  general  and  administrative  expenses  increased  to $449,886 for the
quarter  ended  June 30, 2005, from $272,884 for the second quarter of 2004. The
increase  from  the  prior  year  quarter  was principally due to an increase in
consulting  expenses  related  to  debt  and  equity  financing  efforts  of
approximately  $81,000  and  non-cash  amortization  of deferred compensation of
$49,281  related  to  employee  incentive  stock  grants.  Selling,  general and
administrative  expenses  for  the  six  months ended June 30, 2005 increased to
$860,989 from $632,703 for the six months ended June 30, 2004. The increase from
the  prior  year  period was primarily due to the higher consulting expenses and
the  deferred  compensation  expense  recorded in the second quarter of 2005. In
addition,  higher  contract labor costs in sales and legal fees also contributed
to  the  increase  from  the  prior  year  period.

Depreciation  and  amortization  decreased to $17,718 for the quarter ended June
30,  2005,  as  compared to $25,353 for the second quarter of 2004. Depreciation
and  amortization  for  the  six months ended June 30, 2005 decreased to $38,111
from $53,035 for the six months ended June 30, 2004. These decreases were due to
lower  depreciation  related  to  certain  assets  that became fully depreciated
during  2004. We capitalized $71,747 of computer hardware and software purchased
during  the  six  months  ended  June  30, 2005 and anticipate making additional
capital  expenditures  of approximately $25,000 over the remaining six months of
2005.

Net  other  expense was $72,642 for the quarter ended June 30, 2005, compared to
$3,195  for  the  second quarter of 2004. Net other expense was $115,459 for the
six months ended June 30, 2005, compared to $7,967 for the six months ended June
30,  2004.  The  increases were attributable to $73,660 and $115,725 of interest
expense  and  penalties  incurred  in  the quarter and six months ended June 30,
2005,  respectively,  related  to  our  notes  payable  to  Dutchess.

Net loss increased to $496,531 for the quarter ended June 30, 2005 from $302,949
for  the  prior  year quarter and increased to $952,511 for the six months ended
June  30,  2005  from  $703,665  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 interest
expense  as  discussed.

Liquidity  and  Capital  Resources

At  June  30,  2005,  we  had $463,162 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.

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 June 30, 2005, we have sold a total of
3,194,793  shares  of our common stock pursuant to the equity line of credit and
received  total  proceeds,  net  of issuance costs, of $695,956. 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.

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 $323,678 and $447,973 for the six
months  ended  June  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 $71,747 and $1,079 for the six months
ended  June  30, 2005 and 2004, respectively, and reflected capital expenditures
for computer hardware and software. We anticipate making capital expenditures of
approximately  $25,000  during  the  remaining  six  months  of  2005.

Net  cash  provided by financing activities of $704,621 for the six months ended
June 30, 2005 resulted from receiving $455,496 in net proceeds from the issuance
of  common  stock,  primarily  under  our  equity  line of credit, and receiving
$269,125 in net proceeds under our notes payable. Net cash provided by financing
activities  of  $3,345  for the six months ended June 30, 2004 resulted from the
exercise  of  stock  options.

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 June 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.  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.

FORWARD-LOOKING  STATEMENTS  DISCLAIMER

Except for the historical information contained herein, the matters discussed in
our  Form  10-QSB include certain forward-looking statements, 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.
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. One or more
of  these  factors have affected, and in the future could affect, our businesses
and  financial  results  in  the future and could cause actual results to differ
materially from plans and projections. 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  assume  no  obligation  to  update any forward-looking
statements,  except  as  required  by  law.

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  the  second  quarter  of  the year covered by this report that
materially  affected, or is reasonably likely to materially affect, our internal
control  over  financial  reporting.

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  December  31,  2004.

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.

We  may  institute  litigation  or  arbitration in collection of the outstanding
repayment  obligations  of Mr. Long, Mr. Hoch, Mr. Millard, and Mr. Jones, which
currently  total $1,278,138. Presently, we have refrained from initiating action
to recover these funds from Mr. Long, Mr. Hoch, and Mr. Millard because they may
have  offsetting  claims  that  total  $1,445,500  collectively by virtue of the
change  of control clause in their respective employment agreements based on our
preliminary  analysis.  We  understand  that  these  individuals may assert such
claims  based on our sale of substantially all of our assets to Harbor Payments,
Inc.  on July 25, 2003. We have not initiated any formal settlement negotiations
with  these  individuals because they 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 allege that we,
acting  through  such  directors,  misstated in our 2000 and 2001 Form 10-Ks our
ability to use for operational purposes the funds pledged as security for margin
loans  of  certain of our executive officers, as discussed above. The plaintiffs
allege  and seek resulting economic and exemplary damages, rescission, interest,
attorneys'  fees  and  costs of court. We believe this suit is without merit and
intend  to vigorously defend the company and the directors named in the suit. As
of the date of this report, there have been no material developments in the suit
other  than  the  case  being  set  for trial in late 2005. The results of legal
proceedings  cannot  be  predicted with certainty. If we fail to prevail in this
legal  matter,  our  financial  position,  results of operations, and cash flows
could  be  materially  adversely  affected.

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

During  the  six  months  ended  June  30, 2005, we sold 1,735,358 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 $374,470.

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

At  the  Annual  Meeting  of  Stockholders  held on June 21, 2005, the following
matters  were  adopted  by  the  margins  indicated:

1.     To  elect  director Peter G. Kirby to serve until the 2008 Annual Meeting
of  Stockholders.

     For:                    24,164,782
     Withheld:                   93,564

2.     To  ratify  the  appointment  of  Akin,  Doherty,  Klein  &  Fuege, P.C.,
certified public accountants, as the independent auditors of the Company for the
year  ending  December  31,  2005.

     For:                    24,204,183
     Against:                    29,203
     Abstain:                    24,960

The  following directors continued their term of office subsequent to the Annual
Meeting:  Michael  R.  Long,  Louis  A.  Hoch  and  Peter  G.  Kirby.

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).

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.

(a)     Reports  on  Form  8-K:

On  May  5,  2005,  the  Company filed a report on Form 8-K to disclose that the
Company  entered  into  a  Common Stock Rights Agreement between the Company and
American  Stock  Transfer  &  Trust  Company,  as  Rights  Agent.


                                    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:  August  15,  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)