September 2004

Dear Shareholders:

The past year has been evolutionary for Payment Data Systems. With so many achievements to date and prospects on the horizon, now is a good time to review and update our loyal shareholders.

What is now Payment Data Systems evolved from billserv.com, a successful public company formed in 1998 to provide Electronic Bill Presentment and Payment (EBPP) opportunities for both billers and consumers. At the end of 2002, Billserv had become the largest and most successful EBPP company in its industry. It serviced more than 120 customers, under multi-year contracts, that represented more than 15% of all the paper bills produced in the United States.

But Billserv required significant additional capital to complete its business plan and allow for profitability. After the dotcom fall out and the downturn in the markets of 2002, sources of capital all but dried up for Billserv. To protect shareholders, Billserv, Inc. divested itself of its bill presentment assets (not including billx.com), cleared debt, and used the proceeds to reorganize the remaining Billserv shell into a company focused on electronic payments. That shell became Payment Data Systems (PDS), a multi-faceted electronic payment processing company. 

billx.com now operates as a wholly-owned subsidiary of PDS.  The Company provides consumers with electronic payments for bills; whether presented electronically or otherwise.  Recent enhancements now provide consumers the ability to pay anyone with an e-mail address, transfer money between multiple checking and savings accounts, view and pay additional eBills, and receive eBill summaries in their e-mail inbox. 

billx.com revenues are continuing to grow at double-digit rates.  We believe this growth is in part due to highly competitive product offerings as well as considerable value and ease-of-use for consumers. Additional growth has arisen from partner CheckFree by transferring customer bases from other portals such as Silicon Investor, GO2NET, Dogpile, Hypermart, and Verilytics.

Payment Data Systems, the parent company, continues to be a debt free public company organized to provide integrated electronic payment services, including a full range of merchant services and all forms of ACH processing, delivered over the Web, by phone (Interactive Voice Response) or directly to a Customer Service Representative (using our tools).  Payments can be either one-time or recurring.

The following are additional important, recent developments:

Ø      Patent application filed for the supporting technology to enable bill payment coupled with a Debit/ATM cards. 

Ø      Partnership with Secure Cash Network to provide a dual debit card targeted to the un-banked Hispanic market that provides for secure wire transfers to home countries. Distribution of the card has begun and is now being delivered to over 10,000 retail outlets across the U. S.

Ø      Secured $10 million Equity Line of Credit that will allow for planned expansion and acquisition activities.

To-date, PDS has become nearly as successful as Billserv.com was in attracting and servicing quality and significant companies.  Over the past several months, our ability to move from contracting traditional retail merchant services business to signing customers of an ever-increasing size and scale has proven promising and our sales pipeline is full of opportunities that could lead to exciting new sales from billers and merchants of all sizes and many different industries.

Our organic growth strategies provided by our direct sales force and strategic reseller partnerships with companies such as Harbor Payments, Paymerica and ACH Commerce are proving successful and are expected to allow for continued top line growth.  Development and implementation of our comprehensive acquisition strategy should drive dramatic and accretive growth over the long term. 

I hope this letter has clarified your company’s history and current outlook.  We are committed to earning your continued support through careful management, strategic growth and opportunities.  

I am always available to respond to your inquiries or concerns.  You may reach me directly at (210) 249-4040 or by email at michael.long@paymentdata.com. 

Sincerely,

Michael R. Long

Chairman and CEO