Properly configured Series 1 or Series 2 hardware will work fine with the XBee Lilypad.
Not sure what bouncing back letters means....
The Xbee configuration has proven to be a challenge, especially as there aren't that many good tutorials on setting up the series 2 Xbee's.
I'm assuming that you have code on one Arduino that is bringing a pin high and low when it *receives* "H" and "L" over the serial port. And code on the other Arduino that sends an "H" and "L" to the first one. That's right?