<PAGE>   1
================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                   FORM 10-Q

(Mark One)
[X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30,
       1998.

                                     Or

[ ]    TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
       EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO _____ ,
       __19 . 
       --------------- ------------ -----

                       Commission file number : 000-24695
                                                ---------

                              --------------------

                              TOWNE SERVICES, INC.
             (Exact name of registrant as specified in its charter)

<TABLE>
<S>                                                                       <C>
                       Georgia                                                          62-1618121
(State or other jurisdiction of incorporation or organization)            (I.R.S. Employer Identification No.)
</TABLE>

         3295 River Exchange Drive, Suite 350, Norcross, Georgia 30092
             (Address of principal executive offices and zip code)

                                 (770) 734-2680
              (Registrant's telephone number, including area code)
                                      N/A

  (Former name, former address and former fiscal year, if changed since last
                                    report)


         Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days (1) Yes X No  ; (2) Yes X   No  .
                                                --   --          --    --

         Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. 18,697,059 shares
outstanding at November 11, 1998.

================================================================================



                                       1
<PAGE>   2



                              TOWNE SERVICES, INC.
                               INDEX TO FORM 10-Q

<TABLE>
<CAPTION>
                                                                                                                PAGE
          <S>                        <C>                                                                         <C>
          PART I                     FINANCIAL INFORMATION

              Item 1.                Financial Statements

                                     Balance Sheets as of
                                     September 30, 1998 and December 31, 1997                                     3

                                     Statements of Operations for the Three Months and
                                     Nine Months Ended September 30, 1998 and 1997                                4

                                     Statements of Cash Flows for the Nine Months
                                     Ended September 30, 1998 and 1997                                            5

                                     Notes to Financial Statements                                                6

               Item 2.               Management's Discussion and Analysis of Financial
                                     Condition and Results of Operations                                          8

          PART II                    OTHER INFORMATION

               Item 1.               Legal Proceedings                                                           18

               Item 2.               Changes in Securities and Use of Proceeds                                   18

               Item 3.               Defaults upon Senior Securities                                             18

               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

          Signatures                                                                                             20

          Exhibit 27.1                                                                                           21
                                                                                                                 
</TABLE>



                                       2
<PAGE>   3



                         PART I. FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS


                              TOWNE SERVICES, INC.
                                 BALANCE SHEETS
                    DECEMBER 31, 1997 AND SEPTEMBER 30, 1998

<TABLE>
<CAPTION>
                                                                             DECEMBER 31,   SEPTEMBER 30,
                                                                                1997            1998
                                                                           ------------------------------
                                                                                             (UNAUDITED)
<S>                                                                        <C>               <C>
                                     ASSETS
CURRENT ASSETS:
  Cash and cash equivalents                                                $   2,536,439     $ 23,464,901
  Accounts receivable, net of allowance
     for uncollectible accounts of $25,000 and $70,000
     in 1997 and 1998, respectively                                              121,566        1,797,853
  Note receivable                                                                 78,990          163,985
  Other                                                                           68,273          159,984
                                                                           ------------------------------
       Total current assets                                                    2,805,268       25,586,723
                                                                           ------------------------------

PROPERTY AND EQUIPMENT, net                                                      489,849        1,483,818
DEBT ISSUANCE COSTS, net                                                         288,815                -
OTHER ASSETS, net                                                                  2,500          242,070
                                                                           ------------------------------
                                                                           $   3,586,432     $ 27,312,611
                                                                           ==============================

                      LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
  Accounts payable                                                         $     297,937      $   488,978
  Accrued liabilities                                                            215,109          367,942
  Accrued compensation                                                           220,300               --
  Current portion of long-term debt                                               46,757               --
                                                                           ------------------------------
     Total current liabilities                                                   780,103          856,920
                                                                           ------------------------------

LONG TERM DEBT, net of discount of $249,500 and
     $0  in 1997 and 1998, respectively                                        1,289,666               --
COMMITMENTS AND CONTINGENCIES
WARRANTS WITH REDEMPTION FEATURE                                                 255,000               --
SHAREHOLDERS' EQUITY:
  Preferred stock, no par value; 20,000,000 shares authorized, 0
     issued and outstanding in 1997 and 1998, respectively                            --               --
  Common stock, no par value; 50,000,000 shares authorized,
     11,706,766 and 18,673,734  issued and outstanding in 1997
     and 1998, respectively                                                    4,417,696       47,203,828
  Warrants outstanding                                                            41,000           41,000
  Accumulated deficit                                                         (3,197,033)     (20,789,137)
                                                                           ------------------------------
     Total shareholders' equity                                                1,261,663       26,455,691
                                                                           ------------------------------
                                                                           $   3,586,432     $ 27,312,611
                                                                           ==============================
</TABLE>

     The accompanying notes are an integral part of these balance sheets.



                                       3
<PAGE>   4



                              TOWNE SERVICES, INC.
                            STATEMENTS OF OPERATIONS
        FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998


<TABLE>
<CAPTION>
                                                               FOR THE THREE              FOR THE NINE
                                                               MONTHS ENDED               MONTHS ENDED
                                                               SEPTEMBER 30,              SEPTEMBER 30,
                                                            1997          1998         1997          1998
                                                          ---------------------------------------------------
                                                              (UNAUDITED)                 (UNAUDITED)
<S>                                                       <C>         <C>             <C>         <C>
REVENUES                                                   $ 198,086  $ 1,715,330   $   383,066  $  3,136,865

COSTS AND EXPENSES:
  Costs of processing, servicing, and support                222,417      543,741       475,165     1,321,576
  Research and development                                   114,082      117,068       158,996       293,079
  Purchased in process development                                --           --            --       200,000
  Sales and marketing                                        206,537    1,971,355       419,183     3,596,783
  Stock compensation expense                                      --       36,338            --     6,044,267
  General and administrative                                 267,661      644,746       619,392     2,696,936
                                                          ---------------------------------------------------
     Total costs and expenses                                810,697    3,313,248     1,672,736    14,152,641
                                                          ---------------------------------------------------
OPERATING LOSS                                              (612,611)  (1,597,918)   (1,289,670)  (11,015,776)
                                                          ---------------------------------------------------

OTHER EXPENSES:
  Interest (income) expense, net                              28,990     (158,155)       74,467       (27,123)
  Other expense                                                   --        3,990          (648)        4,242
  Financing costs for stock issued to nonemployees                --           --            --       323,000
                                                          ---------------------------------------------------
     Total other expenses                                     28,990     (154,165)       73,819       300,119
                                                          ---------------------------------------------------

  Loss before extraordinary loss on early extinguishment
    of debt                                               $ (641,601) $(1,443,753)  $(1,363,489) $(11,315,895)
                                                          ---------------------------------------------------

  Extraordinary loss on early extinguishment of debt
                                                                  --      476,239            --       476,239
                                                          ---------------------------------------------------

NET LOSS                                                  $ (641,601) $(1,919,992)  $(1,363,489) $(11,792,134)

PREFERRED STOCK DIVIDENDS                                         --           --            --    (5,108,000)

ACCRETION OF WARRANTS WITH REDEMPTION  FEATURE                    --     (196,975)           --      (691,972)

NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
   BEFORE EXTRAORDINARY LOSS:
                                                          ===================================================
Basic                                                     $ (641,601) $(1,640,728)   (1,363,489)  $(17,115,867)
                                                          ===================================================
Diluted                                                   $ (641,601) $(1,640,728)   (1,363,489)  $(17,115,867)
                                                          ===================================================

NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
   PER COMMON SHARE BEFORE EXTRAORDINARY LOSS:
Basic                                                          (0.07)       (0.10)        (0.15)        (1.20)
                                                          ===================================================
Diluted                                                        (0.07)       (0.10)        (0.15)        (1.20)
                                                          ===================================================

NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS:
                                                          ====================================================
Basic                                                     $ (641,601) $(2,116,967)  $(1,363,489)  $(17,592,106)
                                                          ====================================================
Diluted                                                   $ (641,601) $(2,116,967)  $(1,363,489)  $(17,592,106)
                                                          ====================================================

NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
     PER COMMON SHARE:
Basic                                                     $    (0.07) $     (0.12)  $     (0.15)  $      (1.23)
                                                          ====================================================
Diluted                                                   $    (0.07) $     (0.12)  $     (0.15)  $      (1.23)
                                                          ====================================================

Weighted Average Common Shares Outstanding                 9,683,793   16,997,071     9,069,323     14,309,909
                                                          ====================================================
</TABLE>


       The accompanying notes are an integral part of these statements.



                                       4
<PAGE>   5


                              TOWNE SERVICES, INC.
                            STATEMENT OF CASH FLOWS
             FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998

<TABLE>
<CAPTION>
                                                                                 NINE MONTHS ENDED
                                                                                   SEPTEMBER 30,
                                                                                1997           1998
                                                                           ---------------------------
                                                                                    (UNAUDITED)
<S>                                                                         <C>           <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net Loss                                                                  $(1,363,489)  $(11,792,134)
  Adjustments to reconcile net loss to net cash
     used in operating activities:
      Compensation expense recognized for stock
         option grants                                                               --      6,044,267
      Financing costs for stock issued to nonemployees                               --        323,000
      Extraordinary loss from early extinguishment of debt                           --        476,239
      Purchase in process development                                                --        200,000
      Depreciation and amortization                                              30,472        164,320
      Amortization of debt financing fees                                        24,043         13,496
      Amortization of debt discount                                                  --         33,025
      Changes in operating assets and liabilities, net of assets acquired:
           Accounts receivable                                                  (65,006)    (1,616,380)
           Prepaid & other assets                                                12,652       (185,130)
           Stock subscriptions receivable                                            --        427,500
           Accounts payable                                                     125,891        191,041
           Accrued liabilities                                                   46,657        838,830
           Accrued compensation                                                      --       (906,297)
           Deferred revenue                                                     (13,103)            --
                                                                           ---------------------------
                   Total adjustments                                            161,606      6,003,911
                                                                           ---------------------------
                    Net cash used in operating activities                    (1,201,883)    (5,788,223)
                                                                           ---------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
  Note receivable from shareholder                                              (78,990)       (84,995)
  Purchase of Credit Collection Solutions, Inc., net of cash acquired                --       (510,000)
  Purchase of property and equipment, net                                      (226,534)    (1,104,040)
                                                                           ---------------------------
                    Net cash used in investing activities                      (305,524)    (1,699,035)
                                                                           ---------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from exercise of stock options                                       882,903             --
  Repayment of debt                                                             (67,297)    (2,236,761)
  Proceeds from long-term borrowings                                             59,535        628,849
  Proceeds from issuance of preferred stock                                          --      1,500,000
  Proceeds from issuance of common stock                                      1,369,888     28,523,632
                                                                           ---------------------------
                    Net cash provided by financing activities                 2,245,029     28,415,720
                                                                           ---------------------------
NET INCREASE IN CASH                                                            731,622     20,928,462
CASH AND CASH EQUIVALENTS, beginning of period                                  151,082      2,536,439
                                                                           ===========================
CASH AND CASH EQUIVALENTS, end of period                                    $   888,704   $ 23,464,901
                                                                           ===========================

SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for income taxes                                                  $        --   $         --
                                                                           ===========================
Cash paid for interest                                                      $     6,761   $    234,058
                                                                           ===========================
</TABLE>



       The accompanying notes are an integral part of these statements.



                                       5
<PAGE>   6



                              TOWNE SERVICES, INC.
                         NOTES TO FINANCIAL STATEMENTS

1.       ORGANIZATION AND BACKGROUND

Towne Services, Inc. ("Towne Services" or the "Company") designs, develops and
markets products and services that convert the in-house credit transactions of
small businesses into automated "virtual credit card" accounts which are
processed electronically. Usually, in-house credit transactions are completed
without a credit card or cash, are recorded and processed manually and then
billed to the customer at a later date. To automate this process, Towne
Services offers two main electronic processing systems, TOWNE CREDIT(SM) and
TOWNE FINANCE(SM), which process small business' in-house credit transactions
in much the same way as credit card transactions are processed.

The TOWNE CREDIT system electronically processes in-house consumer credit
transactions of small and medium size retail merchants. The TOWNE FINANCE
system, a commercial version of TOWNE CREDIT, is an automated asset management
and financing system that processes business-to-business credit transactions
for small commercial businesses. Through the use of the Company's products and
services, small businesses can automate certain manual processes, accelerate
cash flow, provide better customer service, reduce paperwork and shift many
other administrative burdens to Towne Services. In addition, the Company
provides complementing products and services to banks that enable them to
generate interest-bearing revolving credit accounts by financing the accounts
receivable of these small businesses. Through the use of the Company's
products, banks can monitor customers' accounts receivable and generate
detailed status reports, and may attract new business customers who, in turn,
may become customers of Towne Services.


2.       BASIS OF PRESENTATION

UNAUDITED INTERIM FINANCIAL INFORMATION

The accompanying financial statements and footnote data as of September 30,
1998 and for the three and nine months ended September 30, 1997 and 1998 are
unaudited. In the opinion of the management of the Company, these financial
statements reflect all adjustments, consisting only of normal recurring
adjustments necessary for a fair presentation of the financial statements.
Certain information and footnote disclosures usually found in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. The results of operations for the three and
nine months ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1998 or for any
other future periods.



                                       6
<PAGE>   7


3.       INITIAL PUBLIC OFFERING

On July 30, 1998 the Company's initial public offering (the "Initial Public
Offering") was declared effective by the Securities and Exchange Commission. In
the Initial Public Offering, the Company sold 3,850,000 shares of common stock
at $8.00 per share. The Company received proceeds of $27.0 million (net), after
deducting underwriting discounts and other offering expenses related to the
Initial Public Offering. Upon completion of the Initial Public Offering, all
outstanding shares of Series A Preferred Stock were converted to 1,217,903
shares of common stock and warrants for 308,982 shares of common stock were
exercised.

4.       NEW ACCOUNTING PRONOUNCEMENTS

In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income," which establishes standards for reporting and presentation of
comprehensive income and its components in a full set of general purpose
financial statements. This statement is effective for periods beginning after
December 15, 1997. The Company adopted SFAS No. 130 on January 1, 1998. The
adoption of SFAS 130 did not have a material impact on the Company's financial
statements as comprehensive income did not differ from the reported net loss for
all periods presented.

In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. This statement is
effective for financial statements for periods beginning after December 15,
1997. The adoption of SFAS No. 131 will not have a material impact on the
Company's financial statements.

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. A company may also implement SFAS No. 133 as of
the beginning of any fiscal quarter after issuance (that is, fiscal quarters
beginning June 16, 1988 and thereafter). SFAS No. 133 cannot be applied
retroactively; it must be applied to (a) derivative instruments and (b) certain
derivative instruments embedded in hybrid contracts that were issued, acquired,
or substantively modified after December 31, 1997. The adoption of SFAS No. 133
will not have a material impact on the Company's financial statements.

5.       ACQUISITION

In June 1998, the Company acquired certain assets and liabilities of Credit
Collection Solutions, Inc. ("CCS") for approximately $510,000 cash and the
issuance of up to 100,000 shares of the Company's common stock if certain
financial results are achieved. CCS is a developer of computer software for
processing payments and tracking collections. In connection with the
acquisition, the Company recorded a pre-tax charge of $200,000 for purchased in
process development, which had not reached technological feasibility and had no
alternative future use.

6.       NOTES PAYABLE AND LONG TERM OBLIGATIONS

In August 1998, the Company repaid all current and long term debt obligations.
This resulted in an extraordinary one-time charge to net income of $476,000, or
$.03 per share, which is comprised of $218,000 unamortized discount on a note
payable to Sirrom Investments, Inc. (the "Sirrom Note") and $258,000 deferred
debt issuance costs.



                                       7
<PAGE>   8



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATION

The following discussion should be read in conjunction with Towne Services'
financial statements and the related notes thereto included elsewhere in this
quarterly report. This discussion contains statements which constitute
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. These statements appear in a number of places in this quarterly
report and include all statements that are not historical statements of fact
regarding the intent, anticipation, belief or current expectations of the
Company, its directors or its officers with respect to, among other things: (i)
the Company's financing plans; (ii) trends affecting the Company's financial
condition or results of operations; (iii) the Company's growth strategy and
operating strategy (including, but not limited to, the Company's development and
implementation of its products and services); and (iv) the declaration and
payment of dividends. The words "may," "would," "could," "will," "expect,"
"estimate," "anticipate," "believe," "intend," "plan," and similar expressions
and variations thereof are intended to identify forward-looking statements.
Investors are cautioned that any such forward-looking statements are not
guarantees of future performance and involve risks and uncertainties, many of
which are beyond the Company's ability to control. Actual results may differ
materially from these forward-looking statements as a result of many factors,
including the Company's limited operating history; the inability to achieve or
maintain profitability; the inability to attract and retain sales and marketing
personnel or enter new marketing alliances; inability to obtain, continue and
manage growth or execute agreements with new customers; market acceptance of new
products and enhancements; increased competition; possible system failures;
rapid changes in technology; and the other factors discussed in the Company's
registration statement on Form S-1 (No. 333-53341) as declared effective by the
Securities and Exchange Commission on July 30, 1998, including the "Risk
Factors" section contained therein.


OVERVIEW

Towne Services designs, develops and markets products and services that convert
the in-house credit transactions of small businesses into automated "virtual
credit card" accounts which are processed electronically. Usually, in-house
credit transactions are completed without a credit card or cash, are recorded
and processed manually and then billed to the customer at a later date. Through
the use of Towne's products and services, small businesses can automate certain
manual processes, accelerate cash flow, provide better customer service, reduce
paperwork and shift many other administrative burdens to Towne Services. In
addition, Towne Services provides complementing products and services to banks
that enable them to generate interest-bearing revolving credit accounts by
financing the accounts receivable of these small businesses. Through the use of
Towne's products, banks can monitor customers' accounts receivable and generate
detailed status reports, and may attract new business customers who, in turn,
may become customers of Towne Services.



                                       8
<PAGE>   9



On July 30, 1998 the Company's Initial Public Offering was declared effective
by the Securities and Exchange Commission. In the Initial Public Offering, the
Company sold 3,850,000 shares of common stock at $8.00 per share. The Company
received proceeds of $27.0 million (net), after deducting underwriting
discounts and other expenses related to the Initial Public Offering. Upon
completion of the Initial Public Offering, all outstanding shares of Series A
Preferred Stock were converted to 1,217,903 shares of common stock and warrants
for 308,982 shares of common stock were exercised.

During the nine months ended September 30, 1997 and 1998, the Company invested
the majority of its resources in researching and developing its products,
expanding its marketing activities, building community bank and merchant sales
channels and developing its general and administrative infrastructure.

The Company's revenues currently are generated through initial set-up fees,
discount fees and monthly transaction processing fees. Management believes the
prices charged for both the initial set-up fees and the recurring transaction
fees are based upon the relative fair value of the related services provided.
Accordingly, the Company recognizes these fees as the related services are
provided. Set-up fees include charges for installation, implementation and
training of the Company's bank and business customers. Towne Services
recognizes revenues related to its set-up fees upon execution of the related
contract or, if appropriate, upon settlement of any contract contingencies.
Set-up fees charged to each bank vary depending on the asset size of the bank
and the number of its branches. The Company also charges set-up fees to its
business customers based either upon a flat rate or upon the expected
transaction volume.

As with credit card transactions, the Company's business customer pays a
discount fee to its bank equal to a percentage of the value of each transaction
processed. In addition, the business' customer pays to the bank interest and
fees for amounts owed on account. Towne Services generates recurring revenue by
collecting a portion of the discount fee and, on occasion, interest paid on
these accounts, as well as by charging monthly transaction processing fees.
Monthly transaction processing fees include charges for electronic processing,
statement rendering and mailing, settling payments, recording account changes
and new accounts, leasing and selling point of sale terminals and collecting
debts.

Costs of processing, servicing and support include installation costs for the
Company's products and costs related to customer service, information systems
personnel and installation services.

Research and development expenses consist of salary and related personnel
costs, including costs for employee benefits, computer equipment and support
services, used in product and technology development. The Company believes that
its research and development expenditures, which aid in the design of new
products and product enhancements to respond to changes in customer demand, are
essential for obtaining and retaining a leadership position in its marketplace.
Most research and development expenditures are expensed as incurred; however,
the Company has capitalized certain development costs under Statement of
Financial



                                       9
<PAGE>   10



Accounting Standards ("SFAS") No. 86 when the products reached technological
feasibility.

Sales and marketing expenses consist primarily of salaries and commissions,
travel expenses, advertising, trade show expenses, and costs of marketing
materials. These expenses also include the costs incurred to develop the
Company's indirect marketing channels.

Towne Services had net losses of approximately $642,000 and $1.9 million for
the three months ended September 30, 1997 and 1998, respectively. For the nine
months ended September 30, 1997 and 1998, the Company had net losses of
approximately $1.4 million and $11.8 million, respectively. As of December 31,
1997, the Company had an accumulated deficit of $3.2 million. As of September
30, 1998, this accumulated deficit was $20.8 million. Approximately $12.8
million of this accumulated deficit resulted from one-time non-cash charges.

The Company's business has grown rapidly with total revenues increasing from
$383,000 for the nine months ended September 30, 1997 to $3.1 million for the
nine months ended September 30, 1998. However, the Company has experienced net
losses in each of these periods and expects to continue to incur losses for the
foreseeable future. The number of Towne Services employees increased from 25 at
September 30, 1997 to 139 at September 30, 1998. The Company currently intends
to expand its sales and marketing operations, to invest more in product
research and development, to pursue strategic acquisitions and to improve its
internal operating and financial infrastructure, all of which will increase its
operating expenses.

Because of the Company's limited operating history, management believes that
period to period comparisons of its operating results are not meaningful.
Although the Company has experienced significant revenue growth recently, there
can be no assurance that such growth rates are sustainable, and they should not
be relied upon as indicators of future performance. The Company's prospects
must be considered in light of the risks, expenses and difficulties frequently
encountered by companies in the early stage of development and relatively new
and changing markets. There can be no assurance that the Company will be
successful in addressing such risks and difficulties or that it will achieve
profitability in the future.

RESULTS OF OPERATIONS

COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1998

         Revenues. The Company's revenues increased from $198,000 for the three
months ended September 30, 1997 to $1.7 million for the three months ended
September 30, 1998. During these two periods, set-up fees accounted for
approximately 65% and 58% of total revenues, respectively. Recurring revenues
accounted for approximately 35% and 32% of total revenues, respectively. The
increase in revenues resulted primarily from an increase in the number of
customers and higher set-up fee and transaction processing fees charged to new
customers.



                                      10
<PAGE>   11



         Costs of Processing, Servicing and Support. Costs of processing,
servicing and support increased from $222,000 for the three months ended
September 30, 1997 to $544,000 for the three months ended September 30, 1998.
These costs were approximately 112% and 32% of total revenues, respectively,
for these two periods. The dollar amount of costs of processing, servicing and
support increased as a result of the addition of new customers and additional
services and support functions required for the Company's growth. Towne
Services anticipates that these costs will continue to increase as new
customers are added. Costs of processing, servicing and support decreased as a
percentage of revenue as a result of substantially increased revenues and
improved operating efficiencies.

         Research and Development. The Company increased its research and
development expenses from $114,000 for the three months ended September 30,
1997 to $117,000 for the three months ended September 30, 1998. Research and
development expenses represented approximately 58% and 7% of total revenues,
respectively, during these two periods. Towne Services expects that the dollar
amount of research and development expenses will continue to increase as the
Company recruits and hires additional experienced programmers and develops new
products and services. The Company does not expect to incur significant costs
to make its products year 2000 compliant because it believes its products are
currently designed to properly function through and beyond the year 2000. See 
"-Effects of the year 2000."

         Sales and Marketing. Sales and marketing expenses increased from
$207,000 for the three months ended September 30, 1997 to $2.0 million for the
three months ended September 30, 1998. Sales and marketing expenses were
approximately 104% and 115% of total revenues, respectively, during these two
periods. The increase in sales and marketing expenses during the third quarter
of 1998 is primarily the result of significant increases in the number of sales
personnel in remote locations, related travel expenses and increased costs for
marketing materials used to recruit potential bank and business customers.
Towne Services anticipates that sales and marketing expenses will continue to
increase as it continues to expand its direct sales and marketing force and
hires additional personnel to promote its indirect sales channels.

         Stock Compensation Expense. In the first quarter of 1998, Towne
Services sold shares of common stock and issued options to acquire common stock
at what management believed to be the fair market value of the common stock at
that time. The Company retained an independent appraiser who subsequently
valued the common stock at a higher price. Based upon outside sales to third
parties, the independent valuation and the anticipated Initial Public Offering
price at the time, the Company recorded a one-time non-cash charge for the
additional value. In the third quarter of 1998, the Company recorded $36,000 of
stock compensation expense based upon the vesting schedules of certain of these
options.

         General and Administrative. General and administrative expenses
increased from $268,000 for the three months ended September 30, 1997 to
$645,000 for the three months ended September 30, 1998. These costs represented
approximately 135% and 38% of total revenues, respectively, for these two
periods. The increase in the dollar amount of these expenses was primarily the
result of increases in the number of administrative and operational



                                      11
<PAGE>   12



employees and the costs associated with executive and administrative expenses
related to the Company's growth. Towne Services anticipates that the dollar
amount of these expenses will continue to increase in the near future as it
upgrades internal and financial reporting systems to enhance management's
ability to obtain and analyze information about its operations. Also, the
Company anticipates additional costs related to being a public company,
including annual and other public reporting costs, directors' and officers'
liability insurance, investor relations programs and professional services
fees.

         Interest (Income) Expense, Net. For the three months ended September
30, 1997, the Company reported net interest expense of $29,000. For the three
months ended September 30, 1998, the Company reported net interest income of
$158,000. Interest expense decreased as a result of the payoff of certain debt
obligations and interest income increased as a result of earnings on investments
of cash proceeds received from the Initial Public Offering.

         Extraordinary Loss. For the three months ended September 30, 1998, the
Company reported an extraordinary loss resulting from the early extinguishment
of debt in the amount of $476,000. The extraordinary loss was comprised of
$218,000 unamortized discount on the Sirrom Note and $258,000 in deferred debt
issuance costs. See Note 6 of Notes to Towne's Financial Statements.

         Income Taxes. For the three months ended September 30, 1998, Towne
Services had a net operating loss ("NOL") of approximately $1.9 million for
federal tax purposes that will expire if not utilized by 2011 and 2012. The
Company has not recognized any benefit from the future use of such NOL because
management's assumptions of future profitable operations contain risks that do
not provide sufficient assurance to recognize such tax benefits currently.

COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND SEPTEMBER 30, 1998

         Revenues. The Company's revenues increased from $383,000 for the nine
months ended September 30, 1997 to $3.1 million for the nine months ended
September 30, 1998. During these two periods, set-up fees accounted for
approximately 53% and 64% of total revenues, respectively. Recurring revenues
accounted for approximately 47% and 31% of total revenues, respectively. The
increase in revenues during these periods resulted primarily from an increase
in the number of customers and higher set-up fee and transactions processing
fees charged to new customers. The increase in set-up fee revenues as a
percentage of total revenues resulted primarily from an increase in the number
of customers and higher set-up fees charged to new customers.

         Costs of Processing, Servicing and Support. Costs of processing,
servicing and support increased from $475,000 for the nine months ended
September 30, 1997 to $1.3 million for the nine months ended September 30,
1998. These costs were approximately 124% and 42% of total revenues,
respectively, for these two periods. The dollar amount of costs of processing,
servicing and support increased as a result of the addition of new customers
and additional services and support functions required for the Company's
growth. Towne Services



                                      12
<PAGE>   13



anticipates that these costs will continue to increase as new customers are
added. Costs of processing, servicing and support decreased as a percentage of
revenue as a result of substantially increased revenues and improved operating
efficiencies.

         Research and Development. The Company increased its research and
development expenses from $159,000 for the nine months ended September 30, 1997
to $293,000 for the nine months ended September 30, 1998. Research and
development expenses represented approximately 42% and 9% of total revenues,
respectively, during these two periods. Towne Services expects that the dollar
amount of research and development expenses will continue to increase as the
Company recruits and hires additional experienced programmers and develops new
products and services. The Company does not expect to incur significant costs
to make its products year 2000 compliant because it believes its products are
currently designed to properly function through and beyond the year 2000. See 
"-Effects of the Year 2000."

         Purchased in Process Development. In connection with the acquisition
of Credit Collection Solutions, Inc. in June 1998, the Company recorded a
pre-tax charge of $200,000 for purchased in-process development, which had not
yet reached technological feasibility and had no alternative future use. See 
Note 5 of Notes to Towne's Financial Statements.

         Sales and Marketing. Sales and marketing expenses increased from
$419,000 for the nine months ended September 30, 1997 to $3.6 million for the
nine months ended September 30, 1998. Sales and marketing expenses were
approximately 109% and 115% of total revenues, respectively, during these two
periods. The increase in sales and marketing expenses during the first nine
months of 1998 is primarily the result of significant increases in the number
of sales personnel in remote locations, related travel expenses and increased
costs for marketing materials used to recruit potential bank and business
customers. Towne Services anticipates that sales and marketing expenses will
continue to increase as it continues to expand its direct sales and marketing
force and hires additional personnel to promote its indirect sales channels.

         Stock Compensation Expense. In the first quarter of 1998, Towne
Services sold shares of common stock and issued options to acquire common stock
at what management believed to be the fair market value of the common stock at
that time. The Company retained an independent appraiser who subsequently
valued the common stock at a higher price. Based upon outside sales to third
parties, the independent valuation and the anticipated Initial Public Offering
price at the time, the Company recorded a one-time non-cash charge for the
additional value. Stock compensation expense was $6.0 million for the nine
months ended September 30, 1998.

         General and Administrative. General and administrative expenses
increased from $619,000 for the nine months ended September 30, 1997 to $2.7
million for the nine months ended September 30, 1998. These costs represented
approximately 162% and 86% of total revenues, respectively, for these two
periods. The increase in the dollar amount of these expenses was primarily the
result of increases in the number of administrative and operational



                                      13
<PAGE>   14


employees and the costs associated with executive and administrative expenses
related to the Company's growth. Towne Services anticipates that the dollar
amount of these expenses will continue to increase in the near future as it
upgrades internal and financial reporting systems to enhance management's
ability to obtain and analyze information about its operations. Also, the
Company anticipates additional costs related to being a public company,
including annual and other public reporting costs, directors' and officers'
liability insurance, investor relations programs and professional services
fees.

         Interest (Income) Expense, Net. For the nine months ended September
30, 1997, the Company reported net interest expense of $74,000. For the nine
months ended September 30, 1998, the Company reported net interest income of
$27,000. Interest expense for these periods decreased as a result of the
repayment of debt obligations and interest income increased as a result of
earnings on investments of cash proceeds received from the Initial Public
Offering.

         Extraordinary Loss. For the nine months ended September 30, 1998 the
Company reported an extraordinary loss resulting from the early extinguishment
of debt in the amount of $476,000. The extraordinary loss was comprised of
$218,000 unamortized discount on the Sirrom Note and $258,000 deferred debt
issuance costs. See Note 6 of Notes to Towne's Financial Statements.

         Income Taxes. For the nine months ended September 30, 1998, Towne
Services had NOL of approximately $11.8 million for federal tax purposes that
will expire if not utilized by 2011 and 2012. The Company has not recognized
any benefit from the future use of such NOL because management's assumptions of
future profitable operations contain risks that do not provide sufficient
assurance to recognize such tax benefits currently.

During the Company's short history, its operating results have varied
significantly and are likely to fluctuate significantly in the future as a
result of a combination of factors. These factors include: whether or not the
market accepts current and future products and services; whether new
competitors emerge or existing competitors gain market share faster than Towne
Services; whether new technologies are developed which make Towne's systems
outdated or obsolete; whether costs of doing business increase as a result of
higher wages, sales commissions, taxes and other operating costs; whether
seasonal trends in consumer purchasing impact the volume of transactions
processed; general economic factors and the impact of potential acquisitions to
Towne's operations. In addition, the amount of revenues associated with
particular set-up fees can vary significantly based upon the number of products
used by customers for any particular period. Towne Services establishes its
expenditure levels for product development, sales and marketing and other
operating expenses based, in large part, on its anticipated revenues. As a
result, if revenues fall below expectations, operating results and net income
are likely to be adversely and disproportionately affected because only a
portion of the Company's expenses vary with its revenues.




                                      14
<PAGE>   15
LIQUIDITY AND CAPITAL RESOURCES

Since its inception, Towne Services has financed its operations primarily
through sales of its equity securities in private placements and through
borrowings under the Sirrom Note. Through December 1997, the Company received
aggregate net proceeds of $4.3 million from the sale of its common stock. In
March 1998, the Company received net proceeds of $1.5 million from the sale of
its Series A Preferred Stock in a private placement. In July 1998, the Company
received net proceeds of $27.0 million from the Initial Public Offering.

In August 1998, Towne Services paid off all current and long term debt
obligations, which consisted of the Sirrom Note, certain lines of credit and a
loan from Citizen's Bank, with proceeds received from the Initial Public
Offering. The early extinguishment of certain debt obligations resulted in an
extraordinary loss of $476,000, which is comprised of $218,000 unamortized
discount on the Sirrom Note and $258,000 in deferred debt issuance costs. The
Company currently is negotiating with certain other financial institutions to
establish a credit facility for future working capital and acquisition
financing, but there can be no assurance that such negotiations will be
successful.

Net cash used in operating activities was approximately $1.2 million for the
nine months ended September 30, 1997 and $5.8 million for the nine months ended
September 30, 1998. Net cash used in operating activities during the nine
months ended September 30, 1997 represents a $1.4 million net loss partially
offset by a $173,000 increase in accounts payable and accrued expenses, a
$65,000 increase in accounts receivable and a $13,000 decrease in prepaid
expenses and other assets. Net cash used in operating activities during the
nine months ended September 30, 1998 represents a $11.8 million net loss
partially offset by a $124,000 increase in accounts payable and accrued
expenses, a $1.6 million increase in accounts receivable, a $185,000 increase
in prepaid expenses and other assets and a $428,000 decrease in stock
subscriptions receivable.

Net cash used in investing activities was approximately $306,000 for the nine
months ended September 30, 1997 and $1.7 million for the nine months ended
September 30, 1998. Net cash used in investing activities during the nine months
ended September 30, 1997 represents an increase of $227,000 for the purchase of
computer equipment used in conducting the Company's business and an increase of
$79,000 of notes receivable due from a shareholder. Net cash used in investing
activities during the nine months ended September 30, 1998 represents an
increase of $85,000 in notes due from shareholders, $510,000 to acquire certain
assets and liabilities of Credit Collection Solutions, Inc. and $1.1 million for
the purchase of computer equipment and other capital equipment used in
conducting the Company's business.

Net cash provided by financing activities was $2.2 million for the nine months
ended September 30, 1997 and $28.4 million for the nine months ended September
30, 1998, which consisted primarily of $27.0 million of net proceeds received
from the Initial Public Offering, proceeds from the issuance of other
securities and payment of all outstanding debt obligations.



                                      15
<PAGE>   16



EFFECTS OF THE YEAR 2000

The Company's business and customer relationships rely on computer software
programs, internal operating systems and telephone and other network
communications connections. If any of these programs, systems or network
connections are not programmed to recognize and properly process dates after
December 31, 1999 (the "Year 2000" issue), significant system failures or
errors may result which could have a material adverse effect on the business,
financial condition, or results of operations of both the effected customers
and the Company. Towne Services has conducted tests on its proprietary point of
sale terminals, network connections and transaction processing software and
believes that its TOWNE CREDIT and TOWNE FINANCE products and network
connections it maintains are able to process dates after December 31, 1999. For
its internal accounting and operating systems and network communications, the
Company uses software and other products provided by third parties and has
received warranties or other assurances that most of these products are
programmed to address the Year 2000 issue. The Company plans to conduct a
limited review of its internal systems and to continue to test its network
connections to help insure that these programs and systems are adequately
programmed to address the Year 2000 issue. Towne Services intends to modify or
replace any products or systems that are unable to properly function as a
result of the Year 2000 issue and currently believes it will be able to do so
without incurring costs or delays which would have a material adverse effect on
its financial condition.

The Company supplies point of sale terminals and other products needed to run
its processing systems to its customers and Towne Services has not tested any
other products or systems used in its customers' businesses. If the Company's
customers do not successfully address Year 2000 issues in their operations and,
as a result, experience temporary or permanent interruptions in their
businesses, the Company may lose revenues from these customers, which could
have a material adverse effect on its business, financial condition and results
of operations. Towne Services believes that many financial institutions and
small businesses (including customers of the Company) are still in the
preliminary stages of analyzing their systems for Year 2000 issues. It is
impossible to estimate the potential expenses involved or delays which may
result from the failure of these institutions and third parties to resolve
their Year 2000 issues in a timely manner and there can be no assurance that
such expenses, failures or delays will not have a material adverse effect on
the Company's business, financial condition or results of operations.

EFFECTS OF ACCOUNTING STANDARDS

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and presentation of comprehensive
income and its components in a full set of general purpose financial statements.
This statement is effective for periods beginning after December 15, 1997. The
Company adopted SFAS No. 130 on January 1, 1998. The adoption of SFAS 130 did
not have a material impact on the Company's financial statements as
comprehensive income did not differ from the reported net loss for all periods
presented.



                                      16
<PAGE>   17



In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
annual financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. This statement is
effective for financial statements for periods beginning after December 15,
1997. The adoption of SFAS No. 131 will not have a material impact on the
Company's financial statements.

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS No. 133
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special accounting
for qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate, and assess the effectiveness of transactions
that receive hedge accounting. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. A company may also implement SFAS No. 133 as of
the beginning of any fiscal quarter after issuance (that is, fiscal quarters
beginning June 16, 1988 and thereafter). SFAS No. 133 cannot be applied
retroactively; it must be applied to (a) derivative instruments and (b) certain
derivative instruments embedded in hybrid contracts that were issued, acquired,
or substantively modified after December 31, 1997. The adoption of SFAS No. 133
will not have a material impact on the Company's financial statements.



                                      17
<PAGE>   18



                           PART II. OTHER INFORMATION

         ITEM 1.  LEGAL PROCEEDINGS
                  None

         ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

                           On July 30, 1998 the Company's Initial Public
                  Offering was declared effective by the Securities and
                  Exchange Commission. In the Initial Public Offering, the
                  Company sold 3,850,000 shares of common stock at $8.00 per
                  share. The Company received proceeds of $27.0 million (net),
                  after deducting underwriting discounts of $2.2 million and
                  expenses related to the Initial Public Offering. Upon
                  completion of the Initial Public Offering, all outstanding
                  shares of Series A Preferred Stock were converted to
                  1,217,903 shares of common stock and warrants for 308,982
                  shares of common stock were exercised.

                           Use of proceeds from the effective date of the
                  Initial Public Offering on July 30, 1998 to the period ended
                  September 30, 1998 have been as follows:

                           1.  $2.2 million for the repayment of indebtedness
                               outstanding under the Company's loan facility
                               with Sirrom Investments, Inc., and the Company's
                               loan from Citizens Bank

                           2.  $4.0 million for working capital and general
                               corporate purposes.

         ITEM 3.  DEFAULTS UPON SENIOR SECURITIES
                  None

          ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 
                  On July 24, 1998, the Company's shareholders, acting by
                  unanimous written consent in lieu of a special meeting,
                  approved the Company's Amended and Restated Articles of
                  Incorporation (Exhibit 3.1 hereto) and approved the Company's
                  1998 Stock Option Plan (Exhibit 10.1 hereto).

         ITEM 5.  OTHER INFORMATION
                  None

         ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K


                                      18
<PAGE>   19


         a)       Exhibits 

         Exhibit  Description
          No.
                 
          3.1     Amended and Restated Articles of Incorporation, as filed with
                  the Secretary of the State of Georgia on July 29, 1998
                  (incorporated by reference to Exhibit 3.1 of the Company's
                  Registration Statement on Form S-1 (No. 333-53341) as declared
                  effective by the SEC on July 30, 1998 (the "Registration
                  Statement")).

          3.2     Amended and Restated Bylaws, effective May 19, 1998
                  (incorporated by reference to Exhibit 3.2 of the Registration
                  Statement).

          4.1     See Exhibits 3.1 and 3.2 for provisions of the Amended and
                  Restated Articles of Incorporation and Amended and Restated
                  Bylaws defining the rights of the holders of Common Stock of
                  the Company.

         10.1     1998 Stock Option Plan (including Form of Stock Option
                  Agreement) (incorporated by reference to Exhibit 10.2 of the
                  Registration Statement).

         27       Financial Data Schedule (for SEC use only).

         b)       Reports on Form 8-K. 

                  There were no reports filed on Form 8-K during the three month
                  period ended September 30, 1998.



                                      19
<PAGE>   20



                                   SIGNATURES

         Pursuant to the requirements of the Securities Exchange Act of
1934,the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.


                                     TOWNE SERVICES, INC.


<TABLE>
<S>                                  <C>
November 12, 1998                    /s/  Drew W. Edwards
-----------------                    -------------------------------------------------
Date                                 Drew W. Edwards
                                     Chairman of the Board and Chief Executive Officer
                                     (principal executive officer)


November 12, 1998                    /s/ Bruce F. Lowthers, Jr.
-----------------                    -------------------------------------------------
Date                                 Bruce F. Lowthers, Jr.
                                     Chief Financial Officer
                                     (principal financial and accounting officer)
</TABLE>



                                      20