<PAGE>   1

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

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                 ---------------

                                    FORM 10-K
(Mark One)
     X          ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE 
   -----                SECURITIES EXCHANGE ACT OF 1934
          

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                                       OR

            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

                           COMMISSION FILE NO. 0-23686

                            PC SERVICE SOURCE, INC.
             (Exact name of registrant as specified in its charter)

         DELAWARE                                  52-1703687
(State or other jurisdiction of           (I.R.S. employer identification no.)
 incorporation or organization)


                              2350 Valley View Lane
                               Dallas, Texas 75234
               (Address of principal executive offices) (Zip Code)

       Registrant's telephone number, including area code: (972) 481-4000

        Securities registered pursuant to Section 12(b) of the Act: NONE

           Securities Registered Pursuant to Section 12(g) of the Act:

COMMON STOCK, PAR VALUE $.01 PER SHARE                    5,773,820
         (Title of class)                        (Number of Shares Outstanding
                                                    as of March 23, 1999)

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.
YES  X    NO    
    ---      ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

The aggregate market value of voting stock held by nonaffiliates of the
registrant is approximately $4,580,940. This amount was calculated by reducing
the total number of shares of the registrant's common stock outstanding by the
total number of shares of common stock held by officers and directors, and
stockholders owning in excess of 5% of the registrant's common stock, and
multiplying the remainder by the average of the bid and asked price for the
registrant's common stock on March 23, 1998, as reported on the National
Association of Securities Dealers, Inc. Automated Quotation System. The
information provided shall in no way be construed as an admission that any
officer, director, or more than 5% stockholder of the registrant may be deemed
an affiliate of the registrant or that such person is the beneficial owner of
the shares reported as being held by such person, and any such inference is
hereby disclaimed.

                      DOCUMENTS INCORPORATED BY REFERENCE:

         Portions of the Registrant's definitive proxy statement concerning the
1999 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A are
incorporated by reference into Part III of this report. The Proxy Statement will
be filed with the Commission not later than 120 days after the Registrant's
fiscal year ended December 31, 1998.

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

<PAGE>   2


                                     PART I

ITEM 1.  BUSINESS.

GENERAL

         PC Service Source, Inc. ("PCSS" or the "Company") is the leading
provider of logistics services ("Service Logistics") to the personal computer
("PC") hardware repair industry. Service Logistics distribution includes
sourcing and distributing spare parts, inventory management, warranty claims
processing, parts repair and related functions. Service Logistics also includes
notebook repair. The foundation of the Company's Service Logistics is its
ability to provide accurate, efficient and rapid delivery of repair parts or
repaired units to its customers. PCSS is the largest independent distributor of
parts used in the repair of PCs in North America, distributing over 440,000
different parts to approximately 20,000 PC service providers such as independent
service organizations, original equipment manufacturers' service operations and
PC resellers (collectively, "Service Providers"). Service Providers purchase
replacement parts for the service and repair of PCs and peripherals. These parts
may be purchased directly from the Original Equipment Manufacturer ("OEM") or
from any of the hundreds of independent distributors, the largest of which is
PCSS. The Company currently maintains in its inventory over 24,000 different
parts. These parts include printer parts, logic boards, controllers, disk
drives, monitors, memory boards, cables and related hardware. PCSS has
established vendor relationships for repair parts with over 30 leading OEMs,
including Canon, Compaq, Dell, Epson, Hewlett-Packard, IBM, Lexmark, Okidata and
Toshiba. To complement its distribution operations, PCSS seeks to supply
additional value-added services to OEMs and Service Providers to allow OEMs and
Service Providers to outsource a substantial portion of their Service Logistics.

         PCSS has leveraged its Service Logistics capabilities and strong vendor
relationships to establish outsourcing arrangements with OEMs. Under the terms
of an OEM outsourcing arrangement, the OEM may re-route authorized Service
Providers, customers and dealers to the Company for some or all of the OEM's
warranty and non-warranty parts business.
See "Business -- Services."

         PCSS believes an important factor in an OEM's decision to outsource
Service Logistics functions is the extent to which such an arrangement relieves
the OEM of functions outside of the OEM's core competencies. These service and
warranty logistics areas often include repair activities. To support this
function and encourage OEMs to consider outsourcing functions to PCSS, the
Company commenced its own repair operations through PC Service Source Repair
Services ("PCSS Repair Services") during 1995 (formerly known as Cyclix
Engineering Corporation). The principal business objectives of PCSS Repair
Services are to provide centralized rapid turnaround notebook computer repair,
and subsystem repair capabilities to OEMs. PCSS believes its repair capabilities
through PCSS Repair Services are an important aspect of the full range of
value-added services it offers to OEMs.

         The Company's principal executive offices and mailing address are 2350
Valley View Lane, Dallas, Texas 75234, and its telephone number is (972)
481-4000. The Company was incorporated in Delaware in January 1990. PCSS Repair
Services, a wholly-owned subsidiary of the Company, was incorporated in Texas in
June 1995. PCSS Repair Services was originally formed as an eighty-five percent
(85%) owned subsidiary of the Company. The balance of PCSS Repair Services was
owned by members of management of PCSS Repair Services. In 1998, the Company
repurchased the minority interests held by management of PCSS Repair Services.
Hi-Tek Services, Inc., a wholly-owned subsidiary of PCSS Repair Services, was
incorporated in California in April 1989.


                                      -1-
<PAGE>   3

OPERATIONS

         PCSS conducts its parts distribution and processing business
principally from its 155,200 square foot distribution center at its Alliance
Airport facility located in the Dallas/Fort Worth Metroplex. Recognizing the
immediate demands of its service customers, PCSS established an automated and
integrated order processing and distribution system which allows the Company to
provide efficient and accurate delivery of products on a next day basis. The
Company has also established a system of "work cells" for receiving, recording
and warehousing daily supply shipments. All parts maintained in the Company's
inventory are bar coded and tracked throughout the facility through radio
frequency scanning equipment that is integrated with the Company's computer
network. Parts are received daily from OEMs and other suppliers, bar coded and
shelved in the Company's warehouse for quick access based on real-time daily
demand.

         In addition, many PC and peripheral replacement parts are
remanufactured from returned goods in need of repair. For example, a part may no
longer work because one of its many components is defective. When a Service
Provider purchases a replacement for a defective part, the defective part
("core") may often be returned for credit. The core may then be repaired and
resold as a remanufactured part. Service Providers often prefer remanufactured
parts because they have performance specifications equivalent to newly
manufactured parts at a lower cost. This aspect of the PC parts business
requires that the Company distribute new or remanufactured parts to its
customers, collect defective but repairable parts and then administer the
remanufacturing of those parts which are offered for resale. Therefore, unlike
many distribution businesses, products flow to and from the Company and its
customers, and to and from its suppliers. In addition to new parts being
received and shelved daily, cores are also received daily from customers, sorted
and distributed to the Company's remanufacturing subcontractors, including PCSS
Repair Services. Following the remanufacturing of a core, it is bar coded and
replaced in inventory.

         Under the terms of the Company's OEM outsourcing arrangements, the OEMs
re-route calls from authorized service providers, customers and dealers to the
Company for some or all of the OEM's warranty and non-warranty parts business.
Typically, when an OEM receives a call from an authorized Service Provider,
customer or dealer for a warranty or non-warranty part, the OEM will re-route
the call via a dedicated T-1 phone line directly to the Company's call center
for handling and order processing. Service Providers and other customers of the
Company can make purchases 24 hours a day, 365 days a year by credit card, cash
on delivery, or, for approved accounts, by open account. Small and medium volume
Service Providers typically call through a regionally specific toll free phone
number to access a team of dedicated account representatives to place orders for
next-day delivery. A larger volume customer typically has a representative or
team of representatives dedicated to its account.

         Utilizing its high capacity Computer Telephony Integrated system, the
Company's call center automatically routes customer calls, including calls
re-routed to the Company by an OEM, to the appropriate account representative.
Each account representative has a work station that provides access to the
Company's information system, through which the account representative may
retrieve detailed information about accounts, products and the status of all
orders. Through the information system's imaging and direct fax capabilities,
the account representative may access exploded-view diagrams of a majority of
parts in inventory from the account representative's work station and fax the
image to the Service Provider to confirm the identification of the ordered part.
Once the order is placed, the account representative immediately transmits the
order to the distribution center where the part is picked, packed and shipped in
accordance with the Service Provider's request, usually the same day the order
is placed.



                                      -2-
<PAGE>   4

         Service Providers may also place orders directly over the Internet
through PC SERVICENET(R). PC SERVICENET, located on the Internet at
http://www.pcservice.com/partsnet.htm, provides customers with an Internet
web-based real-time purchasing and ordering system, which enables customers to
place an order electronically, check parts availability and pricing, and the
status of pending orders. Because many of the Company's customers are familiar
with and have ready access to the Internet, the Company has expanded its
Internet customer service functions to include additional features, such as
warranty processing programs.

SERVICES

         The Company offers a wide range of value-added Service Logistics to
Service Providers and OEMs. These services capabilities, in combination with the
Company's core distribution expertise, effectively allow PCSS to handle many of
the hardware related post-sales support functions for its customers. PCSS offers
these Service Logistics in two formats, Service Provider alliances and OEM
outsourcing arrangements, each based on the demands of its customers.

         Service Provider Alliances. Typically, a substantial portion of a
Service Provider's cost structure is attributable to parts inventory ownership
and logistics management for these materials. The Company offers a range of
services directed at minimizing this cost burden of the Service Provider. These
support services include inventory management, parts sourcing, warranty claims
administration, vendor returns, management reporting and inventory liquidation
and consignment. Because this type of support generally requires a high level of
process integration between the Service Provider and the Company, the Company
seeks to provide these services through long term alliances. Under these
arrangements, the Company becomes the primary source of specified parts for the
Service Provider. The Service Provider benefits from this alliance with the
Company because these value-added services decrease the Service Provider's
inventory carrying costs, improve service and permit the Service Provider to
devote less of its capital to these business functions.

         The Company has entered into Service Provider alliances with CompUSA,
TSS and Vanstar (which has subsequently merged with InaCom), among others. See
"Business--Customers and Suppliers." Generally, these types of arrangements may
be terminated by either party at any time, but the Company enters into Service
Provider alliances with the expectation that these arrangements will lead to
long-term relationships or contracts with those parties.

         OEM Logistics Outsourcing. PCSS seeks arrangements with OEMs of PCs and
peripherals to handle a defined portion of the related parts distribution and
warranty processing functions. Under the terms of such an OEM outsourcing
arrangement, the OEM directs some or all of its customers and dealers to the
Company for some or all of the OEM's warranty and non-warranty parts business.
PCSS believes these arrangements benefit OEMs by reducing infrastructure needs,
reducing the amount of capital committed by the OEM to the non-core segments of
its business and improving customer service and responsiveness. The Company
believes that as a specialist in managing the key business functions associated
with parts distribution, which includes its expertise in two-way distribution
logistics, the Company is able to provide parts and related Service Logistics at
lower costs and greater reliability than the manufacturers themselves can
provide such services. The Company has entered into arrangements with OEMs such
as Compaq, Dell and Toshiba for handling limited functions for those OEMs.

         In November 1998, the Company entered into an agreement with
Hewlett-Packard, which represented the Company's first full Service Logistics
outsourcing program. PCSS was selected to be the exclusive 


                                      -3-
<PAGE>   5

provider of in-warranty and a provider of post-warranty spare parts support for
HP's Pavilion line of desktop computers. This support encompasses all Pavilion
desktop models, including parts distribution logistics and warranty transaction
processing, for HP's on-site service provider, inventory forecasting and
planning, as well as return-to-vendor repair logistics to meet HP defined
service levels. This partnership represents the first to utilize the full
Service Logistics outsourcing capabilities offered by PCSS. This arrangement and
the other arrangements referred to above may generally be terminated by either
party at any time. The Company, however, has entered into them with the
expectation that these arrangements will lead to long-term relationships with
these parties.

         Repair. In June 1995, PCSS established PCSS Repair Services, a provider
of parts repair outsourcing services, to further enhance the broad array of
Service Logistics offered by the Company to its OEM customers. The Company also
conducts a portion of its subsystem repair operations through PCSS Repair
Services. In 1998, the Company expanded the operations of PCSS Repair Services
to include the repair of notebook computers on an expedited basis, generally
within 24 hours of when the broken unit is received. The Company also
consolidated the west coast repair facility of PCSS Repair Services with its
Irving, Texas facility during 1998.

         PCSS believes that its repair capabilities through PCSS Repair Services
are an important aspect of the full range of value-added services it offers to
OEMs in an effort to outsource larger functions of the OEM's service and
warranty logistics functions. The offerings of PCSS Repair Services include
rapid turnaround notebook repair, subsystem repair and component refurbishment.
Regarding the notebook repair operations, the Company is capable of receiving,
repairing and shipping the repaired notebooks back to the customer within
24-hours of its receipt. Subsystem repair is provided at the component-level for
LCD panels, computer boards and power supplies. PCSS Repair Services has entered
into notebook repair arrangements with Gateway, Apple and Dell. These
arrangements may generally be terminated by either party at any time, but the
Company enters into them with the expectation that these arrangements will lead
to long-term relationships with those parties.

         CertiParts(TM). PCSS has also recently created a private brand of
remanufactured parts that are tested and reworked by the Company prior to sale.
Many of the Company's customers prefer a remanufactured part over a new part
because the remanufactured part often has the performance specifications
equivalent to a new part, but costs less. CertiParts was developed to fill this
recognized market demand for reliable, competitively priced parts.

MANAGEMENT INFORMATION SYSTEMS

         The Company maintains sophisticated information systems to improve
efficiency, process orders, monitor operations, manage inventory risks, offer
faster and higher levels of service, and provide innovative Service Logistics to
OEMs and Service Providers. These on-line systems provide management with
information concerning sales, inventory levels, customer payments and other
operations which are essential for the Company to operate efficiently and to
enable it to offer additional services. The Company has invested in advanced
telecommunications, voice response equipment, electronic mail and messaging,
automated fax technology, radio frequency scanning and bar-coding and automated
inventory management.

         The Company maintains a sophisticated call center utilizing an Aspect
switch, which is integrated with the Company's information system. The
information system is a Unix server based Hewlett-Packard 9000 series of
computers utilizing an Informix based system customized to the Company's
requirements. 



                                      -4-
<PAGE>   6

The CTI system is an essential element of the call center's operation,
automatically routing customer calls to the appropriate account representative,
providing the account representative with all account information relevant to
the call being answered and monitoring capabilities which is used by management
to improve efficiency and customer services. The Company compiles and analyzes
data on, among other things, the amount of time a customer waits until the
customer's call is answered, the accuracy of information conveyed by account
representatives, as well as the status of any particular shipment. During 1998,
the call center handled approximately 2,100,000 calls, allowing PCSS to ship
approximately 957,000 packages. Each account representative has a work station
that provides access to the Company's information system, through which the
account representative may retrieve detailed information about customers,
products and the status of all orders. Through the information system's imaging
and direct fax capabilities, the account representative may access exploded-view
diagrams of a majority of parts in inventory from the account representative's
work station and fax the image to the customer to confirm the identification of
the ordered part.

         PCSS has also developed capabilities which allow pre-approved customers
to place orders via the world wide web, reducing the order processing costs for
both the Company and the customer. The Company believes that this capability
will increasingly become a requirement by many customers and some suppliers and,
accordingly, the Company will continue to invest in enhancing those
capabilities.

SALES AND MARKETING

         The Company views Service Logistics as a value-added service business.
As such, sustaining the growth of the Company is dependent upon building and
maintaining relationships and loyalties with Service Providers as well as OEMs.
The Company maintains a Service Provider sales force. Account managers are
assigned to maintain relationships with the Company's largest national accounts
and are assigned other accounts based on the customers' market segment. The
Company also has a separate sales force focusing on OEM repair and outsourcing
arrangements. The Company's sales representatives visit major OEMs, Service
Providers and attend various trade shows.

         The Company advertises its parts and services in recognized trade
magazines, participates at trade shows, distributes news releases, and makes
direct mailings to potential customers. Customers rely upon the Company's
advertisements, newsletters and frequent mailings as a source for product
information, including pricing. In addition, the Company maintains a presence on
the world-wide web at http://www.pcservice.com. The Company has applied for or
registered its PC SERVICESOURCE(R), RIGHT PARTS RIGHT NOW(R), PC SERVICENET(R),
CERTIPARTS(TM), PARTS POINTK, PC PARTS NETK and PC WINK marks and related design
service marks. The Company also conducts customer satisfaction surveys and
purchases market research data to maintain continuous insight into marketplace
trends and requirements.

         The Company provides comprehensive training to its sales and account
representatives regarding technical characteristics of products and the
Company's policies and procedures. Each new account representative attends a
three-week course given by the Company. In addition, the Company's ongoing
training program for sales and account representatives is supplemented by
product seminars offered by OEMs.


                                      -5-
<PAGE>   7

CUSTOMERS AND SUPPLIERS

         PCSS sells parts to customers throughout the United States, Canada and
Latin America, as well as in other countries. In 1999, Vanstar, which accounted
individually for approximately 16% of the Company's net revenues in 1998,
notified the Company of its intention to cancel the exclusive contract with the
Company effective as of June 1999. Although the Company anticipates still doing
business with Vanstar, any such business after June 1999 will not be on an
exclusive basis and may be significantly less than in 1998 and prior years.

         The Company sells a variety of parts to approximately 20,000 Service
Providers, including Best Buy, Circuit City, Decision One, Tandy Services and
Wang. In addition, the Company has entered into Service Provider alliances with
CompUSA, TSS and Vanstar (which has subsequently merged with InaCom), among
others. PCSS also entered into outsourcing arrangements with OEMs, such as
Compaq, Dell, Hewlett-Packard and Toshiba to outsource various service logistics
functions. See "Business -- Services." These arrangements with Service Providers
and OEMs may generally be terminated by either party at any time, but the
Company has entered into them with the expectation that these arrangements will
lead to long-term relationships with these parties.

         The Company depends on numerous suppliers (including more than 30
leading OEMs) to provide the Company with the parts it sells. There are
generally no long-term supply agreements governing the Company's relationships
with its major suppliers. The Company's primary supply arrangements are thus
subject to termination or curtailment at any time, with little or no advance
notice. Although management expects no such loss to occur, the refusal or
inability of any major manufacturer to ship to the Company, or an increase in
prices charged to the Company as compared to the prices charged by such
manufacturers to Service Providers, could have a material adverse effect on the
Company.

COMPETITION

         The Company is the leading provider of Service Logistics to the PC
repair and maintenance industry. These Service Logistics include distribution
and sourcing of spare parts, inventory management, warranty claims, parts
remanufacturing and related functions. Management believes that the Company is
the largest independent distributor of parts used in the repair of PCs in North
America, distributing over 440,000 different parts for PCs (of which it
maintains over 24,000 in its inventory) to approximately 20,000 service and
maintenance providers.

         The market for the Company's products is large but fragmented.
Competition in the industry is widespread and comes from other independent
distributors (including various small independents) that are not affiliated with
an OEM, as well as from the OEMs themselves. When OEMs act as distributors, they
typically distribute only their own products. Independent distributors typically
distribute a variety of manufacturers' parts. Among the Company's major
independent competitors is The Cerplex Group, EFTC Corp., Genicom Corp. and
Sequel Inc. Certain of these competitors, such as the OEMs, are large and have
substantially greater financial and other resources than the Company.

         The Company believes that its growth is attributable to its ability to
consistently process customer orders and supply needed parts on demand, with
rapid delivery, and at competitive prices. Management believes that these
competitive factors will continue to govern customer decisions in the
foreseeable future.



                                      -6-
<PAGE>   8




EMPLOYEES

         As of March 1, 1999, the Company had 922 full time employees, of which
183 were in the customer service center, 183 were in administration, 43 were in
sales, 124 were warehouse services and 389 were engineers or technicians. The
Company is not party to any collective bargaining agreement and believes
relations with its employees are satisfactory. 

GOVERNMENT REGULATION

         The Company is subject to various federal, state and local laws and
regulations relating to worker safety and health, environmental regulations, and
other matters applicable to businesses in general. The Company does not believe
that these regulations as currently in effect have a material effect on its
business.

ITEM 2.  PROPERTIES.

         All but one of the Company's properties are located within the
Dallas/Fort Worth Metroplex area. In 1995, the Company entered into a 10-year
office lease in Dallas, Texas. The Company leases approximately 82,250 square
feet in this facility which houses the Company's corporate offices, account
representatives and information systems.

         In 1995, the Company entered into a 10-year build-to-suit lease for a
155,200 square foot distribution center near the Alliance Airport near Fort
Worth, Texas, out of which parts are received, processed and shipped. The
Company has a build-to-suit lease option for an additional 100,000 square feet
at that location.

         The Company has a lease that expires in June 2001, for approximately
81,500 square foot facility in Irving, Texas which houses the remanufacturing
operations of PCSS Repair Services. The Company has the option to renew the
lease for an additional 3-year term.

         The Company has a lease for approximately 50,500 square feet in a
facility in Hayward, California, which the Company used for its west coast
remanufacturing operations of PCSS Repair Services. In connection with the
Company's decision to consolidate its west coast manufacturing operations with
its Irving, Texas, facility, the Company has provided the landlord with its
written notice terminating this lease. The Company's obligations under this
lease run through January 2001, unless this facility is leased to another tenant
prior to such time.

ITEM 3.  LEGAL PROCEEDINGS.

         The Company is subject to various pending and threatened litigation
from time to time in the ordinary course of business. Although all litigation
involves some degree of uncertainty, in the opinion of management, liabilities,
if any, arising from such litigation or threat thereof are not expected to have
a material adverse effect on the Company's business, financial condition or
results of operation.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

         As contemplated in the Company's Proxy Statement which was mailed to
stockholders beginning November 4, 1998, the Company's stockholders considered
and approved at a special meeting of stockholders held on December 18, 1998, a
proposal to amend the Company's Stock Option Plan to increase the number of
authorized shares from 1,000,000 to 1,500,000. This proposal was approved at the
December 18, 1998, special meeting and the number of votes cast for and against,
as well as the number of abstentions, were as follows:


<TABLE>
<S>                                         <C>      
                  For:                      3,191,184
                  Against:                    903,602
                  Abstentions                   8,600
</TABLE>




                                      -7-
<PAGE>   9


                                     PART II


ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

         The Company's common stock is traded on the Nasdaq National Market
("Nasdaq") under the symbol "PCSS."

         For the periods indicated below, the following table sets forth the
high and low closing prices of the Company's common stock as reported on Nasdaq.


<TABLE>
<CAPTION>
                                     1998 CLOSING PRICES           1997 CLOSING PRICES
                                     -------------------           -------------------
           CALENDAR PERIOD          LOW              HIGH          LOW            HIGH
           ---------------          ---              ----          ---            ----
<S>                                 <C>              <C>           <C>            <C>  
January 1-March 31                  $4.38            $5.81         $6.13          $9.88
April 1-June 30                      3.88             5.44          5.50           8.25
July 1-September 30                  2.50             4.25          6.00           8.00
October 1-December 31                2.19             4.38          4.78           6.50
</TABLE>


         As of March 23, 1999, there were 98 record holders of the Company's
common stock. The Company estimates that there were approximately 2,100
beneficial owners of its common stock as of the same date. The Company has not
declared or paid any cash dividends on the common stock since its organization.
Under the terms of the Company's revolving bank line of credit, the Company's
ability to pay cash dividends to its stockholders is restricted.




                                      -8-
<PAGE>   10





ITEM 6.  SELECTED FINANCIAL DATA.

         The selected consolidated financial information regarding the Company's
financial position and operating results for the five-year period ended December
31, 1998, are derived from the audited consolidated financial statements of the
Company. The data should be read in conjunction with "Management's Discussion
and Analysis of Financial Condition and Results of Operations" and the
consolidated financial statements and related notes included elsewhere in this
report.

                    (In thousands, except per share amounts)


<TABLE>
<CAPTION>
  OPERATING RESULTS:                                                 YEAR ENDED DECEMBER 31,                       
                                                 -------------------------------------------------------------------
                                                    1998           1997          1996         1995           1994
                                                 ---------      ---------     ---------     ---------      ---------
<S>                                              <C>            <C>           <C>           <C>            <C>
   Net revenues ............................     $ 160,773      $ 131,843     $ 110,146     $  68,690      $  42,267
   Cost of revenues(1) .....................       115,807         94,159        78,001        49,766         30,171
                                                 ---------      ---------     ---------     ---------      ---------
      Gross margin .........................        44,966         37,684        32,145        18,924         12,096
   Operating expenses:
      Selling, general and administrative(1)        47,930         33,271        26,457        17,241          8,746
      Restructuring charges(1) .............         2,969             --            --            --             --
      Loss incurred from terminated supply
        agreement(2) .......................            --             --            --         1,935             --
      Depreciation and amortization ........         4,674          3,504         2,151         1,510            384
                                                 ---------      ---------     ---------     ---------      ---------
            Total operating expenses .......        55,573         36,775        28,608        20,686          9,130
                                                 ---------      ---------     ---------     ---------      ---------
      Earnings (loss) from operations ......       (10,607)           909         3,537        (1,762)         2,966
   Net interest expense (income) ...........         1,605            739           577           473           (115)
                                                 ---------      ---------     ---------     ---------      ---------
      Earnings (loss) before income taxes ..       (12,212)           170         2,960        (2,235)         3,081
   Income tax expense (benefit) ............            --             64         1,089          (730)         1,186
                                                 ---------      ---------     ---------     ---------      ---------

       Net earnings (loss) .................     $ (12,212)     $     106     $   1,871     $  (1,505)     $   1,895
                                                 =========      =========     =========     =========      =========
   Earnings (loss) per share - basic .......     $   (2.12)     $    0.02     $    0.38     $   (0.39)     $    0.52
   Earnings (loss) per share - diluted .....     $   (2.12)     $    0.02     $    0.35     $   (0.39)     $    0.46
   Weighted average common shares
       outstanding - basic .................         5,762          5,750         4,970         3,900          3,631
   Weighted average common shares
       outstanding - diluted ...............         5,762          5,882         5,285         3,900          4,103
</TABLE>


<TABLE>
<CAPTION>
BALANCE SHEET DATA:                                DECEMBER 31,       
                               1998        1997        1996        1995       1994
                               ----        ----        ----        ----       ----
<S>                          <C>          <C>         <C>         <C>        <C>    
Working capital              $ 6,192      $23,737     $23,494     $15,310    $10,702
Total assets                  62,734       55,158      50,174      33,127     20,015
Long-term debt                 2,677        8,695       3,059      10,165        873
Stockholders' equity          20,140       32,334      32,196      11,603     13,081
</TABLE>

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


(1)     The 1998 net loss includes pretax charges totaling $6.4 million related
        to certain non-recurring items, including a $3.0 million charge in
        connection with the consolidation of the repair operations, which is
        captioned as restructuring charges; $2.2 million of charges related to
        severance and other expenses included in selling, general and
        administrative expenses and $1.2 million, net, resulting from a review
        of policies, procedures and methodologies undertaken by management
        included in cost of revenues. See "Management's Discussion and Analysis
        of Financial Condition and Results of Operations."

(2)     1995 results include a non-recurring, pre-tax charge of $1.9 million
        related to the supply agreement with Intelogic Trace, Inc. ("Intelogic")
        which was terminated in connection with the bankruptcy of Intelogic.






                                      -9-
<PAGE>   11




ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
         RESULTS OF OPERATIONS.

OVERVIEW

         PC Service Source, Inc. (the "Company") provides logistics services
("Service Logistics") to the personal computer ("PC") hardware repair industry.
Service Logistics distribution includes sourcing and distributing spare parts,
inventory management, warranty claims processing, parts repair and related
functions. Service Logistics also includes notebook repair. During the third
quarter of 1998, the Company underwent certain management changes, which
included the appointment of a new Chief Executive Officer and Chief Financial
Officer. Management then initiated and completed a comprehensive review of the
Company's strategies and business focus. In connection with this review,
management reviewed the policies, procedures and methodologies previously
utilized by the Company to value its assets and liabilities, and recorded
approximately $6.4 million of non-recurring charges in the fourth quarter of
1998. The major components of the charges were (a) a $3.0 million charge in
connection with the consolidation of the Company's west coast repair facility
into its Irving, Texas facility, which included future lease commitments,
severance and the write-off of goodwill associated with the west coast
operations, (b) a $2.2 million charge related to severance in connection with a
reduction of workforce and other expenses included in selling, general and
administrative expenses and (c) charges totaling $1.2 million, net, resulting
from management's review and modification of existing policies, procedures and
methodologies for valuing the Company's assets and liabilities included in cost
of revenues.

RESULTS OF OPERATIONS

         The following table displays the Company's statements of operations as
a percentage of net revenues for the three years ended December 31, 1998:


<TABLE>
<CAPTION>
                                               1998         1997        1996
                                               ----         ----        ----
<S>                                             <C>          <C>         <C>   
Net revenues                                    100.0%       100.0%      100.0%
Cost of revenues                                 72.0         71.4        70.8
                                             --------     --------    --------
     Gross margin                                28.0         28.6        29.2
                                             --------     --------    --------

Operating expenses:
     Selling, general and administrative         29.8         25.2        24.0
     Restructuring charges                        1.9         --          --
     Depreciation and amortization                2.9          2.7         2.0
                                             --------     --------    --------
              Total operating expenses           34.6         27.9        26.0
                                             --------     --------    --------
     Earnings (loss) from operations             (6.6)         0.7         3.2

Net interest expense                              1.0          0.6         0.5
                                             --------     --------    --------
     Earnings (loss) before income taxes         (7.6)         0.1         2.7
Income tax expense                               --           --           1.0
                                             --------     --------    --------
     Net earnings (loss)                         (7.6)%        0.1%        1.7%
                                             ========     ========    ========
</TABLE>


YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997

         The Company recognized a 21.9% increase in net revenues for the year
ended December 31, 1998, with $160.8 million in revenues compared to $131.8
million for the year ended December 31, 1997. The 


                                      -10-
<PAGE>   12

increase in net revenues is primarily the result of a contract to provide
service parts on a exclusive basis to Vanstar that began in the first quarter of
1998. In addition, the Company increased its notebook repair services business
in 1998.

         In February 1999, Vanstar notified the Company of its intention to
terminate the exclusive contract with the Company effective as of June 1999.
Although the Company anticipates that it will continue to do business with
Vanstar after June 1999, any such business will not be on an exclusive basis and
may be significantly less than in 1998.

         Gross margin as a percentage of net revenues decreased to 28.0% from
28.6% in 1997. Since the gross margin is different for each line of computer
spare parts which the Company sells, changes in the mix of parts sold by the
Company during a particular period affect the Company's gross margin. The
decrease in gross margin was due to significantly lower repair service margins
in 1998, which were the result of initiating several major customer
relationships, as well as a 200% increase in the repair business.

         Selling, general and administrative expenses as a percentage of net
revenues rose to 29.8% in 1998 from 25.2% in 1997. The primary reasons for this
increase were (a) deficiencies in the freight monitoring, control and billing
process, which were identified and corrected in the second quarter of 1998, (b)
increased personnel related costs for the conversion of the Company's automated
warehouse management system, (c) a charge related to a discontinued,
unprofitable warranty processing program, (d) changes related to management's
review and modification of the policies, procedures and methodologies for
valuing the Company's assets and liabilities and (e) increased occupancy costs
primarily related to the repair services operations. During the fourth quarter
1998, the Company reviewed its various customer programs and segmented those
programs based on customer requirements. Specific service levels, business terms
and conditions and targeted profit levels were identified, implemented and
established for each customer category. Management believes that the
segmentation of customers and expense reduction programs should reduce selling,
general and administrative expenses as a percentage of net revenues in 1999.

         Restructuring charges totaled 1.9% as a percent of net revenues in
1998. The charges totalled $3.0 million in connection with the consolidation of
the Company's west coast repair facility into its Irving, Texas facility which
included future lease commitments, severance and the write-off of goodwill
associated with the west coast operations.

         Depreciation and amortization increased as a percentage of net revenues
to 2.9% in 1998 compared to 2.7% in 1997. This increase was due to the 1998
capital expenditures and recognizing a full year of depreciation on the
significant 1997 capital expenditures.

         Net interest expense increased slightly in 1998 to 1.0% of net revenues
over 0.6% of net revenues in 1997. The increase is attributable to significantly
greater average borrowings during 1998 versus 1997.

YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996

         The Company recognized nearly a 20% increase in net revenues for the
year ended December 31, 1997, with $131.8 million in revenues compared to $110.1
million for the year ended December 31, 1996. All components of revenue
contributed to the increase.

         Gross margin as a percentage of net revenues declined from 29.2% in
1996 to 28.6% in 1997. The reduction in gross margin as a percentage of revenues
was due to a decision to reduce the number of parts offered for sale on an
exchange basis from approximately 9,000 skus to less than 1,500 skus. This shift
was 


                                      -11-
<PAGE>   13

made in recognition of the improvements made in the Company's programs to
acquire remanufactured, or used parts, as many of the parts formerly offered for
sale as an exchange are now available as a remanufactured part. The gross margin
decline resulted from the inventory value of the exchange parts, many of which
were new when acquired, being substantially in excess of their market value as a
remanufactured part. Had this shift in inventory product mix not taken place,
gross margin as a percentage of revenue would have been consistent with 1996.

         Selling, general and administrative expenses as a percentage of net
revenues rose from 24% in 1996 to 25.2% in 1997. The primary reasons for this
increase were the hiring, training and development of personnel needed to
support the increase in business mainly in the call center and distribution
center, and additions to senior management necessary to grow and improve the
business. Management does not believe this level of selling, general and
administrative expenses is appropriate over the long term. However, to meet
expected revenue growth PCSS must hire associates in anticipation of additional
revenue as the period to recruit, hire and train account representatives can be
six weeks or more. The Company experienced fluctuating average daily revenues
throughout 1997 which made forecasting revenue, as well as required manning,
difficult. PCSS is pursuing a number of productivity initiatives to lower
selling, general and administrative expenses as a percent of revenues in 1998,
including a new warehouse management system, expected to be operational in the
first quarter, a call center activity monitoring system and a review of the
Company's various customer programs to discontinue those which do not generate
an appropriate profit margin.

         Depreciation and amortization increased as a percentage of net revenues
to 2.7% in 1997 compared to 2.0% in 1996. This increase was due to recognizing a
full years depreciation on the significant capital expenditures made in 1996 and
1997.

         Interest expense (net) increased slightly in 1997 to .6% of net
revenues over .5% of net revenues in 1996. The increase is attributable to
greater borrowings in 1997.

LIQUIDITY AND CAPITAL RESOURCES

         As of the quarter ended December 31, 1998, the Company was not in
compliance with the financial covenants under its revolving credit facility with
NationsBank, N.A. The Company received a waiver from NationsBank, N.A., with
respect to the covenants and negotiated the terms of an amendment to this
facility which contained revised financial covenants. On March 11, 1999, the
Company entered into a new $25.0 million Revolving Line of Credit and Security
Agreement with PNC Bank, National Association, the proceeds which were in part
used to retire the revolving line of credit with NationsBank, N.A. The new
Revolving Line of Credit carries a floating interest rate based on either LIBOR
or the PNC prime rate, which were 7.4% and 10.25%, respectively, on March 11,
1999, is due in March 2002 and is secured by substantially all of the assets of
the Company. As of March 11, 1999, the Company had $12.0 million outstanding
under the new Revolving Line of Credit and $7.1 million of availability. The new
credit facility prohibits the payment of dividends to common stockholders and
contains customary covenants. The Company must also maintain a fixed charge
coverage ratio (as defined in the Revolving Line of Credit). As of the date of
this report on Form 10-K, the Company is in compliance with its new covenants.

         With the exception of 1997, the Company has historically been a net
user of cash from operations, and has financed its working capital requirements
and its capital expenditures from revolving credit, capital leases and equity
financing. Cash used by operating activities during the year ended December 31,
1998 is $2.1 million compared with cash provided by operating activities in 1997
of $3.0 million. The change in cash used in operating activities to cash
provided by operating activities is primarily due to the $12.2 million loss 


                                      -12-
<PAGE>   14

in 1998 compared to $0.1 million earnings in 1997, the increases in inventories
and accounts receivable partially offset by the increase in accrued liabilities
and accounts payable.

         Cash used in investing activities was $6.2 million for the year ended
December 31, 1998. Capital expenditures totaled $5.8 million, $5.0 million and
$3.2 million in 1998, 1997 and 1996, respectively. Capital expenditures during
1998 included improvements to the Company's management information systems,
furniture and fixtures, and leasehold equipment at the Company's repair
facility. The Company anticipates capital expenditures of approximately $3.0 to
$4.0 million in 1999 for improvements and modifications to the Company
information systems, warehouse equipment and other necessary equipment. The
Company believes these expenditures are required to support and manage future
profit growth of its business.

         The Company believes that its cash and its borrowing capability,
together with equipment financing related to capital expenditures for the
purchase of equipment, will be sufficient to meet its 1999 working capital and
capital expenditure requirements

EFFECTS OF INFLATION

         The Company believes that the effects of inflation on its operations
have not been material during the past three years.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

         In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Investments and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for
fiscal years beginning after June 15, 1999. SFAS 133 established accounting and
reporting standards for derivative instruments embedded in other contracts and
for hedging activities. Application of this accounting standard is not expected
to have a material impact on the Company's consolidated financial position,
results of operations or liquidity.

YEAR 2000

         The Company's management recognizes the need to ensure that its
operations and relationships with vendors, customers and other third parties
will not be adversely impacted by the Year 2000 issue. The Year 2000 problem is
a result of computer programs being written using two digits rather than four to
define the applicable year. Based on its assessment, the Company determined a
portion of its software and certain hardware will require modification or
replacement so that those systems will properly utilize dates beyond December
31, 1999. Although the Company's assessment indicated that the significant
information technology systems would not be affected, that assessment however,
indicated that the software and hardware used in the Company's telephone
equipment would be at risk. The affected systems are the Company's primary
sources of receiving customer orders. Except for the telephone equipment, which
will be replaced in 1999, the Company believes it has mitigated the Year 2000
issue by modifying or replacing the affected hardware and software.

         The Company has also established a program to review its product line
and identify date-sensitive parts and the level of Year 2000 compliance that the
part supports. This program is to ensure that customers receive products that
are Year 2000 compliant, or at a minimum, are made aware of products that are
not compliant. The Company also depends on the systems of its suppliers and
customers. Consequently, the Company is in the process of receiving adequate
assurances from its suppliers and customers that those systems on which the
Company relies are or will be Year 2000 compliant before the end of 1999.



                                      -13-
<PAGE>   15

         To the extent possible, the Company will develop and implement
contingency plans designed to allow continued operations in the event of failure
of the Company's or third party systems to be Year 2000 compliant. These
contingency plans have been developed and are expected to be implemented by the
end of 1999.

         Management estimates that the total cost of the above initiatives to be
$500,000. The Company is expensing all costs associated with these systems
changes as the costs are incurred. As of December 31, 1998, approximately
$150,000 has been expensed.

         Management of the Company believes it has an effective program in place
to resolve the Year 2000 issue in a timely manner. As noted above, the Company
has not yet completed all necessary phases of the Year 2000 program. Should the
critical applications fail to perform properly in response to the Year 2000
issue, the Company could be unable to receive and ship a substantial number of
orders received by its telephone systems. The amount of potential lost revenue
cannot be reasonably estimated at this time. Further, the failure of the Company
or third parties upon which the Company relies, to identify Year 2000 issues and
successfully and timely resolve them could have a material adverse impact on the
results of operations and the financial condition of the Company.

CAUTION REGARDING FORWARD-LOOKING STATEMENTS

         The Company occasionally makes forward-looking statements concerning
its plans, goals, product and service offerings, and anticipated financial
performance. These forward-looking statements may generally be identified by
introductions such as "outlook" for an upcoming period of time, or words and
phrases such as "should", "expect", "hope", "plans", "projected", "believes",
"forward-looking" (or variants of those words and phrases) or similar language
indicating the expression of an opinion or view concerning the future.

         These forward-looking statements are subject to risks and uncertainties
based on a number of factors and actual results or events may differ materially
from those anticipated by such forward-looking statements. These factors
include, but are not limited to: the growth rate of the Company's revenue and
market share; the consummation of new, and the non-termination of, existing OEM
outsourcing arrangements and service provider alliances; the Company's ability
to effectively manage its business functions while growing the Company's
business in a rapidly changing environment; the ability of the Company to adapt
and expand its services in such an environment; the effective and efficient
purchasing of parts and processing of sales orders; and the quality of the
Company's plans and strategies, and the ability of the Company to execute such
plans and strategies.

         In addition, forward-looking statements concerning the Company's
expected revenue or earnings levels are subject to many additional uncertainties
applicable to competitors generally and to general economic conditions over
which the Company has no control. The Company does not plan to generally
publicly update prior forward-looking statements for unanticipated events or
otherwise and, accordingly, prior forward-looking statements should not be
considered to be "fresh" simply because the Company has not made additional
comments on those forward-looking statements.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         The Company's earnings are affected by changes in interest rates due to
the impact those changes have on the interest expense payable by the Company
under its variable rate debt revolving line of credit, for which the outstanding
balance was $14.2 million as of December 31, 1998. A 1.0% change in the
underlying 


                                      -14-
<PAGE>   16

LIBOR or Prime rate would result in a $142,000 change in the annual amount of
interest on such debt. This amount is determined by considering the impact of
the hypothetical interest rates on the Company's revolving line of credit
outstanding as of December 31, 1998.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

           The Consolidated Financial Statements together with the report
thereon of Ernst & Young LLP and KPMG LLP are included in this report commencing
at Page F-1.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.

           During May and June 1998, the Company requested several independent
accounting firms, including its existing independent auditor, to submit a
proposal for providing audit and tax services to the Company. KPMG LLP, the
Company's independent auditor at that time, advised the Company that it would
not be participating in the request for proposal and resigned as the Company's
independent auditor. At a meeting held on June 17, 1998, the Audit Committee of
the Board of Directors of the Company approved the engagement of Ernst & Young
LLP, as its independent auditor for the fiscal year ending December 31, 1998, to
replace the firm of KPMG LLP.

           The audit reports of KPMG LLP on the Company's financial statements
for the past two fiscal years did not contain an adverse opinion or a disclaimer
of opinion, nor were they qualified or modified as to uncertainty, audit scope,
or accounting principles. In connection with the audits of the Company's
financial statements for each of the two fiscal years ended December 31, 1997,
and December 31, 1996, and the subsequent interim period through June 11, 1998,
there were no disagreements with KPMG LLP on any matter of accounting principles
or practices, financial statement disclosure, or auditing scope and procedures
which, if not resolved to the satisfaction of KPMG LLP, would have caused KPMG
LLP to make reference to the subject matter in its reports. KPMG LLP furnished
the Company with a letter addressed to the Securities and Exchange Commission
stating it agreed with the foregoing statements. A copy of that letter, dated
June 18, 1998, is filed as Exhibit 99.1 to the Company's Report on Form 8-K
filed in June 1998.




                                      -15-
<PAGE>   17


                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         The information set forth under the heading "Election of Directors" of
the definitive proxy statement for the Company's 1999 Annual Meeting of
Stockholders is incorporated by reference in this Form 10-K Annual Report.

ITEM 11. EXECUTIVE COMPENSATION.

         The information set forth under the heading "Executive Compensation" of
the definitive proxy statement for the Company's 1999 Annual Meeting of
Stockholders is incorporated by reference in this Form 10-K Annual Report.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

         The information set forth under the heading "Ownership of Common Stock
by Certain Beneficial Owners and Management" of the definitive proxy statement
for the Company's 1999 Annual Meeting of Stockholders is incorporated by
reference in this Form 10-K Annual Report.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         The information set forth under the headings "Election of Directors --
Board Meetings and Committees of the Board," "Election of Directors --
Compensation of Directors" and "Certain Transactions" of the definitive proxy
statement for the Company's 1999 Annual Meeting of Stockholders is incorporated
by reference in this Form 10-K Annual Report.




                                      -16-
<PAGE>   18


                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

FINANCIAL STATEMENTS

         The following financial statements of the Company and its subsidiaries
are filed as a part of this report:


<TABLE>
<CAPTION>
                                                                                       Page
                                                                                       ----
<S>                                                                                    <C>
Reports of Independent Auditors.........................................................F-1
Consolidated Balance Sheets - December 31, 1998 and 1997................................F-3
Consolidated Statements of Operations -- For the Three Years
  Ended December 31, 1998...............................................................F-5
Consolidated Statements of Stockholders' Equity -- For the Three Years
  Ended December 31, 1998...............................................................F-6
Consolidated Statements of Cash Flows -- For the Three Years
  Ended December 31, 1998...............................................................F-7
Notes to Consolidated Financial Statements..............................................F-8
</TABLE>

         The following consolidated financial statement schedule of the Company
is filed as a part of this report:

Financial Statement Schedule


<TABLE>
<CAPTION>
                                                                                       Page
                                                                                       ----
<S>                                                                                      <C>
Schedule II -- Valuation and Qualifying Accounts -- For the Three Years
  Ended December 31, 1998..............................................................F-19
</TABLE>


         All other financial statement schedules have been omitted because they
are not applicable or the required information is shown in the consolidated
financial statements and notes thereto.

REPORTS ON FORM 8-K

         On December 9, 1998, the Company filed a report on Form 8-K reporting
the Company's adoption and approval of its Amended and Restated Bylaws. The
Amended and Restated Bylaws include a requirement of timely prior notice for
director nominations or other business that a stockholder wishes to properly
bring before a meeting of stockholders.





                                      -17-
<PAGE>   19

The following exhibits are filed as a part of this report:

<TABLE>
<CAPTION>
Exhibit
Number                                         Exhibit
------                                         -------
<S>                 <C>       
3.1+++              Restated Certificate of Incorporation of the Company

3.2++               Amended and Restated Bylaws of the Company

4.1+                Specimen Certificate evidencing Common Stock

4.2*                Certificate of Designations of Series A Junior 
                        Participating Preferred Stock

10.1*               Revolving Credit and Security Agreement by and among the
                        Company, its subsidiaries and PNC Bank, National 
                        Association, as lender and as agent

10.2 +v             Stock Option Plan, including form of Stock Option 
                        Agreements, as amended

10.3*               Rights Plan

10.4*               Stock Price Appreciation Plan

10.5+v              Director Compensation Plan

10.6v               Employee Stock Purchase Plan

10.7*               Fifth Amendment to Stock Option Plan

16v+                Resignation of KPMG LLP

21*                 Subsidiaries of the Company

23.1*               Consent of Ernst & Young LLP

23.2*               Consent of KPMG LLP

27*                 Financial Data Schedule
</TABLE>


----------
+             Previously filed as an exhibit to the Company's Registration
              Statement on Form SB-2, Registration Number 33-76068-D, initially
              filed with the Securities and Exchange Commission on March 4,
              1994, and declared effective on March 4, 1994, and declared
              effective on March 28, 1994.
++            Previously filed as an exhibit to the Company's report on Form 8-K
              filed with the Securities and Exchange Commission on December 9,
              1998.
+++           Previously filed as an exhibit to the Company's report on Form
              S-8, Registration Number 33-98176, filed with the Securities and
              Exchange Commission on October 17, 1995.
+v            Previously filed as an exhibit to the Company's report on Form
              10-K for the year ended December 31, 1995, filed with the
              Securities and Exchange Commission on March 31, 1996.
v             Previously filed as an exhibit to the Company's Registration
              Statement on Form S-1, Registration Number 333-03977, initially
              filed with the Securities and Exchange Commission on May 17, 1996,
              and declared effective on May 28, 1996.
v+            Previously filed as an exhibit to the Company's report on Form 8-K
              filed with the Securities and Exchange Commission on June 18,
              1998.
*             Filed herewith.




                                      -18-
<PAGE>   20




                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) 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.

                                     PC SERVICE SOURCE, INC.


March 31, 1999                       By: /s/ Avery More 
                                        ----------------------------------------
                                           Avery More, Chairman of the Board and
                                           Chief Executive Officer

     Pursuant to the requirements of the Securities Act of 1934, this report has
been signed below by the following persons on behalf of the registrant and in
the capacities indicated on March 31, 1999.


<TABLE>
<CAPTION>
         SIGNATURE                                     CAPACITY

<S>                               <C>
 /s/ Avery More                   Chairman of the Board and Chief Executive Officer
-----------------------------     (Principal Executive Officer)
     Avery More                   


/s/ Robert J. Boutin              Senior Vice President, Chief Financial Officer and
-----------------------------     Secretary, Director, (Principal Financial and
     Robert J. Boutin             Accounting Officer)
                                  


/s/ Morti Tenenhaus               Director
-----------------------------
     Morti Tenenhaus


/s/ Robert S. Leff                Director
-----------------------------
     Robert S. Leff


/s/ Edward Raymund                Director
-----------------------------
     Edward Raymund


/s/ Jay Haft                      Director
-----------------------------
     Jay Haft



                                  Director
-----------------------------
           Mark Hilz
</TABLE>





<PAGE>   21

                                   

Report of Independent Auditors


The Board of Directors and Stockholders of PC Service Source, Inc.


         We have audited the accompanying consolidated balance sheet of PC
Service Source, Inc. and subsidiaries as of December 31, 1998, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended. Our audit also included the financial statement schedule
listed in the index at Item 14. These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audit.

         We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.

         In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of PC
Service Source, Inc. and subsidiaries at December 31, 1998, and the consolidated
results of their operations and their cash flows for the year then ended in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, present fairly in all material
respects the information set forth therein.



                                      Ernst & Young LLP

Dallas, Texas
February 12, 1999, except
for the last paragraph
     of Note 1 and the first
     paragraph of Note 3,
     for which the date is
     March 11, 1999



                                      F-1
<PAGE>   22



                          INDEPENDENT AUDITORS' REPORT



The Stockholders and Board of Directors
PC Service Source, Inc.:

We have audited the accompanying consolidated balance sheet of PC Service
Source, Inc. and subsidiaries as of December 31, 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended December 31, 1997 and 1996. In connection with the audits of
the consolidated financial statements, we also have audited the financial
statement schedule as listed in the accompanying index for the years ended
December 31, 1997 and 1996. These consolidated financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of PC Service Source,
Inc. and subsidiaries as of December 31, 1997, and the results of their
operations and their cash flows for the years ended December 31, 1997 and 1996,
in conformity with generally accepted accounting principles. Also in our
opinion, the related financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein for the
years ended December 31, 1997 and 1996.




                                    KPMG LLP


Dallas, Texas
February 13, 1998


 



                                      F-2
<PAGE>   23


PC SERVICE SOURCE, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In thousands, except share and per share amounts)


<TABLE>
<CAPTION>
                                                                                 December 31,         
                                                                             -------------------
                                                                             1998           1997
                                                                             ----           ----
<S>                                                                       <C>           <C>
Current assets:
   Cash                                                                   $    940      $    717 
   Accounts receivable, less allowance for doubtful accounts of $974                             
    and $977 at 1998 and 1997, respectively                                 19,212        15,973 
   Inventories, less reserve for obsolescence of $6,469 and $2,407 at                            
    1998 and 1997, respectively                                             22,031        17,511 
   Income taxes receivable                                                     699           668 
   Deferred income taxes                                                     1,102         1,190 
   Other current assets                                                      1,023         1,098 
                                                                          --------      --------
      Total current assets                                                  45,007        37,157 
                                                                          --------      --------
                                                                                                 
Property and equipment                                                                           
   Computer equipment                                                       17,367        13,612 
   Furniture and fixtures                                                    7,009         5,660 
   Leasehold improvements                                                    1,993         1,284 
                                                                          --------      --------
                                                                            26,369        20,556 
   Accumulated depreciation and amortization                               (11,288)       (7,030)
                                                                          --------      --------
      Net property and equipment                                            15,081        13,526 
                                                                          --------      --------
                                                                                                 
Goodwill, net of accumulated amortization of $451 and $222 at                                    
   1998 and 1997, respectively                                               1,819         3,206 
Other assets, net                                                              827         1,269 
                                                                          --------      --------
                    Total Assets                                          $ 62,734      $ 55,158 
                                                                          ========      ======== 
</TABLE>



                                      F-3
<PAGE>   24


PC SERVICE SOURCE, INC. AND SUBSIDIARIES
Consolidated Balance Sheets, Continued
(In thousands, except share and per share amounts)


<TABLE>
<CAPTION>

                                                                                           December 31,         
                                                                                           ------------         
                                                                                
                                                                                       1998           1997  
                                                                                       ----           ----  
<S>                                                                                 <C>           <C>     
Current liabilities:
   Accounts payable                                                                 $ 14,058      $  8,864
   Accrued liabilities                                                                 9,129         3,403
   Current portion of obligations under capital leases                                 1,399         1,153
   Revolving line of credit                                                           14,229            --
                                                                                    --------      --------
      Total current liabilities                                                       38,815        13,420
                                                                                    --------      --------
Long-term debt - revolving line of credit                                                 --         5,535

Obligations under capital leases, excluding current portion                            2,677         3,160

Deferred income taxes                                                                  1,102           709

Commitments and contingencies                                                             --            -- 

Stockholders' equity
   Preferred stock, $.01 par value. Authorized 5,000,000 shares;
    none issued                                                                           --            -- 
   Common stock, $.01 par value. Authorized 20,000,000 shares; issued 5,906,582
    and 5,891,082 shares at December 31, 1998 and 1997, respectively                      59            59
Additional paid-in capital                                                            30,996        30,978
Retained earnings (accumulated deficit)                                               (9,125)        3,087
Less treasury stock, at cost (132,762 common shares)                                  (1,790)       (1,790)
                                                                                    --------      --------
      Total stockholders' equity                                                      20,140        32,334
                                                                                    --------      --------
                    Total Liabilities and Stockholders' Equity                      $ 62,734      $ 55,158
                                                                                    ========      ========
</TABLE>


See accompanying notes to consolidated financial statements



                                      F-4
<PAGE>   25



PC SERVICE SOURCE, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1998, 1997 and 1996
(In thousands, except share and per share amounts)


<TABLE>
<CAPTION>
                                                  1998           1997          1996
                                                  ----           ----          ----
<S>                                            <C>            <C>           <C>      
Net revenues                                   $ 160,773      $ 131,843     $ 110,146

Cost of revenues                                 115,807         94,159        78,001
                                               ---------      ---------     ---------
    Gross margin                                  44,966         37,684        32,145
                                               ---------      ---------     ---------

Operating expenses:
    Selling, general and administrative           47,930         33,271        26,457
    Depreciation and amortization                  4,674          3,504         2,151
    Restructuring charges                          2,969             --            --
                                               ---------      ---------     ---------
        Total operating expenses                  55,573         36,775        28,608
                                               ---------      ---------     ---------
    Earnings (loss) from operations              (10,607)           909         3,537

Net interest expense                               1,605            739           577
                                               ---------      ---------     ---------
    Earnings (loss) before income taxes          (12,212)           170         2,960

Income tax expense                                    --             64         1,089
                                               ---------      ---------     ---------
    Net earnings (loss)                        $ (12,212)     $     106     $   1,871
                                               =========      =========     =========

Earnings (loss) per share
    Basic                                      $   (2.12)     $     .02     $     .38
                                               =========      =========     =========
    Diluted                                    $   (2.12)     $     .02     $     .35
                                               =========      =========     =========

Weighted average common shares outstanding
    Basic                                          5,762          5,750         4,970
                                               =========      =========     =========
    Diluted                                        5,762          5,882         5,285
                                               =========      =========     =========
</TABLE>

See accompanying notes to consolidated financial statements.




                                      F-5
<PAGE>   26


PC SERVICE SOURCE, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(In thousands, except share amounts)


<TABLE>
<CAPTION>
                                                                               Retained
                                         Common stock         Additional       earnings                      Total
                                     -------------------        paid-in      (accumulated)    Treasury    stockholders'
                                     Shares        Amount       capital        deficit)        stock          equity
                                     ------        ------       -------        --------        -----          ------
<S>                                 <C>           <C>           <C>           <C>            <C>            <C>      
Balance at December 31, 1995        3,955,371     $      40     $  10,494     $   1,110      $     (41)     $  11,603
     Issuance of stock              1,439,000            14        18,531            --             --         18,545
     Exercise of stock options        150,129             2           442            --           (267)           177
     Exercise of stock warrants       335,082             3         1,479            --         (1,482)            -- 
     Net earnings                          --            --            --         1,871             --          1,871
                                    ---------     ---------     ---------     ---------      ---------      ---------
Balance at December 31, 1996        5,879,582            59        30,946         2,981         (1,790)        32,196
     Issuance of stock                  1,500            --            10            --             --             10
     Exercise of stock options         10,000            --            22            --             --             22
     Net earnings                          --            --            --           106             --            106
                                    ---------     ---------     ---------     ---------      ---------      ---------
Balance at December 31, 1997        5,891,082            59        30,978     $   3,087      $  (1,790)     $  32,334
     Exercise of stock options         15,500            --            18            --             --             18
     Net loss                              --            --            --       (12,212)            --        (12,212)
                                    ---------     ---------     ---------     ---------      ---------      ---------
Balance at December 31, 1998        5,906,582     $      59     $  30,996     $  (9,125)     $  (1,790)     $  20,140
                                    =========     =========     =========     =========      =========      =========
</TABLE>



See accompanying notes to consolidated financial statements.




                                      F-6
<PAGE>   27


PC SERVICE SOURCE, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In thousands)


<TABLE>
<CAPTION>
                                                                                           Year Ended December 31,       
                                                                                           -----------------------       
                                                                                      1998          1997          1996
                                                                                      ----          ----          ----
<S>                                                                               <C>           <C>           <C>     
Cash flows from operating activities:
    Net earnings (loss)                                                           $(12,212)     $    106      $  1,871
   Adjustments to reconcile net earnings (loss) to net cash provided by (used
    in) operating activities:
      Depreciation and amortization                                                  4,674         3,504         2,151
      Deferred income taxes                                                            481          (181)          753
      Stock issuance for directors' compensation                                        --            10            24
      Restructuring charges                                                          2,969            --            --
      Changes in operating assets and liabilities:
        Accounts receivable                                                         (3,239)       (2,995)       (2,727)
        Inventories                                                                 (4,520)        2,079        (5,913)
        Other current assets                                                            75          (335)          (51)
        Accounts payable                                                             5,194         1,043        (1,055)
        Accrued liabilities                                                          4,476           803           697
        Income taxes receivable/payable                                                (31)         (706)          118
        Other, net                                                                      78          (360)         (195)
                                                                                  --------      --------      --------
          Net cash provided by (used in) operating activities                       (2,055)        2,968        (4,327)
                                                                                  --------      --------      --------

Cash flows from investing activities:
   Capital expenditures                                                             (5,813)       (4,999)       (3,244)
   Acquisitions                                                                       (384)       (2,451)       (1,975)
                                                                                  --------      --------      --------
          Net cash used in investing activities                                     (6,197)       (7,450)       (5,219)
                                                                                  --------      --------      --------

Cash flows from financing activities:
   Net revolving debt borrowings (payments)                                          8,694         2,482        (5,881)
   Proceeds from sale-leaseback transaction                                            963            --            -- 
   Principal payments under capital                                                 (1,200)         (955)         (454)
   lease obligations Net proceeds from public offering                                  --            --        18,521
   Proceeds from exercise of common stock options                                       18            22           177
                                                                                  --------      --------      --------
          Net cash provided by financing activities                                  8,475         1,549        12,363
                                                                                  --------      --------      --------

Net increase (decrease) in cash                                                        223        (2,933)        2,817
Cash at beginning of year                                                              717         3,650           833
                                                                                  --------      --------      --------
Cash at end of year                                                               $    940      $    717      $  3,650
                                                                                  ========      ========      ========

Supplemental cash flow disclosures:
   Interest paid                                                                  $  1,493      $    612      $    545
                                                                                  ========      ========      ========
   Income taxes paid (refunded), net                                              $   (461)     $    856      $    225
                                                                                  ========      ========      ========
</TABLE>


See accompanying notes to consolidated financial statements.



                                      F-7
<PAGE>   28


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

           (a) Description of Business

               PC Service Source, Inc. and Subsidiaries (the "Company") are
               providers of logistic services ("Service Logistics") to the
               personal computer ("PC") hardware repair industry. Service
               Logistics distribution includes sourcing and distributing spare
               parts, inventory management, warranty claims processing, parts
               remanufacturing and related functions, and are provided to
               customers throughout the United States, Canada and Latin America,
               as well as other countries. Service Logistics also includes
               notebook repair.

               The net revenues, gross margin and total assets of the Service
               Logistics-distribution business account for in excess of 90% of
               the related total amounts before intersegment eliminations for
               1998, 1997 and 1996.

           (b) Basis of Consolidation

               The consolidated financial statements include the accounts of PC
               Service Source, Inc. and its wholly and majority owned
               subsidiaries. All significant intercompany balances and
               transactions have been eliminated in consolidation.

           (c) Inventories

               Inventories are stated at the lower of average cost or market and
               consist primarily of new and remanufactured personal computer
               parts.

           (d) Property and Equipment

               Property and equipment are stated at cost. Depreciation is
               calculated on the straight-line method over the estimated useful
               lives of assets, which range from 3 to 5 years. Leasehold
               improvements are amortized using the straight-line method over
               the lesser of the estimated useful lives of the assets or the
               remaining term of the lease, which range from 5 to 7 years.

           (e) Goodwill

               Goodwill represents the excess of purchase price over fair value
               of net assets acquired and is amortized on a straight-line basis
               over the expected periods to be benefitted of 7 and 15 years.


                                      F-8
<PAGE>   29


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


           (f) Revenue Recognition

               Revenue is recognized upon completion of services normally
               represented by shipment to the customer.

           (g) Advertising Costs

               Advertising costs are expensed as incurred. Advertising costs
               amounted to $596, $826 and $812 in 1998, 1997 and 1996,
               respectively.

           (h) Income Taxes

               Income taxes are accounted for under the asset and liability
               method. Deferred tax assets and liabilities are recognized for
               the future tax consequences attributable to differences between
               the financial statement carrying amounts of existing assets and
               liabilities and their respective tax bases and operating loss and
               tax credit carryforwards. Deferred tax assets and liabilities are
               measured using enacted tax rates expected to apply to taxable
               income in the years in which those temporary differences are
               expected to be recovered or settled. The effect on deferred tax
               assets and liabilities of a change in tax rates is recognized in
               income in the period that includes the enactment date.

           (i) Use of Estimates

               The preparation of the consolidated financial statements in
               conformity with generally accepted accounting principles requires
               management to make estimates and assumptions that affect the
               reported amounts of assets and liabilities, and the disclosure of
               contingent assets and liabilities at the date of the consolidated
               financial statements, and the reported amounts of revenues and
               expenses during the reported periods. Actual results could differ
               from those estimates.

           (j) Comprehensive Income

               The Company adopted Statement of Financial Standards No. 130
               (SFAS 130), Reporting Comprehensive Income, in the first quarter
               of 1998, which requires companies to disclose comprehensive
               income separately from net income from operations. Comprehensive
               income is defined as the change in equity during a period from
               transactions and other events and circumstances from
               non-ownership sources. It includes all changes in equity during a
               period, except those resulting from investments by owners and
               distributions to owners. Comprehensive income (loss) is equal to
               net earnings (loss) as presented on the Consolidated Statements
               of Operations for the years ended December 31, 1998, 1997 and
               1996.


                                      F-9
<PAGE>   30


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


           (k) Impairment of Long-Lived Assets and Long-Lived Assets to Be
               Disposed Of

               Long-lived assets and certain identifiable intangible assets are
               reviewed for impairment whenever events or changes in
               circumstances indicate that the carrying amount of an asset may
               not be recoverable. Recoverability of assets to be held and used
               is measured by a comparison of the carrying amount of an asset
               to future net cash flows expected to be generated by the asset.
               If such assets are considered to be impaired, the impairment to
               be recognized is measured by the amount by which the carrying
               amount of the assets exceeds the fair value of the assets.
               Assets to be disposed of are reported at the lower of the
               carrying amount or fair value less costs to sell.

           (l) Noncash Financing and Investing Activities

               Capital lease obligations of $963, $1,368 and $2,866 were
               incurred for computer equipment and furniture and fixtures in
               1998, 1997 and 1996, respectively.

               In 1997 and 1996, 1,500 and 1,500 shares of common stock,
               respectively, were issued to directors in lieu of cash payments
               for an expense of $10 and $24, respectively.

               In 1996, 128,038 shares of treasury stock were acquired upon the
               exercise of stock options and warrants.

           (m) Reclassification

               Certain previously reported financial information has been
               reclassified to conform to the 1998 presentation.

           (n) Fair Value of Financial Instruments

               The carrying values of cash, accounts receivable and accounts
               payable approximate fair value due to the short-term maturity of
               these instruments. The carrying value of the revolving line of
               credit outstanding approximates the estimated fair value since
               the obligation bears interest at current market rates.

           (o) Significant Customer

               In 1998, one customer accounted for approximately 16% of
               revenues. No other customer accounted for 10% or more in revenues
               in 1998 and no customer accounted for 10% or more in 1997 or
               1996.

               In February 1999, this customer notified the Company of its
               intention to terminate the exclusive contract with the Company
               effective as of June 1999. Although the Company 


                                      F-10
<PAGE>   31


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


               anticipates that it will continue to do business with this
               customer after June 1999, any such business will not be on an
               exclusive basis and may be significantly less than in 1998.

(2) INCOME TAXES

    Income tax expense for the years ended December 31 is presented below.


<TABLE>
<CAPTION>
                    1998         1997         1996
                    ----         ----         ----
<S>              <C>          <C>          <C>    
Federal:
    Current      $  (633)     $   247      $   272
    Deferred         384         (166)         777
State:
    Current          152           (2)          64
    Deferred          97          (15)         (24)
                 -------      -------      -------
                 $    --      $    64      $ 1,089
                 =======      =======      =======
</TABLE>


    The reconciliation of income taxes at the federal statutory rate of 34% to
    the effective tax rate for the years ended December 31 is presented below.


<TABLE>
<CAPTION>
                                                          1998        1997        1996
                                                          ----        ----        ----
<S>                                                     <C>           <C>         <C>  
Income taxes (benefit) at federal statutory rate        (34.0)%       34.0%       34.0%
State taxes, net of federal income tax benefit           (2.1)%        2.7%        2.7%
Change in valuation allowance                            30.9%         -- %        -- %
Other                                                     5.2%         0.9%        0.1%
                                                        -----         ----        ----
Effective rate                                            -- %        37.6%       36.8%
                                                        =====         ====        ====
</TABLE>




    The tax effects of temporary differences that give rise to significant
    portions of the deferred tax assets and deferred tax liability at December
    31 are presented below.


<TABLE>
<CAPTION>
                                                   1998         1997
                                                   ----         ----
<S>                                               <C>            <C>
Deferred tax assets:
Inventory costs                                   2,072          537
Net operating loss carryforwards                  1,434           --
Accrued expenses                                    899          190
Accounts receivable                                 363          361
Other                                               104          102
Valuation allowance                              (3,770)          --
                                                -------      -------
                   Total deferred tax asset       1,102        1,190

Deferred tax liability - depreciation             1,102          709
                                                -------      -------
                   Net deferred tax asset       $    --      $   481
                                                =======      =======
</TABLE>



                                      F-11
<PAGE>   32


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


     The Company plans to carryback net operating losses of approximately $1,539
     generated in 1998 to offset taxable income from previous years. The Company
     has net operating loss carryforwards of $3,725, which expires in the year
     2012.

     In assessing the realizability of deferred tax assets, management considers
     whether it is more likely than not that some portion of the deferred tax
     assets will not be realized. As a result of this consideration, a valuation
     allowance of $3,770 is recorded as of December 31, 1998.

(3)  REVOLVING LINE OF CREDIT

     On March 11, 1999, the Company entered into a new $25,000 Revolving Line of
     Credit and Security Agreement with PNC Bank, National Association, which
     matures in March 2002 and is secured by substantially all of the assets of
     the Company. The proceeds of this facility were used in part to retire the
     then outstanding balance under a revolving line of credit with NationsBank,
     N.A. described below. The new credit facility has interest payable on the
     outstanding balance at a rate of 2.50% above the then current London
     Interbank Offering Rate (LIBOR) for LIBOR advances (7.4%) and the PNC prime
     rate advances (10.25%) as of March 11, 1999. As of March 11, 1999, the
     Company had $11,955 outstanding under the new Revolving Line of Credit and
     approximately $7,100 of availability. The total availability is calculated
     from the eligible accounts receivable and inventory as specified by the
     agreement. The new credit facility prohibits the payment of dividends to
     common stockholders and contains customary covenants, including a
     limitation on the amount of indebtedness the Company may incur. The Company
     must also maintain a fixed charge coverage ratio (as defined in the
     Revolving Line of Credit).

     The Company had a $20,000 Revolving Bank Credit Line (the Credit Line) of
     which $14,229 was outstanding as of December 31, 1998 that was scheduled to
     mature in June 1999. Outstanding borrowings under the Credit Line were
     collateralized by substantially all of the assets of the Company.

     Interest was payable on the outstanding borrowings at a rate of 1.00% to
     3.50% above LIBOR for LIBOR advances (8.58% at December 31, 1998) and 0.00%
     to 2.00% above the prime rate for base rate advances (9.75% at December 31,
     1998). The weighted average interest rates were 8.44%, 8.34% and 9.29% for
     1998, 1997 and 1996, respectively.

(4)  LEASES

     The Company entered into capital leases for computer equipment and
     furniture and fixtures expiring in various years through 2003. Most
     recently, in 1998, the Company entered into a $963 capital lease through a
     sale-lease back transaction. Depreciation of assets under capital leases is
     included in depreciation and amortization expense. Interest rates on
     capitalized leases vary from 6.06% to 10.69% and are imputed based on the
     lower of the Company's incremental borrowing rate at the inception of each
     lease or the lessor's implicit rate. 


                                      F-12
<PAGE>   33


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


     Property held under capital leases, which is included in property and
     equipment, at December 31, 1998 and 1997, is presented below.


<TABLE>
<CAPTION>
                                    1998       1997
                                    ----       ----
<S>                               <C>        <C>   
Computer equipment                $4,156     $3,193
Furniture and fixtures             2,849      2,849
                                  ------     ------
                                   7,005      6,042
Less accumulated amortization      3,297      2,039
                                  ------     ------
                                  $3,708     $4,003
                                  ======     ======
</TABLE>




     The Company leases office and warehouse distribution space and equipment
     under various noncancellable operating leases with terms from three to ten
     years. Certain of the leases contain renewal options ranging up to five
     years. Total rental expense under operating leases was $2,430, $2,126 and
     $1,665 in 1998, 1997, and 1996, respectively.

     Future minimum lease payments under capital leases and noncancellable
     operating leases, excluding closed locations, are presented below.


<TABLE>
<CAPTION>
                                                                      Capital              Operating
                                                                       Leases                Leases  
                                                                       ------                ------  
<S>                                                                <C>                   <C>          
1999                                                               $     1,720           $     2,312  
2000                                                                     1,452                 2,221  
2001                                                                       999                 2,114  
2002                                                                       415                 1,963  
2003                                                                       142                 1,986  
Thereafter                                                                 --                  3,224   
                                                                   -----------           -----------
Total minimum lease payments                                             4,728           $    13,820   
Less amount representing interest                                          652           ===========
                                                                   -----------
Present value of net minimum lease payments                              4,076  
Less current portion of obligations under capital leases                 1,399
                                                                   -----------
Obligations under capital leases, excluding current portion        $     2,677   
                                                                   ===========   
</TABLE>



(5)  STOCKHOLDERS' EQUITY

     In June 1996, the Company issued 1,437,500 shares of common stock to the
     public. The net proceeds of this secondary public offering were $18,521 net
     of offering costs of $1,604. The net proceeds were used to pay
     approximately $11,400 outstanding under the Company's revolving bank credit
     facility. The balance of the net proceeds was added to the Company's
     working capital for general operating purposes.





                                      F-13
<PAGE>   34


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


     At December 31, 1998, the Company had reserved 1,574,918 shares of common
     stock for future issuances in connection with its stock option plan, stock
     price appreciation plan, employee stock purchase plan and outstanding
     warrants.

(6)  STOCK OPTIONS

     In 1992, the Company adopted a stock option plan (the Plan) pursuant to
     which the Company's Board of Directors may grant incentive and nonqualified
     options to officers and key employees. The Plan authorizes grants of
     options to purchase up to 1,500,000 shares (increased from 1,000,000 shares
     in 1998) of authorized but unissued common stock. Stock options are granted
     with an exercise price not less than the stock's fair market value at the
     date of grant. Stock options generally become exercisable and vest at a
     rate of 33% per year from the date of grant and generally carry an
     expiration date of ten years subsequent to the date of grant. At December
     31, 1998, there were 153,250 additional shares available for grant under
     the Plan.

     In March 1998, the Compensation Committee of the Board of Directors
     approved a program under which certain option holders canceled their
     existing option agreements in exchange for a new agreement covering a
     reduced number of options with an exercise price of $4.75, the fair market
     value of the Company's common stock at March 1, 1998. The Company cancelled
     agreements covering 460,500 options with exercise prices ranging from $9.00
     to $14.50, in exchange for agreements covering 318,250 options. The new
     option agreements vest over three years.

     The Company applies APB Opinion No. 25, Accounting for Stock Issued to
     Employees, in accounting for the Plan and, accordingly, no compensation
     cost has been recognized for its stock options in the consolidated
     financial statements. Had the Company determined compensation cost based on
     the fair value at the grant date for its stock options since January 1995
     under SFAS No. 123, Accounting for Stock-Based Compensation, the Company's
     net earnings (loss) would be adjusted to the pro forma amounts indicated
     below:


<TABLE>
<CAPTION>
                                                 1998          1997           1996
                                                 ----          ----           ----
<S>                                       <C>         <C>             <C>         
Net earnings (loss):
   As reported                            $   (12,212)$         106   $      1,871
   Pro forma                                  (12,364)         (264)         1,643

Earnings (loss) per share as reported:
   Basic                                        (2.12)          .02            .38
   Diluted                                      (2.12)          .02            .35

Earnings (loss) per share-pro forma:
   Basic                                        (2.15)         (.05)           .33
   Diluted                                      (2.15)         (.05)           .31
</TABLE>



                                      F-14
<PAGE>   35


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


      The following schedule utilizes the Black Scholes option-pricing model
with the following weighted-average assumptions:


<TABLE>
<CAPTION>
                                    1998             1997             1996
                                    ----             ----             ----
<S>                                    <C>              <C>              <C>
Expected dividend yield                0%               0%               0%
Expected volatility                 49.8%            57.7%            58.4%
Risk-free interest rate      5.53 - 5.65%     5.67 - 6.83%     5.24 - 6.64%
Expected life                    4 years          5 years          5 years
</TABLE>


     Following is a summary of activity in the Plan during 1998, 1997 and 1996:


<TABLE>
<CAPTION>
                                                  1998                      1997                       1996
                                                Weighted                  Weighted                   Weighted 
                                                average                   average                    average 
                                    1998        exercise     1997         exercise      1996         exercise 
                                  Options        price      Options        price      Options         price 
                                  -------        -----      -------        -----      -------         ----- 
<S>                            <C>             <C>         <C>           <C>         <C>            <C>      
Outstanding at beginning                                                                                     
   of year                        746,900      $   7.70     630,500      $    7.75     624,129      $    5.46
Granted                         1,024,250          5.31     305,500           9.00     212,000          11.84
Exercised                         (15,500)         2.25     (10,000)          2.25    (150,129)          2.96
Cancelled                        (648,900)         8.80    (179,100)         10.39     (55,500)         10.57
                               ----------                  --------                   --------
Outstanding at end of year      1,106,750          4.85     746,900           7.70     630,500           7.75
                               ==========                  ========                   ========
Options exercisable at
   year end                       161,500      $   1.93     275,900      $    5.64     224,500      $    5.25
                               ==========      ========    ========      =========    ========      =========

Weighted average fair                                                                                 
   value of options granted                                                                           
   during the year             $     1.42                  $   3.85                   $   6.68  
                               ==========                  ========                   ========  
</TABLE>


     The exercise price for options outstanding at December 31, 1998, ranged
     from $0.25 to $8.00.

(7)  STOCK WARRANTS AND OTHER

     In October 1998, the Company approved a Stock Price Appreciation Plan
     pursuant to which a total of 200,000 shares of the Company's common stock
     will be available for issuance to certain employees of the Company if the
     closing price per share exceeds $15.00 for twenty consecutive trading days
     prior to February 28, 2002.



                                      F-15
<PAGE>   36


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


     In March 1994, the Company issued 100,000 warrants with an exercise price
     of $10.80. Of those warrants, 85,082 were exercised in 1996. The balance of
     the warrants expire in April 2000.

     In January 1994, the Company issued 250,000 warrants with an exercise price
     of $2.25 which included a net exercise provision which allowed the holder
     to surrender the warrant in exchange for the number of shares of stock
     equal to the difference between the total number of shares under the
     warrant and the number of shares at fair market value equal to the total
     exercise price. The warrants were surrendered in 1996 resulting in the
     issuance of 209,821 shares. No warrants remain outstanding.

(8)  EARNINGS (LOSS) PER SHARE

     Basic earnings per share is computed by dividing net earnings (loss) by the
     weighted average number of common shares outstanding during the period.
     Diluted earnings (loss) per share reflects the potential dilution that
     could occur if securities or other contracts to issue common stock were
     exercised or converted into common stock. Diluted earnings (loss) per share
     is the same as basic earnings (loss) per share for 1998 because the impact
     of potentially dilutive securities was anti-dilutive.

     The following table sets forth the computation of the basic and diluted
     earnings (loss) per share.


<TABLE>
<CAPTION>
                                                 Years Ended
                                                 December 31
                                     -----------------------------------
                                       1998          1997         1996
                                     --------      --------     --------
<S>                                  <C>           <C>          <C>     
Net earnings (loss)                  $(12,212)     $    106     $  1,871
                                     ========      ========     ========

Weighted average common shares
   outstanding-basic                    5,762         5,750        4,970
Employee stock options and other           --           132          315
                                     --------      --------     --------

Weighted average common shares
   outstanding-diluted                  5,762         5,882        5,285
                                     ========      ========     ========
Earnings (loss) per share:
   Basic                             $  (2.12)     $   0.02     $   0.38
   Diluted                           $  (2.12)     $   0.02     $   0.35
</TABLE>


     At December 31, 1998, 1,121,668 employee stock options and other
     potentially dilutive securities were excluded from the weighted average
     common shares outstanding diluted computation for the year ended December
     31, 1998 because their impact would be anti-dilutive.




                                      F-16
<PAGE>   37


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


(9)  BENEFIT PLANS

     The Company sponsors a defined contribution plan under Section 401(k) of
     the Internal Revenue Code. Employees who have attained the age of 21 and
     completed one full quarter of service are eligible to participate.
     Participation may begin on January 1, April 1, July 1, or October 1
     following the full quarter of service. Eligible employees may contribute
     from 1% to 15% of their annual compensation subject to limitations. The
     Company matches 100% of the first 4% an employee contributes. Employee
     contributions vest immediately while the Company contributions vest 100% at
     the end of the second year of employment. In 1998, 1997 and 1996 the
     Company contributed $543, $454 and $299, respectively.

     In 1996, the Company adopted an Employee Stock Purchase Plan (the Purchase
     Plan) covering all employees that have attained the age of 21 and completed
     one year of service. Under the Purchase Plan, eligible participants may
     purchase stock of the Company at not less than 85% of its market value as
     of the date the option to purchase is offered to the employees; employees
     have one year to make sufficient contributions to pay the exercise price.
     No shares have been issued under the Purchase Plan. At December 31, 1998,
     100,000 shares were available for future issuance.

(10) COMMITMENTS AND CONTINGENCIES

     The Company is subject to various pending and threatened litigation from
     time to time in the ordinary course of business. Although all litigation
     involves some degree of uncertainty, in the opinion of management,
     liabilities, if any, arising from such litigation or threat thereof are not
     expected to have a material adverse impact on the Company's business,
     financial conditions or results of operation.

(11) RESTRUCTURING

     In December 1998, the Company decided to consolidate its west coast repair
     facility into the Irving, Texas facility resulting in restructuring charges
     of approximately $3,000. The charges included $1,700 for the write-off of
     goodwill associated with the west coast operation, $700 for future lease
     commitments, $400 for severance for approximately 40 employees which
     represented substantially all of the employees of the facility and $200 for
     the write-down of fixed assets. Completion of the closure of the west coast
     repair facility is expected to occur by June 1999, although lease payments
     are expected to continue through January 2001. No amounts have been paid in
     1998 related to the liabilities recorded for future lease commitments or
     severance.



                                      F-17
<PAGE>   38


                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                   Notes to Consolidated Financial Statements

                           December 31, 1998 AND 1997

               (In thousands, except share and per share amounts)


(12) QUARTERLY FINANCIAL DATA (UNAUDITED)


<TABLE>
<CAPTION>
                                      First      Second       Third     Fourth
   1998                              Quarter     Quarter     Quarter    Quarter 
   ----                              -------     -------     -------    -------
<S>                                  <C>         <C>         <C>        <C>     
Net revenues                         $38,497     $38,309     $42,865    $41,102 
Gross margin                          11,209      11,328      12,349     10,080 
Net earnings (loss)                      168      (2,241)         46    (10,185) 
Earnings (loss) per share:                                                      
        Basic                            .03        (.39)        .01      (1.77) 
        Diluted                          .03        (.39)        .01      (1.77) 
</TABLE>



     The fourth quarter 1998 results include pretax charges totaling $6,400
     related to certain non-recurring items. The major components of the charges
     were: a non-recurring $3,000 charge in connection with the consolidation of
     the repair operations (see note 11), which is included as restructuring
     charges; a $2,200 charge related to severance and other expenses included
     in selling, general and administrative expenses; and a $1,200 charge
     resulting from a review of policies, procedures and methodologies
     undertaken by management, included in cost of revenue. In addition, the
     fourth quarter includes a tax provision of $1,200 which reverses tax
     benefits previously taken, primarily in the second quarter.


<TABLE>
<CAPTION>
                                    First        Second         Third      Fourth
   1997                            Quarter       Quarter       Quarter     Quarter
   ----                            -------       -------       -------     -------
<S>                                <C>           <C>           <C>         <C>    
Net revenues                       $32,421       $31,711       $33,495     $34,216
Gross margin                         8,986         9,472         9,916       9,310
Net earnings (loss)                    447           271             5        (617)
Earnings (loss) per share:                                                        
        Basic                          .08           .05           .00        (.11)
        Diluted                        .08           .05           .00        (.11)
</TABLE>




                                      F-18
<PAGE>   39


                                   SCHEDULE II

                    PC SERVICE SOURCE, INC. AND SUBSIDIARIES

                        VALUATION AND QUALIFYING ACCOUNTS

                   FOR THE THREE YEARS ENDED DECEMBER 31, 1998



<TABLE>
<CAPTION>
                                                              Additions
                                                              ---------
                                         Balance at   Charged to     Charged                    Balance at
                                         Beginning    costs and     to other                       end
    Description                          of period    expenses      accounts       Deductions    of period
    -----------                          ---------    --------      --------       ----------    ---------
<S>                                        <C>         <C>           <C>          <C>               <C>
Accounts receivable -                                                                                   
   allowance for doubtful accounts                                                                      

    1998                                   $ 977       $1,257            --       $1,260 (A)        $974
                                                                                                        
    1997                                     384        1,727            --        1,134 (A)         977
                                                                                                        
    1996                                     267          505            --          388 (A)         384
</TABLE>


         (A) Write-off of uncollectible accounts, net of recoveries.


<TABLE>
<CAPTION>
                                                              Additions
                                                              ---------
                                         Balance at   Charged to     Charged                    Balance at
                                         Beginning    costs and     to other                       end
    Description                          of period    expenses      accounts       Deductions    of period
    -----------                          ---------    --------      --------       ----------    ---------
<S>                                        <C>         <C>           <C>          <C>               <C>
Inventories -
  reserve for obsolescence

     1998                                  $2,407       $6,499       $     --       $2,437(B)         $6,469
                                                                                                            
     1997                                   3,218          231             --        1,042(B)          2,407
                                                                                                            
     1996                                   2,341          781          1,171        1,075(B)          3,218
</TABLE>


         (B) Write down of inventory.



                                      F-19
<PAGE>   40





                                  EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
NUMBER                EXHIBIT
------                -------
<S>                   <C>
3.1+                  Restated Certificate of Incorporation of the Company                           
                                                                                                     
3.2++                 Amended and Restated Bylaws of the Company                                     
                                                                                                     
4.1+                  Specimen Certificate evidencing Common Stock                                   
                                                                                                     
4.2*                  Certificate of Designations of Series A Junior Participating Preferred Stock   
                                                                                                     
                             
10.1*                 Revolving Credit and Security Agreement by and among the Company, its          
                      subsidiaries and PNC Bank, National Association, as lender and as agent        
                                                                                                     
                             
10.2 +v               Stock Option Plan, including form of Stock Option Agreements, as amended       
                                                                                                     
                                                                
10.3*                 Rights Plan                                                                    
                                                                                                     
10.4*                 Stock Price Appreciation Plan                                                  
                                                                                                     
10.5+v                Director Compensation Plan                                                     
                                                                                                     
10.6v                 Employee Stock Purchase Plan                                                   
                                                                                                     
10.7*                 Fifth Amendment to Stock Option Plan                                           
                                                                                                     
16v+                  Resignation of KPMG LLP                                                        
                                                                                                     
21*                   Subsidiaries of the Company                                                    
                                                                                                     
23.1*                 Consent of Ernst & Young LLP                                                   
                                                                                                     
23.2*                 Consent of KPMG LLP

27*                   Financial Data Schedule              
</TABLE>


-------------------------
+              Previously filed as an exhibit to the Company's Registration
               Statement on Form SB-2, Registration Number 33-76068-D, initially
               filed with the Securities and Exchange Commission on March 4,
               1994, and declared effective on March 4, 1994.
++             Previously filed as an exhibit to the Company's report on Form
               8-K filed with the Securities and Exchange Commission on December
               9, 1998.
+++            Previously filed as an exhibit to the Company's report on Form
               S-8, Registration Number 33-98176, filed with the Securities and
               Exchange Commission on October 17, 1995.
+v             Previously filed as an exhibit to the Company's report on Form
               10-K for the year ended December 31, 1995, filed with the
               Securities and Exchange Commission on March 31, 1996.
v              Previously filed as an exhibit to the Company's Registration
               Statement on Form S-1, Registration Number 333-03977, initially
               filed with the Securities and Exchange Commission on May 17,
               1996, and declared effective on May 28, 1996.
v+             Previously filed as an exhibit to the Company's report on Form
               8-K filed with the Securities and Exchange Commission on June 18,
               1998.
*              Filed herewith.