<PAGE>   1
                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

   
                                  FORM 10-K/A
    

(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, 1996

                                       OR

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

               FOR THE TRANSITION PERIOD FROM               TO
                                              -------------    -------------

                         COMMISSION FILE NUMBER 0-22202

                           PAIRGAIN TECHNOLOGIES, INC.
             (Exact name of registrant as specified in its charter)

           DELAWARE                                            33-0282809
(State or other jurisdiction of                             (I.R.S. Employer
 incorporation or organization)                             Identification No.)

                 14402 FRANKLIN AVENUE, TUSTIN, CALIFORNIA 92780
               (Address of principal executive offices) (Zip Code)

       Registrant's telephone number, including area code: (714) 832-9922

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

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                         COMMON STOCK, $.0005 PAR VALUE
                                (Title of Class)

         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/A or any
amendment to this Form 10-K/A. / /
    

         Based on the closing sale price of Nasdaq National Market on January
31, 1997, the aggregated market value of the voting stock held by non affiliates
of the registrant was $2,594,697,000. The number of shares outstanding of the
registrant's common stock, $.0005 par value, was 64,527,013 on January 31, 1997.

DOCUMENTS INCORPORATED BY REFERENCE

         Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders currently expected to be held on June 11, 1997, as filed with the
Commission pursuant to Regulation 14A, are incorporated by reference in Part III
of this Report.

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                                     PART I

ITEM 1.  BUSINESS.

         PairGain Technologies, Inc. ("PairGain" or the "Company") is a leading
provider of telecommunications products based on high-speed Digital Subscriber
Line ("xDSL") technology. The Company designs, manufactures, markets and
supports products that allow telecommunications carriers and private network
owners to more efficiently provide high-speed digital services to end users over
the large existing infrastructure of unconditioned copper wires. These services
enable high-speed data transmission for applications such as T1/E1, high-speed
Internet access, telecommuting, wide area networking and video conferencing.

RISK FACTORS

         Except for the historical information contained herein, the matters
discussed in this Annual Report are forward-looking statements which involve
risk and uncertainties, including but not limited to economic, competitive,
governmental and technological factors affecting the Company's operations,
markets, products, services and prices and other factors discussed in the
Company's filings with the Securities and Exchange Commission.

     Acquisition-Related Risks

         The Company recently completed its first significant acquisition of
another company. This acquisition will present the Company with numerous
challenges, including difficulties in the assimilation of the operations,
technologies and products of the acquired company and managing separate
geographic operations. The Company may make future acquisitions where it
believes that it can acquire new products and channels of distribution or
otherwise rapidly enter new or emerging markets. Mergers and acquisitions of
high technology companies are inherently risky and no assurance can be given
that the recent acquisition or any future acquisitions will be successful and
will not adversely affect the Company's financial condition or results of
operations.

     Average Sales Price Reductions

         Commencing in mid-1993, the Company began reducing the average sales
prices of its HiGain(TM) products in an effort to increase market demand for its
products and in anticipation of expected price competition. These reductions
have been significant, representing a reduction of as much as 14% in 1996, 23%
in 1995 and 40% in 1994. The Company expects to continue to reduce the average
sales prices of its products, including its HiGain products, in future periods.
Accordingly, the Company's ability to maintain or increase revenues will depend
in part upon its ability to increase unit sales volumes of HiGain products and
to introduce and sell new products at rates sufficient to compensate for the
reduced revenue effect of such continuing reductions in the average sales prices
of the Company's HiGain products. Declining average sales prices may also
adversely affect gross margins on the Company's HiGain products if the Company
is unable to fully offset such reductions in average sales prices by reductions
in the Company's per unit costs. There can be no assurance that the Company will
be able to increase the unit sales volumes of its HiGain products, introduce and
sell new products, reduce its per unit costs or maintain or increase revenues or
margins attributable to such products. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations," "Business--Products" and
"--Competition."

     Product Concentration

         Revenues from HiGain products represented approximately 76% of the
Company's total revenues in each of the years 1996, 1995 and 1994. The Company
expects that revenues from HiGain products will continue to account for a
majority of the Company's revenues for the foreseeable future, although there
can be no assurance that the Company will be able to sustain recent levels of
HiGain product sales. A decline in demand for HiGain products, whether as a
result of competition, deployment of fiber cable, technological change or
otherwise, could


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have a material adverse effect on the Company's operating results. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business--Products."

     Future Operating Results Subject to Fluctuation

         The Company's operating results may fluctuate in the future as a result
of a number of factors, including the timing of orders from, and shipments to,
major customers, the timing of new product announcements by the Company or its
competitors, variations in the Company's sales channels or the mix of products
it sells, changes in pricing policies by the Company's suppliers, the
availability and cost of key components, the timing of personnel hirings, the
market acceptance of new and enhanced versions of the Company's products and the
timing of final product approvals from any of the Regional Bell Operating
Companies ("RBOC's"). Further, the Company's expense levels are based in part on
expectations of future revenues, and the Company has been significantly
increasing and intends to continue to significantly increase operating
expenditures and to increase inventories as it expands its levels of operations.
The Company anticipates that the rate of new orders may vary significantly from
month to month. Consequently, if anticipated sales and shipments in any quarter
do not occur when expected, operating expenses and inventory levels could be
disproportionately high, and the Company's operating results for that quarter,
and potentially future quarters, would be adversely affected.

     Competition

         Competition in the Company's markets is intense, and the Company
expects that competition will increase. Many of the Company's potential
competitors have substantially greater name recognition and technical, financial
and marketing resources than the Company. There can be no assurance that the
Company will have the financial resources, technical expertise or marketing,
distribution and support capabilities to compete successfully in the future.
Competitive pressures could reduce demand for the Company's products, cause the
Company to further reduce prices on its existing products, increase expenses or
cause delays or cancellations of customer orders, any one of which could
adversely affect the Company's business and results of operations.

         The Company's most significant domestic competitors are ADTRAN, Inc.
("ADTRAN") and ADC Telecommunications, which offer High-bit-rate Digital
Subscriber Line ("HDSL") systems and have often competed with the Company on the
basis of price. The Company may also face competition from the licensees of its
own HDSL technology. Specifically, the Company and Alcatel Network Systems, Inc.
("Alcatel") have granted each other royalty-free cross licenses of current
PairGain HDSL technology and Alcatel's current Network Management Software.

         Many companies have introduced or announced xDSL-based products,
including both T1 and E1 products, including HDSL chips currently offered by
Brooktree Corporation ("Brooktree"), the former supplier of the Company's SPAROW
I chip, Level One Communications ("Level One") and Metalink. Other companies
that offer xDSL-based products include Ascend, ADTRAN, Westel, Amati and Cisco.
The Company also faces significant competition from providers of other
technologies used by private network users to transmit information, including
fiber and conventional repeatered T1 lines. The Company expects that additional
companies will introduce competitive products in the future, and there can be no
assurance that the Company will continue to compete successfully in the future.
See "Business--Sales and Marketing and Customer Support" and "--Competition."

         All manufacturers of products based on HDSL technology face competition
from fiber optic and conventional repeatered systems as alternate solutions for
the delivery of T1, E1 and other high-bandwidth services to end users. As
telephone companies continue to install fiber cable and conventional repeatered
T1 systems to provide high-bandwidth service in local subscriber loops, the
demand for HDSL products may decline. Further, the deployment of fiber to
replace existing HDSL installations will result in the availability of those
existing HDSL systems for installation elsewhere and may adversely affect future
demand for HDSL products. See "Business--Industry Background" and
"--Competition."


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     Dependence on Suppliers and Subcontractors

         Certain components used in the Company's HDSL products are currently
purchased from a single source (including the Company's SPAROW II chip) and
others are available from a limited number of sources. In the past, the Company
has experienced delays in the receipt of certain of its key components, which
have resulted in delays in product deliveries. There can be no assurance that
delays in key component and product deliveries will not occur in the future. The
inability to obtain sufficient key components as required, or to develop
alternative sources if and as required in the future, could result in delays or
reductions in product shipments to the Company's customers. Any such delays or
reductions could have a material adverse effect on the Company's reputation and
customer relationships which could, in turn, have a material adverse effect on
the Company's business and results of operations. In addition, the Company uses
third-party subcontractors for the manufacture of its products. This reliance on
third-party subcontractors involves several risks, including the potential
absence of adequate capacity, the unavailability of or interruptions in access
to certain process technologies and reduced control over product quality,
delivery schedules, manufacturing yields and costs.

         Shortage of raw materials or production capacity constraints at the
Company's subcontractors could negatively affect the Company's ability to meet
its production obligations and result in increased prices for affected parts.
Any such reduction may result in delays in shipments of the Company's products
or increases in the price of components, either of which could have a material
adverse impact on the Company. See "Business--Manufacturing."

     Customer Concentrations

         Aggregate sales to local telephone companies affiliated with Bell
Atlantic, BellSouth, NYNEX, Pacific Telesis, and SBC Communications (formerly
Southwestern Bell) accounted for approximately 59%, 63% and 66% of the Company's
total revenues for 1996, 1995 and 1994, respectively. As a result of the
Company's dependence on its largest customers, the Company's future success will
significantly depend upon the timeliness and size of future purchase orders, if
any, from its largest customers, the product requirements of such customers, the
financial and operational success of such customers, and in particular, the
success of such customers' services deployed using the Company's products. The
Company's sales to its largest customers have in the past fluctuated and may in
the future fluctuate significantly from quarter-to-quarter and year-to-year. The
loss of any such customer or the occurrence of any such sales fluctuations could
have a material adverse effect on the Company's business and results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and "Business--Customers."

     Dependence on New Markets and Technologies

         The Company is evaluating new applications of high-speed copper
transmission technologies, is investing significant corporate resources in the
development of Asymmetric Digital Subscriber Line ("ADSL") technology, and
expects to devote significant additional resources to the development of other
new technologies in the future. In addition, the Company does not expect to
generate significant revenues from ADSL products in 1997, and there can be no
assurance that the Company will ever generate significant revenues from ADSL
products. There can be no assurance that such technologies will be viable or
that markets for such technologies will develop. Any failure in the development
of new markets and technologies could have a material adverse effect on the
Company's business. "Business--Company Strategy" and "--Product Development."

     Rapid Technological Change and Dependence on New Products

         The market for the Company's products is characterized by rapid
technological advances, evolving industry standards, changes in end user
requirements and frequent new product introductions and enhancements. The
introduction of xDSL products involving superior technologies or the emergence
of alternative technologies or new industry standards could render the Company's
existing products, as well as products currently under development, obsolete and
unmarketable. The Company believes its future success will depend in part upon
its


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ability to continue, on a cost-effective and timely basis, to enhance its xDSL 
products, develop and introduce new products for the xDSL market and other
markets, meet changing customer needs and achieve broad market acceptance for
its products. There can be no assurance that the Company will be able to respond
effectively to technological changes or new product announcements, that the
Company will be able to successfully develop and market new products or product
enhancements or that such products or enhancement will achieve market
acceptance. Any failure by the Company to anticipate or respond on a cost
effective and timely basis to technological developments, changes in industry
standards or end user requirements, or any significant delays in product
development or introduction, could have a material adverse effect on the
Company's business. Further, there are physical limits to the speed at which
transmissions can travel over copper wire, and the Company's copper-based xDSL
products will not be a viable solution for customers requiring service at
performance levels beyond the limits of copper wire. See "Business--Company
Strategy" and "--Product Development."

     Need to Generate International Sales

         To date, sales of the Company's products outside of the United States
and Canada have been limited. The Company's ability to meet its objectives will
require it to generate significant international sales in 1997 and beyond.
International business is subject to risks in addition to those inherent in the
Company's North American business including substantially different regulatory
requirements in different jurisdictions, varying technical standards, tariffs
and trade barriers, political and economic instability, reduced protection for
intellectual property rights in certain countries, difficulties in staffing and
maintaining foreign operations, difficulties in managing distributors,
potentially adverse tax consequences, foreign currency exchange fluctuations,
the burden of complying with a wide variety of complex foreign laws and treaties
and the possibility of difficulties in collecting accounts receivable and
increased days sales outstanding. There can be no assurance that the Company
will be able to generate significant international sales, or establish new
strategic marketing relationships in the future. In addition, in the event the
Company is successful in doing business outside of North America, the Company
may also face economic, political and foreign currency situations that are
substantially more volatile than those commonly experienced in the United States
and other international markets. There can be no assurance that any of these
factors will not have a material adverse effect on the Company's business and
results of operations.

     Proprietary Technology

         The Company's success and future revenue growth will depend, in part,
on its ability to protect trade secrets, obtain or license patents and operate
without infringing on the rights of others. Although the Company regards its
technology as proprietary, it has limited patents on such technology. The
Company relies on a combination of technical leadership, trade secrets,
copyright and trademark law and nondisclosure agreements to protect its
unpatented proprietary know-how. However, there can be no assurance that such
measures will provide meaningful protection for the Company's trade secrets or
other proprietary information. Moreover, in the absence of patent protection,
the Company's business may be adversely affected by competitors who
independently develop substantially equivalent technology. In addition, the laws
of some foreign countries do not protect the Company's proprietary rights to the
same extent as do the laws of the United States. The Company is also subject to
the risk of adverse claims and litigation alleging infringement of the
intellectual property rights of others. From time to time the Company has
received claims of infringement of other parties' proprietary rights, although
the Company is not party to any pending intellectual property litigation. There
can be no assurance that third parties will not assert infringement claims
against the Company in the future or that any such claims will not result in
costly litigation or require the Company to obtain a license to intellectual
property rights of such parties, regardless of the merit of such claims. No
assurance can be given that any necessary licenses will be available or that, if
available, such licenses can be obtained on commercially reasonable terms. See
"Business--Proprietary Rights."

     Dependence on Key Personnel

         The success of the Company is dependent in large part on two of its
founders, Howard S. Flagg and Benedict A. Itri, on its Chairman and Chief
Executive Officer, Charles S. Strauch, and on other key management and technical
personnel, the loss of one or more of whom could adversely affect the Company's
business. The Company does not have employment contracts with any of its
executive officers. In addition, the Company believes


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that its future success will depend in large part upon its continued ability to
attract, retain and motivate highly skilled employees, who are in great demand.
There can be no assurance that the Company will be able to do so.

     Management of Expanding Operations

         The Company has experienced a period of significantly expanding
operations and headcount, which has placed, and will continue to place, a
significant strain on the Company's personnel and other resources. The Company's
ability to manage any future increases in the scope of its operations or
headcount, should they occur, will depend on significant expansion of its
manufacturing, research and development, marketing and sales, management and
financial and administrative capabilities. The failure of the Company's
management to effectively manage any expansion in its business could have a
material adverse effect on the Company's business and results of operations.

     Reliance on Primary Manufacturing Facilities

         The Company historically conducted virtually all final assembly and
final test functions at its manufacturing facility in Tustin, California. In
1996, the Company entered into an agreement to have its PG-2 products
manufactured, on a turnkey basis, by Jabil Circuits at Jabil's St. Petersburg,
Florida facility. Any extended interruption of operations at either of these
facilities could have a material adverse effect on the Company's business and
results of operations.

     Capital Requirements

         The Company's capital requirements will depend on many factors,
including the levels at which the Company maintains inventory, the continued
market acceptance of the Company's products, growth in unit sales volume of
HiGain products, the extent to which the Company invests in new technology and
improvements to its existing xDSL technology, the marketing expenditures
associated with launching new products and maintaining a competitive position in
the marketplace and the response of competitors to products based on the
Company's technology. To the extent that the Company's existing resources,
together with future earnings, are insufficient to fund the Company's future
activities, the Company may need to raise additional funds through public or
private financings. No assurance can be given that additional financing will be
available or that, if available, it can be obtained on terms favorable to the
Company and its stockholders.

INDUSTRY BACKGROUND

         In recent years, demands on the telephone infrastructure have prompted
telephone companies to improve the reliability and increase the speed of
transmission over telephone networks. Telephone networks have evolved from
systems based entirely on low speed analog communication over copper wires to
fiber optic backbones running throughout the interexchange carrier and local
exchange carrier networks. These fiber optic backbones permit digital
communication of much greater volumes of data with greatly enhanced reliability
and increased speed throughout the interexchange network and among the local
carriers. However, the "last mile," the local subscriber loop through which
telephone services are delivered from local carriers to end users, continues to
be predominantly characterized by low speed analog transmission over copper
wires.

         The following diagram depicts the public telephone network
infrastructure:


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                           [DIAGRAM OF INFRASTRUCTURE]

         The quality of telephone service to end users is determined by the
least reliable and slowest link in the network, and the traditional analog
infrastructure was not designed to provide high-speed, high-data capacity
service to end users. However, end users are increasingly demanding higher speed
data transmission for applications such as Internet access, telecommuting,
remote LAN (local area network) access, video conferencing and wide area
networking, which includes communications among computers and telephone systems.
Telephone service carriers are therefore facing increasing pressure to install
digital telecommunications services in the "last mile." Digital transmission has
distinct advantages over analog transmission, including increased speed, higher
reliability and better quality. Installing digital service facilities also
provides telephone companies worldwide with the foundation to offer their
customers high-speed video and multimedia services. In addition, international
carriers, especially those in developing countries where the copper wire
infrastructure is less extensive, are facing a growing demand for digital
service and are deploying it to provide multiple voice circuits (telephone
lines) rather than the high-speed services requested in the United States.

         Competitive pressure from alternate carriers has further accelerated
the telephone companies' deployment of digital service in the "last mile."
Unlike public telephone companies, these alternate carriers are not required to
provide universal service and instead may choose to serve only those customers
with high demand for digital services, an important market targeted by the
telephone companies due to the higher rates and increased usage associated with
these services. By installing primarily fiber cable, these alternate carriers
have provided short delivery intervals and high quality service, which has
enabled them to compete effectively with the local telephone companies for these
high demand customers. As a result of this competitive pressure, the telephone
companies face an increased need to provide digital service approaching the
quality of fiber optic cable quickly and efficiently.

         The basic building blocks of today's high-speed digital
telecommunications networks in North America are T1 lines, which transmit data
at 1.544 Mbps, the equivalent of 24 voice circuits for simple telephone service.
E1 lines, the international functional equivalent of T1 lines, operate at 2.048
Mbps. Telephone companies are seeking cost effective methods of providing T1
service to meet customer demands for high-speed digital transmission. By
providing T1 service, telephone companies can provide the means for increased
customer usage which, in turn, expands the revenue base for these telephone
companies. One way that telephone companies have installed T1 service has been
to deploy fiber cable. However, deploying fiber cable in the "last mile" is
capital and labor intensive, so it is only cost efficient if a number of T1
lines are requested in the particular subscriber loop. A fiber system may be
capable of transporting from four to over one hundred T1 lines. The equipment
required at a customer's premises alone can cost a few thousand dollars for a T1
fiber optic system with four lines to tens of thousands of dollars for higher
capacity systems. In either case, significant additional costs are involved in
installing fiber cable in existing conduit or burying new cable. Installing
fiber cable in the "last mile" is also time consuming, often taking a carrier
weeks or months to complete, depending on the location to which the fiber is
deployed, the timeliness of the carrier's success in obtaining the necessary
rights of way and the extent to which the existing conduit is obstructed or
damaged.

         As an alternative to fiber deployment, telephone companies use
repeatered T1 lines, which require them to "condition" the existing copper wires
to meet T1 or E1 standards. Conditioning copper wires is accomplished through a
time consuming, capital and labor intensive installation process, which involves
the removal of bridged taps and the installation of repeaters. Repeaters are
devices required about every 3,000 to 5,000 feet to regenerate


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the signal as it passes along the line. To condition existing copper wires,
telephone company engineers must (i) identify which copper wires are to be used
(only three to four pairs of wires in a single cable can be used due to
"crosstalk," or interference, from other pairs of wires in the same cable), (ii)
define where repeaters must be installed, (iii) allocate space in repeater
housings and manholes for the necessary equipment and (iv) locate bridged taps
(wire leads from previously disconnected lines) for removal. Technicians,
following the design of the engineers, must then go to each location to remove
the bridged taps, install the repeaters and add new repeater housings when
needed. Next, each repeater span must be measured by the engineers to ensure
that the intent of the design is achieved. The cost of installing a repeatered
T1 line varies widely depending on the amount of conditioning that the copper
wires require, including the number of repeaters that need to be installed.
Generally, the cost of installing a repeatered T1 line on up to 12,000 feet of
unconditioned copper wire can range from approximately $2,500 to $8,000. While
often deployed as an alternative to fiber, the transmission error rates on
repeatered T1 lines are significantly higher than fiber, which is particularly
detrimental for certain data and video transmissions.

         In the late 1980s, Bellcore, the research and development entity
jointly created and funded by the seven RBOCs for the development of new
technologies, developed the parameters for HDSL technology as a high quality,
but lower cost and more efficient method for installing T1 lines in the "last
mile" on copper. HDSL utilizes high-speed digital signal processing technology
to create a mathematical model of copper wire that allows the receiver to
precisely compensate for the predictable distortion that the wire imparts on the
digital signal sent from the distant end.

         The following diagram depicts a comparison of a conventional repeatered
T1 line with an HDSL circuit:

                [COMPARISON DIAGRAM OF T1 LINE WITH HDSL CIRCUIT]

         The Company believes that HDSL technology offers a significant
opportunity to meet end user demand for high-speed digital telecommunications
services in the local subscriber loop. HDSL technology has a number of
advantages over both fiber cable and conventional repeatered T1 systems,
including lower installation costs and faster deployment time. There are,
however, certain situations in which HDSL technology is disadvantaged relative
to these alternative solutions. For example, if a number of T1 lines are
requested at a single location, fiber cable provides the highest quality digital
transmission and may be more cost effective to deploy. However, because HDSL
technology utilizes the existing copper wire infrastructure, it can be deployed
in one or two days instead of weeks or months. HDSL systems operate over copper
wire without the removal of bridged taps and can tolerate crosstalk, resulting
in reduced engineering design time and lower costs. HDSL systems also eliminate
the need for repeaters, thereby reducing a carrier's initial capital
expenditures and its subsequent maintenance costs for trouble shooting. HDSL
provides higher quality digital transmission than repeatered copper and
approaches the low error rate of fiber optic cable.


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PAIRGAIN STRATEGY

         The Company pioneered the development of a very large scale integration
("VLSI") implementation of HDSL technology and is currently a leading provider
of telecommunications products based on xDSL technology. The Company's strategy
for expanding the market for its products consists of three primary elements:

    -  Maintain Technology Leadership. The Company believes that it is a leader
       in xDSL technology and systems. The Company's engineering organization
       includes a core development team focused on applying digital signal
       processing ("DSP") techniques to telecommunications products. The Company
       leverages this core DSP expertise with an in-house VLSI design group that
       designs advanced VLSI components. The Company's in-house VLSI design
       group was the first to deliver an HDSL transceiver on a single chip (the
       SPAROW I chip). The Company believes that the close coordination between
       its VLSI design and product development teams enables it to reduce its
       time to market for new products. The engineering organization places the
       highest priority on maintaining the cost and feature competitiveness of
       the Company's HDSL product line through aggressive cost reduction and
       introduction of new additions to the HiGain product family. As an
       example, the Company's SPAROW II chip provides lower power consumption
       and lowers the individual device cost. The Company is also putting
       significant effort into Asymmetric Digital Subscriber Line ("ADSL"), a
       technology for higher speed transmission over copper wire. The Company
       believes that maintaining its leadership in technology for high-speed
       digital transmission over copper wire is critical to its ability to build
       and maintain strong relationships with the RBOCs and other customers and
       to achieve leadership in new markets.

    -  Leverage Core Technologies Into New Applications. The Company has
       developed its Campus product line based upon the same core HDSL
       technology utilized in the Company's HiGain products, which it markets to
       private network users such as universities, hospitals, military bases,
       corporate complexes and other campus environments. In addition, potential
       demand for the delivery of advanced communication services to residential
       and business customers, including high-speed Internet access, advanced
       video services such as pay-per-view movies, interactive video games,
       educational video and many other on-demand services, may present a
       significant new market opportunity for products incorporating the
       Company's DSP and copper transmission expertise. See "-- Products" and
       "-- Product Development."

    -  Develop OEM Opportunities. The Company intends to pursue opportunities to
       provide products and chipsets to manufacturers of telecommunications and
       data communications equipment. The Company believes that it can provide
       added value to third-party products through higher levels of integration
       with other elements of wide area networking infrastructures, such as
       bridges, routers and multiplexers. The Company also believes an
       opportunity exists to utilize its xDSL technology to connect local
       wireless communication systems to local subscriber loops.

PRODUCTS

     Core Technology

         The core technology for the Company's HiGain and Campus product lines
is based on HDSL and was developed from the Company's dual core competencies in
digital signal processing and microelectronics. HDSL allows the transmission and
receipt of digital data at high speed (768 kbps) on a single twisted pair of
copper wires to attain an aggregate bidirectional bit rate of 1.544 Mbps, the
standard T1 rate, over two twisted pairs of copper wires. HDSL permits the
delivery of an outbound signal on the same pair of wires on which the return
signal is received. The transmitted signal is canceled by the receiver by
precisely predicting the amount of signal "echo" and subtracting it from the
overall input signal. HDSL-based products tolerate crosstalk and operate not
only on continuous unobstructed pairs of wires, but also on cables with mixed
wire gauges and bridged taps.

         The Company's unique implementation of HDSL technology stems from its
development of a special purpose digital signal processing integrated circuit.
This VLSI device, the SPAROW (Signal Processing Adaptive Receiver On Wire) chip,
operates at a speed of 250 million instructions per second, enabling it to
perform the extremely heavy numerical calculations required for the transmission
of signals at HDSL rates. The SPAROW chip


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has enabled the Company to significantly reduce the physical size of its
HDSL-based products. Two SPAROW chips are used in each of the Company's
HDSL-based products, one for each twisted pair of copper wires entering the
unit. The SPAROW I chip was replaced by the Company's SPAROW II chip which
provides all of the features of the original SPAROW I chip, costs less to
produce and consumes less power.

         The Company's microelectronics team has design and development
capabilities that include silicon compilers which allow the Company to develop
chips that are at performance and complexity levels beyond what is achievable on
standard ASIC design systems. The Company has also leveraged its
microelectronics product capabilities into the HiGain and Campus product lines.
The Company is currently focusing its resources on further cost and performance
improvements in HDSL and also is putting significant effort into the new ADSL
technology, for which a highly integrated digital signal processor with over 1.2
million transistors (SPAROW II has 240,000 transistors) is being developed to
perform the Bellcore sanctioned discrete multi-tone transmission algorithms.

         By utilizing its HDSL technology in different forms, the Company offers
products for different markets and varied applications.

     HiGain Systems

         The Company's HiGain systems are used by telephone companies to (i)
provide a T1 or fractional T1 link between the central office and a carrier's
remote hub and (ii) provide T1 or fractional T1 service in the local subscriber
loop between the central office or remote hub and the customer. A HiGain system
consists of two units: a circuit plug-in unit that mounts in a shelf located in
the central office or in a shelf in a remote hub and a unit that mounts at or
near the customer's location. The circuit plug-in unit mounts in standard
telephone company shelves alongside conventional transmission equipment, making
it easily deployable in almost every central office and remote hub.

         HiGain systems are capable of providing T1 service over two twisted
pairs of copper wire of up to 12,000 feet in length over 24-gauge copper wire
and up to 9,000 feet over 26-gauge wire without the repeaters or complicated
engineering design required with repeatered T1 systems. According to Bellcore
and the RBOCs, approximately 85% of the business subscriber loops nationwide are
within these distances from the local central office. Each HiGain system
provides a single end user with the service of one T1 line, which is the
equivalent of 24 voice circuits for simple telephone service. An end user
requiring the capacity of multiple T1 lines will require an equivalent number of
HiGain systems.

         The Company also provides HiGain systems in different forms to address
variances in customer installation and configuration requirements. The Company's
Doubler product regenerates the HDSL signal at the end of a wire to a HiGain
remote unit located a similar distance further on, allowing telephone companies
to increase the distance range of HDSL from 12,000 feet to 24,000 feet and
satisfy T1 demands by its more isolated customers. In addition, the Company has
also introduced a product which provides a T1 connection over shorter distances
requiring only one pair instead of two pairs of wire.

         To ensure flexibility of installation, the Company's HiGain units are
available with a variety of shelf and mounting hardware, weather resistant
housings and connecting hardware. In addition, all HiGain remote units provide
self-diagnostic testing to detect failures and interface with the central office
alarm system. HiGain systems, consisting of two units, have a list price of
$1,445 per unit, although the Company generally sells such systems at a discount
which may exceed 60% to its high volume customers. The Company first shipped
units of its HiGain system to customers in June 1992. As of December 31, 1996,
the Company had shipped approximately 345,000 HiGain units.

     ETSI

         In order to provide digital E1 solutions to the Company's European
customers, including public carriers and private network operators, the Company
introduced the HiGain International Series. These products apply


                                       9
<PAGE>   11

HDSL-based technology in compliance with European Telecommunication Standards
Institute ("ETSI") requirements.

     Campus Systems

         The Company's Campus systems are xDSL transmission products designed by
the Company to meet the digital communications needs of organizations operating
their own private networks. Campus systems are reconfigured versions of the
HiGain product and provide high-speed digital connectivity over one or two
twisted pairs of copper wires between user premises in campus environments.
Examples of these environments include universities, hospitals, utility plants,
military bases, industrial parks and corporate complexes. The Campus systems
enable the interconnection of LANs, video conferencing, PBX extensions and many
other applications.

         A Campus system consists of two base units that operate at T1, E1, 768
kbps or 384 kbps speeds and are compatible with a number of standard data
communications interfaces. These interfaces allow Campus systems to connect
directly to LAN bridges, routers, T1 multiplexers, PBXs, video conferencing
systems and other high-speed networking devices. A Campus system, consisting of
two base units and interfaces, has a list price of approximately $2,500 per base
unit, although certain customers receive significant discounts off of list
price. The Company first shipped Campus systems to customers in June 1993.

         The Company enhanced the Campus family of products in late 1994 with
the Campus-Star(TM) access platform. The Campus-Star is a rack mountable module
that incorporates power supplies and SNMP network management capabilities along
with slots for up to 14 Campus unit equivalents. The use of the Campus-Star
platform is driven by the needs of data communications managers to incorporate
network management capabilities into their network components. PairGain has
further enhanced the Campus-Star to provide Ethernet bridging interfaces and
other high bandwidth interfaces. The Campus-Star is being positioned to provide
flexibility in supporting a broad range of access interfaces and is designed to
be a core element of the networking strategy of Campus data communications
managers. The Company continued to enhance the Campus family of products with
the introduction of the Campus-REX(TM) (Remote Ethernet eXpress), a full
bandwidth Ethernet remote bridge, providing transparent connectivity between
LANs without repeaters at a distance of up to five miles. It provides a 10BASE-T
port, one serial port, an embedded SNMP agent and IEEE 802. 1d transparent MAC
level bridging with Spanning Tree protocol support.

     PG-2 Products

         PG-2 was the Company's first commercial product and was delivered to
customers beginning in 1989. The PG-2 system allows telephone companies to
establish two analog transmission lines over a single twisted pair of copper
wires, where traditional technology only allowed the establishment of one line
over a single twisted pair of copper wires. PG-2 systems are used by telephone
companies to provide emergency service and additional line service to residences
and small businesses. The Company's PG-2 system can also be used to convert a
degraded analog copper pair to high-speed digital transmission. In the
international marketplace, where the copper infrastructure is less extensive,
these digital subscriber systems allow postal, telegraph and telephone companies
("PTTs") to expand telephone service without laying more copper lines.

         A PG-2 system consists of a shelf-mounted line unit, located in the
central office, and a remote transceiver mounted near the subscriber premises.
The list price for the Company's PG-2 system is approximately $700 for two
transceivers, one at each end, although many customers receive discounts off of
list price.

         The PG-2 system is fully approved by three RBOCs and has been accepted
by many of the independent telephone companies, including six of the large
independents. The Company's PG-2 products compete worldwide with products from a
number of telecommunications equipment manufacturers. The Company considers
itself to be at a competitive disadvantage in the international market for the
two channel digital subscriber carrier business served by its PG-2 system
because it lacks a local manufacturing presence, which results in price
disadvantages caused by import duties.


                                       10
<PAGE>   12

     PG-Flex(TM) Systems

         PG-Flex is a small subscriber carrier product. PG-Flex is a hybrid of
the Company's PG-2 and HDSL technologies and provides a system for delivering up
to 32 standard phone lines on two pairs of wire over an operating range of up to
12,000 feet. The Company markets the PG-Flex product to both international and
domestic telephone companies and expects significant competition in both
markets. The Company began production shipments of PG-Flex systems in 1996.

     OEM Products

         The Company has formed an OEM sales group to establish relationships
with manufacturers to integrate PairGain's xDSL technologies into their own
products.

     Megabit Access Products

         The Company's two megabit access products, EtherPhone(TM) and Megabit
Modem(TM), enable telephone companies to deliver high-speed data to the home for
Internet and on-line service access, telecommuting, and work-at-home
applications, including remote LAN access, over ordinary telephone lines. These
products make use of the existing copper wire infrastructure and are intended to
allow carriers and other access providers to compete in the remote office and
residential multimedia access markets. These products provide a higher level of
performance than existing low-speed analog modems and Integrated Services
Digital Network ("ISDN") technology allowing data to be delivered at rates of
704 kbps to 2.5 Mbps over ordinary telephone lines. The Company introduced its
megabit access products in January of 1996 with plans for future announcements
in 1997.

PRODUCTS UNDER DEVELOPMENT

     PG-Plus(TM)

         In 1997, the Company intends to introduce PG-Plus, a small subscriber
carrier system based on HDSL technology. The PG-Plus system can be configured to
support four or six channels for plain old telephone service ("POTS") or ISDN
over one unconditioned copper telephone line at distances up to 21,000 feet. It
is intended to offer low cost solutions to business and residential users who
require additional voice, fax or data lines, or in emergency situations for
temporary voice communications. The PG-Plus system consists of central office
terminal and remote terminal equipment along with the alarm unit which is the
central point of communication within the PG-Plus system.

     ADSL

         The Company has a significant engineering development program in
progress to develop a low cost, high performance module to perform ADSL
transmission. ADSL is designed to allow existing telephone lines to deliver
high-speed data and, in the future, video-on-demand services and provides a
high-speed (up to 6 Mbps) channel to the customer from the telephone company's
central office and a medium speed (up to 640 kbps) upstream channel to the
central office from the customer. Although telephone companies have focused on
deploying fiber and hybrid fiber and coaxial cable networks for delivering these
advanced services, the Company believes the high cost and long implementation
periods that will be involved in setting up these networks will provide a window
of opportunity for equipment that can deliver similar capabilities on ordinary
telephone wires.

         In the first quarter of 1997, the Company plans to introduce its first
ADSL modem using GlobeSpan Technologies, Inc.'s Carrierless Amplitude Phase
modulation ("CAP") technology. The Megabit Modem C1500 will provide asymmetric
bandwidth and will require almost no configuration by the subscriber.


                                       11
<PAGE>   13

CUSTOMERS

         The Company sells its HiGain, PG-2, PG-Flex, megabit access and ADSL
products primarily into the public network market and its Campus products
primarily into the private network market. The Company uses its direct sales
force to market its products to the public network market in the United States
and Canada. The Company markets its domestic Campus products and all
international products through direct sales and distributors.

     Public Networks

         The public network market consists of the seven RBOCs and their local
telephone company affiliates, as well as independent telephone companies and
international carriers.

         RBOCs. Prior to selling products in volume to a local telephone company
affiliated with an RBOC, a vendor must first receive approval of its product
from the RBOC. Although the approval process for a new product varies somewhat
among the seven RBOCs, the process generally consists of the following three
phases:

    -  Laboratory Evaluation. The product's functions and performance are tested
       against all relevant industry standards. This process can take from two
       weeks to three months, or longer, depending on a variety of factors.

    -  Field Trial. A number of actual telephone lines are equipped with the
       product for live operation in a field trial lasting from three weeks to
       three months, or longer. These field trials are for evaluating
       performance, assessing the ease of installation and establishing
       troubleshooting procedures. The RBOCs grant conditional approval upon
       successful completion of a new product's field trial, enabling field
       personnel to order limited quantities of the product under one-time
       approvals.

    -  Final Approval and Contract. Prior to final approval, which may take from
       one to four months, or longer, the RBOC develops and implements a variety
       of procedures that cover ordering, stocking, installation, maintenance,
       returns and all other activities associated with use of the product.


         All seven U.S. RBOCs and Bell Canada have approved the Company's HiGain
products. In addition, three RBOC's have approved the Company's PG-2 system.
Sales to local telephone companies affiliated with Bell Atlantic, BellSouth,
NYNEX, Pacific Telesis and SBC Communications (formerly Southwestern Bell) in
each case accounted for more than 9% of the Company's total revenues in 1996 and
sales in the aggregate to local telephone companies affiliated with these five
RBOCs accounted for approximately 59% of the Company's total revenues in 1996.

         Independent Telephone Companies. There are approximately 1,500
telephone companies in the United States that are unaffiliated with any of the
RBOCs. The Company has targeted approximately 50 of the largest independent
telephone companies as potential customers for its carrier products. Although
the independent telephone company market does not present as large an
opportunity as the RBOC market, the Company's experience has been that the
independents are often more receptive to new technology. As a result, the
approval process for new technology is often less time consuming. Currently, US
Sprint and GTE, the largest independent telephone companies, and a number of the
smaller independents have approved and deployed the Company's HiGain system.

         International Carriers. In most international markets there is one
telephone company per country; there are no alternate carriers and no
independents. Typically these PTTs are highly regulated, government-owned
agencies that have an even more rigorous approval process for new technology
than the RBOCs. While the international carrier network systems are
architecturally similar to the domestic public networks, E1 service is not
deployed as extensively in local subscriber loops internationally as T1 service
is in local loops domestically. The


                                       12
<PAGE>   14

demand for E1 service has grown, however, and international carriers are
deploying it primarily to provide multiple voice circuits rather than the
high-speed service requested in the United States.

   Private Networks

         Customers for the Company's Campus products, first introduced in June
1993, include universities, hospitals, military bases and other government
installations, corporate complexes and other campus-like environments with
private network systems. The Company has shipped over 18,000 units of its Campus
product to such customers. Certain of such customers, none of which individually
accounted for more than 1% of the Company's total revenues in 1996, are
identified below:

       Alyeska Pipeline Service Co.          Louisiana State University
       American Electric Power               Military Department of Indiana
       Bethlehem Steel                       Southern Illinois University
       Burlington Northern Railroad          Stanford University
       Elmendorf Air Force Base              State of Alaska
       Fort Carson - U.S. Army               Unisys Corporation
       Inland Steel Company                  United States Army
       ITT Federal Services Corp.            United States Marine Corps.
       Kaiser Foundation Health Plan         University of Illinois
       Langley Air Force Base                Whiteman Air Force Base

SALES, MARKETING AND CUSTOMER SUPPORT

     Sales and Marketing

         The Company's direct sales force markets its products to the RBOCs and
their local telephone company affiliates and to the larger independent telephone
companies by working closely with the planning, switching and transmission
departments of such customers. The Company sells to other independent carriers
and owners of private networks through direct sales, telesales and distributors.

         The Company's North American sales personnel are located in the
following areas: California, Florida, Georgia, Utah, Texas, Washington, New
Hampshire, Illinois, New Jersey, New York, North Carolina, Oregon,
Massachusetts, Maryland, Missouri, Washington, D.C., and, in the provinces of
Alberta and Quebec. The Company sells its products outside of North America
through its own sales force based in the United States, Switzerland, the United
Kingdom, Hong Kong and China, and a network of international data communications
equipment distributors.

         In addition to the specific sales efforts directed at its public and
private network customers, the Company's marketing activities include
participation in industry trade shows and conferences, distribution of sales and
product literature, media relations, advertising in trade journals, direct mail
and ongoing communications with its customers and industry analysts.

     Customer Support

         Service, repair, and technical support of the Company's products are
performed primarily in-house. Additionally, field service personnel are located
in California, New York, Maryland, Georgia, Florida, Illinois and Ontario,
Canada. The Company offers technical support to its customers on a
24-hours-a-day, 7-days-a-week basis via an 800 hotline and through paging
systems for all support personnel. The Company's product warranties range
between three and five years. Current products are sold with a five year
warranty.


                                       13
<PAGE>   15

PRODUCT DEVELOPMENT

         The Company believes that its future success depends on its ability to
maintain its technological leadership through enhancements of its existing
products and development of new products that meet a wide range of customer
needs. Accordingly, the Company intends to continue to make substantial
investments in product development.

         The Company has organized its product development efforts into three
main groups: microelectronics, software development and hardware development.
Within the microelectronics group, a substantial majority of the Company's
efforts are devoted to the development of ADSL, the enhancement of
microelectronics used in the Company's HiGain and Campus product lines and the
development of microelectronics products based on the Company's existing
products. Within the software development group, the Company's efforts are
devoted to the development and enhancement of network management software and
protocol compliance for its products and the development of firmware for
products such as PG-Flex, PG-Plus and ETSI.

         The remainder of the Company's research and development is devoted to
the development, improvement and enhancement of new and existing hardware
products and is directed at the following:

    -  Cost Reduction. The Company continuously reviews the design and
       manufacturing process of its products to determine areas of product cost
       savings or enhanced product quality. This review includes, among other
       things, an examination of the product design to determine if further
       improvements can be made in the VLSI components.

    -  Product Line Extensions. The Company seeks to extend its existing product
       lines through product modifications and enhancements in order to meet the
       needs of its different customers and their applications. Products
       resulting from the Company's product line extension efforts include the
       PairGain Management System for management of HiGain products, long range
       384 kbps Campus systems, single pair T1 systems, and the HiGain Doubler
       product.

    -  New Technology. The Company explores new transmission technologies to
       determine whether they represent an opportunity for products
       incorporating the Company's DSP and copper transmission expertise.

         During 1996, 1995 and 1994, research and development expenses were
approximately $18.6 million, $10.7 million and $5.8 million, respectively. All
of the Company's research and development expenses were charged to operations as
incurred.

MANUFACTURING

         The Company's manufacturing operations consist primarily of quality
control, functional testing, final assembly, burn-in and shipping. The Company
uses domestic independent third-party contract assembly and test companies on
primarily a consignment but also on a turnkey basis for circuit board assembly
and in-circuit testing for all of its products. The Company conducts virtually
all final assembly and final test functions at its facility in Tustin,
California. In addition, the Company performs extensive burn-in, testing and
inspection of all of its products prior to shipping them to customers. Product
quality and reliability are the Company's prime concerns in all phases of the
manufacturing process. Quality control is maintained through incoming inspection
of components and subassemblies, auditing of consignment and turnkey
contractors, in-house final assembly and test functions, plus a final shipping
inspection of all products. During 1996, the Company entered into an agreement
to have its PG-2 products manufactured, on a turnkey basis, by Jabil Circuits at
Jabil's St. Petersburg, Florida facility. Under the terms of this agreement,
Jabil will manufacture, test, package and ship these products directly to the
Company's customers.

         In April 1996 the Company achieved ISO 9001 certification for its
manufacturing operations location in Tustin, California. ISO 9000 Quality
Standards were developed by the International Organization for Standardization.
It is a quality system standard for ensuring a total quality management system
in engineering and


                                       14
<PAGE>   16

manufacturing and is becoming an accepted prerequisite for international
trade. ISO 9001 is the most comprehensive standard, covering design and
development as well as production, installation and service.

         The Company currently procures all of its components from outside
suppliers, either directly or through its consignment and turnkey contractors.
The Company generally purchases and stores the more expensive components at its
location and allows its assembly and test subcontractors to purchase and store
other necessary components. In procuring components, the Company and its
subcontractors rely upon a number of suppliers that are the sole source for
certain of the components. One such sole supplier part is the SPAROW II chip.
Although the Company has utilized its VLSI expertise to design its SPAROW II
chip in a manner that will facilitate transition to multiple sources of supply,
such a transition could result in delays or reductions in product shipments
which, in turn, could have a material adverse effect on the Company's customer
relationships and operating results.

         The Company's backlog at December 31, 1996 was approximately $5.0
million. The Company includes in backlog all firm purchase orders for products
regardless of their ship date. Because of the quick turnaround that the
Company's customers expect on their orders, and because of the possibility of
customer changes in delivery schedules or cancellation of orders, the Company's
backlog as of any particular date may not be indicative of actual revenues
expected for any future period.

         The Company's products are subject to FCC regulations regarding
emission of electromagnetic energy, which may interfere with other equipment.
All of the Company's currently commercially available products have been tested
and comply with the relevant FCC regulations. The Company's commercially
available products that are sold for use at the end user's premises, such as the
HiGain remote unit and the Campus products, also comply with all required UL
safety specifications.

COMPETITION

         Competition in the Company's markets is intense and the Company expects
that competition will increase. Many of the Company's potential competitors have
substantially greater name recognition and technical, financial and marketing
resources than the Company. The Company's most significant domestic competitors
are ADTRAN, Inc. and ADC Telecommunications, which offer HDSL systems and have
often competed with the Company on the basis of price. The Company may also face
competition from the licensees of its own HDSL technology. Specifically, the
Company and Alcatel have granted each other royalty-free cross licenses of
current PairGain HDSL technology and Alcatel's current Network Management
Software.

         Several companies have developed competing HDSL technology and
products, including HDSL chips currently offered by Brooktree, the former
supplier of the Company's SPAROW I chip, Level One and Metalink. The Company
also faces more competition from a consortium of telecommunications supply
companies with HDSL products based on the chip designed by Level One. In
addition, Brooktree has the unrestricted right to sell the Company's SPAROW I
chip in component form; however, the Company has developed and is currently
shipping its enhanced SPAROW II chip to which Brooktree does not have access.
The Company expects that additional companies will introduce competitive
products in the future.

         Many companies have introduced or announced xDSL-based products,
including both T1 and E1 products. Such companies include ADTRAN, Inc., Nokia,
Ericsson, Orkit, Tadiran, ECI Telecom and a number of lesser known manufacturers
worldwide. The Company also faces significant competition from providers of
other technologies used by private network users to transmit information,
including fiber and conventional repeatered T1 lines. To the extent fiber or
repeatered lines are used, the market for the Company's Campus products may be
reduced.

         The market for the Company's PG-2 products (a product that does not
utilize HDSL technology) is also characterized by intense competition.
Competitive products are offered by several telecommunications device
manufacturers, many of which have substantially greater financial, technical,
marketing and sales resources than the Company.


                                       15
<PAGE>   17

         End users want high bandwidth services, such as T1/E1, Internet and
corporate Intranet access, telecommuting and remote LAN access now. xDSL
technologies provide solutions to these problems using the existing copper
telephone network, allowing telecommunications carriers and companies with
private networks to rapidly meet this demand without costly, time-consuming
re-wiring and fiber installation. All manufacturers of products based on xDSL
technology face competition from fiber optic, conventional repeatered systems,
ISDN or cable modems as alternate solutions for the delivery of high-speed
services to end users. As telephone companies continue to install fiber cable
and conventional repeatered T1 systems to provide high-speed service in local
subscriber loops, the demand for many xDSL products may decline. Further, the
deployment of fiber to replace existing xDSL installations will result in the
availability of those existing xDSL systems for installation elsewhere and may
adversely affect future demand for xDSL products.

         The Company believes that the principal competitive factors in its
markets are conformance to standard transmission formats, size, price,
performance, product features, reliability, technical support and marketing
expertise. In addition, the Company believes that, with respect to its products,
product reputation and the ability for the customer to deploy the Company's
products in the existing copper telephone infrastructure, thereby generating
immediate revenues, and the speed with which the Company can obtain approval
from the RBOCs for its products are important competitive factors. The Company
believes that it competes favorably with respect to all of these factors.

PROPRIETARY RIGHTS

         The Company relies on a combination of technical leadership, trade
secret, patent, copyright and trademark law and nondisclosure agreements to
establish and protect its proprietary rights in its products. Currently, the
Company holds two United States patents and has an application pending for one
additional patent. The Company also has certain registered and other trademarks.
The Company believes that, because of the rapid pace of technological change in
the networking industry, patent and copyright protection are less significant to
the Company's competitive position than factors such as the knowledge, ability
and experience of the Company's personnel, new product development, market
recognition and ongoing product maintenance and support.

EMPLOYEES

         As of December 31, 1996, the Company employed 486 persons, including
185 in manufacturing, 89 in sales and marketing, seven in customer service, 170
in engineering and 42 in finance and administration. The Company also employs a
number of temporary and contract employees. During the last quarter of fiscal
1996, the Company employed between 70 and 73 temporary employees, mostly in
manufacturing. None of the Company's employees is represented by a labor union
and the Company has experienced no work stoppages. The Company does not have any
employment contracts with any of its executive officers.


                                       16
<PAGE>   18

ITEM 2.  PROPERTIES.

         The Company's principal administrative, engineering, manufacturing,
sales and marketing facility is located in an approximately 75,000 square foot
building in Tustin, California, that is leased through February 29, 2000. In
addition, the Company has several other property leases, as detailed below:

<TABLE>
<CAPTION>
                                                                              Approx.
                  Location                           Use                    Square Feet    Expiration
         --------------------------- -------------------------------------  ------------- -------------
<S>                                  <C>                                    <C>           <C>
          Tustin, California          Engineering and marketing offices        15,000       07/31/99
          Tustin, California          Finance and marketing offices             5,000       06/30/97
          Santa Ana, California       Warehouse and distribution               20,000       04/14/98
          Santa Ana, California       Warehouse and distribution                5,000       monthly
          Raleigh, North Carolina     Research and development facility        20,000       08/31/01
          Landover, Maryland          Sales office                              1,000       10/31/99
          Basel, Switzerland          Sales office                              2,000       monthly
          Hong Kong                   Sales office                              1,000       06/15/98
</TABLE>

         In January 1997, the Company leased an approximately 66,000 square foot
building adjacent to its principal facility in Tustin, California. The Company
plans to use this facility to consolidate its personnel and warehouse and
distribution presently located in other Tustin and Santa Ana locations and to
allow for its further expansion requirements. The new building is currently
being improved according to Company specifications to meet requirements for
warehouse space and research and development. Occupancy of the building is
anticipated to begin in June 1997. The Company believes that such facilities are
either adequate to satisfy its projected requirements, including its
requirements for production capacity, through 1997, or that suitable additional
space will be available as needed.

ITEM 3.  LEGAL PROCEEDINGS.

         In January 1996, the Company received a copy of a complaint, filed
derivatively by a Company stockholder on behalf of the Company, naming as
defendants the Company's directors and certain officers, as well as Mr. S. Jay
Goldinger and Capital Insight, Inc., a third party investment advisor. This suit
arose out of losses incurred by the Company in 1995 of approximately $15.8
million in connection with unauthorized trading of investments made by Mr.
Goldinger and Capital Insight on the Company's behalf. The derivative complaint
alleged causes of action for breach of fiduciary duty, abuse of control,
constructive fraud, gross mismanagement and waste of corporate assets. The
complaint sought in excess of $15.8 million in damages and legal fees and
expenses in connection with the loss by the Company of the funds it provided to
Mr. Goldinger and Capital Insight. The suit was filed in Superior Court of the
State of California, County of Orange. Additionally, the same stockholder filed
a separate, related complaint, brought derivatively on behalf of the Company, in
the Orange County Superior Court, against a brokerage firm involved in the
Capital Insight matter.

   
         In September 1996, the Company and other parties to the derivative
suits described above executed definitive settlement agreements to settle and
dismiss the derivative suits. The Court approved the settlement on November 19,
1996. Under the terms of the settlement, the Company received $2.5 million from
a brokerage firm involved in processing the investments for Capital Insight, and
paid plaintiff's attorneys fees of $450,000. The impact of the settlement has
been recorded in the Company's financial statements for the year ended December
31, 1996, included in this Form 10-K/A beginning on page F-1.
    

         In January 1996, the Company filed suit in Los Angeles federal court
against Mr. S. Jay Goldinger and Capital Insight, Inc. charging unauthorized
trading, fraudulent misrepresentation, violation of federal securities laws and
breach of fiduciary duties. The suit seeks $15.8 million in damages by reason of
the losses incurred by the Company, as well as punitive damages and legal fees.


                                       17
<PAGE>   19

         As has been reported in the public media, various government and
regulatory agencies (including the Securities and Exchange Commission and U.S.
Attorney) are, or have been, investigating the activities of Capital Insight and
Mr. Goldinger, including transactions with the Company, and the Company's
accounting therefor.

         The Company does not maintain Directors and Officers liability
insurance. However, under the terms of its certificate of incorporation, the
Company indemnifies its directors and officers for damages and legal fees
arising from litigation matters.

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

         A Special Meeting of Stockholders was held at the Company's offices at
14402 Franklin Avenue, Tustin, California 92780, on December 10, 1996 to vote on
the following matter:

                  To approve a proposal to amend Article IV A. of the Company's
         Amended and Restated Certificate of Incorporation to increase the
         authorized Common Stock of the Company from sixty million (60,000,000)
         shares, par value $.0005 per share, to one hundred seventy-five million
         (175,000,000) shares, par value $.0005 per share.

The proposal was approved.  Results of the voting are shown below:

<TABLE>
<CAPTION>
                         For                           Against                          Abstain
           -------------------------------- -------------------------------  -------------------------------
<S>                                         <C>                              <C>   
                     15,923,501                        479,743                           19,043
</TABLE>


         Following stockholder approval of the increase in authorized stock, the
Company declared a two-for-one stock split effected in the form of a 100% stock
dividend to stockholders of record on December 11, 1996. The stock split was
effective on December 18, 1996.


                                       18
<PAGE>   20

                                     PART II

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

         The Company's Common Stock is traded in the over-the-counter market on
the Nasdaq National Market under the symbol PAIR. As of January 31, 1997, there
were 64,527,013 shares of the Company's Common Stock issued and outstanding. The
number of stockholders of record at that date was 233. This number does not
account for Common Stock registered in street name. Accordingly, the actual
number of holders of record of the Company's Common Stock may be significantly
greater than the number indicated above. The following table sets forth, for the
fiscal periods indicated, the high and low sale prices for the Common Stock as
reported on the Nasdaq National Market. The market quotations set forth below
reflect inter-dealer prices, without retail markup, markdown or commissions, and
may not necessarily represent actual transactions. The Company has never paid
cash dividends and has no present intention of declaring a cash dividend for the
foreseeable future.


<TABLE>
<CAPTION>
                                            QUARTERLY     QUARTERLY
                                              HIGH*          LOW*
                                           ------------- -------------
<S>                                        <C>           <C>    
YEAR ENDED DECEMBER 31, 1995
    First Quarter                             $  6.66       $  3.31
    Second Quarter                               6.03          4.41
    Third Quarter                                8.88          4.69
    Fourth Quarter                              14.00          6.94

YEAR ENDED DECEMBER 31, 1996
    First Quarter                             $ 17.50       $  9.75
    Second Quarter                              31.13         16.41
    Third Quarter                               41.50         19.50
    Fourth Quarter                              34.88         28.88
</TABLE>


         On January 31, 1997, the last reported sales price for the Company's
stock was $40.94.


* All share prices have been adjusted for the June 18, 1996 and December 18, 
  1996 two-for-one stock splits.


                                       19
<PAGE>   21

ITEM 6.  SELECTED FINANCIAL DATA.

                      SELECTED CONSOLIDATED FINANCIAL DATA

         The selected consolidated financial data of the Company as of December
31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994 is
derived from audited consolidated financial statements of the Company included
elsewhere in this Annual Report. The selected consolidated financial data of the
Company as of December 31, 1994, 1993 and 1992 and for the years ended December
31, 1993 and 1992 is derived from audited consolidated financial statements of
the Company not included in this Annual Report. The following information should
be read in conjunction with the Consolidated Financial Statements of the Company
and the related notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" included in separate sections of
this Annual Report.



<TABLE>
<CAPTION>
                                                                                 YEAR ENDED DECEMBER 31,
                                                        ---------------------------------------------------------------------------
                                                            1996             1995          1994            1993           1992
                                                        -------------   -------------  -------------  --------------  -------------
                                                                         (IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<S>                                                       <C>            <C>             <C>            <C>            <C>      
STATEMENT OF OPERATIONS DATA:
 Revenues                                                 $ 205,409      $ 107,224       $  59,518      $  36,307      $   9,502
 Income (loss) from operations                               53,242         23,532          10,513          8,614         (2,000)
 Unusual loss due to unauthorized trading of
  investments by third parties                                   --        (15,827)             --             --             -- 
 Settlement income related to unauthorized trading of
  investments by third parties                                2,500             --              --             --             -- 
 Net income (loss)                                           36,603          1,056           8,567          7,612         (2,085)
 Net income (loss) per share*                             $    0.51      $    0.02       $    0.14      $    0.15      $   (0.05)
 Number of shares used in per share calculations*            72,058         67,280          61,612         49,940         38,084
</TABLE>


<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                               -----------------------------------------------------------------------
                                                   1996           1995          1994          1993           1992
                                               -------------  ------------- ------------- -------------- -------------
                                                                           (IN THOUSANDS)
<S>                                            <C>            <C>           <C>           <C>             <C>       
BALANCE SHEET DATA:
  Working capital                                $ 139,766      $  84,766     $  71,368      $  62,941     $   5,218 
  Total assets                                     193,016        105,326        86,625         68,303         9,693 
  Long-term debt                                        --             --            --             --         2,677 
  Redeemable preferred stock                            --             --            --             --        13,528 
  Common stockholders' equity (deficit)            156,228         93,931        74,846         65,236        (9,859)
</TABLE>


              The Company paid no dividends on its Common Stock during any of
the periods presented.


* All share and per share amounts have been adjusted for the June 18, 1996 and
  December 18, 1996 two-for-one stock splits.


                                       20
<PAGE>   22

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


OVERVIEW

         PairGain, founded in February 1988, designs, manufactures, markets and
supports products that allow telecommunications carriers and private network
owners to more efficiently provide high-speed digital service to end users over
the large existing infrastructure of unconditioned copper wires. The Company's
first product was PG-2, a two-channel digital subscriber carrier system, which
was initially shipped in late 1989. In 1991, the Company undertook the
development of the HiGain system, which was first shipped in June 1992. The
Company's revenue growth subsequent to 1991 and its profitability beginning in
the fourth quarter of 1992 are attributable to the market acceptance and
increased sales of its HiGain systems. In June 1993, the Company introduced its
Campus line of products, and in 1996, began shipping its PG-Flex product, a
small subscriber carrier system for delivering up to 32 voice channels over two
pair of copper wires. HiGain systems represented 76% the Company's total
revenues in each of the years 1996, 1995 and 1994. Although revenues from sales
of the Company's HiGain products have historically represented a substantial
majority of the Company's total revenues and are expected to continue to account
for a majority of its revenues for the foreseeable future, the Company believes
that revenues from sales of its PG-2, Campus, PG-Flex and other products will
continue to increase in the future.

         Commencing in mid-1993, the Company began reducing the average sales
prices of its HiGain products in an effort to increase market demand for its
products and in anticipation of expected price competition. These reductions
have been significant, representing reductions of as much as 14% in 1996, 23% in
1995 and 40% in 1994. Although future effects of price competition and other
competitive pressures inherent in the Company's business are uncertain, the
Company expects to continue to reduce the average sales prices of its HiGain and
other products. Accordingly, the Company's ability to maintain or increase
revenues will depend in part upon its ability to increase unit sales volumes of
existing products and to introduce and sell new products at rates sufficient to
compensate for the reduced revenue effect of such continuing reductions in the
average sales prices of the Company's existing products. Declining average sales
prices may also adversely affect gross margins on the Company's existing
products if the Company is unable to fully offset such reductions in average
sales prices by reductions in the Company's per unit costs. Declining average
sales prices had a significant effect on gross margins in 1994 as they declined
to 44% from 52% in 1993. During 1996 and 1995 the Company's continuing effort
toward cost reduction through engineering design changes, reduced prices for
components, increased manufacturing efficiencies, and increases in volume
resulted in improved gross margins, which climbed to 48% in 1996 and 1995.
However, there can be no assurance that the Company will be able to continue to
increase unit sales volumes, introduce and sell new products or further reduce
its per unit costs in the future.

RESULTS OF OPERATIONS

   
         The results of operations discussed below are comprised of two
sections, the first section compares 1996 to 1995 for all items noted on the
Consolidated Statements of Income contained in a separate section of this Annual
Report on Form 10-K/A commencing on page F-1. The second section compares 1995 
to 1994 for the same items.
    

         All share and per share amounts have been adjusted to reflect the
two-for-one stock splits effective June 18, 1996 and December 18, 1996, for all
periods presented.

         The following table sets forth, for the periods indicated, certain
operating data as a percentage of total revenues.


                                       21
<PAGE>   23

<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                                                         -----------------------
                                                         1996     1995      1994
                                                         ----     ----      ----
<S>                                                      <C>      <C>       <C> 
Revenues:
  Product sales                                           100%      99%       96%
  Technology fees and royalty income                        0        1         4
                                                         ----     ----      ----
Total revenues                                            100      100       100
Cost of revenues                                           52       52        56
                                                         ----     ----      ----
Gross profit                                               48       48        44
Operating expenses:
  Research and development                                  9       10        10
  Selling and marketing                                     8        9        10
  General and administrative                                5        6         7
                                                         ----     ----      ----
Total operating expenses                                   22       25        27
                                                         ----     ----      ----
Income from operations                                     26       23        18
Other income, (loss):
  Interest income, net                                      2        2         2
  Gain on sales of investments, net                        --       --         2
  Unusual loss due to unauthorized trading of
    investments by third parties                           --      (15)       -- 
  Settlement income related to unauthorized
    trading of investments by third parties                 1       --        -- 
                                                         ----     ----      ----
Income before income taxes                                 29       10        22
Provision for income taxes                                 11        9         8
                                                         ----     ----      ----  
Net income                                                 18%       1%       14%
                                                         ====     ====      ====
</TABLE>

1996 COMPARED TO 1995

     Revenues

         Revenues increased 92% to $205.4 million in 1996 compared with $107.2
million in 1995. This increase was primarily due to a 106% increase in unit
sales volume of the Company's HiGain products and, to a lesser extent, a 90% and
64% increase in unit sales volume of the Company's Campus and PG-2 products,
respectively. These increases were somewhat offset by declines in the average
sales prices of the HiGain and Campus products. Revenue per average employee
increased 48% to $405,000 in 1996, compared to $274,000 in 1995.

         Aggregate sales to local telephone companies affiliated with five RBOCs
accounted for approximately 59% and 63% of the Company's total revenues for 1996
and 1995, respectively. In addition, included in revenues for 1996 and 1995 were
technology licensing fees and royalty income totaling $97,000 and $1.1 million,
respectively. The technology licensing fees and royalties were paid to the
Company primarily in connection with technology licensing agreements entered
into with Alcatel and ADC Telecommunications, Inc. As a result of the
renegotiated terms of the agreement between the Company and Alcatel, technology
licensing fees and royalty rates will be minimal in future periods.

     Gross Profit

   
         Gross profit represents total revenues for a period, including
technology fees and royalty income, less the cost of revenues for such period.
Cost of revenues represents primarily product costs, together with associated
overhead expenditures and provisions for inventory and related reserves. In 
1996, the Company's gross profit as a percentage of total revenues continued 
at 48% in spite of decreases in average sales prices, a decline in technology 
fees and royalty income and increases in overhead spending and provisions for
inventory and related reserves. The Company's continuing effort toward cost 
reduction through engineering design changes, reduced prices for components, 
increased manufacturing efficiencies and increases in volume, was the primary
reason for the Company's ability to maintain gross margin at 48% of revenues.
    


                                       22
<PAGE>   24

     Operating Expenses

         Research and development expense increased to $18.6 million in 1996
from $10.7 million in 1995. Research and development expense was 9% of total
revenues in 1996 compared to 10% in 1995. The increase in absolute expense
levels was primarily due to the addition of personnel for the development of new
products, specifically, development programs for PG-Flex, PG-Plus, ADSL
technology and Megabit Access products, and sustaining, enhancement and cost
reduction programs for HiGain and Campus products. Costs for prototype
expenditures as new products were tested in the lab and payments to consultants
where specific resources were needed in the development process also increased
in 1996 over the prior year. In addition, the Company's research and development
facility in Raleigh, North Carolina, which was established in the second half of
1995, was expanded significantly during 1996.

         Selling and marketing expense increased to $17.2 million in 1996 from
$9.9 million in 1995. This increase in expense levels was primarily due to the
addition of personnel and the associated increase in salaries, commission and
travel expenses, and additional advertising and trade show expenditures. Selling
and marketing expense as a percentage of total revenues was 8% in 1996 compared
to 9% in 1995. This decrease as a percentage of total revenues was primarily
attributable to the slower growth of personnel, salaries and commissions
relative to overall revenue growth from 1995 to 1996.

         General and administrative expense increased to $9.9 million in 1996
from $6.8 million in 1995. This increase was primarily due to the addition of
personnel, payments to outside consultants related to the implementation of an
information systems upgrade, legal and accounting fees related to the unusual
trading losses and subsequent settlement and an overall increase in spending
commensurate with the Company's increase in headcount and operating activities.
General and administrative expense as a percentage of total revenues was 5% in
1996 compared to 6% in 1995.

     Interest Income, Net

         Net interest income was $3.7 million in 1996 and $2.1 million in 1995.
The increase in interest income was the result of increased average cash
balances.

     Gain on Sales of Investments, Net

         There were no net realized gains on sales of investments in 1996. Net
realized gains on sales of investments were $415,000 in 1995. Net unrealized
gains on short-term investments, net of tax, aggregated $71,000 and $67,000 in
1996 and 1995, respectively, and are included as a separate component of
stockholders' equity.

     Unusual Loss and Settlement Income Related to Unauthorized Trading of
     Investments by Third Parties

         As described in Notes 14 and 15 of Notes to the Consolidated Financial
Statements, the Company incurred a loss of $15.8 million from unauthorized and
inappropriate trading of investments by third parties in 1995.

         In January 1996, the Company received copies of complaints filed
derivatively by a Company stockholder on behalf of the Company, naming as
defendants the Company's directors and certain officers, as well as Capital
Insight and Mr. S. Jay Goldinger, its president, and a brokerage firm used in
executing and clearing transactions authorized by Mr. Goldinger. The derivative
complaint stated causes of action for breach of fiduciary duty, abuse of
control, constructive fraud, gross mismanagement and waste of corporate assets.
The suit sought an award in the amount of all damages sustained by the Company
including the losses of $15.8 million and legal fees and expenses.

         In September 1996, the Company and other parties to the derivative
suits described above executed definitive settlement agreements to settle and
dismiss the derivative suits. The Court approved the settlement on November 19,
1996. Under the terms of the settlement, the Company received $2.5 million from
a brokerage firm involved in processing the investments for Capital Insight, and
the Company paid plaintiff's attorneys fees of


                                       23
<PAGE>   25

   
$450,000. The impact of the settlement has been recorded in the Company's
financial statements for the year ended December 31, 1996, included in this Form
10-K/A.
    

     Provision for Income Taxes

         The Company's provision for income taxes increased to $22.8 million in
1996, compared to $9.2 million in 1995. The effective tax rate during 1996 was
38.4%. The effective tax rate during 1995 was 90%, since the Company did not
record any tax benefit on the unusual trading losses in 1995.

         Excluding the $15.8 million unusual loss, the Company's effective tax
rate in 1995 was 37%. The increased effective tax rate in 1996 over 1995 was
attributed to tax credits and tax-free interest income representing a smaller
proportion of total pre-tax income as a result of the earnings growth.

     Net Income and Earnings Per Share

         Net income for the year ended December 31, 1996 was $36.6 million or
$0.51 per share, compared to $1.1 million or $0.02 per share, for the year ended
December 31, 1995. Excluding the impact of the unauthorized trading loss, 1995
net income was $16.5 million or $0.24 per share. The weighted average number of
common and common equivalent shares outstanding were 72.1 million and 67.3
million for the years ended December 31, 1996 and 1995, respectively. This
increase in common and common equivalent shares was primarily attributable to
the granting of options to key employees of the Company and the reduction in the
number of shares assumed to be repurchased upon the exercise of options and
warrants, using the treasury stock method, as a result of the Company's higher
stock price in 1996 over 1995.


1995 COMPARED TO 1994

     Revenues

         Revenues increased 80% to $107.2 million in 1995 compared with $59.5
million in 1994. This increase was primarily due to a 120% increase in unit
sales volume of the Company's HiGain products and, to a lesser extent, a 218%
and 69% increase in unit sales volume of the Company's Campus and PG-2 products,
respectively. These increases were somewhat offset by declines in the average
sales prices of the products.

         Aggregate sales to local telephone companies affiliated with five RBOCs
accounted for approximately 63% of the Company's total revenues for 1995
compared to 66% of total revenues in 1994. In addition, included in revenues for
1995 and 1994 were technology licensing fees and royalty income totaling $1.1
million and $2.1 million, respectively. The technology licensing fees and
royalties were paid to the Company primarily in connection with technology
licensing agreements entered into with Alcatel and ADC Telecommunications, Inc.
As a result of the renegotiated terms of the agreement between the Company and
Alcatel, technology licensing fees and royalty rates will continue to decline.

         Annual revenue per average employee during 1995 was $274,000 compared
to $228,000 in 1994.

     Gross Profit

         In 1995, the Company's gross profit as a percentage of total revenues
increased to 48% from 44% in 1994. This increase was primarily the result of the
Company's cost reduction efforts through engineering design changes, reduced
prices for components, increased manufacturing efficiencies and increases in
volume. These reductions were partially offset by reductions in average sales
prices of products and a decrease in technology fees and royalty income.


                                       24
<PAGE>   26

     Operating Expenses

         Research and development expense increased to $10.7 million in 1995
from $5.8 million in 1994. Research and development expense as a percentage of
revenue was 10% in both 1995 and 1994. The increase in expense levels was
primarily due to the addition of personnel for the development of PG-Flex and
Megabit Access products and the FALCON chip and enhancement of existing
products, in addition to prototype expenditures as these new products were
tested in the lab and payments to consultants where specific resources were
needed in the development process.

         Selling and marketing expense increased to $9.9 million in 1995 from
$5.8 million in 1994, although selling and marketing expense as a percentage of
total revenues was 9% in 1995 compared to 10% in 1994. The increase in expense
levels in 1995 was primarily due to the addition of personnel, increases in
salaries and commissions and additional advertising and trade show expenditures.

         General and administrative expense increased to $6.8 million in 1995
from $4.3 million in 1994. This increase was primarily due to the addition of
personnel, payments to outside consultants related to the implementation of an
information systems upgrade and an overall increase in spending commensurate
with the Company's increase in headcount and operating activities. General and
administrative expense as a percentage of total revenues was 6% in 1995 compared
to 7% in 1994.

     Interest Income, Net

         Net interest income was $2.1 million in 1995 compared to $1.5 million
in 1994. The increase in interest income principally consisted of net interest
income earned on the cash received by the Company in its secondary offering
completed in March 1995, as well as increased average cash balances due to
higher revenue levels.

     Gain on Sales of Investments, Net

         Net realized gains on sales of investments were $415,000 and $1.2
million in 1995 and 1994, respectively. Net unrealized gain (loss) on short-term
investments, net of tax, aggregated $67,000 and ($210,000) in 1995 and 1994,
respectively, and is included as a separate component of stockholders' equity.

     Unusual Loss Due to Unauthorized Trading of Investments by Third Parties

         As more fully described in Note 14 of Notes to the Consolidated
Financial Statements, the Company incurred a loss of $15.8 million from
unauthorized trading of investments by third parties in 1995.

         In January 1996, the Company received copies of complaints filed
derivatively by a Company stockholder on behalf of the Company, naming as
defendants the Company's directors and certain officers, as well as Capital
Insight and Mr. S. Jay Goldinger, its president, and a brokerage firm used in
executing and clearing transactions authorized by Mr. Goldinger. The derivative
complaint stated causes of action for breach of fiduciary duty, abuse of
control, constructive fraud, gross mismanagement and waste of corporate assets.
The suit sought an award in the amount of all damages sustained by the Company
including the losses of $15.8 million and legal fees and expenses.

     Provision for Income Taxes

         The Company's provision for income taxes increased to $9.2 million in
1995, compared to $4.6 million in 1994. The effective tax rate during 1995 was
90%, since the Company did not record any tax benefit on the unusual trading
losses in excess of 1995 and 1994 gains on sales of investments of $1.6 million.

         Excluding the $15.8 million unusual loss, the Company's effective tax
rate in 1995 was 37% compared to 35% in 1994. The principal reason for the
increased effective tax rate was the elimination of the valuation allowance on
deferred tax assets in 1994 as management believes it is more likely than not
that such deferred tax assets will be realized in future periods.


                                       25
<PAGE>   27

     Net Income and Earnings Per Share

         Net income for the year ended December 31, 1995 was $1.1 million or
$0.02 per share, compared to $8.6 million or $0.14 per share, for the year ended
December 31, 1994. Excluding the impact of the unauthorized trading loss, 1995
net income was $16.5 million or $0.24 per share. The weighted average number of
common and common equivalent shares outstanding were 67.3 million and 61.6
million for the years ended December 31, 1995 and 1994, respectively. This
increase in common and common equivalent shares was primarily attributable to
the issuance of 2,000,000 shares in the Company's secondary offering in March
1995, the granting of options to key employees of the Company, and the reduction
in the number of shares assumed to be repurchased upon the exercise of options
and warrants, using the treasury stock method, as a result of the Company's
higher stock price in 1995 over 1994.


                                       26
<PAGE>   28

LIQUIDITY AND CAPITAL RESOURCES

         In 1996, the Company had cash flow from operations of $61.6 million.
Additionally, $7.4 million in cash was generated from the issuance of stock as a
result of exercises of common stock options and common stock sold under the
Employee Stock Purchase Plan. In 1995, the Company had cash flow from operations
of $12.5 million. In addition, $15.5 million in cash was generated from the
issuance of stock, of which $11.0 million was from the Company's March 1995
secondary offering. These amounts were offset by unusual trading losses of $15.8
million, which resulted from unauthorized trading in options and futures by an
independent financial advisor, as mentioned above. In 1994, the Company
generated cash flow from operations of $4.7 million.

   
         As of December 31, 1996, the Company had $112.6 million in cash, cash
equivalents and short-term investments and $139.6 million in working capital,
compared to $55.7 million in cash, cash equivalents and short-term investments
and $84.8 million in working capital in 1995. The increase in the Company's
accounts receivable to $23.9 million at December 31, 1996, compared to $13.0
million at December 31, 1995, was primarily due to increased sales for the
period. Days sales outstanding was 35 days in 1996 compared to 34 in 1995.
Gross inventories increased $13.9 million to $40.7 million at December 31, 1996
compared to $26.8 million at December 31, 1995, due to increased stocking
levels to support future shipments. Further increases in gross inventories were
avoided by the Company's implementation of an inventory and production
management program with several of its key component suppliers and assembly
sub-contractors during the fourth quarter of 1996. As a result of this program,
the Company was able to reduce its component and purchased material inventories
by approximately $9.0 million. Reserves for inventory obsolescence, excess
quantities, cost reductions and test and evaluation inventories increased to
$14.6 million at December 31, 1996 compared to $4.2 million at December 31,
1995. The primary reasons for the increase in these reserves were: (a) an
increase in components, materials and sub-assemblies to support production
builds; (b) an increase in excess and obsolete inventories; (c) valuation
reductions due to product cost reduction programs; and (d) an increase in test
and evaluation inventories of new products on trial at customers. While the
Company continued to maintain high levels of gross inventories in 1996, as a
result of the above, net inventory turns increased from two-and-a-half times in
1995 to four times in 1996.
    

         Capital expenditures relating primarily to the purchase of computer
equipment, test equipment, furniture and fixtures and leasehold improvements
were $7.5 million, $5.9 million and $2.0 million for the years ended December
31, 1996, 1995 and 1994, respectively. Included in these amounts were
approximately $450,000 and $750,000 in 1996 and 1995, respectively, of software
and equipment purchased to upgrade the Company's information system
capabilities. Expenditures in 1996 also included $251,000 in leasehold
improvements at the Company's two Tustin facilities and $158,000 in leasehold
improvements at the Company's Raleigh, North Carolina research and development
center. Included in the 1995 additions is $1.0 million in leasehold improvements
at the Company's Tustin, California manufacturing, engineering and
administrative headquarters.

         During 1996, the Company made investments in Sourcecom Corporation
("Sourcecom") and E/O Networks ("E/O") of $544,000 and $3.0 million,
respectively. Sourcecom, of Westlake Village, California, develops, 
manufactures and markets next generation access networking product. Hayward, 
California-based E/O supplies low-density fiber optic access equipment to 
public carriers worldwide. Both investments were made with internally 
generated funds.

         The Company maintains an unsecured line of credit with a bank. The line
allows maximum borrowings of $5,000,000, including the issuance of letters of
credit and foreign exchange contracts. The line bears interest at prime (8.25%
at December 31, 1996). At December 31, 1996, the Company had no outstanding
borrowings under this line of credit. The debt agreement specifies certain
financial and other covenants. The Company was in compliance with the financial
and other covenants at December 31, 1996. The agreement expires May 1, 1997.

         The Company has no other material near-term commitments for its funds.
The Company believes that the current cash and short-term investment balances
and internally generated cash flow will be sufficient to meet its working
capital and capital expenditure requirements through 1996. To the extent that
the Company's existing resources, together with future earnings, are
insufficient to fund the Company's future activities, the Company may need to
raise additional funds through public or private financings.


                                       27
<PAGE>   29

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

   
         The Company's consolidated financial statements and schedule appear in
a separate section of this Annual Report on Form 10-K/A beginning on page F-1 
and S-1, respectively.
    

     SUPPLEMENTARY FINANCIAL DATA

<TABLE>
<CAPTION>
                                                                 SELECTED QUARTERLY FINANCIAL DATA
                                                                           (UNAUDITED)

                                                                    FOR THE THREE MONTHS ENDED
                                            ---------------------------------------------------------------------------
                                                MARCH 31,          JUNE 30,         SEPTEMBER 30,      DECEMBER 31,
                                                                  (RESTATED)         (RESTATED)
                                            ------------------ ------------------ ------------------ ------------------
                                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                <C>                <C>                <C>                <C>       
 1995
   Revenues                                        $  19,078          $  23,919          $  29,602          $  34,625 
   Gross Profit                                        9,425             11,448             13,768             16,360 
   Operating income                                    4,214              4,719              6,459              8,140 
   Unusual gain (loss) due to unauthorized
     trading of investments by third parties              --            (26,774)             1,660              9,287 
   Net income (loss)                                   3,142            (22,756)             6,165             14,505 
                                                                                                                      
   Net income (loss) per share *                   $    0.05          $   (0.38)         $    0.09          $    0.21 

   Weighted average number of common and
     common equivalent shares *                       64,412             59,687             68,206             69,613 
</TABLE>

<TABLE>
<CAPTION>
                                                                    FOR THE THREE MONTHS ENDED
                                            ---------------------------------------------------------------------------
                                                MARCH 31,          JUNE 30,         SEPTEMBER 30,      DECEMBER 31,
                                            ------------------ ------------------ ------------------ ------------------
                                                              (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                <C>                <C>                <C>                <C>       
 1996
   Revenues                                        $  40,511          $  47,239          $  54,609          $  63,050 
   Gross Profit                                       19,039             22,665             26,140             31,116 
   Operating income                                    9,360             11,415             13,858             18,609 
   Settlement income related to
     unauthorized trading of investments                                                                              
     by third parties                                     --                 --                 --              2,500 
   Net income                                          6,250              7,570              9,069             13,714 

   Net income per share *                          $    0.09          $    0.11          $    0.12          $    0.19 

   Weighted average number of common and
     common equivalent shares *                       70,580             72,043             72,736             72,876 
</TABLE>


         The Company restated its quarterly financial statements for the three
month periods ended June 30, 1995 and September 30, 1995, as described in Note
14 in Notes to Consolidated Financial Statements, which begins on page F-16 of
this Annual Report.

         * Net income (loss) per share and weighted average number of common and
  common equivalent shares have been adjusted to reflect the June 18, 1996 and
  December 18, 1996 two-for-one stock splits.


                                       28
<PAGE>   30

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

         On July 7, 1995, the Company dismissed Ernst & Young LLP as the
principal independent auditor for the audit of the Company's financial
statements. There were no disagreements with Ernst & Young LLP on any matter of
accounting principles or practices. Their accountant's report on the financial
statements of the Company for the year ended December 31, 1994 was unqualified.

         Also on July 7, 1995, the Registrant engaged Deloitte & Touche LLP as
principal independent public auditor for the Registrant's financial statements
for the fiscal year ending December 31, 1995.

         The decision to dismiss Ernst & Young LLP and appoint Deloitte & Touche
LLP as the Company's principal independent public accountant was approved by the
Company's Board of Directors.


                                       29
<PAGE>   31

                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         The sections tilted "Directors and Nominees" and "Compliance with
Section 16(a) of the Exchange Act" appearing in the Company's Proxy Statement
for the 1997 Annual Meeting of Stockholders is incorporated herein by reference.

               DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

         The following table sets forth certain information concerning the
Executive Officers and Directors of the Company.

<TABLE>
<CAPTION>
                 NAME                            AGE                                 POSITION
-----------------------------------------  ------------------  -----------------------------------------------------
<S>                                        <C>                 <C>
Charles S. Strauch                                61           Chairman of the Board and Chief Executive Officer
Howard S. Flagg                                   42           President and Director
Benedict A. Itri                                  43           Chief Technical Officer and Director
Charles W. McBrayer                               48           Vice President, Finance and Administration and
                                                                   Chief Financial Officer
Dennis Young                                      54           Vice President, Operations
Bruce Kimble                                      47           Vice President, Engineering
Tom Reynolds                                      45           Senior Vice President, Sales, Service and Field
                                                                   Marketing
Robert C. Hawk (1)                                57           Director
Robert A. Hoff (1)(2)                             44           Director
B. Allen Lay (1)(2)                               62           Director
</TABLE>

-----------------------------------------
(1)  Member of the Audit Committee
(2)  Member of the Compensation Committee


         Mr. Strauch became a director of the Company in October 1991, Chairman
of the Board of Directors of the Company in November 1991 and Chief Executive
Officer of the Company in April 1992. From May 1989 until December 1991, Mr.
Strauch was self-employed providing management services to technology companies.
From October 1991 to December 1991, in his self-employed role, Mr. Strauch
provided management services to the Company. Also as a part of providing such
management services, from May 1989 to May 1991 he served as Vice Chairman of the
Board of Directors of EECO, Inc., a manufacturer of electronic switches and
computer components. From November 1988 to May 1989, Mr. Strauch served as
President of MSI Data Corporation, a manufacturer of hand-held data collection
devices and then a subsidiary of Symbol Technologies, Inc., having been acquired
by Symbol Technologies in November 1988. Mr. Strauch also served as a member of
the Board of Directors of Symbol Technologies from November 1988 to May 1989.
From August 1984 until November 1988, Mr. Strauch served as Chief Executive
Officer of MSI Data Corporation.

         Mr. Flagg, a founder of the Company, has been President and a director
of the Company since November 1991. He served as Chief Executive Officer from
November 1991 to April 1992 and as Vice President, Research and Development from
February 1988 to November 1991. Prior to founding the Company, Mr. Flagg founded
and served as a principal of Advanced Telecommunications, Inc., an aerospace
telecommunications consulting firm.

         Mr. Itri, a founder of the Company, was named Chief Technical Officer
in April 1996. Previously, Mr. Itri was Vice President, Engineering of the
Company since its inception in February 1988 and has been a director of the
Company since November 1991. Prior to founding the Company, Mr. Itri founded and
served as a principal of Advanced Telecommunications, Inc.


                                       30
<PAGE>   32

         Mr. McBrayer joined the Company in March 1995 as Vice President,
Finance and Administration and Chief Financial Officer. Mr. McBrayer served as
Vice President, Finance and Chief Financial Officer for Triconex Corporation, a
publicly held corporation, from 1986 to March 1995 and as a director of Triconex
Corporation in 1993 and 1994.

         Mr. Young joined the Company in September 1993 as Director, European
Operations and assumed the position of Vice President, Operations in December
1994. From 1985 to 1993 Mr. Young served as Managing Director for the U.K.
subsidiary of EECO, Inc. and for Talley (U.K.) Ltd. These companies manufactured
and sold consumer and industrial electronic products throughout the European
market.

         Mr. Kimble joined the Company in September 1993 as Project Manager and
later assumed the position of Director of Engineering. He was named Vice
President, Engineering in April 1996. From 1991 to 1993 Mr. Kimble was a Product
Line Manager at Cable and Computer Technology, Inc., a military computer systems
manufacturer. From 1985 to 1991 Mr. Kimble was President and owner of Semaphore
Corporation, a telemetry equipment and DSP consulting firm.

         Mr. Reynolds joined the Company in October 1996 as Senior Vice
President, Sales, Customer Service and Field Marketing. Mr. Reynolds was
employed by Motorola Information Systems Group from 1990 to 1996 where he served
in various senior management positions in sales and marketing. From 1983 to 1990
Mr. Reynolds held field sales management positions at Hewlett-Packard and Harris
Corporation, manufacturers of workstation and data communications products.

         Mr. Hawk became a director of the Company in November 1992. Mr. Hawk is
President and CEO of U S WEST Multimedia Communications, Inc. Mr. Hawk also
serves as a director of Premisys Communications and Xylan Corporation, as well
as several other private companies. From 1988 until 1996, Mr. Hawk served as
President-Carrier Division of U S WEST Communications, Inc., one of the seven
RBOCs. Prior to that time, Mr. Hawk served as Vice President, Marketing of U S
WEST and as Director, Advanced Services of AT&T.

         Mr. Hoff became a director of the Company in February 1989. Mr. Hoff
has been a general partner of Crosspoint Venture Partners, a private venture
capital investment company, since September 1983. Mr. Hoff also serves as a
director of privately-held Com21 Incorporated, Efficient Networks, Accredited
Home Lenders and US Web Corporation and publicly-held Onyx Acceptance
Corporation.

         Mr. Lay became a director of the Company in February 1989. Mr. Lay has
been a general partner of Southern California Ventures, a private venture
capital investment partnership, since May 1983. Mr. Lay also serves as Chairman
and CEO of Vestro Natural Foods, Inc. and as a director of privately-held
Physical Optics Corporation, Kofax Imaging Corporation, Waveband, Inc. and
Medclone, Inc., and of publicly-held ViaSat, Inc. and Helisys, Inc.

ITEM 11.  EXECUTIVE COMPENSATION.

         The section titled "Executive Compensation and Related Information"
appearing in the Company's Proxy Statement for the 1997 Annual Meeting of
Stockholders is incorporated herein by reference.

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

         The section titled "Principal Stockholders" appearing in the Company's
Proxy Statement for the 1997 Annual Meeting of Stockholders is incorporated
herein by reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         The section titled "Certain Transactions" appearing in the Company's
Proxy Statement for the 1997 Annual Meeting of Stockholders is incorporated
herein by reference.


                                       31
<PAGE>   33

                                     PART IV

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

     (a)(1)  FINANCIAL STATEMENTS:

   
         The following financial statements are included in a separate section
of this Annual Report on Form 10-K/A commencing on page F-1:
    

     Independent Auditors' Reports
     Consolidated Balance Sheets
     Consolidated Statements of Income
     Consolidated Statements of Stockholders' Equity
     Consolidated Statements of Cash Flows
     Notes to Consolidated Financial Statements

        (2)  FINANCIAL STATEMENT SCHEDULE:

   
         The following financial schedule for the years 1996, 1995 and 1994 is
included in a separate section of this Annual Report on Form 10-K/A commencing 
on page S-1:
    

     Schedule II - Valuation and Qualifying Accounts.

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

        (3)  EXHIBITS:

              (a)     3.4 Certificate of Incorporation of Registrant, a Delaware
                          corporation.

              (a)     3.5 Form of Agreement and Plan of Merger of Registrant, a
                          Delaware corporation, and Registrant, a California
                          corporation.

              (a)     3.6 Bylaws of Registrant, a Delaware corporation.

              (a)    10.1 PairGain Technologies, Inc. 1990 Stock Option Plan
                          (the "1990 Plan").

              (a)    10.2 Form of Incentive Stock Option Agreement pertaining to
                          the 1990 Plan.

              (a)    10.3 Form of Supplemental Incentive Stock Option Agreement
                          pertaining to the 1990 Plan.

              (a)    10.4 Form of Nonstatutory Stock Option Agreement pertaining
                          to the 1990 Plan.

              (a)    10.5 PairGain Technologies, Inc. 1993 Option/Stock Issuance
                          Plan (the "1993 Plan").

              (a)    10.6 Form of Stock Option Agreement pertaining to the 1993
                          Plan.

              (a)    10.7 Form of Stock Issuance Agreement pertaining to the
                          1993 Plan.

              (a)    10.8 Contract No. BA07617 dated as of October 27, 1990,
                          between the Registrant and Bell Atlantic Network
                          Services, Inc., as amended.

              (a)    10.9 Stock Option Agreement dated June 23, 1992 between the
                          Registrant and Charles S. Strauch.


                                       32
<PAGE>   34

              (a)    10.10 Stock Option Agreement dated June 23, 1992 between
                           the Registrant and Howard S. Flagg.

              (a)    10.11 Stock Option Agreement dated June 23, 1992 between
                           the Registrant and Benedict A. Itri.

              (a)    10.12 Agreement dated April 26, 1991 between the Registrant
                           and Brooktree Corporation.

              (a)    10.13 Loan and Security Agreement dated as of July 31,
                           1991, between the Registrant and Silicon Valley
                           Bank, as amended.

              (a)    10.14 Standard Sublease dated as of October 29, 1991,
                           between the Registrant and Kirkwood Dynaelectric
                           Company.

              (a)    10.15 Series B Preferred Stock Purchase Agreement dated as
                           of January 17, 1992, among the Registrant and the
                           investors listed therein.

              (a)    10.16 Industrial Lease dated as of March 17, 1992, between
                           the Registrant and Alondra Shoemaker Associates.

              (a)    10.17 Warrant to Purchase Stock dated June 22, 1992, issued
                           to Silicon Valley Bank.

              (a)    10.18 Development and license Agreement and Remote HDSL OEM
                           Agreement both dated June 30, 1992, between the
                           Registrant and ADC Telecommunications, Inc.

              (a)    10.19 Agreement No. PR-6727-A dated September 11, 1992,
                           between the Registrant and Bell South
                           Telecommunications, Inc., as amended.

              (a)    10.20 Series B Preferred Stock Purchase Agreement dated as
                           of September 30, 1992, among the Registrant and the
                           investors listed therein.

              (a)    10.21 Registration Rights Agreement dated as of September
                           30, 1992, among the Registrant, Alcatel Network
                           Systems, Inc., and the investors listed therein.

              (a)    10.22 License and Distribution Agreement dated September
                           30, 1992, between the Registrant and Alcatel Network
                           Systems, Inc.

              (a)    10.23 PairGain Technologies, Inc. Series D Preferred Stock
                           Purchase Warrant dated September 30, 1992, issued to
                           Alcatel Network Systems, Inc.

              (a)    10.24 Subordinated Demand Promissory Note, principal amount
                           $3,000,000, dated September 30, 1992, issued to
                           Alcatel Network Systems, Inc.

              (a)    10.25 PairGain Technologies, Inc. Common Stock Purchase
                           Warrant dated March 25, 1993, issued to Ventana
                           Leasing, Inc.

              (a)    10.26 PairGain Technologies, Inc. Common Stock Purchase
                           Warrant dated March 25, 1993, issued to
                           Praktikerfinans A.B.

              (a)    10.27 Form of Indemnification Agreement

              (b)    10.28 Sublease Agreement dated as of August 1, 1994,
                           between the Registrant and LH Research.

              (b)    10.29 Lease Agreement dated January 30, 1995 between the
                           Registrant and Mr. Niles Gates.


                                       33
<PAGE>   35

              (c)    10.30 Senior Note and Warrant Purchase Agreement dated July
                           24, 1995 between PairGain Technologies, Inc. and
                           Sourcecom Corporation

              (c)    10.31 Warrant Agreement dated July 24, 1995 between
                           PairGain Technologies, Inc. Sourcecom Corporation

              (c)    10.32 Investor Right Agreement dated July 24, 1995 between
                           PairGain Technologies, Inc. Sourcecom Corporation

              (c)    10.33 Stock Purchase Agreement dated July 24, 1995 between
                           PairGain Technologies, Inc. Sourcecom Corporation

              (d)    10.34 PairGain Technologies, Inc. Common Stock Purchase
                           Warrant dated May 10, 1995, issued to Brobeck,
                           Phleger & Harrison

              (d)    10.35 PairGain Technologies, Inc. Common Stock Purchase
                           Warrant dated August 3, 1995, issued to Nexus
                           Applied Research, Inc.

              (d)    10.36 Amendment to Loan and Security Agreement dated May 3,
                           1995, between the Registrant and Silicon Valley Bank

              (e)    10.37 Lease Agreement dated May 30, 1996 between the
                           Registrant and Parker-Raleigh Development XXIII,
                           Limited Partnership

              (f)    10.38 PairGain Technologies, Inc. 1996 Non-Employee
                           Directors Stock Option Plan

              (g)    10.39 Amendment to Certificate of Incorporation of PairGain
                           Technologies, Inc.

              (i)    10.40 Amendment to Certificate of Incorporation of PairGain
                           Technologies, Inc.

              (j)    10.41 Lease Agreement dated December 25, 1996 between the
                           Registrant and the Cheek Family Trust "D"

              (j)    10.42 Lease Agreement dated January 7, 1997 between the
                           Registrant and Catellus Development Corporation

                     11.1  Statement Regarding Computation of Earnings Per Share

              (h)    20.1 Notice to Company Shareholders of Hearing on Proposed
                          Settlement of derivative Action, Case No. 758117.

              (b)    21.  Subsidiaries of the Registrant

              (b)    23.1 Consent of Ernst & Young LLP, Independent Auditors

                     23.2 Consent of Deloitte & Touche LLP, Independent Auditors

              (j)    27    Financial Data Schedule

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

(a)      Incorporated herein by reference to the same Exhibit number to the
         Company's Registration Statement on Form S-1 (Registration No.
         33-66680) declared effective by the Commission on September 14, 1993,
         as amended.


                                       34
<PAGE>   36

(b)      Incorporated herein by reference to the same Exhibit number to the
         Company's Annual Report on Form 10-K for the fiscal year ended December
         31, 1994, as filed with the Commission on February 22, 1995.

(c)      Incorporated herein by reference to the same Exhibit number to the
         Company's Quarterly Report on Form 10-Q for the second quarter ended
         June 30, 1995, as filed with the Commission on August 10, 1995.

(d)      Incorporated herein by reference to the same Exhibit number to the
         Company's Quarterly Report on Form 10-Q for the third quarter ended
         September 30, 1995, as filed with the Commission on November 6, 1995.

(e)      Incorporated herein by reference to the same Exhibit number to the
         Company's Quarterly Report on Form 10-Q for the second quarter ended
         June 30, 1996, as filed with the Commission on August 13, 1996.

(f)      Incorporated herein by reference to Exhibit number 99-1 of Form S-8
         Registration Statement as filed with the Commission on July 23, 1996.

(g)      Incorporated herein by reference to Appendix A of Proxy Statement for
         the Annual Meeting of Stockholders to be held June 12, 1996 as filed
         with the Commission on May 9, 1996.

(h)      Incorporated herein by reference to the same Exhibit number to the
         Company's Quarterly Report on Form 10-Q for the third quarter ended
         September 30, 1996, as filed with the Commission on November 8, 1996.

(i)      Incorporated herein by reference to Appendix A of Proxy Statement for
         the Special Meeting of Stockholders to be held December 10, 1996 as
         filed with the Commission on November 12, 1996.

   
(j)      Incorporated herein by reference to the same Exhibit number to the
         Company's Annual Report on Form 10-K for the fiscal year ended 
         December 31, 1996, as filed with the Commission on March 19, 1997.
    

     (b)  REPORTS ON FORM 8-K:

         A Form 8-K was filed on March 5, 1997 reporting the Company's
         acquisition of Avidia Systems, Inc. on February 27, 1997.


                                       35
<PAGE>   37

                                   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.

   
<TABLE>
<S>                                                   <C>
                                                                         PAIRGAIN TECHNOLOGIES, INC.

        Date:     April 30, 1997                      By:                  /S/ CHARLES S. STRAUCH
                                                           -------------------------------------------------------
                                                                             Charles S. Strauch
                                                                                (Registrant)
                                                                    Chairman and Chief Executive Officer
                                                                        (Principal Executive Officer)

        Date:     April 30, 1997                      By:                  /S/ CHARLES W. MCBRAYER
                                                           -------------------------------------------------------
                                                                             Charles W. McBrayer
                                                                 Vice President, Finance and Administration
                                                                           Chief Financial Officer
                                                                        (Principal Financial Officer)

        Date:     April 30, 1997                      By:                    /S/ ROBERT R. PRICE
                                                           -------------------------------------------------------
                                                                               Robert R. Price
                                                                            Corporate Controller
                                                                       (Principal Accounting Officer)
</TABLE>
    

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

   
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report on Form 10-K/A is signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
    

   
<TABLE>
                   Signature                                    Title                         Date
                   ---------                                    ------                        -----
<S>                                                 <C>                                   <C> 
      /S/ CHARLES S. STRAUCH                        Chairman, Chief Executive             April 30, 1997
      ------------------------------------             Officer and Director
      Charles S. Strauch                  

      /S/ HOWARD S. FLAGG                           President and Director                April 30, 1997
      ------------------------------------
      Howard S. Flagg

      /S/ BENEDICT A. ITRI                          Chief Technical Officer               April 30, 1997
      ------------------------------------             and Director
      Benedict A. Itri                    

      /S/ ROBERT C. HAWK                            Director                              April 30, 1997
      ------------------------------------
      Robert C. Hawk

      /S/ ROBERT A. HOFF                            Director                              April 30, 1997
      ------------------------------------
      Robert A. Hoff

      /S/ B. ALLEN LAY                              Director                              April 30, 1997
      ------------------------------------
      B. Allen Lay
</TABLE>
    


                                       36
<PAGE>   38

                           PAIRGAIN TECHNOLOGIES, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994


                                    CONTENTS


                                                                          PAGE
                                                                        --------

Independent Auditors' Reports                                              F-2

Consolidated Financial Statements:
   Consolidated Balance Sheets                                             F-4
   Consolidated Statements of Income                                       F-5
   Consolidated Statements of Stockholders' Equity                         F-6
   Consolidated Statements of Cash Flows                                   F-7
   Notes to Consolidated Financial Statements                              F-8


                                      F-1
<PAGE>   39

                          INDEPENDENT AUDITORS' REPORT


To the Board of Directors and Stockholders
PairGain Technologies, Inc.
Tustin, California

We have audited the accompanying consolidated balance sheets of PairGain
Technologies, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity, and cash flows
for the years then ended. Our audits also included the financial statement
schedule listed in the index at Item 14 (a)(2) for the years ended December 31,
1996 and 1995. 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 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, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company and subsidiaries as of
December 31, 1996 and 1995, and the results of their operations and their cash
flows for the years 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,
presents fairly in all material respects the information set forth therein.



DELOITTE & TOUCHE LLP

Costa Mesa, California
February 27, 1997


                                      F-2
<PAGE>   40

                          INDEPENDENT AUDITORS' REPORT

Board of Directors
PairGain Technologies, Inc.

We have audited the accompanying consolidated statements of income,
stockholders' equity and cash flows of PairGain Technologies, Inc. for the year
ended December 31, 1994. Our audit also included the financial statement
schedule listed in the index at Item 14 (a)(2). 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 results of PairGain Technologies, Inc.
operations and its cash flows for the year ended December 31, 1994, 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, presents fairly in all material
respects the information set forth therein.



                                                            ERNST & YOUNG LLP
Orange County, California
February 17, 1995


                                      F-3
<PAGE>   41

                           PAIRGAIN TECHNOLOGIES, INC.

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                     ASSETS
                                                                            DECEMBER 31,
                                                                      -----------------------
                                                                        1996          1995
                                                                      ---------     ---------
                                                                       (DOLLARS IN THOUSANDS)
<S>                                                                   <C>           <C>      
Current assets:
   Cash and cash equivalents                                          $  46,840     $  24,576
   Short-term investments (Note 3)                                       65,779        31,149
   Accounts receivable, less allowance for doubtful accounts of
     $900 and $469 at December 31, 1996 and 1995, respectively           23,873        13,044
   Inventories (Note 4)                                                  26,010        22,522
   Deferred tax assets (Note 9)                                          11,074         3,353
   Other current assets                                                   2,767         1,517
                                                                      ---------     ---------
TOTAL CURRENT ASSETS                                                    176,343        96,161
Property and equipment, net (Note 5)                                     10,295         6,402
Note receivable and long-term investments (Note 6)                        6,252         2,708
Other assets                                                                126            55
                                                                      ---------     ---------
TOTAL ASSETS                                                          $ 193,016     $ 105,326
                                                                      =========     =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
   Trade accounts payable                                             $   5,960     $   6,402
   Accrued compensation and related expenses                              5,702         2,605
   Accrued expenses                                                       9,300         2,388
   Accrued income taxes (Note 9)                                         15,826            -- 
                                                                      ---------     ---------
TOTAL CURRENT LIABILITIES                                                36,788        11,395
                                                                      ---------     ---------

COMMITMENTS AND CONTINGENCIES  (NOTES 10 AND 16)

Stockholders' equity (Note 11): 
   Preferred stock, $.001 par value:
     Authorized shares -- 2,000,000
     Issued and outstanding shares -- None                                   --            -- 
   Common stock, $.0005 par value:
     Authorized shares -- 175,000,000
     Issued and outstanding shares-- 64,042,596 and 60,709,068
       at December 31, 1996 and 1995, respectively                           32            15
   Additional paid-in-capital                                           112,782        87,175
   Deferred compensation                                                     --           (82)
   Unrealized gain on short-term investments                                 71            67
   Retained earnings                                                     43,343         6,756
                                                                      ---------     ---------
TOTAL STOCKHOLDERS' EQUITY                                              156,228        93,931
                                                                      ---------     ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                            $ 193,016     $ 105,326
                                                                      =========     =========
</TABLE>

                 See notes to consolidated financial statements.


                                      F-4
<PAGE>   42

                                            PAIRGAIN TECHNOLOGIES, INC.

                                         CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
                                                                            YEAR ENDED DECEMBER 31,
                                                               -----------------------------------------------
                                                                   1996             1995             1994
                                                               ------------     ------------      ------------
                                                                (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                                            <C>              <C>               <C>         
Revenues:
   Product sales                                               $    205,312     $    106,173      $     57,417
   Technology fees and royalty income  (Note 8)                          97            1,051             2,101
                                                               ------------     ------------      ------------
TOTAL REVENUES                                                      205,409          107,224            59,518

Cost of revenues                                                    106,449           56,223            33,141
                                                               ------------     ------------      ------------
Gross profit                                                         98,960           51,001            26,377
                                                               ------------     ------------      ------------
Operating expenses:
    Research and development                                         18,593           10,728             5,849
    Selling and marketing                                            17,218            9,944             5,765
    General and administrative                                        9,907            6,797             4,250
                                                               ------------     ------------      ------------
Total operating expenses                                             45,718           27,469            15,864
                                                               ------------     ------------      ------------
INCOME FROM OPERATIONS                                               53,242           23,532            10,513

Other income (loss):
   Interest income, net                                               3,677            2,118             1,482
   Gain on sales of short-term investments, net                          --              415             1,185
   Unusual loss due to unauthorized trading of investments
     by third parties  (Note 14)                                         --          (15,827)               -- 
   Settlement income related to unauthorized trading of
     investments by third parties (Note 15)                           2,500               --                -- 
                                                               ------------     ------------      ------------
Income before income taxes                                           59,419           10,238            13,180

Provision for income taxes  (Note 9)                                 22,816            9,182             4,613
                                                               ------------     ------------      ------------
NET INCOME                                                     $     36,603     $      1,056      $      8,567
                                                               ============     ============      ============
Per Share Data (Note 1):
   Earnings per share                                          $       0.51     $       0.02      $       0.14
                                                               ============     ============      ============
   Weighted average number of common and common
      equivalent shares                                          72,058,000       67,280,000        61,612,000
                                                               ============     ============      ============
</TABLE>

                 See notes to consolidated financial statements.


                                      F-5
<PAGE>   43

                           PAIRGAIN TECHNOLOGIES, INC.

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                        UNREALIZED
                                         COMMON STOCK         ADDITIONAL                GAIN(LOSS)     RETAINED      TOTAL
                                  -------------------------    PAID-IN     DEFERRED    ON SHORT-TERM   EARNINGS   STOCKHOLDERS'
                                     SHARES       AMOUNT       CAPITAL   COMPENSATION   INVESTMENTS    (DEFICIT)     EQUITY
                                   ----------   ----------   ----------  ------------   -----------   ----------    ----------
<S>                                <C>          <C>          <C>          <C>           <C>           <C>           <C>       
BALANCE AT JANUARY 1, 1994         49,350,440   $       12   $   68,348   $     (257)   $       --    $   (2,867)   $   65,236
  Exercise of common stock          1,484,104            1          203           --            --            --           204
   options
  Tax benefits from exercise of
   common stock options                    --           --          962           --            --            --           962
  Amortization of deferred
   compensation                            --           --           --           87            --            --            87
  Unrealized loss on short-term
   investments, net of tax
   benefit of $141                         --           --           --           --          (210)           --          (210)
  Net income                               --           --           --           --            --         8,567         8,567
                                   ----------   ----------   ----------   ----------    ----------    ----------    ----------
BALANCE AT DECEMBER 31, 1994       50,834,544           13       69,513         (170)         (210)        5,700        74,846
  Issuance of common stock for
   cash, net of offering costs
   of $842                          2,000,000            1       10,969           --            --            --        10,970
  Exercise of warrants              5,771,124            1        2,726           --            --            --         2,727
  Exercise of common stock          2,024,380           --        1,440           --            --            --         1,440
   options
  Issuance of common stock
   sold under Employee Stock
   Purchase Plan                       79,020           --          386           --            --            --           386
  Tax benefits from exercise of
   common stock options                    --           --        2,141           --            --            --         2,141
  Amortization of deferred
   compensation                            --           --           --           88            --            --            88
  Unrealized gain on short-term
   investments, net of tax of ($181)       --           --           --           --           277            --           277
  Net income                               --           --           --           --            --         1,056         1,056
                                   ----------   ----------   ----------   ----------    ----------    ----------    ----------
BALANCE AT DECEMBER 31, 1995       60,709,068           15       87,175          (82)           67         6,756        93,931
  Exercise of common stock          3,258,320            1        6,252           --            --            --         6,253
   options
  Issuance of common stock
   sold under Employee Stock
   Purchase Plan                       75,208           --        1,110           --            --            --         1,110
  Tax benefits from exercise of
   common stock options                    --           --       18,245           --            --            --        18,245
  Amortization of deferred
   compensation                            --           --           --           82            --            --            82
  Unrealized gain on short-term
   investments, net of tax of $1           --           --           --           --             4            --             4
  Stock split effected as a
   stock dividend (Note 11)                --           16           --           --            --           (16)           -- 
  Net income                               --           --           --           --            --        36,603        36,603
                                   ----------   ----------   ----------   ----------    ----------    ----------    ----------
BALANCE AT DECEMBER 31, 1996       64,042,596   $       32   $  112,782   $       --    $       71    $   43,343    $  156,228
                                   ==========   ==========   ==========   ==========    ==========    ==========    ==========
</TABLE>

                 See notes to consolidated financial statements.


                                      F-6
<PAGE>   44

                           PAIRGAIN TECHNOLOGIES, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                             YEAR ENDED DECEMBER 31,
                                                                    ---------------------------------------
                                                                      1996           1995           1994
                                                                    --------       --------       ---------
                                                                             (DOLLARS IN THOUSANDS)
<S>                                                                 <C>            <C>            <C>      
Cash flows from operating activities:
Net income                                                          $ 36,603       $  1,056       $   8,567
Adjustments  to reconcile  net income to net cash  provided by
    operating activities:
    Depreciation and amortization                                      4,683          4,048           1,726
    Gains on sales of investments                                         --           (415)         (1,185)
    Unusual loss due to unauthorized trading of investments by
       third parties                                                      --         15,827              -- 
    Provision for deferred tax assets                                 (7,721)        (1,400)         (2,133)
    Change in operating assets and liabilities:
       Accounts receivable                                           (10,829)        (2,876)         (4,718)
       Inventories                                                    (3,488)        (6,048)         (5,875)
       Other current assets                                           (1,651)          (421)           (508)
       Other assets                                                      (71)            (8)            (17)
       Trade accounts payable                                           (442)          (268)          4,408
       Accrued compensation                                            3,097          1,259             758
       Accrued expenses                                                6,912          1,634             537
       Income taxes  (Note 1)                                         34,472            132           3,112
                                                                    --------       --------       ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES                             61,565         12,520           4,672
                                                                    --------       --------       ---------
Cash flows from investing activities:
Purchases of short-term investments                                  (68,620)       (43,272)       (115,610)
Proceeds from sales of short-term investments                         33,025         48,711          98,817
Purchase of property and equipment                                    (7,525)        (5,909)         (2,022)
Issuance of note receivable                                               --         (2,708)             -- 
Purchases of long-term investments                                    (3,544)            --              -- 
                                                                    --------       --------       ---------
NET CASH USED IN INVESTING ACTIVITIES                                (46,664)        (3,178)        (18,815)
                                                                    --------       --------       ---------
Cash flows from financing activities:
Net (payments on) borrowings under bank line of credit                    --         (1,000)          1,000
Proceeds from issuance of common stock                                 7,363         15,523             204
                                                                    --------       --------       ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES                              7,363         14,523           1,204
                                                                    --------       --------       ---------
Increase (decrease) in cash and cash equivalents                      22,264         23,865         (12,939)
Cash and cash equivalents at beginning of year                        24,576            711          13,650
                                                                    --------       --------       ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR                            $ 46,840       $ 24,576       $     711
                                                                    ========       ========       =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid                                                   $  4,335       $ 10,887       $   3,625
                                                                    ========       ========       =========
Income tax refunds received                                         $  8,342       $     --       $      -- 
                                                                    ========       ========       =========
</TABLE>

                 See notes to consolidated financial statements.


                                      F-7
<PAGE>   45

                           PAIRGAIN TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES

         PairGain Technologies, Inc., (the "Company") designs, manufactures,
markets and supports a comprehensive line of digital telecommunications products
that enable telecommunication exchange carriers and private networks to more
efficiently provide high-speed digital service to end users over the large
infrastructure of unconditioned copper wires.

PRINCIPLES OF CONSOLIDATION

         The consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries: PairGain Services Group, Inc., which
provides support services for the Company's customers worldwide; PairGain Canada
Inc., a sales company focused on the Canadian market; and PairGain International
Sales Corporation, a foreign sales corporation ("FSC"). All significant
intercompany transactions have been eliminated in consolidation.

TRANSLATION OF FOREIGN CURRENCIES

         Foreign subsidiary financial statements are translated into U.S.
dollars in accordance with Statement of Financial Accounting Standards ("SFAS")
No. 52, "Foreign Currency Translations." The functional currency of the
Company's Canadian subsidiary is the U.S. dollar, therefore, translation gains
and losses are included in results of operations. Transaction and translation
gains and losses were not significant in 1996, 1995 or 1994.

USE OF ESTIMATES

         The preparation of 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
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.

RECLASSIFICATIONS

         Certain prior year amounts have been reclassified to conform with the
current year presentation.

CASH AND CASH EQUIVALENTS

         The Company considers all highly liquid investments with maturities at
the date of purchase of less than three months to be cash equivalents.

SHORT-TERM INVESTMENTS

         Effective January 1, 1994, the Company adopted the provisions of SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities". The
adoption did not have a significant impact on the Company's consolidated
financial statements. Management determines the appropriate classification of
such securities at the time of purchase and reevaluates such classification as
of each balance sheet date. Based on its intent, the Company's investments are
classified as available-for-sale and are carried at fair value, with unrealized
gains and losses, net of tax, reported as a separate component of stockholders'
equity. The investments are adjusted for amortization of premiums and discounts
to maturity and such amortization is included in interest income. Realized gains
and losses and declines in value judged to be other than temporary are
determined based on the specific identification method and are reported in the
consolidated statements of income.


                                      F-8
<PAGE>   46

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

INVENTORIES

         Inventories are stated at lower of cost (determined on a first-in,
first-out basis) or market. The Company maintains allowances for estimated
obsolete and excess inventories based upon projected sales levels.

PROPERTY AND EQUIPMENT

         Property and equipment are carried at cost. The Company provides for
depreciation and amortization using the straight-line method. Equipment is
depreciated over an estimated useful life of three years. Leasehold improvements
are amortized over the lesser of five years or the life of the lease.

REVENUE RECOGNITION

         Revenue from product sales is recognized at the time of shipment.
Provision is made currently for estimated product returns. Revenue for
technology and licensing fees and royalty income is recognized when earned.

RESEARCH AND DEVELOPMENT COSTS

         Research and development costs are expensed as incurred.

PER SHARE INFORMATION

         Earnings per share is computed using the weighted average number of
common shares and common share equivalents outstanding during the periods
presented. Common share equivalents result from outstanding options and warrants
to purchase common stock and are calculated using the treasury stock method.

STOCK SPLIT

         All share and per share amounts have been adjusted to reflect the
two-for-one stock splits, effective June 18, 1996 and December 18, 1996, for all
periods presented. (See Note 11)

ACCOUNTING FOR STOCK-BASED COMPENSATION

         The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board ("APB")
Opinion No. 25, "Accounting for Stock Issued to Employees". (See Note 12)

STATEMENT OF CASH FLOWS

         Significant noncash transactions in 1996, 1995 and 1994 affecting the
Company's accounts consisted of tax benefits from exercises of common stock
options of $18.2 million, $2.1 million and $962,000, respectively.

2.  CONCENTRATION OF CREDIT RISK, MAJOR CUSTOMERS AND PRODUCTS

         The Company markets its products principally to telephone companies in
the United States and Canada. Credit is extended based on an evaluation of the
customer's financial condition and collateral is not required. Credit losses are
provided for in the financial statements and consistently have been
insignificant. Sales to major customers as a percentage of total product revenue
were as follows:


                                      F-9
<PAGE>   47

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


<TABLE>
<CAPTION>
                                      1996           1995           1994
                                  -------------- -------------  -------------
<S>                               <C>            <C>            <C>
    Customer A                          15%           15%            18%
    Customer B                          13%           17%            19%
    Customer C                          12%           12%            13%
    Customer D                          10%           11%            10%
</TABLE>

         A decision by a significant customer to substantially decrease or delay
purchases from the Company or the Company's inability to collect receivables
from these customers could have a material adverse effect on the Company's
financial condition and results of operations.

         Revenues from HiGain products represented approximately 76% of the
Company's total revenues in each of the years 1996, 1995 and 1994. A decline in
demand for HiGain products, whether as a result of competition, deployment of
fiber cable, technological change or otherwise, could have a material adverse
effect on the Company's financial condition and results of operations.

3.  SHORT-TERM INVESTMENTS

         Short-term investments as of December 31, 1996 and 1995 are summarized
as follows:

<TABLE>
<CAPTION>
                                                                        GROSS           GROSS
                                                                     UNREALIZED      UNREALIZED         FAIR
                                                       COST             GAINS          LOSSES           VALUE
                                                  ---------------- ---------------- -------------- ----------------
                                                                           (IN THOUSANDS)
<S>                                               <C>              <C>              <C>            <C>      
 1996
     Municipal bonds                                   $  59,686        $      41      $      --        $  59,727
     Other short-term investments                          5,982               70             --            6,052
                                                  ---------------- ---------------- -------------- ----------------
                                                       $  65,668        $     111      $      --        $  65,779
                                                  ================ ================ ============== ================

 1995
     Municipal bonds                                   $  31,042        $     107      $      --        $  31,149
                                                  ================ ================ ============== ================
</TABLE>

         Unrealized gains on short-term investments, net of tax, included as a
separate component of stockholders' equity were $71,000 and $67,000 in 1996 and
1995, respectively.

         The amortized cost and estimated fair value of investments at December
31, 1996 by contractual maturity are shown below. Actual maturities may differ
from contractual maturities because the issuer of the securities may have the
right to repurchase such securities.

<TABLE>
<CAPTION>
                                                                                                   FAIR
                                                                            COST                  VALUE
                                                                       ----------------      -----------------
                                                                                   (IN THOUSANDS)
<S>                                                                    <C>                   <C>     
         Due in one year or less                                              $ 30,084               $ 30,242
         Due after one year through three years                                 35,584                 35,537
                                                                       ----------------      -----------------
                                                                              $ 65,668               $ 65,779
                                                                       ================      =================
</TABLE>


                                      F-10
<PAGE>   48

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


4.  INVENTORIES

         Inventories consist of:

<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                    ----------------------------
                                                     1996                 1995
                                                    -------              -------
                                                           (IN THOUSANDS)
<S>                                                 <C>                  <C>    
Finished goods                                      $10,597              $ 7,842
Work in process                                       9,745                9,693
Purchased parts                                       5,668                4,987
                                                    -------              -------
                                                    $26,010              $22,522
                                                    =======              =======
</TABLE>

5.  PROPERTY AND EQUIPMENT

         Property and equipment consist of:

<TABLE>
<CAPTION>
                                                              DECEMBER 31,
                                                        -----------------------
                                                          1996           1995
                                                        --------       --------
                                                            (IN THOUSANDS)
<S>                                                     <C>            <C>     
Machinery and equipment                                 $ 16,888       $  9,772
Leasehold improvements                                     1,520          1,111
                                                        --------       --------
                                                          18,408         10,883
Less accumulated depreciation and amortization            (8,113)        (4,481)
                                                        --------       --------
                                                        $ 10,295       $  6,402
                                                        ========       ========
</TABLE>

6.  NOTE RECEIVABLE AND LONG-TERM INVESTMENTS

         On July 20, 1995, the Company entered into certain agreements with
Sourcecom Corporation of Westlake Village, California ("Sourcecom"). Sourcecom 
designs, manufactures and markets remote networking devices which enable the 
integration of Ethernet local area networks with wide area networking over 
copper wire. The agreements provide for the incorporation of Sourcecom's 
networking technology into the Company's current and future transmission 
products. Under the terms of the agreements, the Company loaned Sourcecom 
$2.7 million and has rights to purchase a minority ownership position. The 
note bears interest at the prime rate less one percent (7.25% at December 31, 
1996), payable monthly, with the principal balance due July 1999.

         In April 1996, the Company purchased approximately 150,000 shares of
Sourcecom's Series A Preferred Stock for an aggregate of $273,000. In September
1996, the Company purchased approximately 321,000 shares of Sourcecom's Common
Stock for an aggregate of $271,000. Shares purchased have been adjusted to
reflect Sourcecom's two-for-one stock split, effective September 24, 1996.

         In June 1996, the Company made a minority investment in E/O Networks of
Hayward, California ("E/O"). E/O supplies low-density fiber optic access
equipment to public carriers both domestically and internationally. The Company
purchased approximately 545,000 shares of E/O's Series D Preferred Stock for an
aggregate of $3.0 million.

         These investments are accounted for using the cost method.


                                      F-11
<PAGE>   49

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


7.  BANK LINE OF CREDIT

         The Company maintains an unsecured line of credit with a bank. The line
allows maximum borrowings of $5,000,000, including the issuance of letters of
credit and foreign exchange contracts. The line bears interest at the prime rate
(8.25% at December 31, 1996). At December 31, 1996, the Company had no
outstanding borrowings under this line of credit. The debt agreement specifies
certain financial and other covenants. The Company was in compliance with the
financial and other covenants at December 31, 1996. The agreement expires May 1,
1997.

8.  LICENSE AND DISTRIBUTION AGREEMENTS

         In 1992, the Company granted an exclusive worldwide noncancelable
license to its HDSL technology configured for general use in specified markets
outside the U.S. and a nonexclusive, worldwide, noncancelable license to its
HDSL technology configured for general use in the U.S. to a U.S. subsidiary of
Alcatel, SA, a French telecommunications company. In November 1995, this
agreement was terminated. As part of terminating the agreement, the Company
granted royalty-free licenses of current Company technology to Alcatel and
Alcatel granted a royalty-free license of its network management software to the
Company. The agreement also revised the royalty rate for standalone T1 products
which incorporate the Company's HDSL technology being sold by Alcatel.

9.  INCOME TAXES

         The components of the provision for income taxes are as follows:

<TABLE>
<CAPTION>
                                                                                   1996        1995         1994
                                                                                ----------- ------------ -----------
                                                                                          (IN THOUSANDS)
<S>                                                                              <C>          <C>         <C>     
Current:
   Federal                                                                       $25,179      $ 8,150     $ 5,546 
   State and foreign                                                               5,358        2,432       1,200 
                                                                                 -------      -------     ------- 
Total current                                                                     30,537       10,582       6,746 
                                                                                 -------      -------     ------- 
Deferred:
   Federal                                                                        (6,600)      (1,207)     (1,875)
   State and foreign                                                              (1,121)        (193)       (258)
                                                                                 -------      -------     ------- 
Total deferred                                                                    (7,721)      (1,400)     (2,133)
                                                                                 -------      -------     ------- 
Total provision                                                                  $22,816      $ 9,182     $ 4,613 
                                                                                 =======      =======     ======= 
</TABLE>

         The provision for income taxes for the years ended December 31, 1996,
1995, and 1994 differs from the U.S. federal statutory tax expense for the years
as follows:

<TABLE>
<CAPTION>
                                                                                   1996        1995         1994
                                                                                ----------- ------------ -----------
                                                                                           (IN THOUSANDS)
<S>                                                                              <C>          <C>         <C>     
 U.S. federal statutory tax expense                                              $20,797      $ 3,583     $ 4,481 
 Unusual loss due to unauthorized trading of investments by third parties             --        4,980          -- 
 State taxes, net of federal tax benefit                                           2,104        1,422         792 
 Decrease in valuation allowance for deferred tax assets                              --           --        (994)
 Other items, net                                                                    (85)        (803)        334 
                                                                                 -------      -------     ------- 
 Total provision                                                                 $22,816      $ 9,182     $ 4,613 
                                                                                 =======      =======     ======= 
</TABLE>


                                      F-12
<PAGE>   50

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components for the Company's deferred tax assets at December 31 are as follows:

<TABLE>
<CAPTION>
                                                                              1996              1995
                                                                            --------           --------
                                                                                  (IN THOUSANDS)
<S>                                                                         <C>                <C>     
        Deferred tax assets:
             Inventory and related reserves                                 $  6,867           $  1,915
             Warranty reserve                                                  1,538                400
             Other reserves and accruals                                       1,450                457
             Other                                                             1,219                581
                                                                            --------           --------
        Total deferred tax assets                                           $ 11,074           $  3,353
                                                                            ========           ========
</TABLE>

10.  COMMITMENTS

         The Company has entered into several operating leases for its
facilities with varying terms and escalation clauses. Future annual minimum
lease payments under the noncancelable operating leases are as follows:

<TABLE>
<CAPTION>
                               Years ending December 31,       (IN THOUSANDS)
                            ---------------------------------  ----------------
                                      <S>                        <C>     
                                          1997                    $  1,195
                                          1998                       1,122
                                          1999                       1,002
                                          2000                         670
                                          2001                         601
                                       Thereafter                    1,522
                                                                  --------
                                                                  $  6,112
                                                                  ========
</TABLE>

         Rent expense for the years ended December 31, 1996, 1995 and 1994
aggregated $717,000, $424,000 and $298,000, respectively.

11.  STOCKHOLDERS' EQUITY

STOCK SPLITS

         In June 1996, the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation (the "Amendment") to increase the
authorized Common Stock of the Company from 30 million shares, par value $.001,
to 60 million shares, par value $.0005, and to effect a two-for-one stock split
(the "Stock Split").

         In December 1996, the Company's stockholders approved an amendment to
the Company's Amended and Restated Certificate of Incorporation (the "Second
Amendment") to increase the authorized Common Stock of the Company from 60
million shares, par value $.0005, to 175 million shares, par value $.0005. The
Second Amendment was proposed to facilitate a two-for-one stock split (the
"Second Stock Split") which was effected in the form of a 100% stock dividend.


                                      F-13
<PAGE>   51

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         All references in the accompanying consolidated financial statements
related to common stock, common stock options, common stock warrants and
earnings per share have been adjusted to reflect both stock splits.

SECONDARY PUBLIC OFFERING

         In March 1995, the Company completed a secondary offering and sold
2,000,000 shares of its common stock at a price of $5.91 per share. The net
proceeds raised by the Company were approximately $10,970,000. In connection
with the offering, certain outstanding warrants were exercised to purchase
5,750,620 shares of common stock at an aggregate exercise price of $2,717,000.

WARRANTS

         In 1995, the Company granted warrants for the purchase of 40,000 shares
of its common stock at exercise prices of $5.00 to $6.25 per share in exchange
for services. Such warrants were outstanding at December 31, 1996 and expire
beginning in May 1998 through September 1999.

         In 1993, the Company granted warrants for the purchase of 57,240 shares
of its common stock at an exercise price of $0.47 per share to a company and its
affiliate in connection with an equipment leasing transaction. Such warrants
were exercised during 1995.

12.  STOCK OPTION PLANS

1993 EMPLOYEE STOCK OPTION PLAN

         Under the Company's 1993 Stock Option/Stock Issuance Plan ("the Plan"),
which is the successor plan to its 1990 Stock Option Plan ("the 1990 Plan"), a
Committee consisting of non-employee members of its Board of Directors, is
authorized to grant stock options or issue common stock to officers, key
employees, members of the Board of Directors, and certain consultants or other
independent contractors of the Company. In addition, the Plan also provides for
the purchase of the Company's common stock by eligible individuals at a price
per share not less than 85% of the fair market value at the time of issuance. No
shares have been issued under the purchase provisions. Incentive options are
granted at a price equal to 100% of the fair market value at the date of grant
(at least 85% of the fair market value for non-qualified options) and vested
options are exercisable for a period determined by the Committee that is not to
exceed ten years from the date of grant. Options issued under the 1990 Plan are
exercisable immediately upon grant and shares issued related to options
exercised but not vested are subject to repurchase by the Company at the
exercise price of such options. At the discretion of the Committee, the Plan
provides option holders stock appreciation rights which allow the holder to
exercise such options in exchange for the payment of the difference between the
fair market value and option price of the underlying shares in the form of cash
or shares of common stock. Under certain circumstances in the event of a merger,
sale or other significant transaction involving the Company, the options and
stock issued may become fully vested and exercisable.

         In January 1995, the Company's Board of Directors approved an increase
in the number of common shares reserved and available for issuance under the
Plan from 14,800,000 shares to 18,800,000 shares.


                                      F-14
<PAGE>   52

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


1996 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN

         In June 1996, the Company's stockholders approved the 1996 Non-Employee
Directors Stock Option Plan (the "Directors Plan"). Under the terms of the
Directors Plan, 400,000 shares of Common Stock have been reserved for issuance
to non-employee members of the Board. Following the 1996 Annual Meeting, initial
options to purchase 40,000 shares of the Company's Common Stock were granted to
each non-employee director who had not previously received any stock option
grants from the Company. On an annual basis beginning with the 1997 Annual
Meeting, an option to purchase an additional 20,000 shares of Common Stock will
be granted to each individual who is to continue to serve as a non-employee
Board member. There is no limit to the number of such annual 20,000-share option
grants any one non-employee Board member may receive over his or her period of
continued Board service during the term of the Directors Plan. Each option will
have an exercise price per share equal to 100% of the fair market value per
share of Common Stock on the option grant date and a maximum term of ten years
measured from the option grant date. Each option will be immediately exercisable
for all the option shares, but any purchased shares will be subject to
repurchase by the Company, at the exercise price paid per share, upon the
optionee's cessation of Board service. Each initial option grant will vest (and
the Company's repurchase rights will lapse) in four successive equal annual
installments over the optionee's period of Board service, with the first such
installment to vest upon the completion of one year of Board service measured
from the option grant date. Additional option grants will vest (and the
Company's repurchase rights will lapse) upon the completion of one year of Board
service measured from the option grant date. The term of the Directors Plan is
ten years.

         Option activity under the plans is as follows:

<TABLE>
<CAPTION>
                                                                                          WEIGHTED
                                                                         NUMBER OF        AVERAGE
                                                                          SHARES       EXERCISE PRICE
                                                                      ---------------  ----------------
<S>                                                                   <C>                 <C>        
Outstanding, January 1, 1994                                             9,630,784         $ 0.35
Granted                                                                  3,240,400         $ 2.36
Exercised                                                               (1,484,104)        $ 0.07
Canceled                                                                  (705,908)        $ 1.52
                                                                       -----------
Outstanding, December 31, 1994
     (4,649,244 exercisable at a weighted average price of $0.34)       10,681,172         $ 0.90

Granted (weighted average fair value of $2.96)                           4,956,400         $ 5.14
Exercised                                                               (2,024,380)        $ 0.71
Canceled                                                                  (286,700)        $ 3.39
                                                                       -----------
Outstanding, December 31, 1995
     (5,692,132 exercisable at a weighted average price of $0.66)       13,326,492         $ 2.48

Granted (weighted average fair value of $12.11)                          2,843,000         $20.95
Exercised                                                               (3,258,320)        $ 1.92
Canceled                                                                  (228,611)        $ 6.87
                                                                       ===========
Outstanding, December 31, 1996                                          12,682,561         $6.68
                                                                       ===========
</TABLE>


                                      F-15
<PAGE>   53

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         The outstanding stock options primarily vest ratably over a four year
period. Stock options outstanding at December 31, 1996 are summarized as
follows:

<TABLE>
<CAPTION>
                                         OPTIONS OUTSTANDING                            OPTIONS EXERCISABLE
                         ----------------------------------------------------- --------------------------------------
                                                 WEIGHTED
                                                 AVERAGE
                              NUMBER            REMAINING        WEIGHTED            NUMBER             WEIGHTED
       RANGE OF            OUTSTANDING AT      CONTRACTUAL        AVERAGE        EXERCISABLE AT          AVERAGE
   EXERCISE PRICES        DECEMBER 31, 1996        LIFE       EXERCISE PRICE    DECEMBER 31, 1996    EXERCISE PRICE
-----------------------  -------------------- --------------- ---------------- --------------------- ----------------
<S>                      <C>                  <C>             <C>              <C>                   <C>   
    $0.04 - $0.07                3,503,410         5.3              $ 0.07              3,494,568          $ 0.07
    $0.83 - $3.44                3,364,276         7.4              $ 2.48              1,538,184          $ 2.17
    $4.00 - $7.63                3,029,223         8.6              $ 5.86                781,781          $ 5.79
   $10.31 - $17.31               1,328,258         9.2              $14.15                 91,990          $13.40
   $20.50 - $30.00               1,457,394         9.6              $27.19                142,182          $26.39
                         -------------------- --------------- ---------------- --------------------- ----------------

    $0.04 - $30.00              12,682,561         7.5              $ 6.68              6,048,705          $ 2.16
                         ====================                                  =====================
</TABLE>

         At December 31, 1996, 1,039,615 and 320,000 shares were available for
future grants under the Option Plan and Directors' Plan, respectively.

EMPLOYEE STOCK PURCHASE PLAN

         Under the Company's Employee Stock Purchase Plan, (the "Purchase
Plan"), eligible employees are permitted to have salary withholdings to purchase
shares of common stock at a price equal to 85% of the lower of the market value
of the stock at the beginning or end of each six-month offer period, subject to
an annual limitation. Stock issued under the Purchase Plan was 75,208 and 
79,020 shares in 1996 and 1995 at weighted average prices of $14.77 and $4.89,
respectively. The weighted average fair value, per share, of the 1996 and 1995
awards was $17.38 and $5.75, respectively. At December 31, 1996, 845,772 shares
were reserved for future issuances under the Purchase Plan.

ADDITIONAL STOCK PLAN INFORMATION (SFAS NO. 123)

         As discussed in Note 1, the Company continues to account for its
stock-based awards using the intrinsic value method in accordance with APB 
Opinion No. 25, "Accounting for Stock Issued to Employees," and its related
interpretations. No compensation expense has been recognized in the financial
statements for employee stock arrangements.

         SFAS No. 123, "Accounting for Stock-Based Compensation", requires the
disclosure of pro forma net income and earnings per share had the Company
adopted the fair value method as of the beginning of fiscal 1995. Under SFAS No.
123, the fair value of stock-based awards to employees is calculated through the
use of option pricing models, even though such models were developed to estimate
the fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
values.


                                      F-16
<PAGE>   54

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

         The Company's calculations were made using the Black-Scholes option
pricing model with the following weighted average assumptions: expected life,
six months following vesting; stock volatility, 65% in 1996 and 65% in 1995;
risk free interest rates, 6.26% in 1996 and 6.11% in 1995; and no dividends
during the expected term. The Company's calculations are based on a single
option valuation approach and forfeitures are recognized as they occur. If the
computed fair values of the 1996 and 1995 awards had been amortized to expense
over the vesting period of the awards, pro forma net income would have been
$31.3 million, or $0.43 per share, in 1996 and a loss of $258,000, or $0.00 per
share, in 1995. These amounts are based on calculated values for option awards
in 1996 and 1995 of $34.4 million and $14.7 million, respectively. The impact of
stock options granted prior to 1995 has been excluded from the pro forma
calculation; accordingly, the 1996 and 1995 pro forma adjustments are not
indicative of future period pro forma adjustments, when the calculation may
apply to all applicable stock options.

13.  EMPLOYEE BENEFIT PLANS

         The Company sponsors a defined contribution 401(K) Savings and
Investment Plan, which was established in 1993, covering substantially all of
the Company's employees subject to certain eligibility requirements. At its
discretion, the Company may make contributions to the plan. In April 1996, the
Board approved a resolution to match employee contributions provided that a
threshold earnings per share level was reached. Employee deferrals from April
28, 1996 through December 31, 1996 were eligible for a matching contribution
equal to fifty percent (50%) of the employee's salary deferral, not to exceed
$500 per employee. Matching contributions vest over a period of four years of
service. The aggregate accrual for this contribution included in the
accompanying consolidated balance sheet as of December 31, 1996 was $145,000. No
contributions were made by the Company in 1995 or 1994.

14.  UNUSUAL LOSS DUE TO UNAUTHORIZED TRADING OF INVESTMENTS BY THIRD PARTIES

         In 1993 and 1994, the Company invested a portion of its excess cash
with Capital Insight, Inc. ("Capital Insight"), a financial advisor and broker
based in Beverly Hills, California. The Company had no funds invested with
Capital Insight at either December 31, 1993 or December 31, 1994, as all such
invested funds were returned to the Company prior to the end of each of those
years.

         In early 1995, the Company again invested a portion of its excess cash
with Capital Insight, with instructions that the funds be invested solely in
U.S. Treasury securities with maturities of one year or less. These instructions
were consistent with the investment guidelines which had been approved by the
Company's Board of Directors in October 1994. However, these instructions were
violated and the funds were used to engage in unauthorized trading in options
and futures. In November 1995, the Company confirmed that it had incurred
non-recurring losses of $15.8 million resulting from these inappropriate and
unauthorized trading activities.

         The Company's outside directors retained independent legal counsel and
forensic accountants to determine the facts and circumstances surrounding this
matter. This investigation revealed no improper involvement by any Company
director, officer or employee in the unauthorized trading. Additionally, the
investigation found that the Company was provided with fictitious statements by
Capital Insight, and the Company had actually incurred substantial losses in the
second quarter of 1995. During the third and fourth quarters of 1995, the
unauthorized trading generated significant gains resulting in net trading losses
of $15.8 million for the year. Furthermore, it was determined that the 1994
statements provided by this advisor and relied upon by the Company for its
quarterly reporting were also incorrect. Although total financial results for
1994 were not impacted by these false statements, previously reported 1994
quarterly financial statements did not reflect the proper periods in which the
trading gains and losses occurred. Based on the results of the investigation,
the Company amended its quarterly statements for both 1994 and 1995 to
reflect the proper reporting of the trading gains and losses.



                                      F-17
<PAGE>   55

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


         In January 1996, the Company filed suit in Los Angeles federal court
against Mr. S. Jay Goldinger and Capital Insight, Inc. charging unauthorized
trading, fraudulent misrepresentation, violation of federal securities laws and
breach of fiduciary duties. The suit seeks $15.8 million in damages by reason of
the losses incurred by the Company, as well as punitive damages and legal fees.

15.  SETTLEMENT INCOME RELATED TO UNAUTHORIZED TRADING OF INVESTMENTS BY
     THIRD PARTIES

         In January 1996, the Company received a copy of a complaint, filed
derivatively by a Company stockholder on behalf of the Company, naming as
defendants the Company's directors and certain officers, as well as Capital
Insight and Mr. S. Jay Goldinger, its president. The derivative complaint stated
causes of action for breach of fiduciary duty, abuse of control, constructive
fraud, gross mismanagement and waste of corporate assets by reason of unusual
losses incurred by the Company as a result unauthorized trading of investment by
third parties (See Note 14). The suit sought an award in the amount of all
damages sustained by the Company including the losses of $15.8 million and legal
fees and expenses.

         In September 1996, the Company and other parties to the derivative
suits described above executed definitive settlement agreements to settle and
dismiss the derivative suits. The Court approved the settlement in November
1996. Under the terms of the settlement, the Company received $2.5 million from
a brokerage firm involved in processing the investments for Capital Insight, and
paid plaintiff's attorneys fees of $450,000. The impact of the settlement has
been recorded in the Company's financial statements for the year ended December
31, 1996.

16.  SUBSEQUENT EVENTS

         On February 27, 1997, the Company acquired all the outstanding shares
of Avidia Systems, Inc., ("Avidia") pursuant to an Agreement and Plan of
Reorganization (the "Merger Agreement") among Avidia and others, with Avidia
surviving as a wholly-owned subsidiary of the Company (the "Acquisition"). The
Avidia Common Stock, Preferred Stock and outstanding options and warrants to
purchase Avidia Common Stock were converted into the right to receive
approximately 2,366,865 shares of the Company's Common Stock, consisting of
directly issued shares and warrants and options to acquire the Company's Common
Stock. The Company intends to account for the Acquisition as a
pooling-of-interests.

         Avidia was formed in December 1995 to address the growing market
requirements for high-speed, low-cost desktop networking products in business
and residential environments. Avidia has entered that market with a family of
standards-compliant ATM ("Asynchronous Transfer Mode") digital desktop products,
including high performance ATM switches for 25 Mbps connectivity for the
corporate, government and education markets. The Company intends to continue to
market Avidia's line of ATM desktop products under the Avidia name.

         Following is pro forma revenue, net income and earnings per share
had the acquisition occurred as of January 1, 1996.

<TABLE>
<CAPTION>
                                                PRO FORMA CONSOLIDATED
                                                ----------------------
                                                (IN THOUSANDS, EXCEPT
                                                  EARNINGS PER SHARE)
        <S>                                            <C>
        Revenues                                       $ 205,505
        Net income                                     $  34,908
        Earnings per share                             $    0.47
</TABLE>


         The pro forma information presented is not necessarily indicative of
either the results of operations that would have occurred had the merger been
effected on January 1, 1996 nor of future results of operations.



                                      F-18
<PAGE>   56

                           PAIRGAIN TECHNOLOGIES, INC.

                 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS


<TABLE>
<CAPTION>
                                                         ADDITIONS
                                                  ------------------------
                                    BALANCE AT    CHARGED TO    CHARGED TO
                                   BEGINNING OF   COSTS AND        OTHER                     BALANCE AT
DESCRIPTION                           PERIOD       EXPENSES      ACCOUNTS     DEDUCTIONS   END OF PERIOD
                                   ------------   ----------    ----------    ----------   -------------
                                                             (IN THOUSANDS)
<S>                                  <C>           <C>           <C>           <C>           <C>     
Year ended December 31, 1996:
Allowance for doubtful accounts
  receivable                         $    469      $    428      $      3      $     --      $    900
Inventory reserves                      4,235        13,877            --         3,456        14,656
                                     --------      --------      --------      --------      --------
Total                                $  4,704      $ 14,305      $      3      $  3,456      $ 15,556
                                     ========      ========      ========      ========      ========
Year ended December 31, 1995:
Allowance for doubtful accounts
  receivable                         $    298      $    159      $     91      $     79      $    469
Inventory reserves                      1,882         3,353            --         1,000         4,235
                                     --------      --------      --------      --------      --------
Total                                $  2,180      $  3,512      $     91      $  1,079      $  4,704
                                     ========      ========      ========      ========      ========
Year ended December 31, 1994:
Allowance for doubtful accounts
  receivable                         $    155      $    150      $     --      $      7      $    298
Inventory reserves                      1,183           812            --           113         1,882
                                     --------      --------      --------      --------      --------
Total                                $  1,338      $    962      $     --      $    120      $  2,180
                                     ========      ========      ========      ========      ========
</TABLE>


                                       S-1
<PAGE>   57
                                 EXHIBIT INDEX

                                                                   SEQUENTIALLY
EXHIBIT NO.                    DESCRIPTION                         NUMBERED PAGE
-----------                    -----------                         -------------
 
(a)     3.4 Certificate of Incorporation of Registrant, a Delaware
            corporation.

(a)     3.5 Form of Agreement and Plan of Merger of Registrant, a
            Delaware corporation, and Registrant, a California
            corporation.

(a)     3.6 Bylaws of Registrant, a Delaware corporation.

(a)    10.1 PairGain Technologies, Inc. 1990 Stock Option Plan
            (the "1990 Plan").

(a)    10.2 Form of Incentive Stock Option Agreement pertaining to
            the 1990 Plan.

(a)    10.3 Form of Supplemental Incentive Stock Option Agreement
            pertaining to the 1990 Plan.

(a)    10.4 Form of Nonstatutory Stock Option Agreement pertaining
            to the 1990 Plan.

(a)    10.5 PairGain Technologies, Inc. 1993 Option/Stock Issuance
            Plan (the "1993 Plan").

(a)    10.6 Form of Stock Option Agreement pertaining to the 1993
            Plan.

(a)    10.7 Form of Stock Issuance Agreement pertaining to the
            1993 Plan.

(a)    10.8 Contract No. BA07617 dated as of October 27, 1990,
            between the Registrant and Bell Atlantic Network
            Services, Inc., as amended.

(a)    10.9 Stock Option Agreement dated June 23, 1992 between the
            Registrant and Charles S. Strauch.

<PAGE>   58

(a)    10.10 Stock Option Agreement dated June 23, 1992 between
             the Registrant and Howard S. Flagg.

(a)    10.11 Stock Option Agreement dated June 23, 1992 between
             the Registrant and Benedict A. Itri.

(a)    10.12 Agreement dated April 26, 1991 between the Registrant
             and Brooktree Corporation.

(a)    10.13 Loan and Security Agreement dated as of July 31,
             1991, between the Registrant and Silicon Valley
             Bank, as amended.

(a)    10.14 Standard Sublease dated as of October 29, 1991,
             between the Registrant and Kirkwood Dynaelectric
             Company.

(a)    10.15 Series B Preferred Stock Purchase Agreement dated as
             of January 17, 1992, among the Registrant and the
             investors listed therein.

(a)    10.16 Industrial Lease dated as of March 17, 1992, between
             the Registrant and Alondra Shoemaker Associates.

(a)    10.17 Warrant to Purchase Stock dated June 22, 1992, issued
             to Silicon Valley Bank.

(a)    10.18 Development and license Agreement and Remote HDSL OEM
             Agreement both dated June 30, 1992, between the
             Registrant and ADC Telecommunications, Inc.

(a)    10.19 Agreement No. PR-6727-A dated September 11, 1992,
             between the Registrant and Bell South
             Telecommunications, Inc., as amended.

(a)    10.20 Series B Preferred Stock Purchase Agreement dated as
             of September 30, 1992, among the Registrant and the
             investors listed therein.

(a)    10.21 Registration Rights Agreement dated as of September
             30, 1992, among the Registrant, Alcatel Network
             Systems, Inc., and the investors listed therein.

(a)    10.22 License and Distribution Agreement dated September
             30, 1992, between the Registrant and Alcatel Network
             Systems, Inc.

(a)    10.23 PairGain Technologies, Inc. Series D Preferred Stock
             Purchase Warrant dated September 30, 1992, issued to
             Alcatel Network Systems, Inc.

(a)    10.24 Subordinated Demand Promissory Note, principal amount
             $3,000,000, dated September 30, 1992, issued to
             Alcatel Network Systems, Inc.

(a)    10.25 PairGain Technologies, Inc. Common Stock Purchase
             Warrant dated March 25, 1993, issued to Ventana
             Leasing, Inc.

(a)    10.26 PairGain Technologies, Inc. Common Stock Purchase
             Warrant dated March 25, 1993, issued to
             Praktikerfinans A.B.

(a)    10.27 Form of Indemnification Agreement

(b)    10.28 Sublease Agreement dated as of August 1, 1994,
             between the Registrant and LH Research.

(b)    10.29 Lease Agreement dated January 30, 1995 between the
             Registrant and Mr. Niles Gates.


                                       

<PAGE>   59

(c)    10.30 Senior Note and Warrant Purchase Agreement dated July
             24, 1995 between PairGain Technologies, Inc. and
             Sourcecom Corporation

(c)    10.31 Warrant Agreement dated July 24, 1995 between
             PairGain Technologies, Inc. Sourcecom Corporation

(c)    10.32 Investor Right Agreement dated July 24, 1995 between
             PairGain Technologies, Inc. Sourcecom Corporation

(c)    10.33 Stock Purchase Agreement dated July 24, 1995 between
             PairGain Technologies, Inc. Sourcecom Corporation

(d)    10.34 PairGain Technologies, Inc. Common Stock Purchase
             Warrant dated May 10, 1995, issued to Brobeck,
             Phleger & Harrison

(d)    10.35 PairGain Technologies, Inc. Common Stock Purchase
             Warrant dated August 3, 1995, issued to Nexus
             Applied Research, Inc.

(d)    10.36 Amendment to Loan and Security Agreement dated May 3,
             1995, between the Registrant and Silicon Valley Bank

(e)    10.37 Lease Agreement dated May 30, 1996 between the
             Registrant and Parker-Raleigh Development XXIII,
             Limited Partnership

(f)    10.38 PairGain Technologies, Inc. 1996 Non-Employee
             Directors Stock Option Plan

(g)    10.39 Amendment to Certificate of Incorporation of PairGain
             Technologies, Inc.

(i)    10.40 Amendment to Certificate of Incorporation of PairGain
             Technologies, Inc.

(j)    10.41 Lease Agreement dated December 25, 1996 between the
             Registrant and the Cheek Family Trust "D"

(j)    10.42 Lease Agreement dated January 7, 1997 between the
             Registrant and Catellus Development Corporation

       11.1  Statement Regarding Computation of Earnings Per Share

(h)    20.1 Notice to Company Shareholders of Hearing on Proposed
            Settlement of derivative Action, Case No. 758117.

(b)    21.  Subsidiaries of the Registrant

(b)    23.1 Consent of Ernst & Young LLP, Independent Auditors

       23.2 Consent of Deloitte & Touche LLP, Independent Auditors

(j)    27    Financial Data Schedule

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

(a)      Incorporated herein by reference to the same Exhibit number to the
         Company's Registration Statement on Form S-1 (Registration No.
         33-66680) declared effective by the Commission on September 14, 1993,
         as amended.


 
<PAGE>   60

(b)      Incorporated herein by reference to the same Exhibit number to the
         Company's Annual Report on Form 10-K for the fiscal year ended December
         31, 1994, as filed with the Commission on February 22, 1995.

(c)      Incorporated herein by reference to the same Exhibit number to the
         Company's Quarterly Report on Form 10-Q for the second quarter ended
         June 30, 1995, as filed with the Commission on August 10, 1995.

(d)      Incorporated herein by reference to the same Exhibit number to the
         Company's Quarterly Report on Form 10-Q for the third quarter ended
         September 30, 1995, as filed with the Commission on November 6, 1995.

(e)      Incorporated herein by reference to the same Exhibit number to the
         Company's Quarterly Report on Form 10-Q for the second quarter ended
         June 30, 1996, as filed with the Commission on August 13, 1996.

(f)      Incorporated herein by reference to Exhibit number 99-1 of Form S-8
         Registration Statement as filed with the Commission on July 23, 1996.

(g)      Incorporated herein by reference to Appendix A of Proxy Statement for
         the Annual Meeting of Stockholders to be held June 12, 1996 as filed
         with the Commission on May 9, 1996.

(h)      Incorporated herein by reference to the same Exhibit number to the
         Company's Quarterly Report on Form 10-Q for the third quarter ended
         September 30, 1996, as filed with the Commission on November 8, 1996.

(i)      Incorporated herein by reference to Appendix A of Proxy Statement for
         the Special Meeting of Stockholders to be held December 10, 1996 as
         filed with the Commission on November 12, 1996.

   
(j)      Incorporated herein by reference to the same Exhibit number to the
         Company's Annual Report on Form 10-K for the fiscal year ended 
         December 31, 1996, as filed with the Commission on March 19, 1997.
    

     (b)  REPORTS ON FORM 8-K:

         A Form 8-K was filed on March 5, 1997 reporting the Company's
         acquisition of Avidia Systems, Inc. on February 27, 1997.