<PAGE>   1

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

                                    FORM 10-K

(MARK ONE)
[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
     EXCHANGE ACT OF 1934

     FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

                                       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                                (IRS 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
                         PREFERRED STOCK PURCHASE RIGHTS
--------------------------------------------------------------------------------
                                (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 or any
amendment to this Form 10-K. [ ]

         Based on the closing sale price on The Nasdaq Stock Market(SM) on
February 25, 2000, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $1,253,753,000. The number of shares
outstanding of the registrant's Common Stock, $.0005 par value, was 72,867,865
on February 25, 2000.

DOCUMENTS INCORPORATED BY REFERENCE

         None.

<PAGE>   2

                  GLOSSARY OF TERMS USED IN THIS ANNUAL REPORT

10BASE-T--The Institute of Electrical and Electronic Engineers (IEEE) 802.3
specification for Ethernet over unshielded twisted pair cable.

2B1Q--2 binary, one quarternary. A one-dimensional modulation for transmitting 2
bits per symbol. 2B1Q is a 4-level PAM (pulse amplitude modulation) system used
for HDSL, S-HDSL, and ISDN BRI.

ACCESS PROVIDER--Organization providing and maintaining network services for
subscribers.

ASYMMETRIC DIGITAL SUBSCRIBER LINE (ADSL)--A method of transmitting at speeds of
approximately 8 Mbps in one direction over a single copper telephone line and at
speeds of approximately 1 Mbps in the other direction.

ANSI T1.403--The performance-monitoring, data-link and network-interface
requirements for ESF CSUs as defined by the Exchange Carriers Standards
Association. T1.403 specifies automatic performance reports transmitted to the
network once per second via the data link. (In an E1 environment, Performance
Monitor is the equivalent of T1.403).

ANSI T1.413--The interface standard for DMT ADSL.

ASYNCHRONOUS TRANSFER MODE (ATM)--A key emerging technology that uses
fixed-length packets or cells to switch voice, data and video traffic over the
local- and wide-area network.

BACKBONE NETWORK--The main artery or link for a private or public network.
Typically the backbone carries a greater quantity of traffic (data, voice, video
or some combination), is capable of carrying significant bandwidth and is the
network to which small/remote networks/links are attached.

BANDWIDTH--A term now used to describe the capacity or amount of traffic (data,
voice or video) a certain communications line is capable of accommodating.
Bandwidth is often measured or stated in kilobits per second (kbps) or Megabits
per second (Mbps) for data transmission.

BASIC ENCODING RATE (BER)--Rule for encoding data units described in ANS.1.

BASIC RATE INTERFACE (BRI)--Reference ISDN.

BIT ERROR RATE (BER)--The ratio of received bits that are in error.

BITS PER SECOND (BPS)--The number of bits passing a point every second. The
transmission rate for digital information.

BRIDGE/ROUTER--A device that can provide the functions of a bridge, router or
both concurrently. Bridge/router can route one or more protocols, such as TCP/IP
and/or XNS, and bridge all other traffic.

BROADBAND--Data transmission at a high rate, generally greater than T1 speeds
(1.5 Mbps). This allows the transmission of voice, data and video signals over a
single medium.

CABLE MODEM--Modem designed for use on TV coaxial cable circuit.

CAMPUS AREA NETWORK--A network which encompasses interconnectivity between
floors of a building and/or buildings in a confined geographic area such as a
campus or industrial park. Such networks would not require public rights-of-way
and operate over fairly short distances.

CAP--Carrierless Amplitude Phase Modulation. A two-dimensional line code used in
ADSL.


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                                GLOSSARY OF TERMS
                                    CONTINUED

CENTRAL OFFICE (CO)--A local telephone company office which connects to the main
system where circuit switching of customer lines occurs.

COMPETITIVE ACCESS PROVIDER (CAP)--Alternative access provider to Inter-Exchange
Carriers (IXCs).

CIRCUIT SWITCHING--Switching system in which a dedicated physical circuit path
must exist between sender and receiver for the duration of the "call". Used
heavily in the phone company network, circuit switching often is contrasted with
contention and token passing as a channel-access method, and with message
switching and packet switching as a switching technique.

CLEC--A Competitive Local Exchange Carrier. Provides competitive local access
services to Local Exchange Carrier (LEC) or Incumbent LEC (ILEC).

CONCENTRATOR--Device that serves as a wiring hub in star-topology network.
Sometimes refers to a device containing multiple modules of network equipment.

COPPEROPTICS--A PairGain trademark referring to the functionality of the our
xDSL technology. In essence, with PairGain xDSL products, users can achieve
fiber optic-quality signal transmission over copper cable.

CROSSTALK--Interference that can occur when wire pairs within the same bundles
are used for separate signal transmission. Especially evident with repeatered
T1/E1 transmission.

CUSTOMER PREMISES EQUIPMENT (CPE)--Terminating equipment, such as terminals,
phones, routers and modems, supplied by the phone company, installed at customer
sites, and connected to the phone company network.

DEDICATED LINE--A transmission circuit installed between two sites of a private
network and "open," or available, at all times.

DIGITAL SIGNAL 0 (DS-0)--(1) North American Digital Hierarchy signaling standard
for transmission at 64 kbps. (2) Digital Signal Level 0 is the worldwide
standard transmission rate (64 kbps) for PCM digitized voice channels. 24 DS-0s
exist in each DS-1 (T1) signal.

DIGITAL SIGNAL 1 (DS-1)--North American Digital Hierarchy signaling standard for
transmissions at 1.544 Mbps. Supports 24 simultaneous DS-0 signals. Term often
used interchangeably with T-1, although DS-1 signals may be exchanged over other
transmission systems.

DIGITAL SUBSCRIBER LINE (DSL)--Another name for an ISDN BRI channel. Operated at
the Basic Rate Interface (with two 64 kbps circuit switched channels and one 16
kbps packet switched channel), the DSL can carry both voice and data signal at
the same time, in both directions, as well as the signaling data used for call
information and customer data. Also used to represent other DSL-based solutions,
including HDSL and ADSL.

DIGITAL SUBSCRIBER LINE ACCESS MULTIPLEXER (DSLAM)--Delivers high-speed Internet
access, voice and video with a frame-switching network.

DIGITAL SIGNAL PROCESSING (DSP)--The processing of signal transmission using
digital techniques.

DMT--Discrete Multitone. In DMT, a large number of low-rate carrier frequencies
are QAM-modulated at a low rate to transmit a single high-rate data stream. DMT
is used for ADSL and proposed for VDSL.

E1--The term for a digital facility used for transmitting data over a telephone
network at 2.048 Mbps. The European equivalent of T1.


                                      G-2

<PAGE>   4

                                GLOSSARY OF TERMS
                                    CONTINUED

E3--The highest transmission rate generally available in the European digital
infrastructure (34 Mbps).

ENTERPRISE NETWORK--A large typical corporate network under the auspices of one
organization.

ETHERNET--A baseband LAN specification invented by Xerox Corporation and
developed jointly by Xerox, Intel and Digital Equipment Corporation. Ethernet
networks typically operate at 10 Mbps or 100 Mbps over twisted pair, coaxial or
fiber optic cable. Ethernet transmission standards are produced by IEEE and are
referred to as IEEE 802.3.

FIBER OPTICS--A method for the transmission of information (sound, pictures,
data). Light is modulated and transmitted over high purity, hair-thin fibers of
glass. The potential bandwidth capacity of fiber optic cable is much greater
than that of conventional cable or copper wire.

FIBER OPTIC CABLE--A transmission medium that uses glass or plastic fibers,
rather than copper wire, to transport data or voice signals. The signal is
imposed on the fiber via pulses (modulation) of light from a laser or a
light-emitting diode (LED). Because of its high bandwidth and lack of
susceptibility to interference, fiber-optic cable is used in long-haul or other
applications where electromagnetic noise is problematic.

FRACTIONAL T1--A WAN communications service that provides the user with some
portion of a T1 circuit which has been divided into 24 separate 64 kbps
channels.

FRAME RELAY--A streamlined packet switching protocol designed to provide
high-speed frame or packet switching with minimal delay and efficient bandwidth
usage.

G.992.2 SPLITTERLESS ASYMMETRICAL DIGITAL SUBSCRIBER LINE TRANSFERS
(G.LITE)--International standard adopted by the International Telecommunications
Union as a splitterless version of the ANSI standard T1.413 "full-rate" ADSL.

GIGABITS PER SECOND (GBPS)--1,000,000,000 (one billion) bits per second. A
measure of transmission speed.

HIGH-BIT-RATE DIGITAL SUBSCRIBER LINE (HDSL)--Designed to be a cost-effective
method of delivering T1/E1 line speeds over unconditioned copper cable, without
the use of repeaters.

HDSL2--Second generation HDSL designed to deliver full T1 performance over a
single twisted pair cable, with the same reach, robustness and spectral
compatibility of two-pair HDSL technology. HDSL2 is also designed with an
interoperability standard.

INTEGRATED ACCESS CONCENTRATOR--Telecommunications platform that combines
multiple technologies in order to support voice, data and video transmission
from a single entity. This enables service providers to offer a wider variety of
services as a lower cost while maintaining profitability.

INTEGRATED SERVICES DIGITAL NETWORK (ISDN)--a CCITT networking standard devised
to provide end-to-end, simultaneous handling of digitized voice and data traffic
on the same link.

INTEREXCHANGE CARRIER (IXC)--(1) A long-distance telephone company offering
circuit-switched, leased-line or packet-switched service or some combination.
(2) Any individual, partnership, association, joint-stock company, trust,
governmental entity or corporation engaged for hire in interstate or foreign
communication by wire or radio, between two or more exchanges.


                                      G-3

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                                GLOSSARY OF TERMS
                                    CONTINUED

INTERFACE--(1) The point at which two systems or pieces of equipment are
connected. (2) A connection between two systems or devices. A shared boundary
defined by common physical interconnection characteristics, signal
characteristics and meaning of interchange signals.

ISP--Internet Service Provider

INTRANET--A private network that uses Internet software and standards.

KILOBITS PER SECOND (KBPS)--1,000 bits per second. A measure of transmission
speed.

LAST MILE--A reference to the local loop, the distance between a local telco
wire center and the subscriber, a distance of about 0 to 3 miles (0 to 4
kilometers).

LIFELINE POTS--A minimal telephone service designed to extend "lifeline"
communications service to the subscriber in case of emergency, particularly when
electric power is lost.

LINE CODE--Any method of converting digital information to analog form for
transmission on a telephone line. 2B1Q, DMT, and CAP are all line codes.

LOCAL AREA NETWORK (LAN)--The means by which a community of computer users can
share information and resources electronically. Many communications protocols
are used to accomplish this, the most prevalent of which is Ethernet.

LOCAL LOOP--Refers to the physical copper pair or loop of wire from the
telephone company's wire center to the subscriber.

MODULATION--Process by which signal characteristics are transformed to represent
information. Types of modulation include frequency modulation (FM), where
signals of different frequencies represent different data values.

MULTIPLEXER (MUX)--A device that enables several data streams to be sent over a
single physical line.

NETWORK MANAGEMENT SYSTEM (NMS)--A system responsible for managing at least part
of a network. NMSs communicate with agents to help keep track of network
statistics and resources.

PACKET SWITCHED NETWORK--A network in which data is transmitted in units called
packets. The packets can be routed individually over the best available network
connection and reassembled to form a complete message at the destination.

PAIR GAIN--The multiplexing of "x" phone conversations over a lesser number of
physical lines. "Pair gain" is the number of conversations obtained, divided by
the number of wire pairs used by the system.

POTS--Plain old telephone service.

POSTAL, TELEGRAPH AND TELEPHONE COMPANY (PTT)--Generic term for a provider of
these services. A governmental agency in many countries.

QAM--Quadrature Amplitude Modulation. A two-dimensional modulation scheme used
for ADSL, cable modems and proposed for VDSL. CAP is a special case of QAM.


                                      G-4

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                                GLOSSARY OF TERMS
                                    CONTINUED

RADSL--Rate-Adaptive DSL. A simple extension of ADSL to encompass a wide variety
of data rates depending on the line's transmission capability. Rate adaption can
be achieved via CAP or DMT ADSL.

REGIONAL BELL OPERATING COMPANIES (RBOCS) --The local exchange carrier telephone
companies created after AT&T divestiture and subsequent mergers; presently, they
are: Bell Atlantic, BellSouth, Ameritech, SBC Communications and U S WEST.

REMOTE LAN ACCESS--A data communications such as a corporate or campus
environment in which the computer networks can be accessed remotely via public
telecommunications networks.

REPEATER--An electronic device used to regenerate digital signals and restore
signal quality across a certain distance of cable.

SDSL--Symmetric, single-pair 2B1Q-based xDSL.

S-HDSL--Single-pair transmission using HDSL technology, normally 2B1Q.

SIMPLE NETWORK MANAGEMENT PROTOCOL (SNMP)--A network management standard
established to allow multi-vendor networks to be managed more easily using
common management tools.

SPANNING TREE--An algorithm, standardized by the IEEE to prevent bridge loops
and allow backup network paths.

SYMMETRIC TRANSMISSION--Transmission in which a channel sends and receives data
at the same rate.

SYNCHRONOUS OPTICAL NETWORK (SONET)--A networking standard that utilizes fiber
optics to create backbone networks, capable of transmitting at very high speeds
and accommodating gigabit-level bandwidth.

T1--Digital transmission facility operating with a nominal bandwidth of 1.544
Mbps. Also known as Digital Signal Level 1 (D1). Composed of 24 DS-0 channels in
many cases. T1 is the most common digital transmission technique in North
America.

T3--Digital transmission facility operating at 45 Mbps bandwidth. Composed of 28
DS-1 channels in many cases.

TELECOMMUTER--Person who performs work at home while linked to the office by
means of a telecommunications-equipped computer system.

TRANSMISSION CONTROL PROTOCOL/INTERNET PROTOCOL (TCP/IP)--A reliable, full
duplex, connection-oriented end to end transport protocol running on top of IP.

TRANSPARENT LAN SERVICE--Service offered by a provider that is used to connect
LANs at geographically separated sites. "Transparent" means the connection is
invisible to the user.

TWISTED PAIR--Cable consisting of two 18 to 24 AWG (American Wire Gauge) solid
copper strands twisted around each other. The twisting provides a measure of
protection from electromagnetic and radio-frequency interference.

VLSI--Very large scale integration.

WIDE AREA NETWORK (WAN)--A network which encompasses interconnectivity between
devices over a wide geographic area.

XDSL--High-speed Digital Subscriber Line technology. A family of technologies
that provide high bandwidth over copper twisted pair. Varieties of xDSL include
HDSL, ADSL and RADSL.


                                      G-5

<PAGE>   7

                                     PART I

ITEM 1. BUSINESS.

        PairGain Technologies, Inc. ("PairGain"), founded in 1988, is a leading
provider of telecommunications products based on DSL networking systems. We
design, manufacture, market and support products that allow telecommunications
carriers and private network owners to expand the capabilities of copper cable
and 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, POTS,
high-speed Internet access, telecommuting, local and wide area networking and
video conferencing.

        The following discussion and other sections of this Form 10-K may
contain forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, Section 21E of the Securities Exchange Act of
1934, as amended, and Section 27A of the Securities Act of 1933, as amended, and
is subject to the safe harbors created by those sections. This Form 10-K and our
Annual Report to Shareholders, any Form 10-Q or Form 8-K, or any other written
or oral statements made by or on our behalf may include forward-looking
statements which are identified by words such as "believes," "anticipates,"
"expects," "intends," "estimates," "forecasts," "projects," "could," "may" and
other similar expressions. However, these words are not the exclusive means of
identifying such statements.

        We wish to caution you that any forward-looking statements made by or on
our behalf are subject to uncertainties and other factors that could cause such
statements to be wrong. Some of these uncertainties and other factors are listed
under the caption "Risk Factors" below. Though we have attempted to list
comprehensively these important factors, we wish to caution you that other
factors may in the future prove to be important in affecting our results of
operations. New factors emerge from time to time, and it is not possible for us
to predict all of such factors, nor can we assess the impact each factor or
combination of factors may have on our business.

        You are further cautioned not to place undue reliance on those
forward-looking statements because they speak only of our views as of the date
the statements were made. We disclaim any obligation to publicly release the
results of any revisions to these forward-looking statements which may be made
to reflect events or circumstances occurring subsequent to the filing of this
Form 10-K with the Securities and Exchange Commission (the "SEC") or otherwise
to revise or update any oral or written forward-looking statement that may be
made from time to time by or on behalf of us. The following discussion should be
read in conjunction with the consolidated financial statements and related notes
included elsewhere in this Report. You are urged to carefully review and
consider the various disclosures made by us in this Report that attempt to
advise you of certain risks, uncertainties and other factors that may affect our
business.

RECENT DEVELOPMENTS

        On January 21, 2000, we signed a definitive agreement with GlobeSpan,
Inc. ("GlobeSpan") for GlobeSpan to purchase the Company's microelectronics
engineering group. The purchase price was a combination of 3,243,591 shares of
GlobeSpan common stock (adjusted to reflect a three-for-one stock split as of
February 29, 2000) and a $90.0 million subordinated convertible promissory note.
The sale of the microelectronics engineering group to GlobeSpan closed on
February 24, 2000. Based upon the closing sale price on The Nasdaq Stock
MarketSM on February 24, 2000, the value of stock we received was approximately
$255.7 million.

        On February 22, 2000, we executed an Agreement and Plan of Merger, dated
as of February 22, 2000 (the "Merger Agreement"), by and among PairGain, ADC
Telecommunications, Inc., a Minnesota corporation ("ADC"), and Roman Acquisition
Corp., a Delaware corporation and wholly-owned subsidiary of ADC ("Merger Sub").
Pursuant to the Merger Agreement, Merger Sub will merge with and into us and we
will survive the merger as a wholly-owned subsidiary of ADC. As a result of the
merger, each share of our common stock issued and outstanding immediately prior
to the effective time of the merger (other than any shares owned by ADC or its
subsidiaries) will be automatically converted into the right to receive 0.43
shares of ADC common stock. The merger is expected to be treated as a
reorganization for federal income tax purposes and to be accounted for as a
pooling of interests. The consummation of the transaction is subject to a number
of conditions, including approval of the Merger Agreement by our stockholders
and receipt of applicable regulatory approvals. A Current Report on


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<PAGE>   8

Form 8-K was filed with Securities Exchange Commission on February 28, 2000
citing Item 5, Other Events, following our February 23, 2000 press release which
announced the execution of the Merger Agreement.

        On March 1, 2000, our wholly-owned subsidiary, PairGain Canada, Inc., a
Canadian corporation ("PairGain Canada") entered into an Asset Purchase
Agreement (the "Agreement") with ABL Canada Inc., a Canadian corporation
("ABL"), under which PairGain Canada agreed to purchase ABL's assets, operations
and business related to ABL's SONET Multiplexing and Access Products
(collectively, the "Assets"). Under the Agreement, PairGain Canada agreed to pay
an aggregate of $10.4 million for the Assets, which was paid on March 8, 2000
when the transaction closed. See Note 17 of Notes to the Consolidated Financial
Statements contained in a separate section of this Annual Report on Form 10-K
commencing on page F-1.

RISK FACTORS

     We will continue to reduce the average sales prices of our products.

        In mid-1993, we began reducing the average sales prices of our HiGain(R)
products in an effort to increase demand and to compete with expected price
competition. We reduced our prices on HiGain products 14% during 1999, 42%
during 1998 and 30% during 1997. We expect to continue to reduce the average
sales prices of all of our products, including HiGain. Our ability to maintain
or increase revenues depends in part on our ability to increase unit sales of
our HiGain and other product lines in an effort to make up for lost revenues
resulting from price reductions. Gross margins on our products may also be
reduced if we cannot reduce our per unit costs of production. We cannot be
certain that we will be able to:

         o  increase unit sales volumes;

         o  introduce and sell new products with higher margins; or

         o  reduce per unit costs.

         Our failure to maintain our margins and increase our product revenues
could seriously harm our business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations," "Business--Products" and "--Competition."

     We continue to rely on revenues from our HiGain products.

         Our HiGain product revenues represented 48% of our total revenues in
1999, 59% in 1998 and 67% in 1997. We expect that revenues from HiGain products
may continue to account for a substantial portion of our future sales. However,
we may not be able to maintain these sales levels. A decline in demand for
HiGain products may result from, among other things:

         o  competition;

         o  industry use of fiber cable and repeaters; or

         o  technological change.

See "Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business--Products."

     Our future operating results may fluctuate.

         Our future operating results may fluctuate due to various factors,
including, but not limited to:

         o  the timing of shipments to major customers;

         o  the timing of new product announcements by us or our competitors;

         o  variations in our sales channels;

         o  variations in the mix of the products we sell;

         o  price competition;

         o  the availability and cost of key components;

         o  the timing of personnel hirings;

         o  the market acceptance of new and enhanced versions of our products;
            and

         o  the timing of final product approvals from any of our major
            customers.


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<PAGE>   9

     We face intense competition.

         We face intense and increasing competition. Competitive pressures could
reduce the demand for our products, cause us to further reduce our prices, cause
reduced gross margins and loss of market share, increase our expenses or cause
delays or cancellations of our customer's orders.

         High-bit-rate digital subscriber line technology, commonly known as
HDSL, uses high-speed digital signal processing to compensate for distortions
caused by sending a signal over a copper wire. All manufacturers of products
based on HDSL technology face competition from fiber optic and conventional
repeatered systems as alternate solutions for the delivery of high-bandwidth
services to end users. As telephone companies continue to install fiber cable
and conventional repeatered systems to provide high-bandwidth service from the
local telephone company office to end users, the demand for HDSL products may
decline. In addition, as fiber optics are more readily deployed to replace HDSL
systems, companies may reuse the replaced systems and will not need to buy new
systems from us.

         The group of digital subscriber line technologies, including HDSL, are
commonly referred to as DSL. We are devoting substantial resources in the
development and marketing of DSL products. The market for DSL-based products is
emerging and will change dramatically over a very short time. The DSL products
that we develop may not be commercially successful. In addition, many of our
competitors have more extensive engineering, manufacturing, marketing, financial
and personnel resources than we have. As a result, they may be able to respond
more quickly to new or emerging technologies and changes in customer
requirements. We cannot predict whether we will be able to compete successfully
with our existing and new products and services or with current and future
competitors. See "Business--Industry Background" and "--Competition."

     We substantially depend on our largest customers.

         Our aggregate sales to local telephone companies affiliated with the
major telephone companies, commonly known as RBOCs, accounted for approximately
45% of our total revenues in 1999, 55% in 1998 and 58% in 1997. Our future
success will significantly depend upon several factors related these large
customers, such as:

         o  the timeliness and size of their future orders placed to us;

         o  their product requirements;

         o  their financial and operational success; and

         o  the success of their services deployed using our products.

Sales to our largest customers may continue to fluctuate significantly from
quarter-to-quarter. In addition, the RBOCs have been going through a period of
consolidation, resulting in larger portions of our revenues being attributable
to certain RBOCs. Future sales fluctuations or the loss of any major customer
may harm our business and results of operations. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations," and
"Business--Customers."

     We have changed our manufacturing strategy.

         We historically engaged Jabil Circuits to manufacture our subscriber
carrier products, on a turnkey basis, at their St. Petersburg, Florida facility
and conducted virtually all final assembly and final test functions of our other
products at our manufacturing facility in Tustin, California. In December 1999,
we announced plans to move the manufacturing of our high-volume products to
Monterrey, Mexico through our contract manufacturing partner, SCI Systems, Inc.
If we are not able to manage the transition of manufacturing operations
successfully, our business and results of operations could be adversely
affected.

     We depend on our suppliers and subcontractors.

         We purchase certain components for our HDSL products, including our
SPAROW II chip, from a single source. Certain other components are only
available from a limited number of sources. In the past, we have experienced
delays in the receipt of certain key components, which has resulted in delays in
product deliveries. We cannot be certain that key component and product
deliveries will be timely in the future. If delays occur and


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<PAGE>   10

alternative sources cannot be found, we may experience delays or reductions in
product shipments to our customers. Such delays or reductions could harm our
reputation, customer relationships, business and results of operations.

         In addition, we use third-party subcontractors to manufacture our
products. Our reliance on third-party subcontractors involves several risks,
including but not limited to inadequate capacity and reduced control over
product quality, delivery schedules, manufacturing yields and costs.

         If we experience a shortage of raw materials or if our subcontractors
experience production capacity constraints, we may not be able to meet our
production obligations. This may cause our product costs to increase. Increased
product costs or failure to meet our production obligations may harm our
business and results of operations. See "Business--Manufacturing."

     We are developing products and technologies for new markets.

         We continually evaluate new applications of high-speed copper
transmission technologies. We are committing significant corporate resources to
the development of asymmetric digital subscriber line technology, commonly known
as ADSL. We also expect to devote significant additional resources to the
development of other new technologies in the future. We do not expect to
generate significant revenues from ADSL products until mid to late 2000. We
cannot be certain that products based on ADSL technologies will be viable or
that markets for such technologies will develop. See "Business--Company
Strategy" and "--Product Development."

     We must respond to rapid technological change.

         The market for our products is characterized by:

         o  rapid technological advances;

         o  evolving industry standards;

         o  changes in end user requirements; and

         o  frequent new product introductions and enhancements.

         New industry standards, alternative technologies and new product
introductions which use superior DSL technologies could render our existing
products, and the products currently under development, obsolete and
unmarketable. We believe our future success depends in part on our efficient and
timely ability to continue to:

         o  enhance our DSL products;

         o  develop and introduce new products for the DSL market and other
            markets;

         o  meet changing customer needs; and

         o  achieve broad market acceptance for our products.

         We may not be able to continue to respond effectively to these market
risks. Our failure to anticipate or respond to such technological developments,
changes in industry standards or end user requirements could harm our business.
Any significant delays in product development or introduction could also
adversely affect our business. Further, there are physical limits to the speed
at which transmissions can travel over copper wire. Our copper-based DSL
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."

     We have limited backlog orders.

         We generally ship products within a short time after receipt of an
order. We typically do not have a significant backlog of unfilled orders. As a
result, revenues in any quarter are substantially dependent on orders booked and
shipped in that quarter. Our expense levels are relatively fixed in the
short-term. Our inability to accurately predict future product demand may affect
our operating margins and the ability to support our expense levels. We intend
to continue to increase operating expenditures and inventories as we expand our
levels of operations. We may be unable to adjust spending in a timely manner to
compensate for any unexpected shortfall of orders. If demand is lower than our
expectations or we experience material delays in our customers orders, there
would be an immediate adverse impact on our business and results of operations.


                                       4

<PAGE>   11

     We need to generate international sales.

         To date, we have sold a limited amount of products outside of the
United States and Canada. Our ability to meet our objectives will require us to
generate significant international revenues in 2000 and beyond. International
business is subject to risks in addition to those inherent in our North American
business, including:

         o  substantially different regulatory requirements in different
            jurisdictions;

         o  varying technical standards;

         o  tariffs and trade barriers;

         o  political and economic instability;

         o  reduced protection for intellectual property rights in certain
            countries;

         o  difficulties in staffing and maintaining foreign operations;

         o  difficulties in managing distributors;

         o  potentially adverse tax consequences;

         o  foreign currency exchange fluctuations;

         o  the burden of complying with a wide variety of complex foreign laws
            and treaties; and

         o  longer payment cycles and the possibility of difficulties in
            collecting accounts receivable.

We may not be able to generate significant future international sales or
establish new strategic marketing relationships. In addition, if our
international business operations are successful, we may also face economic,
political and foreign currency situations that are substantially more volatile
than those we commonly experience. These factors may have an adverse effect on
our business and results of operations.

     Protection of our proprietary rights is uncertain.

         Our success and future revenue growth will depend, in part, on our
ability to protect trade secrets, obtain or license patents and operate without
infringing on the rights of others. Although we regard a portion of our
technology as proprietary, we have limited patents on such technology. We rely
on a combination of technical leadership, trade secrets, copyright and trademark
law and nondisclosure agreements to protect our unpatented proprietary know-how.
However, we cannot be certain that we have taken adequate steps to protect our
trade secrets or other proprietary information. In the absence of patent
protection, our business may be adversely affected by competitors who
independently develop substantially equivalent technology. The laws of some
foreign countries do not protect our proprietary rights to the same extent as do
the laws of the United States.

         We are also subject to potential claims and litigation alleging
infringement of others' intellectual property rights. From time to time, we have
received claims of infringement of other parties' proprietary rights, and have
recently received a claim of patent infringement. Regardless of their merit,
future third party claims against us could result in costly litigation or
require us to license the intellectual property rights of such parties. We may
not be able to obtain such licenses on commercially reasonable terms, if at all.
See "Business--Proprietary Rights."

     We depend on key personnel.

         We depend on the continued services and performance of certain key
management and technical personnel. Although we do not have employment contracts
with any of our executive officers, the loss of any of these key personnel could
disrupt our business. Our future success also depends on our ability to
identify, attract, hire and retain other highly skilled technical and managerial
personnel. Competition for such personnel, particularly engineers, is intense
and we may be unable to successfully find and retain sufficiently qualified
personnel.

     Our stock price may be volatile.

         The market price of our common stock has fluctuated significantly since
our initial public offering in September 1993 and may continue to be volatile in
the future. Factors that may cause fluctuations in the trading price of our
common stock include, but are not limited to:

         o  quarter-to-quarter variations in our operating results and those of
            our competitors;

         o  changes in revenue and earnings estimates by analysts;

         o  announcements of technological innovations or new products by us or
            our competitors;


                                       5

<PAGE>   12

         o  developments in our relationships with our suppliers or customers;

         o  challenges associated with integration of businesses;

         o  competitive pressures; and

         o  general economic pressures.

         In addition, the stock market has from time to time experienced extreme
price and volume fluctuations which have particularly affected the market price
for many high technology companies, often without regard to their operating
performance. These broad market fluctuations may adversely affect the market
price of our common stock.

INDUSTRY BACKGROUND

         Demands on the telephone infrastructure have prompted telephone
companies to improve the reliability and increase the speed of transmission over
telephone networks. Increased demand for higher-speed, high-capacity services
such as Internet access, digital video and broadband wireless access has in turn
resulted in substantial demands to build and upgrade the communications network
infrastructure. 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. 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.
Telephone service carriers are therefore facing increasing pressure to install
digital telecommunications services in the "last mile," the local subscriber
loop through which telephone services are delivered from local carriers to end
users.

         Digital transmission has distinct advantages over analog transmission,
including increased speed, higher reliability, lower costs, ease of installation
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." As a
result of global deregulation of communications markets, thousands of new
competitive service providers have entered the market to compete with the
incumbent services providers of Internet/data, video and voice communications.
These new service providers are rapidly changing the marketplace by offering new
choices and bundles of communications services never before offered to consumers
and businesses. The dynamics of the deregulated communications market has
resulted in the recent high growth rate of sales for suppliers of communications
equipment, software and services. Increased demand by end users of higher speed
data transmission for applications such as Internet access, telecommuting,
remote LAN access, video conferencing and wide area networking, including
communications among computers and telephone systems has been driving this
growth. Unlike public telephone companies, these new competitive service
providers 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. In addition, telephone
companies are facing competition from cable companies that offer high-speed
cable modem service. 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.

     T1/E1 Access

         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


                                       6


<PAGE>   13

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 100 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 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 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.

         A cost and performance comparison of a two-mile connection for the
three types of T1 deployment follows:

<TABLE>
<CAPTION>
                                                   APPROXIMATE
   TRANSMISSION TYPE         AVERAGE COST       INSTALLATION TIME           BANDWIDTH            QUALITY ACHIEVED
------------------------  -----------------     -----------------         --------------         ----------------
<S>                       <C>                    <C>                      <C>                    <C>
Fiber                     More than $20,000      2 to 4 Months            T1 (1.54 Mbps)            BER 10-10
Repeatered T1             Less than $10,000      4 to 8 Weeks             T1 (1.54 Mbps)            BER 10-7
HDSL                      Less than $1,500       Less than 1 Hour         T1 (1.54 Mbps)            BER 10-10
</TABLE>

BER 10(-10) = one bit error every week in a constant transmission versus BER
10(-7) which is one bit error every 6 to 7 seconds. The fiber optics and
repeatered T1 cost and installation estimates are based on industry averages and
will vary on a case by case basis. Average costs include equipment, engineering
and labor.


                                       7

<PAGE>   14

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

             [ILLUSTRATION OF REPEATERED T1 LINE AND HDSL CIRCUIT]

         We believe 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. 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. 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 may be more cost
effective to deploy.

         We have been collaborating with leading telecommunications companies to
develop a new standard for second generation HDSL technology, known as HDSL2.
The purpose of setting a standard is to move the industry toward
interoperability. HDSL2 is being developed to deliver full T1 performance over a
single twisted pair cable, with the same reach, robustness and spectral
compatibility of current two-pair HDSL technology. The T1E1.4 approved
transmission scheme enables HDSL2 to coexist in the same cable bundle with T1,
ADSL and ISDN without crosstalk interference. HDSL2 operates at 1.552 Mbps for
up to 12,000 feet in length with 5 dB of noise margin.

     Subscriber Carrier Systems

         Subscriber carrier systems use HDSL technology allowing for rapid
deployment of new telephone service, cable capacity transmission and
full-featured services over existing copper lines. The systems increase the
channel capacity of copper lines in the local loop. Subscriber carrier systems
can be used to satisfy additional line demand from businesses, apartment
complexes, hotels, etc. In addition, some subscriber carrier systems can provide
access through a digital loop carrier.

     Megabit Access

         Various telecommuting, Internet access and remote LAN access
applications are driving the need for new higher-speed access technologies. T1
lines are not feasible for use by small businesses and residential customers.
Solutions for these customers have historically been limited to ISDN or analog,
voice grade circuits, which when equipped with 28.8 or 56 kbps modems offer some
minimally useful capacities.


                                       8


<PAGE>   15

         Megabit access products, including the Avidia(R) system, go beyond
modem and ISDN capabilities, offering high-speed data services to business and
residential customers. These services include high-speed Internet and Intranet
access, remote LAN access, advanced services such as pay-per-view movies,
telemedicine, distance learning, interactive video games, educational video and
many other on-demand services. The following chart shows the relative efficiency
of the various transmission methodologies.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
                                                  MODEM      ISDN        DSL        DSL        DSL         DSL
                                                  28.8       128         384        768        1,544       6,144
   APPLICATION FILE TYPE            FILE SIZE     KBPS       KBPS        KBPS       KBPS       KBPS        KBPS
--------------------------------------------------------------------------------------------------------------------
<S>                                 <C>         <C>        <C>         <C>        <C>         <C>        <C>
E-mail Users                         30 Kbytes   8.3 sec.   1.9 sec.   0.63 sec.  0.31 sec.   0.16 sec.  0.04 sec.
--------------------------------------------------------------------------------------------------------------------
Consumer Digitized Photo            125 Kbytes  34.7 sec.   7.8 sec.   2.6 sec.   1.3 sec.    0.6 sec.   0.2 sec.
--------------------------------------------------------------------------------------------------------------------
Business User Word Files            250 Kbytes  69.4 sec.  15.6 sec.   5.2 sec.   2.6 sec.    1.3 sec.   0.3 sec.
--------------------------------------------------------------------------------------------------------------------
Telecommuter Videoconferencing      384 kbps    No         No          Yes        Yes         Yes        Yes
--------------------------------------------------------------------------------------------------------------------
Telemedicine X-ray                  5 Mbytes    23.1 min.  5.2 min     1.7 min.   52.1 sec.   25.9 sec.  6.5 sec.
--------------------------------------------------------------------------------------------------------------------
Remote LAN Access Bulk File         20 Mbytes   1.5 hr.    20.0 min.   6.9 min.   3.5 min.    1.7 min.   26.0 sec.
--------------------------------------------------------------------------------------------------------------------
</TABLE>

         Desired and acceptable response time is less than 3.0 seconds.

PAIRGAIN STRATEGY

         We pioneered the development of a VLSI implementation of HDSL
technology and are currently a leading provider of telecommunications products
based on DSL technology. Our strategy for expanding the market for our products
consists of several elements:

     o Maintain Technology Leadership. We believe that we are a leader in DSL
       technology and systems. We intend to be able to offer clients whatever
       form of DSL they desire at competitive prices. In response to changes in
       the marketplace, we have placed emphasis on providing platform-oriented,
       end-to-end solutions using in-depth knowledge of ATM and IP networking,
       traditional telco circuit switching, DSL and local loop operations. Many
       of these solutions require a combination of hardware and software, and
       value added services, such as training and support.

       Our engineering organization includes a core development team focused on
       applying DSP techniques to telecommunications products. The engineering
       organization places the highest priority on maintaining the cost and
       feature competitiveness of our HDSL product line through aggressive cost
       reduction and introduction of new products that provide high-speed
       transmission over copper wire.

       We believe that maintaining our leadership in technology for high-speed
       digital transmission over copper wire is critical to our ability to build
       and maintain strong relationships with the RBOCs and other customers and
       to achieve leadership in new markets.

     o Leverage Core Technologies Into New Applications. We developed our Campus
       product line and our PG-Flex(R), PG-Plus(R) and PG-FlexPlusTM products
       based on the same core HDSL technology utilized in our HiGain products.
       We market our Campus products to private network users such as
       universities, hospitals, military bases and corporate complexes.

       In addition to providing HDSL-based products, we provide products that
       use ADSL technology. We released our Falcon DMT ADSL chip in 1998, which
       supports DMT ADSL and "splitterless" ADSL, or G.lite. The Avidia System
       is an integrated access concentrator that includes support for a wide
       range of service options including G.lite, full rate DMT ADSL, SDSL T1,
       E1 and frame relay. The Avidia System was developed in response to
       increasing 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. See "--
       Products" and "-- Product Development."


                                       9

<PAGE>   16

     o Subscriber Carrier Systems. Due to a shortage in copper lines, our
       subscriber carrier systems, PG-Flex, PG-Plus and PG-FlexPlus, represent
       an enormous potential market as carriers look to offer competitive local
       access and to provision second and third lines quickly and
       cost-effectively. The systems increase the channel capacity of copper
       cables in the local loop, allowing service providers to maximize the
       utility of the lines.

     o Develop OEM Opportunities. We will continue to pursue opportunities to
       provide products and chipsets to manufacturers of telecommunications and
       data communications equipment. We believe that we 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. We also believe an opportunity exists to
       utilize our DSL technology to connect local wireless communication
       systems to local central offices.

     o Create Development Partnerships and Alliances. We have and will continue
       to establish partnerships with industry leaders in an effort to pursue
       new market opportunities. We collaborated with leading telecommunications
       companies to develop HDSL2 specifications which have been adopted as the
       industry standard. We are also supporting a new open systems standard for
       T1 access. The Open Span Termination Systems ("OSTS") standard was
       developed in an effort to make T1 access equipment within central office
       networks standard for easy integration and maintenance and deployment
       cost savings. The purpose of setting a standard is to move the industry
       toward interoperability.

       We are members of the International Telecommunication Union ("ITU") and
       the DSL Forum. These groups created an ITU standard and have been working
       to accelerate the adoption and availability of high-speed Internet access
       for the mass market.

PRODUCTS

     Core Technology

         The core technology for our HiGain, Campus, PG-Flex and PG-Plus product
lines is based on HDSL and was developed from our dual core competencies in
digital signal processing and microelectronics. HDSL allows the symmetric
transmission and receipt of digital data at T1 rates (1.544 Mbps) over two
twisted pair of copper wires or at 768 kbps over a single twisted pair of copper
wire. 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, in
most cases, operate not only on continuous unobstructed pairs of wires, but also
on cables with mixed wire gauges and bridged taps.

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

         Our microelectronics team has design and development capabilities that
include silicon compilers which has allowed us in the past to develop chips that
are at performance and complexity levels beyond what is achievable on standard
ASIC design systems. We have leveraged our microelectronics product capabilities
into the HiGain and Campus product lines and have focused our resources on
further cost and performance improvements in HDSL including the HDSL2 standard
that lets service providers deliver full T1 performance over a single twisted
pair cable with the same reach, robustness and spectral compatibility of
two-pair HDSL. On February 24, 2000, the employees in our microelectronics group
became employees of GlobeSpan in connection with the sale of our
microelectronics engineering group. See Note 17 of Notes to the Consolidated
Financial Statements contained in a separate section of this Annual Report on
Form 10-K commencing on page F-1.


                                       10

<PAGE>   17

         We are a supporter and contributor of multiple organizations aimed at
accelerating the adoption and availability of high-speed digital Internet access
for the mass market. We have also joined with three other T1 access
manufacturers in support a new open systems standard for T1 access. The new Open
Span Termination System ("OSTS") standard was developed in response to service
providers' demand for equipment compatible with existing central office
networks. The OSTS standard is based on the widely used STS mechanical
dimensions and backplane connections, also known as 3191 mechanics, a
telecommunications standard upon which many systems have been built, including
central office shelves and line cards.

         By utilizing our DSL technologies in different forms, we offer products
for different markets and varied applications.

     T1/E1 Access

         HIGAIN SYSTEMS

         Our 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.

         We also provide HiGain systems in different forms to address variances
in customer installation and configuration requirements. Our 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
our more isolated customers. In addition, we offer a product which provides a T1
connection over shorter distances requiring only one pair instead of two pairs
of wire. We recently introduced a comprehensive range of HDSL-based HiGain
products designed specifically to be deployed in digital loop carrier ("DLC")
feeder environments where multiple T1s are used to link remote DLC systems to
telephone company central offices.

         To ensure flexibility of installation, our 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. We first shipped units of our HiGain system to customers in June
1992. As of December 31, 1999, we had shipped over 1.3 million HiGain units.


                                       11

<PAGE>   18

                        [ILLUSTRATION OF HIGAIN SYSTEM]


                                   [GRAPH]


         HIGAIN '98 SYSTEMS

         We introduced HiGain '98 systems in 1998. HiGain '98 systems expand the
reach capability of a traditional HiGain system up to 11 miles and at the same
time reduce the power consumption and unit size. These changes allow for high
density and lower deployment and maintenance costs. HiGain '98 systems are
backward compatible and fully interoperable and interchangeable with original
HiGain products.

         HIGAIN WIDEBAND SYSTEM 3190

         We introduced the HiGain Wideband System 3190 ("WBS-3190") in January
1999. The WBS-3190 is a managed DS3-based T1 access platform that is OSTS
standard compliant, which means that it is interoperable with any product
conforming to the OSTS specification. The WBS-3190 is an open T1 access platform
which enables service providers to deploy T1 services from a managed platform
that is not proprietary. It can be used with existing HDSL 3192 mechanics cards.

         HIGAIN SOLITARE(TM)

         We introduced the HiGain Solitare in 1999. The HiGain Solitare uses
HDSL2 technology to deliver full T1 performance over a single twisted pair cable
with the same reach, robustness and spectral compatibility of two-pair HDSL.
HiGain Solitare also guarantees interoperability with other vendors'
standards-compliant HDSL2 products.

         HIGAIN ETSI SYSTEMS

         In order to provide digital E1 solutions to our customers outside of
North America, including public carriers and private network operators, we
introduced the HiGain ETSITM Global Access product line. These products apply
HDSL-based technology in compliance with ETSI requirements. They allow service
providers to rapidly establish E1 connections between central offices and the
customer. The equipment transfers data at rates of 2.048 Mbps over four-wire
circuits. ETSI applications include LAN and PBX networking, WAN connections,
high-speed Internet access and videoconferencing. Our HiGain ETSI systems were
approved by the British Approvals Board for Telecommunications ("BABT") for use
with unconditioned, two-wire and four-wire circuits from British
Telecommunications. This allows service providers to link their private circuit
networks into British Telecom's public network over unconditioned copper
telephone lines.


                                       12

<PAGE>   19

Subscriber Carrier Systems

         PG-2

         PG-2 was our 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. Our 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 PTTs to expand telephone service without laying more copper lines.

         Our PG-2 products compete worldwide with products from a number of
telecommunications equipment manufacturers. We believe that we are at a
competitive disadvantage in the international market for the two channel digital
subscriber carrier business served by our PG-2 system because it lacks a local
manufacturing presence, which results in price disadvantages caused by import
duties.

         PG-FLEX

         PG-Flex is a subscriber carrier product. PG-Flex employs HDSL
technology to provide 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 PG-Flex
system operates in the local loop at carrier service area distances. The remote
terminals are powered from the central office which enables virtually
uninterrupted service during local power outages. We market the PG-Flex product
to both international and domestic telephone companies and expects significant
competition in both markets. We began production shipments of PG-Flex systems in
1996. PG-Flex has received numerous approvals from RBOCs and independent telcos.

                        [ILLUSTRATION OF PG-FLEX SYSTEM]



                                   [GRAPH]



         PG-PLUS

         In 1997, we introduced PG-Plus, a subscriber carrier system based on
HDSL technology. The PG-Plus system can be configured to support four or six
channels for POTS or ISDN over one unconditioned copper telephone line at
distances up to 21,000 feet. PG-Plus can be deployed rapidly and 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.


                                       13


<PAGE>   20

         PG-FLEX(PLUS)

         PG-FlexPlus is a Universal Multi-line Access Platform that incorporates
features of the PG-Flex and PG-Plus systems into one system and adds a GR-303
interface. GR-303, a Telcordia (Bellcore) standard, is a Class 5 switch software
application for accommodating voice concentration into the telco switch
architecture.

     Campus Systems

         Our Campus systems are DSL transmission products that we designed to
meet the digital communications needs of organizations operating their own
private networks. Campus systems 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, Internet
and Intranet access, PBX extensions and many other applications.

         A Campus system consists of two base units that operate at T1, E1, 768
kbps, 384 kbps, among other 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. We first shipped Campus systems
to customers in June 1993.

         CAMPUS STAR(R)

         We enhanced the Campus family of products in late 1994 with the
Campus-Star 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. We have 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.

         CAMPUS-REX(R)

         We continued to enhance the Campus family of products with the
introduction of the Campus-REX (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.


                                       14

<PAGE>   21

                     [PAIRGAIN CAMPUS PRODUCT APPLICATIONS]
                             (Campus Area Network)


                                    [GRAPH]



         CAMPUS-RS(TM)

         In 1998, we introduced the Campus-HRS (HDSL Rate Selectable), group of
products, now known as Campus-RS, an extension of our existing Campus product
line. The Campus-RS products allow organizations with private enterprise
networks to interconnect LANs, providing remote data and internet access at high
speeds over ordinary copper telephone lines. Applications of the Campus-RS
products include LAN internetworking, fiber backbone extensions, PBX networking,
remote LAN access, Internet access, video applications and distance learning.
New features of the Campus-RS systems include rate selectability for greater
reach, speed and scaleability and single platform operations to simplify
deployment and management.

     OEM Products

         We formed an OEM sales group to establish relationships with
manufacturers to integrate our DSL technologies into their products. We
currently have relationships with Nortel (Northern Telecom), DSC Communications,
Conexant and Motorola.

     Megabit Access Products

         Our megabit access products offer high-speed solutions for a wide range
of consumer and business applications, including Internet and remote LAN access.
Megabit access products are designed for local exchange carriers, ISPs and
private network owners.

         AVIDIA SYSTEM

         In late 1998, we introduced the Avidia System, an integrated access
concentrator based on a fully distributed ATM packet and circuit switched
architecture that combines redundancy, scaleability and quality of service
support. Avidia means Audio, VIDeo and Internet over ATM. The Avidia System
enables CLECs (competitive local exchange carriers) and ILECs (incumbent local
exchange carriers) to deploy advanced services


                                       15


<PAGE>   22

such as voice over DSL (VoDSL), virtual private networks, high-speed business
Internet access, video on demand and telecommuting and private network
connection services. Avidia's architecture supports frame and cell switching
over G.lite, ADSL, SDSL, HDSL2, IDSL and DS1. The system can be configured as a
next-generation DSLAM, access server or LAN extension concentrator. The Avidia
System has demonstrated interoperability with a variety of G.lite modems and
VoDSL integrated access devices.

         The Avidia product line is available in three forms: the 8000 system
which is a high-end next-generation central office DSLAM; the 3000 which is
configured for remote cabinets or fewer subscribers; and the 2200 which would
typically be used at a customer location as an integrated access device.

         In conjunction with the introduction of the Avidia System, we
introduced a suite of Megabit Modems designed for use with the Avidia System.
These new Megabit Modems, based on our Falcon chip, include G.lite-rate and
full-rate DMT ADSL, ATM over ADSL functionality and splitterless ADSL. These
modems will allow service providers to deploy high-speed remote access service
for a wide variety of customers, including those who require maximum voice
quality and consumers that install the modem by themselves.

             [ILLUSTRATION OF NETWORK MODEL USING THE AVIDIA SYSTEM]



                                    [GRAPH]



         MEGABIT MODEM(R)

         Our Megabit Modem products provide high-speed access to the Internet or
corporate LANs at speeds up to 768 kbps in each direction. The Megabit Modem may
also be installed at remote office sites to extend high-speed services across
wide area networks. It operates over a single copper telephone line and
outperforms ISDN, cable modems and dial-up modems.

         MEGABIT MODEM CRA(TM)

         The Megabit Modem CRA are RADSL modems that were designed to support a
variety of applications in residential and business environments. The modems
automatically adjust transmission speeds to the highest rate possible according
to distance, traffic, line quality and other factors. The Megabit Modem CRA
transfers data at speeds up to 3.2 Mbps downstream (to the subscriber) and 1
Mbps upstream to distances as far as 25,000 feet. With the addition of a S1 NID
ADSL Splitter, both digital and analog signals can be transmitted
simultaneously. The network management function for the RADSL products can be
integrated with other xDSL products, consolidating network management functions
for all network elements into one system. RADSL modems are easy to install and
require no end user configuration.

         ADSL CHIPS

         In 1998, we introduced our Falcon DMT ADSL chip which is the industry's
first single-chip DMT ADSL processor. The Falcon chip will support DMT ADSL and
"splitterless ADSL," or G.lite, a standard which will simplify modem deployment
by eliminating customer premises splitter installation for simultaneous data and
analog voice connections. The Falcon chip was developed by our microelectronics
team and was included as part of the


                                       16

<PAGE>   23

assets sold to GlobeSpan under the terms of the Asset Purchase Agreement dated
as of January 21, 2000. See Note 17 of Notes to the Consolidated Financial
Statements contained in a separate section of this Annual Report on Form 10-K
commencing on page F-1.

CUSTOMERS

         We sell our HiGain, PG-2, PG-Flex, PG-Plus and megabit access products
primarily into the public network market and our Campus products primarily into
the private network market. We use our direct sales force to market our products
to the public network market in the United States and Canada. We market our
domestic Campus products and all international products through both direct
sales and distributors.

     Public Networks

         The public network market consists of the RBOCs and their local
telephone company affiliates, as well as independent telephone companies,
interexchange carriers, CLECs, ISPs 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 our product
from the RBOC. Although the approval process for a new product varies somewhat
among the RBOCs, the process generally consists of the following three phases:

         o  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.

         o  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.

         o  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 U.S. RBOCs and Bell Canada have approved our HiGain products. In
addition, several carriers have approved our subscriber carrier systems: one
RBOC and Bell Canada have approved our PG-2 system, four RBOCs have approved the
PG-Flex system and one RBOC has approved the PG-Plus system. Sales in the
aggregate to local telephone companies affiliated with the RBOCs accounted for
approximately 45% of our total revenues in 1999. See Note 3 of Notes to
Consolidated Financial Statements contained in a separate section of this Annual
Report on Form 10-K commencing on page F-1.

         Independent Telephone Companies. There are approximately 1,500
telephone companies in the United States that are unaffiliated with any of the
RBOCs. We have targeted approximately 50 of the largest independent telephone
companies as potential customers for our carrier products. Although the
independent telephone company market does not present as large an opportunity as
the RBOC market, our experience has been that the independent telephone
companies are often more receptive to new technology. As a result, the approval
process for new technology is often less time consuming. Several of the large
and small independent telephone companies have approved and deployed our HiGain
system. One large independent telephone company has approved our PG-Flex and
PG-2 subscriber carrier systems. Also, several small independent telephone
companies have deployed the Avidia System.

         CLECs and ISPs. There are numerous competitive local exchange carriers
and Internet service providers throughout North America. These providers supply
Internet access, T1, long distance and other residential services to consumers
or businesses. In many cases, CLECs will lease unbundled network elements from
the local exchange carrier to deliver digital services using their own
transmission equipment. Most CLECs are focused on new types of data or voice
services and are potential customers for our products. The CLEC market is
relatively new (since the 1996 Telecom Act), and it is unknown at this point how
CLECs will evolve. The PG-FlexPlus has been approved by two CLECs.


                                       17

<PAGE>   24

         International Carriers. In most international markets there is one
telephone company per country. Typically these PTTs are highly regulated,
government-owned agencies that have an even more rigorous approval process for
new technology than the RBOCs. There are a number of markets that have recently
opened up, as competitive carriers are now able to compete with the incumbent
carriers. 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 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. Our
products have been successfully deployed in over 95 countries, and in 1999,
sales outside of North America comprised approximately 14% of total revenues.

     Private Networks

         Customers for our Campus products, first introduced in 1993, include
universities, hospitals, military bases and other government installations,
corporate complexes and other campus-like environments with private network
systems.

SALES, MARKETING AND CUSTOMER SUPPORT

     Sales and Marketing

         Our direct sales force markets our 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. We sell to other independent carriers, CLECs and
owners of private networks through direct sales, telesales and distributors.

         Our North American sales personnel are located in the following areas:

         States:                                               Provinces:
         ------                                                ---------
         California      Massachusetts        Tennessee        Alberta
         Colorado        Minnesota            Texas            British Columbia
         Georgia         Missouri             Utah             Ontario
         Illinois        New Hampshire        Virginia         Quebec
         Kansas          North Carolina       Washington

         We sell our products outside of North America through our own sales
force based in the United States, Switzerland, Germany, United Kingdom, Israel,
United Arab Emirates, Brazil, Columbia, Hong Kong and China, and a network of
international data communications equipment distributors.

         In addition to the specific sales efforts directed at our public and
private network customers, our 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 our customers, the media and industry analysts. We
also maintain a website (www.pairgain.com) which provides up-to-date product,
sales and support information.

     Global Services and Support

         Service, repair, installation and technical support of our products are
performed primarily in-house, however, we also use an independent third party
repair service. Our field service and support personnel are located in:

         States:                                                Other Countries:
         -------                                                ----------------
         Alabama          Florida             Missouri          Brazil
         California       Georgia             New York          Canada
         Colorado         Maryland            North Carolina    China
         Connecticut      Massachusetts       Texas             Hong Kong
                          Michigan            Washington        Mexico


                                       18


<PAGE>   25

         We offer technical support to our customers on a 24-hours-a-day,
7-days-a-week basis via an 800 hotline and through paging systems for all
support personnel. Our products are sold with a five year warranty.

         We are in the process of expanding our service and support solutions to
customers deploying DSL services by providing education and training courses;
engineering, furnishing and installation services (EF&I); system assembly and
on-site set-up and testing. In addition, we will offer marketing assistance
including business plans, cooperative marketing funds, economic model
development, market analysis and research and product deployment.

PRODUCT DEVELOPMENT

         We believe that our future success depends on our ability to maintain
our technological leadership through enhancements of our existing products and
development of new products that meet a wide range of customer needs.
Accordingly, we intend to continue to make substantial investments in product
development.

         Our future engineering efforts will be focused on software development
and hardware development. Within the software development group, our efforts are
devoted to the development and enhancement of network management software and
protocol compliance for our products and the development of firmware for
products such as Avidia, PG-Flex, PG-Plus and HiGain ETSI.

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

         o  Cost Reduction. We continuously review the design and manufacturing
            process of our 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.

         o  Product Line Extensions. We seek to extend our existing product
            lines through product modifications and enhancements in order to
            meet the needs of our different customers and their applications.
            Products resulting from our 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.

         o  New Technology. We explore new transmission technologies to
            determine whether they represent an opportunity for products
            incorporating our DSP and copper transmission expertise.

         During 1999, 1998 and 1997, research and development expenses were
approximately $45.3 million, $37.6 million and $32.0 million, respectively. All
of our research and development expenses were charged to operations as incurred.

MANUFACTURING

         Our manufacturing operations consist primarily of final assembly,
burn-in, full system test, packaging and shipping. We use domestic independent
third-party contract assembly companies on a consignment basis for circuit
board assembly, including in-circuit and functional testing, for new, complex,
and low volume products. We conduct final assembly and final test functions for
those products at our facility in Tustin, California. During the fourth quarter
1999, we began transitioning high volume products to our contract-manufacturing
partner, SCI Systems, Inc., in Monterrey, Mexico. SCI, using a hybrid
consignment model, performs the complete manufacturing process, including
direct shipment to our customers from SCI's San Antonio, Texas facility. The
transition is scheduled to be completed during the second quarter of 2000. We
perform extensive burn-in, testing and inspection of all products prior to
shipping to customers from both the Tustin and San Antonio facilities. Product
quality and reliability are prime concerns in all phases of the manufacturing
process. Quality is maintained through a combination of qualified dock-to-stock
suppliers, inspection and auditing of both consignment and turnkey contractors,
in-house assembly and test functions, and a final shipping inspection of all
products.

         During the fourth quarter of 1998, we entered into an agreement to have
our ETSI products manufactured on a turnkey basis by SCI in their Sao Paulo,
Brazil facility. Under the terms of this agreement, SCI manufactures, tests,
packages and ships these products directly to our Brazilian and other South
American customers.

                                       19


<PAGE>   26

         In April 1996 we achieved ISO 9001 certification for our manufacturing
operations located in Tustin, California, and our engineering and design
facility in Raleigh, North Carolina. In May 1999, these facilities were
re-certified through April 2002. ISO is a quality system standard for ensuring
total quality management in engineering and manufacturing and is a prerequisite
for international trade. ISO 9001 is a comprehensive standard, covering design,
production, installation and service.

         PairGain is in the process of implementing TL 9000 Quality System
Requirements. TL 9000 is based on ISO 9001 standards and includes additional
requirements specific to the telecommunications industry. TL 9000 was developed
by suppliers and service providers in the telecommunications industry with the
goal of continued improvements to the quality and reliability of
telecommunication service.

         We currently procure components from outside suppliers, either directly
from manufacturers or distributors. Assemblies are procured through our
consignment and turnkey contractors. While the majority of devices are purchased
from our distributors at the time of consumption, we generally purchase and
store the more expensive or custom components at our Tustin location. Our
assembly and test subcontractors purchase and store other necessary components.
In procuring certain components, we and our subcontractors rely upon a number of
original equipment manufacturers that are the sole source for certain of the
components. One such sole supplier part is the SPAROW II chip. Although we have
utilized our VLSI expertise to design our 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 our customer relationships and operating results.

         Our backlog at December 31, 1999 was approximately $9.3 million. We
include in backlog all firm purchase orders for products regardless of their
ship date. Because of the quick turnaround that our customers expect on their
orders, and because of the possibility of customer changes in delivery schedules
or cancellation of orders, our backlog as of any particular date may not be
indicative of actual revenues expected for any future period.

         Our products are subject to FCC regulations regarding emission of
electromagnetic energy, which may interfere with other equipment. All of our
currently commercially available products have been tested and comply with the
relevant FCC regulations. Our 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 our markets is intense, and we expect that competition
will increase. Many of our potential competitors have substantially greater name
recognition and more extensive engineering, manufacturing, marketing, financial
and personnel resources than us. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements.
There can be no assurance that we 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 our
products, cause us to further reduce prices on our existing products, increase
expenses or cause delays or cancellations of customer orders, any one of which
could adversely affect our business and results of operations.


                                       20
<PAGE>   27

         Some companies that offer competitive products in our primary revenue
markets are listed below:

<TABLE>
<CAPTION>
         -------------------------------------------------------------------------------------------------
                                                                 SUBSCRIBER
                                                      T1/E1        CARRIER
                        COMPETITOR                   ACCESS        SYSTEMS       CAMPUS        AVIDIA
         -------------------------------------------------------------------------------------------------
<S>                                                  <C>         <C>             <C>           <C>
         ADC Telecommunications                         X
         -------------------------------------------------------------------------------------------------
         Adtran, Inc.                                   X                           X
         -------------------------------------------------------------------------------------------------
         Alcatel Network Systems, Inc.                                              X             X
         -------------------------------------------------------------------------------------------------
         Cisco/Netspeed                                                                           X
         -------------------------------------------------------------------------------------------------
         CopperCom                                                    X
         -------------------------------------------------------------------------------------------------
         Copper Mountain Networks                                                                 X
         -------------------------------------------------------------------------------------------------
         ECI Telecom                                                  X
         -------------------------------------------------------------------------------------------------
         GoDigital Telecommunications, Inc.                           X
         -------------------------------------------------------------------------------------------------
         Jetstream Communications                                     X
         -------------------------------------------------------------------------------------------------
         Lucent Technologies                                                                      X
         -------------------------------------------------------------------------------------------------
         Nokia/Diamond Lane                                                                       X
         -------------------------------------------------------------------------------------------------
         Nortel (Promatory)                                                                       X
         -------------------------------------------------------------------------------------------------
         Paradyne                                                                   X             X
         -------------------------------------------------------------------------------------------------
         Siemens                                        X
         -------------------------------------------------------------------------------------------------
         Tollbridge Technologies                                      X
         -------------------------------------------------------------------------------------------------
         Tut Systems                                                                X             X
         -------------------------------------------------------------------------------------------------
         Tyco International Ltd.                                      X
         -------------------------------------------------------------------------------------------------
         Wescom Communications, Inc.                                  X
         -------------------------------------------------------------------------------------------------
         Westell, Inc./Teltrend                         X                                         X
         -------------------------------------------------------------------------------------------------
</TABLE>

         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.

         We are investing heavily in DSL developments. The market for DSL-based
products is emerging and will change dramatically over a very short time. There
can be no assurance that the products we develop will be commercially
successful.

PROPRIETARY RIGHTS

         We rely on a combination of technical leadership, trade secret, patent,
copyright and trademark law and nondisclosure agreements to establish and
protect our proprietary rights in our products. We also have certain registered
and other trademarks. We believe that, because of the rapid pace of
technological change in the networking industry, patent and copyright protection
are less significant to our competitive position than factors such as the
knowledge, ability and experience of our personnel, new product development,
market recognition and ongoing product maintenance and support. On February 24,
2000, we sold certain patent rights to GlobeSpan under the terms of the Asset
Purchase Agreement dated as of January 21, 2000. See Note 17 of Notes to the
Consolidated Financial Statements contained in a separate section of this Annual
Report on Form 10-K commencing on page F-1.


                                       21

<PAGE>   28

EMPLOYEES

         As of December 31, 1999, we employed 722 persons, including 231 in
manufacturing, 133 in sales and marketing, 29 in customer service and support,
270 in engineering and 59 in finance and administration. We also employ a number
of temporary and contract employees. During the last quarter of fiscal 1999, we
employed between 91 and 96 temporary and contract employees. None of our
employees is represented by a labor union and we have experienced no work
stoppages. We do not have any employment contracts with any of our executive
officers, however, executive officers and other key employees have agreements
which provide for severance payments and certain other benefits in the event the
employee is terminated without cause following a change in control. On
February 24, 2000, the 39 employees in our microelectronics group became
employees of GlobeSpan in connection with the sale of our microelectronics
engineering group. See Note 17 of Notes to the Consolidated Financial Statements
contained in a separate section of this Annual Report on Form 10-K commencing
on page F-1.

ITEM 2.  PROPERTIES.

         In 1999, we purchased our Tustin, California headquarters facility. In
addition, we have several property leases for other facilities. The details of
the owned facility and property leases are detailed below:

<TABLE>
<CAPTION>
                                                              Approx.        Lease
                    Use / Location                          Square Feet    Expiration
                    ---------------                         -----------    ----------
<S>                                                         <C>            <C>
Principal administrative, engineering,
  manufacturing, sales and marketing facilities
         Tustin, California                                    75,000         Owned
         Tustin, California                                    66,000        12/31/04
         Tustin, California                                    41,000        12/31/04

Research and development facilities
         Raleigh, North Carolina                               40,000        09/30/07

Sales offices
         Miami, Florida                                         2,000        03/31/01
         Norcross, Georgia                                      2,000        11/30/00
         Toronto, Ontario, Canada                               1,000        10/31/01
         Baden-Daettwil, Switzerland                            2,000        06/30/00
         Wanchai, Hong Kong                                     2,000        07/31/00
</TABLE>


                                       22

<PAGE>   29

ITEM 3.  LEGAL PROCEEDINGS.

         As discussed in Item 3. Legal Proceedings in our Annual Report on Form
10-K for the year ended December 31, 1998, the U.S. Attorney's office and the
Securities and Exchange Commission had been investigating S. Jay Goldinger and
Capital Insight, Inc. in connection with their 1995 loss of nearly $100 million
of their clients' funds, including $15.8 million of PairGain's funds.

         As discussed in Item 1. Legal Proceedings in our Quarterly Report on
Form 10-Q for the first quarter ended March 31, 1999, the U.S. Attorney had
named PairGain, Charles S. Strauch, our Chairman and former Chief Executive
Officer, and Charles W. McBrayer, our then Chief Financial Officer, as targets
of its criminal investigation.

         On November 8, 1999, PairGain announced a final agreement with the U.S.
Attorney's office. Pursuant to the agreement, we pled guilty, in U.S. District
Court in Santa Ana, California, to one felony count for failing to implement a
system of internal accounting controls and to maintain accurate books and
records in violation of 15 U.S.C. Sections 78m(b) (2) and 78ff, and 18 U.S.C.
Section 2, for aiding and abetting or causing these acts to be done.

         Under the terms of the agreement, we agreed to pay a fine of
$1,000,000, to reimburse the government $400,000 for the costs of its
investigation and to pay a $200 special assessment. We also agreed to four years
probation. During the term of probation, we:

         o  agreed not to commit a federal, state or local crime;

         o  agreed to file a Form 8-K with the SEC within ten days to disclose
            the nature of the offense committed, the fact of conviction, the
            nature of the punishment and the steps that will be taken to prevent
            the recurrence of similar offenses;

         o  agreed to submit financial statements reviewed by our outside
            accountants in connection with the filing of our quarterly reports
            with the SEC. In addition, each member of the Board of Directors,
            with the exception of the Chairman of the Board, will be required to
            sign each of our quarterly reports during the probationary period
            and certify that he or she has read and reviewed the report and
            believes it to be true and correct. The then Chief Financial Officer
            and the current Chairman of the Board may not exclusively direct the
            preparation of the quarterly reports or financial statements during
            this period, but may participate in their review; and

         o  agreed to engage an expert approved by the Probation Office and the
            U.S. Attorney's Office to conduct an examination, at our expense, in
            order to: (i) assess whether our internal accounting controls are
            adequate such that transactions are recorded as necessary to
            maintain accountability for our assets; (ii) assess whether our
            books, records and accounts accurately and fairly reflect our
            transactions and dispositions of our assets; and (iii) assess
            whether we properly disclose our financial transactions in a timely
            manner in the appropriate fashion to the appropriate persons or
            agencies. In addition, the expert will review our procedures for
            making and maintaining corporate documents.

            The expert is to make recommendations deemed appropriate to improve
            our system of internal accounting controls and record-keeping. The
            expert will report the recommendations to the Probation Office and
            the U.S. Attorney's Office. The Probation Office will determine
            which recommendations must be implemented. We must then implement
            the recommendations identified by the Probation Office as soon as
            reasonably practical, but in no event later than 60 days, and shall
            report on the progress of such implementation to the Probation
            Office. During the term of our probation, we are also required to
            permit the expert to conduct follow-up examinations on an annual
            basis to determine that we have implemented and maintained the
            recommendations identified by the Probation Office.

         Since the first quarter of 1996, we have requested our outside
accountants and legal counsel to look at our quarterly financial statements and
public disclosures, including financial press releases and periodic SEC reports,
prior to publication. In addition, we have regular meetings with our outside
accountants to discuss the accounting and disclosure of transactions in our
books, records and financial statements. Also, in the first quarter of 1996, we
retained our outside accountants to assist and make recommendations in the
preparation of our "Investment Policy Guidelines" which, among other things,
require a comprehensive system of documentation and record-keeping. These
Guidelines require comprehensive management reports on the status of our
investments to provide assurance of the accuracy of our financial records and
periodic reports to the Board of Directors regarding compliance with the
provisions of the Guidelines. PairGain first adopted these Guidelines in April
1996.


                                       23

<PAGE>   30

         In addition to the agreement reached with the U.S. Attorney's Office
discussed above, PairGain, our Chairman, Charles S. Strauch, and our then Chief
Financial Officer, Charles W. McBrayer, also reached a settlement with the SEC.
Without admitting or denying the SEC's findings, we consented to an SEC order
directing us to cease and desist from committing or causing any violations or
future violations of the antifraud, periodic reporting, books and records and
internal accounting control provisions. Messrs. Strauch and McBrayer agreed,
also without admitting or denying the SEC's allegations, not to violate the
antifraud provisions. In addition, Mr. McBrayer agreed not to violate the
periodic reporting, books and records and internal accounting control
provisions. Messrs. Strauch and McBrayer have also agreed to pay civil money
penalties of $25,000 each.

         PairGain's Board of Directors authorized the settlement of all
outstanding claims with the U.S. Attorney's office and the SEC in the interest
of avoiding protracted litigation and in order to bring closure to these
matters.

         The agreements with the U.S. Attorney's office and the SEC were
announced in a press release issued on November 8, 1999, a copy of which is
attached to our Form 8-K filed with the SEC on November 15, 1999.

         In May 1999, we reached an agreement with Harris Corporation ("Harris")
to settle and dismiss the lawsuit brought by Harris against PairGain and others,
which lawsuit was described in our Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1998. Under the terms of the settlement, we
agreed to pay the sum of $1.5 million to Harris, and both parties agreed to
dismiss their actions with prejudice. The impact of the settlement is recorded
in our financial statements for the year ended December 31, 1999.

         On January 21, 2000, a former employee filed a lawsuit against PairGain
in Superior Court of the State of California, County of Orange, citing breach of
implied covenant of good faith and fair dealing, wrongful termination in
violation of state statute and wrongful discharge in violation of public policy.
We maintain insurance coverage which covers costs of defense up to a maximum of
$1.0 million with a deductible of $25,000. We intend to vigorously defend the
suit.

         We are involved from time to time in litigation incidental to our
business. We believe that none of our pending litigation matters, individually
or in the aggregate, will have a material adverse effect on our financial
position or results of operations.

         Under the terms of our certificate of incorporation, we indemnify our
directors and officers for certain damages and legal fees arising from
litigation matters.

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

        None.


                                       24

<PAGE>   31

                                     PART II

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

         The Company's Common Stock is traded on The Nasdaq Stock MarketSM under
the symbol "PAIR". As of February 25, 2000, there were 72,867,865 shares of the
Company's Common Stock issued and outstanding. The number of stockholders of
record at that date was 618. 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 Stock MarketSM. 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.

                                                       QUARTERLY     QUARTERLY
                                                          HIGH          LOW
                                                       ---------     ---------
         YEAR ENDED DECEMBER 31, 1999
            Fourth Quarter                              $ 18.56       $ 11.00
            Third Quarter                                 14.13          8.00
            Second Quarter                                16.13          8.50
            First Quarter                                 12.00          7.81

         YEAR ENDED DECEMBER 31, 1998
            Fourth Quarter                              $ 13.63       $  6.00
            Third Quarter                                 17.50          7.38
            Second Quarter                                24.13         12.75
            First Quarter                                 24.38         15.50

         On February 25, 2000, the last reported sales price for the Company's
stock was $17.81.


                                       25

<PAGE>   32

ITEM 6. SELECTED FINANCIAL DATA.

                      SELECTED CONSOLIDATED FINANCIAL DATA

         The selected consolidated financial data of the Company as of December
31, 1999 and 1998 and for the years ended December 31, 1999, 1998 and 1997 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, 1997, 1996 and 1995 and for the years ended December
31, 1996 and 1995 are derived from audited consolidated financial statements of
the Company not included in this Annual Report but filed previously with the
Commission. 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,
                                         -------------------------------------------------------------------
                                           1999           1998          1997          1996(1)         1995
                                         ---------     ---------      ---------     ---------      ---------
                                                      (IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<S>                                      <C>           <C>            <C>           <C>            <C>
STATEMENT OF OPERATIONS DATA:
 Revenues                                $ 224,875     $ 283,100      $ 282,325     $ 205,505      $ 107,224
 (Loss) income from operations             (16,065)       55,536         71,739        51,526         23,532
 Net income                                  2,423        39,499         47,637        34,908          1,056
 Earnings per common share(2)
    Basic                                $    0.03     $    0.56      $    0.70     $    0.54      $    0.02
    Diluted                              $    0.03     $    0.53      $    0.63     $    0.47      $    0.02
 Average shares outstanding(2)
    Basic                                   70,994        70,234         67,991        64,247         58,225
    Diluted                                 75,668        74,802         75,225        73,768         67,280
</TABLE>


<TABLE>
<CAPTION>
                                                                      DECEMBER 31,
                                          -------------------------------------------------------------------
                                            1999           1998          1997          1996(1)         1995
                                          ---------     ---------      ---------     ---------      ---------
                                                                   (IN THOUSANDS)
<S>                                       <C>           <C>            <C>           <C>            <C>
BALANCE SHEET DATA:
 Working capital                          $ 259,591     $ 257,713      $ 214,724     $ 140,681      $  84,766
 Total assets                               325,081       328,520        282,419       195,004        105,326
 Long-term debt                               1,735            --             --            --             --
 Total stockholders' equity                 292,957       279,041        235,517       157,596         93,931
</TABLE>

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

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

(1) Financial data for 1996 reflect the February 27, 1997 business combination
    between PairGain and Avidia Systems, Inc. accounted for on a
    pooling-of-interests basis. Avidia was formed in December 1995 and had no
    significant transactions prior to January 1, 1996. See Notes 1 and 2 of
    Notes to the Consolidated Financial Statements contained in a separate
    section of this Annual Report on Form 10-K commencing on page F-1.

(2) All share and per share amounts have been adjusted for the June 18, 1996 and
    December 18, 1996 two-for-one stock splits and have been restated to reflect
    the adoption of SFAS No. 128, "Earnings Per Share" ("SFAS No. 128").


                                       26

<PAGE>   33

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

         The following discussion and other sections of this Form 10-K may
         contain forward-looking statements within the meaning of the private
         securities Litigation Reform Act of 1995, Section 21E of the Securities
         Exchange Act of 1934, as amended, and Section 27A of the Securities Act
         of 1933, as amended, and is subject to the safe harbors created by
         those sections. These forward-looking statements are subject to
         significant risks and uncertainties, including without limitation those
         identified in the section entitled "Risk Factors" in Item 1 of this
         Annual Report. Such risks and uncertainties may cause actual results to
         differ materially and adversely from those discussed in such
         forward-looking statements. The forward-looking statements within this
         Form 10-K are identified by words such as "believes," "anticipates,"
         "expects," "intends," "estimates," "forecasts," "projects," "could,"
         "may" and other similar expressions. However, these words are not the
         exclusive means of identifying such statements. In addition, any
         statements that refer to expectations, projections or other
         characterizations of future events or circumstances are forward-looking
         statements. We disclaim any obligation to publicly release the results
         of any revisions to these forward-looking statements which may be made
         to reflect events or circumstances occurring subsequent to the filing
         of this Form 10-K with the Securities and Exchange Commission (the
         "SEC") or otherwise to revise or update any oral or written
         forward-looking statement that may be made from time to time by or on
         behalf of us. The following discussion should be read in conjunction
         with the consolidated financial statements and related notes included
         elsewhere herein. Readers are urged to carefully review and consider
         the various disclosures made by the Company in this Report that attempt
         to advise interested parties of certain risks, uncertainties and other
         factors that may affect our business.

OVERVIEW

         PairGain is a leading provider of products based on DSL networking
systems. We design, manufacture, market and support a comprehensive line of
digital telecommunications 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, local and wide area
networking and video conferencing.

         Our first product was PG-2, a two-channel digital subscriber carrier
system, which was initially shipped in late 1989. In 1991, we undertook the
development of our HiGain products, which were first shipped in June 1992. In
June 1993, we introduced our Campus line of products, and in 1996, began
shipping our PG-Flex product, a subscriber carrier system for delivering up to
32 voice channels over two pair of copper wires. In the first quarter of 1997,
we commenced shipments of our PG-Plus and ETSI products. In 1999, we began
shipping the Avidia System, a DSL access switch that enables CLECs and ILECS to
deploy advanced data services, such as voice of DSL, Virtual private networks,
business Internet access and video on demand.

         Revenues from HiGain products represented approximately 48% of our
total revenues in 1999, and 59% and 67% of our total revenues in 1998 and 1997,
respectively. Although revenues from sales of HiGain products are expected to
continue to account for a substantial portion of our revenues for the
foreseeable future, we believe that revenues from sales of our PG-Flex, PG-Plus,
Avidia and other products will continue to increase as a percentage of total
revenues in the future.

         Commencing in mid-1993, we began reducing the average selling prices of
our HiGain products in an effort to increase market demand for our products and
in anticipation of expected price competition. These reductions have been
significant, representing reductions of then current prices averaging as much as
40% in 1999, 34% in 1998 and 16% in 1997. Although future effects of price
competition and other competitive pressures inherent in our business are
uncertain, we expect to continue to reduce the average selling prices of our
HiGain and other products. Accordingly, our ability to maintain or increase
revenues will depend in part upon our 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 selling prices of our existing products. Declining average selling
prices may also adversely affect gross margins on our existing products if we
are unable to fully offset such reductions in average selling prices by
reductions in our per unit costs through cost


                                       27


<PAGE>   34

reduction resulting from engineering design changes, reduced prices for
components, increased manufacturing efficiencies and increases in volume.
However, there can be no assurance that we will be able to continue to increase
unit sales volumes, introduce and sell new products or further reduce our per
unit costs in the future.

RESULTS OF OPERATIONS

         The results of operations discussed below are comprised of two
sections. The first section compares 1999 to 1998 for all items noted on the
Consolidated Statements of Income contained in a separate section of this Annual
Report on Form 10-K commencing on page F-1. The second section compares 1998 to
1997 for the same items.

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

<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                                    --------------------------------
                                                    1999          1998          1997
                                                    ----          ----          ----
<S>                                                 <C>           <C>           <C>
Revenues:
  Product sales                                       97%           97%         100%
  Royalty income and technology licensing fees         3             3           --
                                                     ---           ---          ---
Total revenues                                       100           100          100
Cost of revenues                                      62            52           51
                                                     ---           ---          ---
Gross profit                                          38            48           49

Operating expenses:
  Research and development                            20            13           11
  Selling and marketing                               15            11            8
  General and administrative                          10             5            4
  Merger expenses                                     --            --            1
                                                     ---           ---          ---
Total operating expenses                              45            29           24
                                                     ---           ---          ---
(Loss) income from operations                         (7)           19           25

Other income (loss):
  Interest and other income, net                       4             3            3
  Loss on long-term investments                       (1)           --           --
                                                     ---           ---          ---
(Loss) income before income taxes                     (4)           22           28
(Benefit from) provision for income taxes             (5)            8           11
                                                     ---           ---          ---
Net income                                             1%           14%          17%
                                                     ===           ===          ===
</TABLE>

     1999 Compared to 1998

         REVENUES

         Revenues of $224.9 million in 1999 declined 21% compared with 1998
revenues of $283.1 million. Product revenues decreased 20% to $218.9 million in
1999 compared to $274.4 million in 1998, and royalty income and technology fees
decreased to $5.9 million in 1999 versus $8.7 million in 1998. The decrease in
product revenues was largely the result of a 35% decrease in revenues from sales
of HiGain products. Unit shipments of HiGain products during 1999 were 2% higher
than 1998 unit shipments, but average selling prices decreased 40%. In addition
to the decline in HiGain revenue, 1999 revenues from sales of PG-Flex products
declined 9% when compared to 1998. Unit shipments of PG-Flex products during
1999 were also 2% higher than 1998 unit shipments, but average selling prices
decreased 13%. Revenues from 1999 sales of PG-Plus products increased 63% over
the 1998. PG-Flex and PG-Plus revenues represented 24% of total revenues, up
from 17% of total 1998 revenues. Revenues from sales of Campus products
increased 9% in 1999 over 1998, despite a 27% decline in average selling prices.
Revenues from sales of the Avidia products, newly introduced in 1999, were $4.0
million in 1999. We expect that PG-Flex, PG-Plus and Avidia revenues will
continue to become a greater portion of total revenue in the future. Revenues
from sales of PG-2 products decreased 41% in 1999 compared to 1998, primarily
the result of decreased unit shipments. Unit shipments of PG-2 products
decreased 40% and average selling prices decreased 2%


                                       28

<PAGE>   35

in 1999. Much of the decline in revenues resulted from primary source HDSL
contracts from two major customers being awarded to one of our competitors.
Revenues from those two major customers declined 66% and 31%, respectively, in
1999 compared to 1998. We previously supplied the dominant share of HDSL product
to these accounts. If we are unable to regain at least a portion of sales to
these accounts in the future, or find other customers to replace them, a
continued decline in HDSL revenues could have a material adverse effect on our
future operating results.

         Revenues from royalty income and technology fees were primarily the
result of the Falcon chip licensing agreement entered into during the first
quarter of 1998, and consisted of $3.5 million in non-refundable royalties and
$2.2 million in technology fees. An additional $200,000 in technology fees were
unrelated to the Falcon agreement.

         Aggregate sales to local telephone companies affiliated with the RBOCs
accounted for approximately 45% and 55% of our total revenues for 1999 and 1998,
respectively. Revenue per average employee decreased to $287,000 in 1999,
compared to $381,000 in 1998.

         GROSS PROFIT

         Gross profit represents total revenues for a period, including 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 warranty reserves. In 1999, our gross profit as a
percentage of total revenues decreased to 38% from 48% in 1998. The decrease in
gross margin percentage was largely the result of decreases in average selling
prices, which were partially offset by our cost reduction. We continue to place
emphasis on continuing cost reduction through engineering design changes,
reduced prices for components, increased manufacturing efficiencies and increase
in volume to offset declining average selling prices of our products. We expect
that increased competition will continue to place downward pressure on average
selling prices. To the extent that we are unable to offset these decreases with
our cost reduction efforts, or to introduce and sell new products with higher
gross product margins, we will continue to experience a decline in our gross
margin.

         OPERATING EXPENSES

         Operating expenses increased 27% to $102.5 million in 1999 from $81.0
million in 1998. Included in 1999 operating expenses were $5.6 million of
non-recurring charges related to settlement agreements. Excluding these charges,
operating expenses were $96.9 million in 1999, a 20% increase over 1998. Nearly
half of the increase in absolute operating expense levels related to research
and development expenses and approximately one third of the increase related to
selling and marketing expenses. We increased our relative spending in
engineering and field sales support in 1999 in an effort to continue to develop
and market new products and technologies. As a percentage of total revenues,
operating expenses were 45% for 1999 and 29% for 1998. Excluding the
non-recurring charges in 1999, operating expenses were 43% of total revenues.

         Research and development expense increased 21% to $45.3 million in 1999
from $37.6 million in 1998. Research and development expense was 20% of total
revenues in 1999 compared to 13% in 1998. The increase in expenses was due in
part to the addition of personnel for the development of new products,
specifically, development programs for HDSL2 and megabit access products,
including the Avidia System, and sustaining, enhancement and cost reduction
programs for HiGain, PG-Flex, PG-Plus and Campus products. The remainder of the
increases consisted of outside development consulting fees and costs for
prototype materials and other costs specific to achieving new product approval
for the HDSL2 and Avidia products.

         Selling and marketing expense increased 16% to $35.0 million in 1999
from $30.1 million in 1998. The increase in expense levels was primarily due to
the addition of personnel and the associated increase in salaries, benefits and
travel expenses. This was offset by a decrease in advertising, trade show and
other promotional expenses. Costs related to the expansion of our presence in
the international market increased 16% over the prior year. Selling and
marketing expense as a percentage of total revenues was 15% in 1999 and 11% in
1998.

         General and administrative expense increased 66% to $22.1 million in
1999 from $13.3 million in 1998. Included in 1999 expenses were $5.6 million of
non-recurring charges related to settlement agreements (see below). Excluding
these charges, general and administrative expense was $16.5 million, a 24%
increase over the prior year. Increased salary and related expenses made up half
of the increase over the prior year. The remainder of the increase was comprised
of fees for outside services related to the upgrade of our software systems and
Year 2000


                                       29


<PAGE>   36

compliance project, and increased professional fees, offset by a reduction in
legal fees. General and administrative expense as a percentage of total revenues
was 10% in 1999 compared to 5% in 1998. Excluding the non-recurring charges,
general and administrative expense was 7% of total revenues in 1999.

         Non-Recurring Charges Related to Settlement Agreements

         Included in 1999 general and administrative expense were $5.6 million
of non-recurring charges related to settlement agreements. These charges consist
of the following:

         In May 1999, we reached an agreement with Harris Corporation ("Harris")
         to settle and dismiss a lawsuit brought by Harris against us in April
         1998. Under the terms of the settlement, in order to avoid further
         litigation and controversy, we agreed to pay the sum of $1.5 million to
         Harris and both parties agreed to dismiss their actions with prejudice.
         The impact of the settlement was recorded in our financial statements
         during the quarter ended June 30, 1999.

         On September 2, 1999, we announced a tentative agreement with the U.S.
         Attorney's office for failing to implement a system of internal
         accounting controls and to maintain accurate books and records. The
         agreement with the U.S. Attorney's office was finalized on November 8,
         1999. In addition to the agreement reached with the U.S. Attorney's
         office, PairGain, our Chairman and our then Chief Financial Officer
         also reached a settlement with the SEC. These agreements relate to the
         1995 loss of $15.8 million of our funds through our former money
         manager, S. Jay Goldinger, and his firm, Capital Insight, Inc., the
         disclosures of such investments and the disclosure of the loss
         incurred. Based upon these settlements, we paid $1.4 million for
         fines and reimbursement of the government's cost of investigation.
         In addition, we accrued $200,000 for other costs and expenses
         associated with the settlement. The impact of the settlement was
         recorded in our financial statements during the quarter ended
         September 30, 1999.

         In November 1999, we announced our decision to sell our
         microelectronics engineering group. In this regard, we signed a Mutual
         Release and Settlement Agreement with a third party to terminate a
         Memorandum of Understanding between the two companies for a joint
         technology development. In consideration of the settlement, we agreed
         to pay up to $3.5 million to the other party. Of that amount, $2.5
         million was paid in November 1999 and was recorded in general and
         administrative expense for the year ended December 31, 1999. The
         additional payment of $1.0 million became due upon the signing of the
         agreement to sell the microelectronics engineering group, which
         occurred on February 24, 2000.

         (LOSS) INCOME FROM OPERATIONS

         As a result of the above, loss from operations for 1999 was $16.1
million compared to income of $55.5 million in 1998. As a percentage of
revenues, loss from operations was 7% in 1999. Income from operations was 19% of
revenues in 1998. Excluding the non-recurring settlement charges, loss from
operations was $10.5 million or 5% of revenues in 1999.

         INTEREST AND OTHER INCOME, NET

         Interest and other income of $9.1 million in 1999 was consistent with
interest and other income in 1998 of $9.0 million.

         LOSS ON LONG-TERM INVESTMENTS

         In June 1996, we 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. We purchased
approximately 545,000 shares of E/O's Series D Preferred Stock for an aggregate
of $3.0 million. In the fourth quarter of 1998, we determined that E/O's market
value had decreased. Based upon that determination, we recorded an impairment
adjustment of $1.5 million during the fourth quarter of 1998 to reflect an
impairment in our investment in E/O.

                                       30
<PAGE>   37
         During the second quarter of 1999, E/O filed for protection under
Chapter 11 of the U.S. Bankruptcy Act. Following notification of the bankruptcy
filing, we wrote-off the remaining $1.5 million investment in E/O during the
second quarter of 1999.

         (BENEFIT FROM) PROVISION FOR INCOME TAXES

         For the year ended December 31, 1999, we recorded a tax benefit of
$10.9 million. Included in that amount was a $5.5 million tax benefit from the
recognition of previously incurred capital loss carryforwards and the reversal
of valuation allowances on certain deferred tax assets. The majority of the
benefit related to a capital loss incurred in 1995, which had previously been
unrecognized due to the uncertainty of generating capital gains under our
current investment policies. Due to our divestiture of our microelectronics
engineering group in the first quarter of 2000, the realization of these capital
losses is now assured. Our provision for income taxes in 1998 was $23.6 million,
an effective tax rate of 37%.

         NET INCOME AND EARNINGS PER SHARE

         Net income for the year ended December 31, 1999 was $2.4 million
compared to $39.5 million for the year ended December 31, 1998. Basic earnings
per share for 1999 were $0.03 per share compared to $0.56 per share for 1998.

         The weighted average number of common shares outstanding were 71.0
million for 1999 and 70.2 million for 1998. This increase in common shares
outstanding was attributable to the exercise of stock options and warrants and
the issuance of shares under the Employee Stock Purchase Plan, offset by the
repurchase of shares during 1999 under the Employee Incentive Stock Option/Stock
Issuance Plan and the Share Buyback Plan.

         Diluted earnings per share, which take into account the dilutive
effects of common stock options and warrants, were $0.03 per share in 1999
compared to $0.53 per share in 1998. The weighted average number of common and
common equivalent shares outstanding was 75.7 million in 1999 and 74.8 million
in 1998.

     1998 Compared to 1997

         REVENUES

         Revenues of $283.1 million in 1998 were essentially flat when compared
with 1997 revenues of $282.3 million. Although product revenues decreased 3% to
$274.4 million in 1998 compared to $282.1 million in 1997, royalty income and
technology fees increased to $8.7 million in 1998 versus $208,000 in 1997. The
decrease in product revenues was largely the result of a 12% decrease in
revenues from sales of HiGain products. Unit shipments of HiGain products during
1998 were 30% higher than 1997 unit shipments, but average selling prices
decreased 34%. This decline in HiGain revenue was offset by increases in sales
of ETSI, PG-Flex and PG-Plus products. Revenues from sales of ETSI products
increased 87% in 1998 despite a 16% decrease in average selling prices for those
products. Revenues from 1998 sales of PG-Flex and PG-Plus products were more
than three times the level of sales in 1997. PG-Flex and PG-Plus revenues
represented 17% of total revenue, up from 5% of total 1997 revenues. We expect
that PG-Flex and PG-Plus revenues will continue to become a greater portion of
total revenue in the future. Revenues from sales of PG-2 and Campus products
decreased 39% and 40%, respectively, in 1998 compared to 1997, the result of
decreased unit shipments and lower average selling prices. Unit shipments of
PG-2 products decreased 35% and average selling prices decreased 6% in 1998.
Unit shipments of Campus products decreased 33% and average selling prices
decreased 10% in 1998. The increase in royalty income and technology fees was
primarily the result of the Falcon chip licensing agreement entered into during
the first quarter of 1998.

         Aggregate sales to local telephone companies affiliated with the RBOCs
accounted for approximately 55% and 58% of our total revenues for 1998 and 1997,
respectively. Revenue per average employee decreased to $381,000 in 1998,
compared to $432,000 in 1997.


                                       31
<PAGE>   38

         As reported in Form 10-Q for the quarter ended September 30, 1998, a
large customer awarded a primary source HDSL contract to one of our competitors
during the fourth quarter of 1998. We previously supplied the dominant share of
HDSL product to this account. This will result in a decline in HDSL revenue sold
to this account. This decline could have a material adverse effect on our future
operating results.

         GROSS PROFIT

         Gross profit represents total revenues for a period, including 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 warranty reserves. In 1998, our gross profit as a
percentage of total revenues decreased to 48% from 49% in 1997. The decrease in
gross margin percentage was largely the result of decreases in average selling
prices, which were partially offset by our cost reduction efforts and higher
margin royalty income. We continue to place emphasis on continuing cost
reduction through engineering design changes, reduced prices for components,
increased manufacturing efficiencies and increase in volume to offset declining
average selling prices of our products. We expect that increased competition
will continue to place downward pressure on average selling prices. To the
extent that we are unable to offset these decreases with our cost reduction
efforts, or to introduce and sell new products with higher gross product
margins, we will continue to experience a decline in our gross margin.

         OPERATING EXPENSES

         Operating expenses, excluding merger expenses, increased 24% to $81.0
million in 1998 from $65.4 million in 1997. Nearly half of the increase in
absolute operating expense levels related to selling and marketing expenditures
and approximately one third of the increase related to research and development
expenses. We plan to increase our relative spending in engineering and field
sales support in an effort to continue to develop and market new products and
technologies. As a percentage of revenue, operating expenses, excluding merger
expenses in 1997, were 29% for 1998 and 23% for 1997.

         Research and development expense increased 17% to $37.6 million in 1998
from $32.0 million in 1997. Research and development expense was 13% of total
revenues in 1998 compared to 11% in 1997. The increase in expenses was primarily
due to the addition of personnel for the development of new products,
specifically, development programs for PG-Plus II and megabit access products,
including the Avidia System integrated access concentrator, and sustaining,
enhancement and cost reduction programs for HiGain, PG-Flex, PG-Plus, Falcon
chip technology and Campus products. The remainder of the increases consisted of
outside development consulting fees, external engineering charges and costs
specific to achieving new product approval, offset by reimbursement for
development services sold to outside parties.

         Selling and marketing expense increased 32% to $30.1 million in 1998
from $22.8 million in 1997. The increase in expense levels was primarily due to
the addition of personnel and the associated increase in salaries, benefits and
travel expenses, and additional advertising, trade show and other promotional
expenditures designed to market our new products and technology. In addition,
costs related to the expansion of our presence in the international market
increased 30% over the prior year. We anticipate higher selling and marketing
spending levels in the future in order to maintain our leadership position in
the DSL market and to secure market share in the subscriber and megabit access
markets. Selling and marketing expense as a percentage of total revenues was 11%
in 1998 and 8% in 1997.

         General and administrative expense increased to $13.3 million in 1998
from $10.6 million in 1997. Fees for outside services related to the upgrade of
our software systems, and increases in expenditures for computer software and
equipment repair and maintenance, insurance and legal fees represented the
majority of these increases. General and administrative expense as a percentage
of total revenues was 5% in 1998 compared to 4% in 1997.

         MERGER EXPENSES

         Expenses related to the acquisition of Avidia Systems, Inc. aggregating
approximately $2.6 million were charged against PairGain's operations in the
quarter ended March 31, 1997. These expenses consisted of $1.8 million in
investment banking fees, $588,000 in legal fees, $120,000 in accounting fees and
$121,000 in other expenses.


                                       32

<PAGE>   39

         INCOME FROM OPERATIONS

         As a result of the above, income from operations for 1998 was $55.5
million compared to $71.7 million in 1997. As a percentage of revenues, income
from operations was 19% in 1998 and 25% in 1997. Excluding merger expenses,
income from operations was $74.4 million or 26% of revenues in 1997.

         INTEREST AND OTHER INCOME, NET

         Net interest income was $9.1 million in 1998 and $6.9 million in 1997.
The increase in interest income was the result of increased average cash
balances.

         LOSS ON LONG-TERM INVESTMENTS

         In June 1996, we 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. We purchased
approximately 545,000 shares of E/O's Series D Preferred Stock for an aggregate
of $3.0 million. In the fourth quarter of 1998, we determined that E/O's market
value had decreased. Based upon that determination, we recorded an impairment
adjustment of $1.5 million during the fourth quarter of 1998 to reflect an
impairment in our investment in E/O.

         In July 1995, we entered into certain agreements with Sourcecom
Corporation of Westlake, California ("Sourcecom"). The agreements provided for
the incorporation of Sourcecom's networking technology into our current and
future transmission products. Under the terms of the agreements, we loaned
Sourcecom $2.7 million and had rights to purchase a minority ownership position.
The note bore interest at the prime rate less one percent, payable monthly, with
the principal balance due July 1999.

         In April 1996, we purchased approximately 150,000 shares of Sourcecom's
Series A Preferred Stock for an aggregate of $273,000. In September 1996, we
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 the third quarter of 1997, Sourcecom filed for protection from
creditors under the U.S. Bankruptcy Act. Accordingly, we recorded an impairment
adjustment of $544,000 during the third quarter of 1997 to reflect an impairment
in our investment in Sourcecom. In December 1997, Sourcecom and PairGain reached
an agreement for a mutual release of all claims. Under the terms of the release,
Sourcecom paid us $2.6 million to settle the loan made under the original
agreements. In the fourth quarter of 1997, we wrote-off the balance of the note
and associated legal fees aggregating $200,000.

         PROVISION FOR INCOME TAXES

         Our provision for income taxes decreased to $23.6 million in 1998,
compared to $30.3 million in 1997. The effective tax rate during 1998 was 37%.
The effective tax rate during 1997 was 39%.

         Excluding non-deductible merger expenses, the 1997 effective tax rate
was 38%. The primary reason for the reduction in our effective tax rate was due
to an increase in non-taxable interest income.

         NET INCOME AND EARNINGS PER SHARE

         Net income for the year ended December 31, 1998 was $39.5 million
compared to $47.6 million for the year ended December 31, 1997. Excluding merger
expenses, net income was $50.3 million in 1997.

         Basic earnings per share for 1998 were $0.56 per share compared to
$0.70 per share for 1997. Excluding merger expenses, basic earnings per share
for 1997 were $0.74 per share.

         The weighted average number of common shares outstanding were 70.2
million for 1998 and 68.0 million for 1997. This increase in common shares
outstanding was attributable to the exercise of stock options and warrants and
the issuance of shares under the Employee Stock Purchase Plan, offset by the
repurchase of shares during 1998 under the Employee Incentive Stock Option/Stock
Issuance Plan, the Employee Stock Purchase Plan and the Share Buyback Plan.


                                       33


<PAGE>   40

         Diluted earnings per share, which take into account the dilutive
effects of common stock options and warrants, were $0.53 per share in 1998
compared to $0.63 per share in 1997. Excluding merger expenses, dilutive
earnings per share were $0.67 per share in 1997. The weighted average number of
common and common equivalent shares outstanding was 74.8 million in 1998 and
75.2 million in 1997.

LIQUIDITY AND CAPITAL RESOURCES

         As of December 31, 1999, we had $191.6 million in cash, cash
equivalents and short-term investments and $259.6 million in working capital,
compared to $233.9 million in cash, cash equivalents and short-term investments
and $257.7 million in working capital in 1998. These figures represent a
decrease of $42.3 million in cash, cash equivalents and short-term investments
and an increase of $1.9 million in working capital over December 31, 1998. The
decrease in cash, cash equivalents and short-term investments was primarily
attributable to cash used in operations of $16.9 million, capital expenditures
of $17.5 million, long-term investments of $6.4 million, the issuance of a $2.0
million note receivable and $7.5 million for the repurchase of shares in 1999
under the Employee Incentive Stock Option/Stock Issuance Plan and the Share
Buyback Plan. These uses of cash were offset by proceeds from the issuance of
Common Stock resulting from exercises of options and warrants and Common Stock
sold under the Employee Stock Purchase Plan of $9.7 million and the assumption
of a note for $1.8 million related to the purchase of our headquarters
facilities. In 1998, we had cash flow from operations of $70.3 million offset by
capital expenditures of $10.6 million and the net effect of cash generated from
the issuance of Common Stock resulting from exercises of options and warrants
and Common Stock sold under the Employee Stock Purchase Plan of $6.8 million,
less $8.0 million for the repurchase of shares in 1998 under the Employee
Incentive Stock Option/Stock Issuance Plan, the Employee Stock Purchase Plan and
the Share Buyback Plan.

         Accounts receivable increased to $28.9 million at December 31, 1999,
compared to $20.2 million at December 31, 1998. The increase in accounts
receivable at December 31, 1999 was primarily due to a greater proportion of
shipments for the fourth quarter of 1999 occurring in December. In the fourth
quarter of 1998, the greater proportion of shipments occurred in October. Gross
inventories remained relatively flat, decreasing $115,000 to $51.6 million at
December 31, 1999 compared to $51.7 million at December 31, 1998. Reserves for
inventory obsolescence, excess quantities, cost reductions and test and
evaluation inventories decreased to $11.3 million at December 31, 1999 compared
to $17.4 million at December 31, 1998. The decrease in these reserves resulted
primarily from the write-off of obsolete and surplus inventories of $5.1
million, loss on the sale of excess component inventories of $318,000 and a
reduction of $643,000 on the amount of reserve required. Our net inventory turns
were 3.4 times in 1999 compared to 4.3 times in 1998.

         Capital expenditures were $17.5 million, $10.6 million, and $13.5
million for the years ended December 31, 1999, 1998 and 1997, respectively.
Included in 1999 expenditures was $4.5 million of software and equipment
purchased to upgrade our information system capabilities, including $906,000 in
software development costs capitalized under the provisions of AICPA Statement
of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." Software and equipment purchased to
upgrade our information system capabilities in 1998 and 1997 were $5.8 million
and $3.5 million, respectively. Included in 1998 expenditures was $2.2 million
in software development costs capitalized under SOP 98-1.

         During the second quarter of 1999, we purchased our Tustin, California
headquarters facility for $4.9 million. The purchase was paid with $3.1 million
in cash and assumption of a $1.8 million note. The note bears interest at 8.25%
and is due December 1, 2005. Additional expenditures in 1999 included
expenditures for test equipment of $4.8 million, $1.2 million in leasehold
improvements to a new 41,000 square foot facility located near our headquarters
facility that replaced a previous facility we vacated in the third quarter of
1999, and $965,000 for leasehold improvements to a new 40,000 square foot
facility for our research and development office in Raleigh, North Carolina. The
lease for the old facility in Raleigh was terminated without penalty once we
took occupancy of the new facility in the third quarter of 1999.

         On January 21, 2000, we signed a definitive agreement with GlobeSpan
for GlobeSpan to purchase the Company's microelectronics engineering group. The
purchase price was a combination of 3,243,591 shares of GlobeSpan common stock
(adjusted to reflect a three-for-one stock split as of February 29, 2000) and a
$90.0 million subordinated convertible promissory note. The sale of the
microelectronics engineering group to GlobeSpan


                                       34


<PAGE>   41
closed on February 24, 2000. Based upon the closing sale price on The Nasdaq
Stock MarketSM on February 24, 2000, the value of stock we received was
approximately $255.7 million. See Note 17 of Notes to the Consolidated
Financial Statements contained in a separate section of this Annual Report on
Form 10-K commencing on page F-1.

         On March 1, 2000, PairGain, through our wholly-owned subsidiary,
PairGain Canada, Inc., a Canadian corporation, entered into an Asset Purchase
Agreement with ABL Canada Inc., a Canadian corporation ("ABL"), under which we
agreed to purchase certain of ABL's assets, operations and business related to
ABL's SONET Multiplexing and Access Products. Under the Agreement, we agreed to
pay an aggregate of $10.4 million for the assets, which was paid on March 8,
2000 when the transaction closed. See Note 17 of Notes to the Consolidated
Financial Statements contained in a separate section of this Annual Report on
Form 10-K commencing on page F-1.

         In July 1999, we made a minority investment in @Link Communications
("@Link"), a Wisconsin-based Competitive Local Exchange Carrier (CLEC) which
provides xDSL-based data communications networking services for businesses,
internet service providers and network integrators. We purchased 3,874,416
shares of @Link's Series A Convertible Preferred Stock for an aggregate of
$833,000. In December 1999, we purchased an additional 2,582,944 shares of
@Link's Series A Convertible Preferred Stock for an aggregate of $556,000. We
have committed to purchase an additional 5,165,888 shares for an aggregate of
$1.1 million during 2000.

         In December 1999, we issued a note to Analog and Digital Devices
Telecommunications, Inc. ("ADDT"), a California-based company that manufactures
devices used in customer premises equipment. We issued ADDT a $2.0 million
secured promissory note which bears interest at prime (8.5% at December 31,
1999). We received a warrant for the right to purchase up to 7.5% of ADDT shares
for $2.0 million. We have committed to lend ADDT an additional $2.0 million on
April 1, 2000. At that time, we will receive a warrant for the right to purchase
an additional 7.5% of ADDT shares. The note is to be repaid between January 1,
2002 and December 16, 2004.

         In March 1999, we made a minority investment in ANDA Networks, Inc., a
California-based private company which develops next generation access systems.
We purchased 2,500,000 shares of ANDA's Series C Preferred Stock for an
aggregate of $5.0 million.

         On October 14, 1998 we announced that our Board of Directors approved a
plan to repurchase up to 7,000,000 shares, or approximately 10%, of our
outstanding common shares. As of December 31, 1999, we had repurchased 1,400,000
shares at a cost of approximately $10.9 million. On February 20, 2000, our Board
of Directors adopted a resolution to rescind the plan to repurchase shares of
outstanding Common Stock in connection with the ADC Merger Agreement.

         In July 1998, the Employee Stock Option Plan was amended to include an
automatic share increase feature which allowed us to repurchase shares on the
open market with cash proceeds received from the exercise of options under the
Option Plan. As of December 31, 1999, we had repurchased 391,400 shares at a
cost of approximately $4.2 million.

         We maintain an unsecured line of credit with a bank. The line allows
maximum borrowings of $5.0 million, including the issuance of letters of credit
and foreign exchange contracts. The line bears interest at the prime rate (8.50%
at December 31, 1999). At December 31, 1999, we had no outstanding borrowings
under this line of credit. The debt agreement specifies certain financial and
other covenants. We were in compliance with the financial and other covenants at
December 31, 1999. The agreement expires May 1, 2000.

         We have no other material near-term commitments for our funds. We
believe that the current cash and short-term investment balances and internally
generated cash flow will be sufficient to meet our working capital and capital
expenditure requirements through 1999. To the extent that our existing
resources, together with future earnings, are insufficient to fund our future
activities, we may need to raise additional funds through public or private
financings.

YEAR 2000 READINESS DISCLOSURE

         Many of the world's computer systems historically recorded years in a
two-digit format. Such computer systems would not be able to properly interpret
dates beyond the year 1999, which could have lead to business disruptions
globally (the "Year 2000 Issue"). PairGain implemented a Year 2000 Project (the
"Project") to address

                                       35
<PAGE>   42

and correct Year 2000 compliance issues with regard to our operating systems and
the readiness of our products, customer and suppliers. The Project was composed
of several phases which were designed to make sure that we did not encounter any
material adverse effects related to the Year 2000 Issue.

         To test our products' compliance, we adopted BellCore GR-2945-CORE,
Issue 1 standard for definition of "Year 2000 Compliant" products as the
majority of our products are sold to Bell operating companies. To date, all
PairGain products tested have been Year 2000 compliant without modification. If
any products are subsequently determined not to be compliant, we have pledged to
immediately notify all customers who have purchased any of the non-compliant
products and to upgrade or replace any of the installed, non-compliant products
in accordance with our standard warranty policy, regardless of whether the
equipment is still in the warranty period. Our internal operating systems have
also been assessed as being Year 2000 compliant. No material complications
occurred once we reached the Year 2000 in January.

         The total cost to address our Year 2000 Issue has not been material to
our financial condition. We used both internal and external resources to
reprogram, or replace, and test our software for Year 2000 modifications.
Excluding internal costs (which were not tracked separately), we budgeted
approximately $1.1 million for activities specific to the Year 2000 compliance
of our information systems. An additional $5.0 million was budgeted for various
other upgrades to software and hardware related to operational functionality
which also made those systems Year 2000 compliant. Purchased hardware and
software was capitalized in accordance with our standard capitalization policy.
All other costs related to the project were expensed as incurred. Budgeted
amounts were spent during 1998 and 1999 but were not incurred equally over all
phases of the Project. As of December 31, 1999 we had spent approximately $5.6
million of these budgeted amounts. These costs were funded through operating
cash flows.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         At December 31, 1999, we had an investment portfolio of fixed income
securities, including those classified as cash equivalents, of $184.1 million.
These securities are subject to interest rate fluctuations. An increase in
interest rates could adversely affect the market value of our fixed income
securities.

         A sensitivity analysis was performed on our investment portfolio as of
December 31, 1999. This sensitivity analysis is based on a modeling technique
that measures the hypothetical market value changes that would result from a
parallel shift in the yield curve of plus 50, plus 100 or plus 150 basis points
over a 12-month time horizon. The market value changes for a 50, 100 or 150
basis point increase in short-term treasury security yields were not material
due to the overall short-term maturity of our portfolio. As of December 31,
1999, the weighted average maturity of our portfolio is 233 days.

         We limit our exposure to interest rate and credit risk by establishing
and strictly monitoring clear policies and guidelines for our fixed income
portfolios. At the present time, the maximum average maturity of our overall
investment portfolio is limited by policy to 36 months. The guidelines also
establish credit quality standards, limits on exposure to one issue, issuer, as
well as the type of instrument. Due to the limited duration and credit risk
criteria established in our guidelines, the exposure to market and credit risk
is not expected to be material. We do not use derivative financial instruments
in our investment portfolio to manage interest rate risk.


                                       36

<PAGE>   43

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 beginning on page F-1 and
S-1, respectively.

     SUPPLEMENTARY FINANCIAL DATA

                        SELECTED QUARTERLY FINANCIAL DATA
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                           FOR THE THREE MONTHS ENDED
                                        ------------------------------------------------------------------
                                        MARCH 31,          JUNE 30,        SEPTEMBER 30,      DECEMBER 31,
                                        ---------         ---------        -------------      ------------
                                                    (IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<S>                                     <C>               <C>                <C>                <C>
1999

 Revenues                               $  60,896         $  61,171          $  51,193          $  51,615
 Gross profit                              25,510            25,348             17,770             17,784
 Income  (loss) from operations             3,911             1,474            (10,645)           (10,805)
 Net income (loss)(1)                       4,186             1,050             (4,162)             1,349

 Earnings per common share
   Basic                                $    0.06         $    0.01          $   (0.06)         $    0.02
   Diluted                              $    0.06         $    0.01          $   (0.06)         $    0.02
 Average shares outstanding
   Basic                                   70,351            71,010             71,141             71,475
   Diluted                                 74,491            75,549             71,141             76,482
</TABLE>

<TABLE>
<CAPTION>
                                                           FOR THE THREE MONTHS ENDED
                                       --------------------------------------------------------------------
                                         MARCH 31,         JUNE 30,         SEPTEMBER 30,      DECEMBER 31,
                                        ---------         ---------         -------------      ------------
                                                    (IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<S>                                     <C>               <C>                <C>                <C>
1998

 Revenues                               $  72,619         $  73,416          $  76,386          $  60,679
 Gross profit                              36,885            37,283             36,866             25,497
 Income from operations                    17,061            16,406             16,802              5,267
 Net income                                12,162            11,752             11,986              3,599

 Earnings per common share
   Basic                                $    0.17         $    0.17          $    0.17          $    0.05
   Diluted                              $    0.16         $    0.16          $    0.16          $    0.05
 Average shares outstanding
   Basic                                   69,543            70,120             70,589             70,682
   Diluted                                 75,203            75,111             74,632             74,257
</TABLE>

-----------------
(1)  Included in the fourth quarter of 1999 was a $5.5 million tax benefit from
     the recognition of previously incurred capital loss carryforwards and the
     reversal of valuation allowances on certain deferred tax assets. The
     majority of the benefit related to a capital loss incurred in 1995, which
     had previously been unrecognized due to the uncertainty of generating
     capital gains under the Company's current investment policies. Due to the
     Company's divestiture of its microelectronics engineering group in the
     first quarter of 2000, the realization of these capital losses is now
     assured.

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

        None.

                                       37

<PAGE>   44

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

         The following table sets forth certain information concerning
PairGain's Executive Officers and Directors.

<TABLE>
<CAPTION>

       NAME                   AGE                           POSITION
-----------------             ---         -----------------------------------------------------------
<S>                           <C>         <C>
Charles S. Strauch (1)         64         Chairman of the Board
Michael Pascoe (1)             47         Chief Executive Officer, President and Director
Howard S. Flagg                45         Executive Vice President, Business Development and Director
Charles W. McBrayer (2)        51         Executive Vice President
Robert R. Price (2)            47         Senior Vice President, Chief Financial Officer and Secretary
Dennis Young                   57         Executive Vice President, Business Units
Benedict A. Itri (3)           46         Director
Howard G. Bubb (4)             45         Director
Robert C. Hawk (4)             60         Director
Robert A. Hoff (5)             47         Director
B. Allen Lay (4) (5)           65         Director
</TABLE>

------------------------
(1)  Through January 11, 1999, Mr. Strauch had the additional title of Chief
     Executive Officer. On January 11, 1999, Mr. Pascoe was appointed Chief
     Executive Officer and President.

(2)  During 1999 and through January 9, 2000, Mr. McBrayer had the additional
     title of Executive Vice President, Chief Financial Officer and Secretary.
     On January 10, 2000, Mr. McBrayer announced his March 31, 2000 retirement
     and Robert R. Price was appointed Senior Vice President, Chief Financial
     Officer and Secretary.

(3)  During 1999 and through February 23, 2000, Mr. Itri had the additional
     title of Executive Vice President, Chief Technical Officer. On February 24,
     2000, in conjunction with the Agreement with GlobeSpan, Inc. Mr. Itri
     tendered his resignation as an officer of PairGain. Mr. Itri retained the
     position as a PairGain director.

(4)  Member of the Audit Committee

(5)  Member of the Compensation Committee

         Mr. Strauch became a PairGain director in October 1991 and has been
Chairman of our Board of Directors since November 1991. Mr. Strauch served as
our Chief Executive Officer from April 1992 until January 1999. Prior to his
employment with PairGain, Mr. Strauch held executive management positions and
directorships with various publicly traded companies including Chief Executive
Officer of MSI Data Corporation, a manufacturer of hand-held data collection
devices (AMEX); Chief Executive Officer of Magnuson Computer Systems, a
manufacturer of main frame computers (Nasdaq); and President/Chief Operating
Officer of Memorex, a manufacturer of computer peripherals (NYSE). Mr. Strauch
has also held several directorships including Symbol Technologies, EECO Inc. and
BMC Industries.

         Mr. Pascoe joined PairGain as a part-time employee in December 1998 and
was appointed Chief Executive Officer, President and a member of the Board of
Directors on January 11, 1999. Mr. Pascoe was employed by Newbridge Networks
from 1986 to 1998, where his most recent position was President, Newbridge
Networks - US and Executive Vice President, North and South America. Mr. Pascoe
has also held senior sales, marketing and technical management positions at
Rockwell Telcom, MiTel and Nortel/Bell Northern Research.

         Mr. Flagg, a PairGain founder, was named Executive Vice President,
Business Development in January 1999, and has been a PairGain director since
November 1991. He served as President from November 1991 to December 1998, 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
PairGain, Mr. Flagg founded and served as a principal of Advanced
Telecommunications, Inc., an aerospace telecommunications consulting firm.


                                       38


<PAGE>   45

         Mr. Itri, a PairGain founder, was Executive Vice President, Chief
Technical Officer from April 1996 until February 24, 2000, when he tendered his
resignation in conjunction with the Agreement with GlobeSpan, Inc. Mr. Itri
retained the position as a PairGain director. Previously, Mr. Itri was Vice
President, Engineering of PairGain since its inception in February 1988 and has
been a PairGain director since November 1991. Prior to founding PairGain, Mr.
Itri founded and served as a principal of Advanced Telecommunications, Inc.

         Mr. McBrayer announced his March 31, 2000 retirement from his position
as PairGain's Executive Vice President and Chief Financial Officer on January
10, 2000, a position he held since April 1999. Mr. McBrayer joined PairGain in
March 1995 as Vice President, Finance and Administration and Chief Financial
Officer and was named Senior Vice President and Chief Financial Officer in
February 1998. Mr. McBrayer served as Vice President, Finance and Chief
Financial Officer for Triconex Corporation, a publicly held corporation
(Nasdaq), from 1986 to March 1995 and was named to the Board of Directors of
Triconex in January 1994.

         Mr. Price was appointed Senior Vice President, Chief Financial Officer
on January 10, 2000. Mr. Price joined PairGain in September 1995 as Corporate
Controller and was promoted to Vice President & Corporate Controller in January
1998. Mr. Price was Corporate Controller for Triconex Corporation, a publicly
held corporation (Nasdaq), from 1992 until he joined PairGain in 1995. Prior to
Triconex, Mr. Price held financial management positions at both public and
privately-held companies.

         Mr. Young was named Executive Vice President, Business Units in May
1999. Mr. Young joined PairGain in September 1993 as Director, European
Operations. Mr. Young assumed the position of Vice President, Operations in
December 1994 and was Senior Vice President, Operations and Business Units from
February 1998 until May 1999. From 1985 to 1993, Mr. Young served as Managing
Director of Talley (UK) Ltd. and EECO (UK) Ltd. These companies designed,
manufactured and marketed both consumer and industrial products throughout the
United Kingdom, Europe and certain world markets.

         Mr. Bubb became a PairGain director in December 1997. Mr. Bubb has been
President of Dialogic and Vice President of Intel Communications Product Group
since Dialogic's acquisition in July 1999. Mr. Bubb was President and CEO of
Dialogic Corporation from June 1993 until July 1999. From July 1991 through June
1993, Mr. Bubb was an Executive Vice President of Dialogic. Mr. Bubb has served
as director for Dialogic since 1994. Mr. Bubb joined Dialogic from Telenova's
Lexar subsidiary where he was senior vice president and general manager. Mr.
Bubb also held senior management positions at United Technologies, Memorex and
Telex corporations.

         Mr. Hawk became a PairGain director in November 1992. Mr. Hawk is
President of Hawk Communications and retired as President and CEO of U S WEST
Multimedia Communications, Inc. From 1988 until 1996, Mr. Hawk served as
President of the Carrier Division of U S WEST Communications, Inc. Prior to that
time, Mr. Hawk served as Vice President, Marketing and Strategic Planning for
CXC Corporation and as Director, Advanced Systems Development for AT&T/American
Bell. Mr. Hawk also serves as a director of Covad Communications Group, Inc.
(Nasdaq), Concord Communications (Nasdaq), Efficient Networks, Inc. (Nasdaq) and
Com21 Incorporated (Nasdaq).

         Mr. Hoff became a PairGain director 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 Sonoma Systems and publicly-held Efficient Networks, Inc.
(Nasdaq) and Com21 Incorporated (Nasdaq).

         Mr. Lay became a PairGain director 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 serves as a director of
privately-held Physical Optics Corporation and Waveband, Inc. and of
publicly-held ViaSat, Inc. (Nasdaq).

COMPLIANCE WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934

         Section 16(a) of the Securities Exchange Act of 1934 requires
PairGain's officers and directors, and persons who own more than 10% of a
registered class of our equity securities, to file reports of ownership and
changes in ownership with the Securities and Exchange Commission. They are
further required by SEC Regulation to furnish us with copies of all reports
filed pursuant to Section 16(a).


                                       39


<PAGE>   46

         Based solely on our review of copies of such reports we received, or
written representations of certain reporting persons, we believe that, during
1999, all filing requirements applicable to our executive officers, directors
and greater than ten percent stockholders were complied with, with the following
exceptions:

         o  Mr. Flagg filed an amended Form 4 for May 1998 on December 10, 1999
            to report a change in beneficial ownership of 10,000 shares of
            PairGain common stock;

         o  Mr. Lay failed to timely file a Form 4 for the month of May 1999
            with respect to a sale of 15,000 shares of PairGain common stock.
            Mr. Lay filed a Form 4 on June 28, 1999 reporting this sale; and

         o  Mr. Pascoe filed a Form 5 on February 14, 2000 to report the receipt
            of a stock option grant dated as of December 16, 1998.

ITEM 11. EXECUTIVE COMPENSATION.

     SUMMARY OF CASH AND OTHER COMPENSATION

         The following table provides certain summary information concerning the
compensation earned by PairGain's Chief Executive Officer, former Chief
Executive Officer and each of our four additional most highly compensated
Executive Officers (the "Named Executive Officers") serving as such as of the
end of the last fiscal year whose compensation for such year was in excess of
$100,000 for services rendered in all capacities to PairGain and our
subsidiaries for the 1999, 1998 and 1997 fiscal years.

                                     TABLE I

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                                                      LONG TERM
                                                      ANNUAL COMPENSATION                           COMPENSATION
                               ------------------------------------------------------------------   --------------
                                                                                                      SECURITIES
          NAME AND                            SALARY($)                          OTHER ANNUAL         UNDERLYING
     PRINCIPAL POSITION          YEAR          (1)(2)         BONUS($)(2)      COMPENSATION($)(3)      OPTIONS(#)
------------------------------   ----         ---------       -----------      ------------------    -------------
<S>                              <C>          <C>             <C>              <C>                   <C>
Charles S. Strauch (4)           1999          224,615          51,896             169,305                   --
Chairman of the Board            1998          280,000              --              75,631               40,000
                                 1997          280,000          33,697                 500                   --

Michael Pascoe (4)               1999          353,500         121,875                  --                   --
Chief Executive Officer and      1998            7,700              --                  --              450,000
 President                       1997               --              --                  --                   --

Howard S. Flagg                  1999          175,000          28,127              67,714               15,000
Executive Vice President,        1998          154,808              --              51,833               25,000
 Business Development            1997          144,231          17,357              11,610                   --

Benedict A. Itri (5)             1999          170,000          27,192              36,743                   --
Director                         1998          149,808              --              53,459               25,000
                                 1997          139,231          16,756              31,339                   --

Charles W. McBrayer (6) (7)      1999          192,692          28,904              42,719               20,000
 Executive Vice President        1998          157,885              --              16,019              130,334
                                 1997          145,385          17,496                 514                8,000

Dennis Young (8)                 1999          186,538          36,174                  --               20,000
Executive Vice President,        1998          146,346              --                 500               36,000
 Business Units                  1997          125,385          15,089                  --                8,000
</TABLE>

--------------------
(1)  Includes amounts deferred pursuant to PairGain's 401(k) Plan, where
     applicable.

(2)  Includes amounts deferred pursuant to PairGain's Management Deferred
     Compensation Plan. Specific amounts earned but deferred for each Named
     Executive Officer follow.


                                       40

<PAGE>   47

                             1999 ($)     1998 ($)    1997 ($)
                             --------     --------    --------

       Mr. Strauch            50,257      140,000     282,232
       Mr. Pascoe                 --           --          --
       Mr. Flagg                  --       92,885      86,538
       Mr. Itri              178,614      144,818     151,026
       Mr. McBrayer           20,940       47,366      48,864
       Mr. Young                  --           --          --


(3)  Other Annual Compensation includes the excess earnings accrued for each
     fiscal year on the account balances under the Management Deferred
     Compensation Plan. A breakdown of Other Annual Compensation for the Named
     Executive Officers follows.

<TABLE>
<CAPTION>
                                                                                   EXCESS EARNINGS
                                                               CASH IN LIEU          ON DEFERRED
                                             401(K)              OF 401(K)           COMPENSATION
           NAME              YEAR        CONTRIBUTION ($)      CONTRIBUTION($)         ACCOUNTS
       -----------           ----        ----------------      ---------------     ---------------
<S>                          <C>         <C>                   <C>                 <C>
       Mr. Strauch           1999            1,000                     --               156,720
                             1998            1,000                     --                74,631
                             1997              500                     --                    --

       Mr. Pascoe            1999               --                     --                    --
                             1998               --                     --                    --
                             1997               --                     --                    --

       Mr. Flagg             1999            1,000                     --                61,276
                             1998            1,000                     --                50,833
                             1997              500                     --                11,110

       Mr. Itri              1999               --                     --                24,498
                             1998               --                    500                52,959
                             1997               --                     --                31,339

       Mr. McBrayer          1999            1,000                     --                39,012
                             1998            1,000                     --                15,019
                             1997              500                     --                    14

       Mr. Young             1999               --                     --                    --
                             1998               --                    500                    --
                             1997               --                     --                    --
</TABLE>

       401(k) Contribution is the amount of the matching contribution made by
       PairGain the Named Executive Officer's 401(k) account.

       Cash in lieu of 401(k) Contribution is a one-time bonus paid company-wide
       to those not in the 401(k) Plan during 1998.

       Excess Earnings on Deferred Compensation Accounts are the excess earnings
       accrued for each fiscal year on the account balances under the Management
       Deferred Compensation Plan in excess of 120% of the applicable federal
       rate in effect at the start of each such fiscal year.

(4)   Through January 11, 1999, Mr. Strauch had the additional title of Chief
      Executive Officer. On January 11, 1999, Mr. Pascoe was appointed Chief
      Executive Officer and President.

(5)   During 1999 and through February 23, 2000, Mr. Itri had the additional
      title of Executive Vice President, Chief Technical Officer. On February
      24, 2000, in conjunction with the Agreement with GlobeSpan, Inc. Mr. Itri
      tendered his resignation as an officer of PairGain. Mr. Itri retained the
      position as a PairGain director.


                                       41


<PAGE>   48

(6)   During 1999 and through January 9, 2000, Mr. McBrayer had the additional
      title of Executive Vice President, Chief Financial Officer and Secretary.
      On January 10, 2000, Mr. McBrayer announced his March 31, 2000 retirement
      and Robert R. Price was appointed Senior Vice President, Chief Financial
      Officer and Secretary.

(7)   1998 grants to Mr. McBrayer include 20,000 option shares granted in 1998,
      plus 110,334 option shares granted under repricing programs to replace
      shares previously granted at higher exercise prices.

(8)   1998 grants to Mr. Young include 20,000 option shares granted in 1998,
      plus 16,000 option shares granted under repricing programs to replace
      shares previously granted at higher exercise prices.

       MANAGEMENT DEFERRED COMPENSATION PLAN

         The Management Deferred Compensation Plan was established January 1,
1996 to provide a tax deferred capital accumulation opportunity to senior
management and other key employees through deferrals of salary, commission and
incentive compensation awards. Any employee whose annual base salary is $100,000
or greater is eligible to participate. Up to 100% of annual base salary,
commission and/or annual incentive income may be deferred. The minimum election
amount is $5,000 which can be satisfied from salary, commission, and/or
incentive compensation. Deferral elections can be changed annually before the
beginning of the next plan year. Deferrals may be invested in one or more of
certain selected investment funds. Investment elections may be changed
quarterly. PairGain may make discretionary contributions at any time, but all
contributions must be approved by the Compensation Committee of the Board of
Directors. All deferrals are 100% vested at the time of the contribution,
however, any company contributions would be subject to a vesting schedule.
PairGain made no contributions or provisions for contributions to this Plan in
1999, 1998 or 1997.

Amounts owed as of December 31, 1999 under the Management Deferred Compensation
Plan for the Named Executive Officers is as follows:

<TABLE>
<CAPTION>

                           NAME AND PRINCIPAL POSITION                                  $
         ---------------------------------------------------------------           ---------
<S>                                                                                <C>
         Charles S. Strauch, Chairman of the Board (1)                               967,025
         Michael Pascoe, Chief Executive Officer and President (1)                        --
         Howard S. Flagg, Executive Vice President, Business Development             438,374
         Benedict A. Itri, Director (2)                                              911,604
         Charles W. McBrayer, Executive Vice President (3)                           231,295
         Dennis Young, Executive Vice President, Business Units                           --

         All executive officers as a group (six persons)                           2,548,298
</TABLE>

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

(1) Through January 11, 1999, Mr. Strauch had the additional title of Chief
    Executive Officer. On January 11, 1999, Mr. Pascoe was appointed Chief
    Executive Officer and President.

(2) During 1999 and through February 23, 2000, Mr. Itri had the additional title
    of Executive Vice President, Chief Technical Officer. On February 24, 2000,
    in conjunction with the Agreement with GlobeSpan, Inc. Mr. Itri tendered his
    resignation as an officer of PairGain. Mr. Itri retained the position as a
    PairGain director.

(3) During 1999 and through January 9, 2000, Mr. McBrayer had the additional
    title of Executive Vice President, Chief Financial Officer and Secretary. On
    January 10, 2000, Mr. McBrayer announced his March 31, 2000 retirement and
    Robert R. Price was appointed Senior Vice President, Chief Financial Officer
    and Secretary.


                                       42

<PAGE>   49

     OPTION GRANTS

         The following table contains information concerning the grant of stock
options made under PairGain's 1993 Plan for the fiscal year ended December 31,
1999 to the Named Executive Officers.

                                    TABLE II

                        OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
                                                  INDIVIDUAL GRANTS
                              ----------------------------------------------------------    POTENTIAL REALIZABLE
                                                                                             VALUE AT ASSUMED
                                 NO. OF                                                       ANNUAL RATES OF
                               SECURITIES     PERCENT OF                                        STOCK PRICE
                               UNDERLYING    TOTAL OPTIONS                                    APPRECIATION FOR
                                OPTIONS       GRANTED TO      EXERCISE OR                    OPTION TERM(S) (3)
                                GRANTED      EMPLOYEES IN     BASIC PRICE    EXPIRATION     ----------------------
       NAME                     (#) (1)          1999        ($/SHARE) (2)      DATE          5% ($)       10% ($)
 ----------------------        ----------    -------------   -------------   -----------    ------------ ---------
<S>                            <C>           <C>             <C>             <C>            <C>          <C>
 Charles S. Strauch (4)              --           --               --            --             --           --

 Michael Pascoe (4)                  --           --               --            --             --           --

 Howard S. Flagg                 15,000           0.5            8.4375       08/09/09        79,594      201,708

 Benedict A. Itri (5)                --           --               --            --             --           --

 Charles W. McBrayer (6)         20,000           0.6            8.4375       08/09/09       106,126      268,944

 Dennis Young                    20,000           0.6            8.4375       08/09/09       106,126      268,944
</TABLE>

 ------------------------
(1)    All of the options were granted under PairGain's 1993 Plan. The option
       shares will vest in 48 equal monthly installments upon the completion of
       each month of service beginning one month after the date of grant. The
       options shares may be subject to accelerated vesting in connection with
       certain changes in control or ownership of PairGain. Each option will
       have a maximum term of ten years, subject to earlier termination
       following the optionee's cessation of service with PairGain.

(2)    The exercise price per share of the options granted represented the fair
       market value of the underlying shares of common stock on the dates the
       respective options were granted. The exercise price may be paid in cash
       or in shares of common stock valued at fair market value on the exercise
       date.

(3)    There is no assurance provided to any executive officer or any other
       holder of PairGain's securities that the actual stock price appreciation
       over the ten-year option term will be at the assumed 5% and 10% levels or
       at any other defined level. Unless the market price of the common stock
       does in fact appreciate over the option term, no value will be realized
       from the option grants made to the executive officers.

(4)    Through January 11, 1999, Mr. Strauch had the additional title of Chief
       Executive Officer. On January 11, 1999, Mr. Pascoe was appointed Chief
       Executive Officer and President.

(5)    During 1999 and through February 23, 2000, Mr. Itri had the additional
       title of Executive Vice President, Chief Technical Officer. On February
       24, 2000, in conjunction with the Agreement with GlobeSpan, Inc. Mr. Itri
       tendered his resignation as an officer of PairGain. Mr. Itri retained the
       position as a PairGain director.

(6)    During 1999 and through January 9, 2000, Mr. McBrayer had the additional
       title of Executive Vice President, Chief Financial Officer and Secretary.
       On January 10, 2000, Mr. McBrayer announced his March 31, 2000 retirement
       and Robert R. Price was appointed Senior Vice President, Chief Financial
       Officer and Secretary.


                                       43

<PAGE>   50

         The following table sets forth information concerning option exercises
and option holdings for the fiscal year ended December 31, 1999 with respect to
the Named Executive Officers. No stock appreciation rights were exercised by any
such officer during such year and no stock appreciation rights were outstanding
on December 31, 1999.

                                    TABLE III

 AGGREGATE OPTION EXERCISE IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                                                    NUMBER OF                  VALUE OF UNEXERCISED
                               NUMBER                         UNEXERCISED OPTIONS AT         IN-THE-MONEY OPTIONS AT
                             OF SHARES        VALUE             DECEMBER 31, 1999           DECEMBER 31, 1999 ($) (2)
                              ACQUIRED       REALIZED     ------------------------------- -------------------------------
           NAME             ON EXERCISE       ($)(1)       EXERCISABLE    UNEXERCISABLE    EXERCISABLE    UNEXERCISABLE
 -------------------------- ------------- --------------- -------------- ---------------- -------------- ----------------
<S>                           <C>            <C>              <C>             <C>           <C>             <C>
 Charles S. Strauch (3)        535,456        4,534,577        585,757         28,335        7,338,015       225,793

 Michael Pascoe(3)                  --               --        112,500        337,500          808,594     2,425,781

 Howard S. Flagg               176,608        2,004,549        524,032         31,460        6,776,712       220,186

 Benedict A. Itri(3)           151,612        1,284,185        575,902          4,590        7,287,758        36,576

 Charles W. McBrayer(3)        100,000          878,906         89,200        109,880          841,669       772,053

 Dennis Young                   15,000          143,438        179,744         39,336        1,531,547       264,490
</TABLE>

 ---------------------
(1)  Based on the market price at the time of exercise less the exercise price.

(2)  Based upon the closing selling price of $14.19 per share on the last day of
     the 1999 fiscal year, less the option exercise price payable per share.

(3)  Through January 11, 1999, Mr. Strauch had the additional title of Chief
     Executive Officer. On January 11, 1999, Mr. Pascoe was appointed Chief
     Executive Officer and President.

(4)  During 1999 and through February 23, 2000, Mr. Itri had the additional
     title of Executive Vice President, Chief Technical Officer. On February 24,
     2000, in conjunction with the Agreement with GlobeSpan, Inc. Mr. Itri
     tendered his resignation as an officer of PairGain. Mr. Itri retained the
     position as a PairGain director.

(5)  During 1999 and through January 9, 2000, Mr. McBrayer had the additional
     title of Executive Vice President, Chief Financial Officer and Secretary.
     On January 10, 2000, Mr. McBrayer announced his March 31, 2000 retirement
     and Robert R. Price was appointed Senior Vice President, Chief Financial
     Officer and Secretary.

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

         The following table sets forth information concerning the beneficial
ownership of shares of PairGain's common stock by:

         o  each beneficial owner of more than 5% of the outstanding shares of
            common stock;

         o  each PairGain director;

         o  the Chief Executive Officer and the four most Highly compensated
            other Executive Officers; and

         o  by all PairGain directors and executive officers as a group.


                                       44

<PAGE>   51

         Except as otherwise noted, this information is presented as of February
25, 2000, and each beneficial owner listed has sole investment and voting power
with respect to the common stock indicated.

<TABLE>
<CAPTION>

NAME OF INDIVIDUAL                                                           SHARES          OPTIONS
   OR NUMBER OF                                                           BENEFICIALLY     EXERCISABLE        PERCENT
 PERSONS IN GROUP                 POSITION WITH PAIRGAIN                     OWNED       WITHIN 60 DAYS(1)   OF SHARES
---------------------             ----------------------                  ------------   ----------------    ----------
<S>                               <C>                                     <C>            <C>                 <C>
Howard G. Bubb                      Director                                      --         80,000              *

Robert C. Hawk                      Director                                      --         70,169              *

Robert A. Hoff                      Director                                  19,980        100,000              *

Benedict A. Itri (2)                Director                               1,049,747         17,189            1.5%

B. Allen Lay                        Director                                  85,676        100,000              *

Charles S. Strauch                  Chairman of the Board                    792,173        589,091            1.9%

Michael Pascoe                      Chief Executive Officer                       --        150,000              *
                                      and President

Howard S. Flagg                     Executive Vice President, Business       491,376        437,365            1.3%
                                      Development and Director

Charles W. McBrayer (3)             Executive Vice President                  39,764         91,130              *

Robert R. Price                     Senior Vice President,                       602         13,886              *
                                      Chief Financial Officer

Dennis Young                        Executive Vice President,                  2,415        184,578              *
                                      Business Units

All directors and executive                                                2,481,733      1,833,408            5.8%
 officers as a group
 (eleven persons)
</TABLE>

-----------------------
(*)  Less than 1%

(1)  Number of shares subject to options that are exercisable as of February 25,
     2000 or within 60 days after that date.

(2)  During 1999 and through February 23, 2000, Mr. Itri had the additional
     title of Executive Vice President, Chief Technical Officer. On February 24,
     2000, in conjunction with the Agreement with GlobeSpan, Inc. Mr. Itri
     tendered his resignation as an officer of PairGain. Mr. Itri retained the
     position as a PairGain director.

(3)  During 1999 and through January 9, 2000, Mr. McBrayer had the additional
     title of Executive Vice President, Chief Financial Officer and Secretary.
     On January 10, 2000, Mr. McBrayer announced his March 31, 2000 retirement
     and Robert R. Price was appointed Senior Vice President, Chief Financial
     Officer and Secretary.


                                       45

<PAGE>   52

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

         None.


                                       46

<PAGE>   53
                                     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 commencing on page F-1:

    Independent Auditors' Report
    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 1999, 1998 and 1997 is
included in a separate section of this Annual Report on Form 10-K 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:

         (q)2.1   Agreement and Plan of Merger, dated as of February 22, 2000,
                  among ADC Telecommunications, Inc., Roman Acquisition Corp.
                  and PairGain Technologies, Inc.

         (r)2.2   Asset Purchase Agreement, dated as of January 21, 2000,
                  between GlobeSpan, Inc. and PairGain Technologies, Inc.

         (a)3.1   Certificate of Incorporation of Registrant, a Delaware
                  corporation

         (g)3.2   Amendment to Certificate of Incorporation of PairGain
                  Technologies, Inc.

         (i)3.3   Amendment to Certificate of Incorporation of PairGain
                  Technologies, Inc.

         (a)3.4   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


                                       47
<PAGE>   54

         (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

         (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


                                       48
<PAGE>   55

         (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

         (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

         (k)10.43 Avidia Systems, Inc. 1996 Stock Plan (the "Avidia Plan")

         (k)10.44 Form of Incentive Stock Option Agreement pertaining to the
                  Avidia Plan

         (k)10.45 Form of Non-Qualified Stock Option Agreement pertaining to the
                  Avidia Plan

         (k)10.46 Form of Stock Option Assumption Agreement pertaining to the
                  Avidia Plan

         (l)10.47 PairGain Technologies, Inc. 1993 Option/Stock Issuance Plan as
                  amended (the "1993 Plan")

         (m)10.48 PairGain Technologies, Inc. 1993 Option/Stock Issuance Plan as
                  amended (the "1993 Plan")

         (n)10.49 Rights Agreement between PairGain Technologies, Inc. and U.S.
                  Stock Transfer Corporation as Rights Agent, dated as of
                  December 3, 1998

         (o)10.50 Form of Change in Control Agreement with Executive Officers
                  and Other Key Employees

         (p)10.51 PairGain Technologies, Inc. 1993 Option/Stock Issuance Plan as
                  amended (the "1993 Plan").

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

         21.1     Subsidiaries of the Registrant

         23.1     Consent of Deloitte & Touche LLP, Independent Auditors

         27.1     Financial Data Schedule


                                       49

<PAGE>   56

--------------------
(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.

(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.

(k)   Incorporated herein by reference to Exhibit number 99.1 to the Company's
      Registration Statement No. 333-26643 on Form S-8, as filed with the
      Commission on May 7, 1997.

(l)   Incorporated herein by reference to Exhibit number 99.1 to the Company's
      Registration Statement No. 333-33739 on Form S-8, as filed with the
      Commission on August 15, 1997.

(m)   Incorporated herein by reference to Exhibit number 99.1 to the Company's
      Registration Statement No. 333-60067 on Form S-8, as filed with the
      Commission on July 28, 1998.

(n)   Incorporated herein by reference to Exhibit number 1 to the Company's
      Registration Statement on Form 8-A, as filed with the Commission on
      December 15, 1998.

(o)   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, 1998, as filed with the Commission on March 29, 1999.

(p)   Incorporated herein by reference to Exhibit number 99.1 to the Company's
      Registration Statement No. 333-81947 on Form S-8, as filed with the
      Commission on June 30, 1999.

(q)   Incorporated herein by reference to the same Exhibit number to the
      Company's Current Report on Form 8-K ,as filed with the Commission on
      February 28, 2000.

(r)   Incorporated herein by reference to Exhibit number 2.1 to the Company's
      Current Report on Form 8-K ,as filed with the Commission on March 10,
      2000.

                                       50
<PAGE>   57

         (b) REPORTS ON FORM 8-K:

         A Form 8-K was filed on November 15, 1999 citing Item 5, Other Events,
to record the final settlement between the Company, Charles S. Strauch and
Charles W. McBrayer, the U.S. Attorney's Office and the Securities and Exchange
Commission.



                                       51

<PAGE>   58

                                   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.

                                        PAIRGAIN TECHNOLOGIES, INC.

Date: March 17, 2000                    By:       /s/ MICHAEL PASCOE
                                           -------------------------------------
                                                      Michael Pascoe
                                                       (Registrant)
                                           Chief Executive Officer and President
                                                (Principal Executive Officer)


Date: March 17, 2000                    By:       /s/ ROBERT R. PRICE
                                            ------------------------------------
                                                      Robert R. Price
                                               Senior Vice President, Chief
                                                    Financial Officer
                                               (Principal Financial and Chief
                                                   Accounting Officer)

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

<TABLE>
<CAPTION>

                  Signature                                    Title                               Date
    --------------------------------------     -------------------------------                --------------
<S>                                            <C>                                            <C>
    /s/ CHARLES S. STRAUCH                     Chairman of the Board                          March 17, 2000
    --------------------------------------
    Charles S. Strauch

    /s/ MICHAEL PASCOE                         Chief Executive Officer,                       March 17, 2000
    --------------------------------------     President and Director
    Michael Pascoe

    /s/ HOWARD S. FLAGG                        Executive Vice President, Business             March 17, 2000
    --------------------------------------     Development and Director
    Howard S. Flagg

    /s/ ROBERT R. PRICE                        Senior Vice President,                         March 17, 2000
    --------------------------------------     Chief Financial Officer
    Robert R. Price

    /s/ HOWARD G. BUBB                         Director                                       March 17, 2000
    --------------------------------------
    Howard G. Bubb

    /s/ BENEDICT A. ITRI                       Director                                       March 17, 2000
    --------------------------------------
    Benedict A. Itri

    /s/ ROBERT C. HAWK                         Director                                       March 17, 2000
    --------------------------------------
    Robert C. Hawk

    /s/ ROBERT A. HOFF                         Director                                       March 17, 2000
    --------------------------------------
    Robert A. Hoff

    /s/ B. ALLEN LAY                           Director                                       March 17, 2000
    --------------------------------------
    B. Allen Lay
</TABLE>


                                       52

<PAGE>   59

                           PAIRGAIN TECHNOLOGIES, INC.

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

              FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997


                                    CONTENTS


                                                                PAGE
                                                               ------

    Independent Auditors' Report                                F-2

    Consolidated Financial Statements:
      Consolidated Balance Sheets                               F-3
      Consolidated Statements of Income                         F-4
      Consolidated Statements of Comprehensive 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>   60

                          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 (the "Company") as of December 31, 1999 and
1998, and the related consolidated statements of income, comprehensive income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1999. Our audits 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
audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. 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 PairGain Technologies, Inc. and
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States of America. 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 24, 2000


                                      F-2

<PAGE>   61

                           PAIRGAIN TECHNOLOGIES, INC.

                           CONSOLIDATED BALANCE SHEETS

                  (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

                                     ASSETS

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                           ---------------------------
                                                              1999              1998
                                                           ---------         ---------
<S>                                                        <C>               <C>
Current assets:
   Cash and cash equivalents                               $  86,522         $ 131,923
   Short-term investments (Note 4)                           105,050           102,011
   Accounts receivable, less allowance for doubtful
     accounts of $900 at both December 31,
     1999 and 1998                                            28,856            20,226
   Inventories (Note 5)                                       40,285            34,320
   Deferred tax assets (Note 9)                               17,884            13,249
   Other current assets                                       11,383             5,463
                                                           ---------         ---------
TOTAL CURRENT ASSETS                                         289,980           307,192
Property, plant and equipment, net (Note 6)                   26,522            19,482
Long-term investments (Note 7)                                 8,389             1,500
Other assets                                                     190               346
                                                           ---------         ---------
TOTAL ASSETS                                               $ 325,081         $ 328,520
                                                           =========         =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Trade accounts payable                                  $  11,267         $   6,358
   Accrued expenses (Note 8)                                  19,089            27,002
   Accrued income taxes (Note 9)                                  --            16,119
   Current portion of note payable (Note 10)                      33                --
                                                           ---------         ---------
TOTAL CURRENT LIABILITIES                                     30,389            49,479
Note payable, net of current portion (Note 10)                 1,735                --

COMMITMENTS AND CONTINGENCIES (NOTES 11, 16 AND 17)

Stockholders' equity (Notes 12 and 13):
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 -- 71,779,523
       and 70,039,814 at December 31, 1999 and
       1998, respectively                                         36                35
   Additional paid-in-capital                                163,870           150,807
   Deferred compensation                                          --               (84)
   Accumulated other comprehensive loss (Note 15)             (2,156)             (501)
   Retained earnings                                         131,207           128,784
                                                           ---------         ---------
TOTAL STOCKHOLDERS' EQUITY                                   292,957           279,041
                                                           ---------         ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                 $ 325,081         $ 328,520
                                                           =========         =========
</TABLE>

                 See notes to consolidated financial statements.

                                       F-3

<PAGE>   62

                           PAIRGAIN TECHNOLOGIES, INC.

                        CONSOLIDATED STATEMENTS OF INCOME

                  (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                          YEAR ENDED DECEMBER 31,
                                                          ------------------------------------------------------
                                                              1999                 1998                 1997
                                                          ------------         ------------         ------------
<S>                                                       <C>                  <C>                  <C>
Revenues (Note 3):
   Product sales                                          $    218,932         $    274,377         $    282,117
   Royalty income and technology licensing fees                  5,943                8,723                  208
                                                          ------------         ------------         ------------

TOTAL REVENUES                                                 224,875              283,100              282,325

Cost of revenues                                               138,463              146,569              142,571
                                                          ------------         ------------         ------------

Gross profit                                                    86,412              136,531              139,754
                                                          ------------         ------------         ------------

Operating expenses:
   Research and development                                     45,334               37,576               31,982
   Selling and marketing                                        35,016               30,098               22,808
   General and administrative                                   22,127               13,321               10,583
   Merger expenses (Note 2)                                         --                   --                2,642
                                                          ------------         ------------         ------------

Total operating expenses                                       102,477               80,995               68,015
                                                          ------------         ------------         ------------

(LOSS) INCOME FROM OPERATIONS                                  (16,065)              55,536               71,739

Other income (loss):
   Interest and other income, net                                9,083                9,029                6,948
   Loss on long-term investments (Note 7)                       (1,500)              (1,500)                (744)
                                                          ------------         ------------         ------------

(Loss) income before income taxes                               (8,482)              63,065               77,943

(Benefit from) provision for income taxes (Note 9)             (10,905)              23,566               30,306
                                                          ------------         ------------         ------------

NET INCOME                                                $      2,423         $     39,499         $     47,637
                                                          ============         ============         ============

Per Share Data (Note 1):
   Earnings per common share
     Basic                                                $       0.03         $       0.56         $       0.70
                                                          ============         ============         ============
     Diluted                                              $       0.03         $       0.53         $       0.63
                                                          ============         ============         ============
   Weighted average shares outstanding
     Basic                                                  70,994,000           70,234,000           67,991,000
                                                          ============         ============         ============
     Diluted                                                75,668,000           74,802,000           75,225,000
                                                          ============         ============         ============
</TABLE>

                 See notes to consolidated financial statements.

                                      F-4

<PAGE>   63

                           PAIRGAIN TECHNOLOGIES, INC.

                 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                          YEAR ENDED DECEMBER 31,
                                                                  --------------------------------------
                                                                    1999            1998          1997
                                                                  -------         --------      --------
<S>                                                               <C>             <C>           <C>
Net income                                                        $ 2,423         $ 39,499      $ 47,637
                                                                  -------         --------      --------
Other comprehensive (loss) income, net of tax:

 Foreign currency translation adjustments                            (974)            (441)         (427)
                                                                  -------         --------      --------

 Unrealized (losses) gains on securities:
   Unrealized holding (losses) gains arising during period           (681)             292           (34)
   Reclassification adjustment for (losses) gains
     included in net income                                            --               (7)           45
                                                                  -------         --------      --------
   Net unrealized (losses) gains on securities                       (681)             285            11
                                                                  -------         --------      --------

Other comprehensive (loss) income (Note 15)                        (1,655)            (156)         (416)
                                                                  -------         --------      --------

Comprehensive income                                              $   768         $ 39,343      $ 47,221
                                                                  =======         ========      ========
</TABLE>

            See notes to condensed consolidated financial statements.


                                      F-5

<PAGE>   64

                           PAIRGAIN TECHNOLOGIES, INC.

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                           ACCUMULATED
                                            COMMON STOCK       ADDITIONAL                     OTHER                      TOTAL
                                       --------------------     PAID-IN      DEFERRED     COMPREHENSIVE  RETAINED    STOCKHOLDERS'
                                         SHARES      AMOUNT     CAPITAL     COMPENSATION   INCOME(LOSS)  EARNINGS       EQUITY
                                       ----------    ------    ----------   ------------  -------------  --------    -------------
<S>                                    <C>            <C>      <C>          <C>           <C>            <C>         <C>
BALANCE AT JANUARY 1, 1997             66,278,293     $33      $ 116,081       $(237)      $    71       $ 41,648      $ 157,596
  Exercise of common stock options      2,556,330       1          6,955          --            --             --          6,956
  Exercise of common stock warrants       131,168      --            495          --            --             --            495
  Issuance of common stock under
   Employee Stock Purchase Plan            57,922      --          1,059          --            --             --          1,059
  Tax benefits from exercise of
   common stock options                        --      --         22,114          --            --             --         22,114
  Amortization of deferred
   compensation                                --      --             --          76            --             --             76
  Other comprehensive loss (Note 15)           --      --             --          --          (416)            --           (416)
  Net income                                   --      --             --          --            --         47,637         47,637
                                       ----------     ---      ---------       -----       -------       --------      ---------
BALANCE AT DECEMBER 31, 1997           69,023,713      34        146,704        (161)         (345)        89,285        235,517
  Exercise of common stock options      1,907,226       1          4,520          --            --             --          4,521
  Exercise of common stock warrants        15,046      --             --          --            --             --             --
  Issuance of common stock under
   Employee Stock Purchase Plan           144,029      --          2,295          --            --             --          2,295
  Common stock repurchased
   (Notes 12 and 13)                   (1,050,200)     --         (7,999)         --            --             --         (7,999)
  Tax benefits from exercise of
   common stock options                        --      --          5,287          --            --             --          5,287
  Amortization of deferred
   compensation                                --      --             --          77            --             --             77
  Other comprehensive loss (Note 15)           --      --             --          --          (156)            --           (156)
  Net income                                   --      --             --          --            --         39,499         39,499
                                       ----------     ---      ---------       -----       -------       --------      ---------
BALANCE AT DECEMBER 31, 1998           70,039,814     $35      $ 150,807       $ (84)      $  (501)      $128,784      $ 279,041
  Exercise of common stock options      2,234,163       1          7,440          --            --             --          7,441
  Exercise of common stock warrants        10,384      --             --          --            --             --             --
  Issuance of common stock under
   Employee Stock Purchase Plan           265,162      --          2,261          --            --             --          2,261
  Common stock repurchased
   (Notes 12 and 13)                     (770,000)     --         (7,515)         --            --             --         (7,515)
  Tax benefits from exercise of
   Common stock options and warrants           --      --         10,877          --            --             --         10,877
  Amortization of deferred
   compensation                                --      --             --          84            --             --             84
  Other comprehensive loss (Note 15)           --      --             --          --        (1,655)            --         (1,655)
  Net income                                   --      --             --          --            --          2,423          2,423
                                       ----------     ---      ---------       -----       -------       --------      ---------
BALANCE AT DECEMBER 31, 1999           71,779,523     $36      $ 163,870       $  --       $(2,156)      $131,207      $ 292,957
                                       ==========     ===      =========       =====       =======       ========      =========
</TABLE>

                 See notes to consolidated financial statements.

                                      F-6

<PAGE>   65

                           PAIRGAIN TECHNOLOGIES, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

                             (DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                           YEAR ENDED DECEMBER 31,
                                                                  -----------------------------------------
                                                                     1999           1998            1997
                                                                  ---------       ---------       ---------
<S>                                                               <C>             <C>             <C>
Cash flows from operating activities:
Net income                                                        $   2,423       $  39,499       $  47,637
Adjustments to reconcile net income to net cash (used in)
    provided by operating activities:
    Depreciation and amortization                                    12,224          10,002           7,677
    Gains on sales of investments                                        --              --             (23)
    Provision for deferred taxes                                     (3,985)          2,011          (5,663)
    Loss on long-term investments                                     1,500           1,500             652
    Change in operating assets and liabilities:
       Accounts receivable                                           (8,595)         15,043         (11,541)
       Inventories                                                   (6,087)         (3,905)         (4,389)
       Other current assets                                          (5,931)         (1,805)           (872)
       Other assets                                                      67             102             (97)
       Trade accounts payable                                         2,230          (2,168)          2,188
       Accrued expenses                                              (5,170)          5,294           6,459
       Income taxes (Note 1)                                         (5,530)          4,767          24,273
                                                                  ---------       ---------       ---------
NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES                 (16,854)         70,340          66,301
                                                                  ---------       ---------       ---------

Cash flows from investing activities:
Purchases of short-term investments                                 (71,614)       (120,986)        (81,034)
Proceeds from sales of short-term investments                        65,868          82,937          80,724
Purchase of property and equipment                                  (17,450)        (10,597)        (13,488)
(Issuance) repayment of note receivable                              (2,000)             --           2,600
Purchases of long-term investments                                   (6,389)             --              --
                                                                  ---------       ---------       ---------
NET CASH USED IN INVESTING ACTIVITIES                               (31,585)        (48,646)        (11,198)
                                                                  ---------       ---------       ---------

Cash flows from financing activities:
Payments for repurchase of common stock                              (7,515)         (7,999)             --
Proceeds from issuance of common stock                                9,702           6,816           8,510
Proceeds from note payable, net                                       1,768              --              --
                                                                  ---------       ---------       ---------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES                   3,955          (1,183)          8,510
                                                                  ---------       ---------       ---------

Effect of exchange rate changes on cash balances                       (917)           (190)           (427)
                                                                  ---------       ---------       ---------

(Decrease) increase in cash and cash equivalents                    (45,401)         20,321          63,186
Cash and cash equivalents at beginning of year                      131,923         111,602          48,416
                                                                  ---------       ---------       ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR                          $  86,522       $ 131,923       $ 111,602
                                                                  =========       =========       =========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid                                                 $   7,864       $  18,999       $  12,719
                                                                  =========       =========       =========
Income tax refunds received                                       $   6,094       $   2,202       $   1,055
                                                                  =========       =========       =========
</TABLE>

                 See notes to consolidated financial statements.

                                      F-7

<PAGE>   66

                           PAIRGAIN TECHNOLOGIES, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES

         PairGain Technologies, Inc. ("PairGain" or the "Company") designs,
manufactures, markets and supports a comprehensive line of digital
telecommunications products that allow telecommunications carriers and private
network owners to more efficiently provide high-speed digital services to end
users over the large 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.

         The accompanying consolidated financial statements reflect the February
27, 1997 business combination between PairGain and Avidia Systems, Inc.
("Avidia") accounted for on a pooling-of-interests basis. Avidia was formed in
December 1995 and had no significant transactions prior to January 1, 1996. (See
Note 2)

PRINCIPLES OF CONSOLIDATION

         The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany balances
and 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 Swiss subsidiary is the Swiss Franc. The functional currency of the
Company's Canadian subsidiary is the Canadian dollar. The functional currency of
the Company's Brazilian subsidiary is the Brazilian Real. Assets and liabilities
of these subsidiaries are translated at the exchange rate in effect at each
year-end. Income statement accounts are translated at the average rate of
exchange prevailing during the year. Translation adjustments arising from
differences in exchange rates from period to period are included as accumulated
other comprehensive loss within stockholders' equity. Realized gains or losses
from foreign currency transactions are included in operations as incurred, and
have historically been insignificant.

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.

FAIR VALUE OF FINANCIAL INSTRUMENTS

         Pursuant to SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," the Company is required to estimate the fair value of all
financial instruments included on its balance sheets at December 31, 1999 and
December 31, 1998. The Company considers the carrying value of such amounts in
the financial statements to approximate their fair value due to the relatively
short period of time between origination of the instruments and their expected
realization or the overall immateriality of the amounts.


                                      F-8

<PAGE>   67

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

COMPREHENSIVE INCOME

         Pursuant to SFAS No. 130, "Reporting Comprehensive Income," the Company
has included Consolidated Statements of Comprehensive Income for the years ended
December 31, 1999, 1998 and 1997. See Note 15 for further discussion.

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

         Short-term investments are accounted for in accordance with SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities."
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, included in accumulated other comprehensive income in
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.

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, PLANT AND EQUIPMENT

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

LONG-TERM INVESTMENTS

         The Company accounts for long-term investments using the cost method.
However, when it is determined that an investment is permanently impaired, the
Company records an impairment adjustment.

WARRANTY RESERVE

         The Company accrues warranty reserves, which are charged against cost
of goods sold, based upon historical rates and estimated future costs.

REVENUE RECOGNITION

         Revenue from product sales is recognized at the time of shipment.
Provision is made currently for estimated product returns which historically
have been insignificant. Royalty income and technology fees are recognized when
earned pursuant to development milestones. Advance payments are classified as
deferred revenue.


                                      F-9

<PAGE>   68

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

RESEARCH AND DEVELOPMENT COSTS

         Research and development costs are expensed as incurred.

PER SHARE INFORMATION

         Pursuant to SFAS No. 128, "Earnings Per Share," ("SFAS No. 128"), the
Company provides dual presentation of "Basic" and "Diluted" earnings per share
("EPS"). SFAS No. 128 replaced "Primary" and "Fully diluted" EPS under
Accounting Principles Board ("APB") Opinion No. 15.

         Basic EPS excludes dilution from common stock equivalents and is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution from common stock equivalents, similar to fully diluted
EPS, but uses only the average stock price during the period as part of the
computation.

         The following table reconciles the weighted average shares outstanding
for basic and diluted earnings per share for the periods presented.

<TABLE>
<CAPTION>
                                                                   YEAR ENDED DECEMBER 31,
                                                           --------------------------------------
                                                             1999           1998           1997
                                                           --------       --------       --------
                                                           (IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S>                                                        <C>            <C>            <C>
Net income                                                 $  2,423       $ 39,499       $ 47,637
                                                           ========       ========       ========
Basic earnings per common share:

   Weighted average of common shares outstanding             70,994         70,234         67,991
                                                           ========       ========       ========
   Basic earnings per common share                         $   0.03       $   0.56       $   0.70
                                                           ========       ========       ========
Diluted earnings per common share:

   Weighted average of common shares outstanding             70,994         70,234         67,991
   Weighted average of common share equivalents:
      Weighted average warrants outstanding                       6             26             62
      Weighted average options outstanding                   11,669         11,133         11,853
      Anti-dilutive options                                    (463)        (2,972)        (1,256)
      Shares assumed to be repurchased using the
        treasury stock method                                (5,519)        (2,804)        (2,265)
      Shares assumed to be repurchased to reflect the
        effects of tax benefits                              (1,019)          (815)        (1,160)
                                                           --------       --------       ---------
   Weighted average number of common and common
     equivalent shares                                       75,668         74,802         75,225
                                                           ========       ========       ========

   Diluted earnings per common share                       $   0.03       $   0.53       $   0.63
                                                           ========       ========       ========
</TABLE>

ACCOUNTING FOR STOCK-BASED COMPENSATION

         The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with APB Opinion No. 25, "Accounting for
Stock Issued to Employees." (See Note 13)


                                      F-10
<PAGE>   69
                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

         In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," ("SFAS No. 133"), which the Company is
required to adopt in 2001. This statement establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts for hedging activities. As of December 31, 1999, the
Company had no derivative instruments nor had it engaged in hedging activities,
but it will continue to evaluate the effects of adopting SFAS No. 133.

STATEMENT OF CASH FLOWS

         Significant noncash transactions in 1999, 1998 and 1997 affecting the
Company's accounts consisted of tax benefits from exercises of common stock
options of $3.9 million, $5.3 million and $22.1 million, respectively. In
addition, tax benefits from exercises of common stock warrants of $7.0 million
were realized in 1999.

2. ACQUISITION OF AVIDIA

         On February 27, 1997, the Company acquired 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") in a transaction accounted for as a pooling-of-interests.
Pursuant to the Merger Agreement, the Company issued 2,235,697 shares of
PairGain Common Stock to Avidia stockholders in exchange for all outstanding
Avidia Common Stock, Preferred Stock and vested warrants to purchase Avidia
Common Stock. In addition, outstanding options and unvested warrants to purchase
Avidia Common Stock were exchanged for options and warrants to purchase 232,521
and 131,168 shares, respectively, of the Company's Common Stock. Merger expenses
of $2.6 million, which consisted of investment banking, legal, accounting and
other costs, were charged to expense upon the closing of the Acquisition. The
Company's historical consolidated financial statements have been restated to
reflect the financial position and results of operations of Avidia.

3. CONCENTRATION OF CREDIT RISK, MAJOR CUSTOMERS, PRODUCTS AND MARKET DATA

         In June 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information," ("SFAS No. 131"). This statement establishes standards for the way
companies report information about operating segments in annual financial
statements. It also establishes standards for related disclosure about products
and services, geographic areas and major customers.

         The Company engages in business activity in only one operating segment
which entails the design, manufacture and sale of a comprehensive line of
digital telecommunications products that allow telecommunications carriers and
private network owners to more efficiently provide high-speed digital services
to end users over the large infrastructure of unconditioned copper wires. The
Company offers a wide variety of products for sale which are manufactured at
common production facilities. The Company sells all of its products to a similar
customer base made up of telecommunications carriers and private network owners
through a common sales organization.

         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 minimal. Sales to major
customers as a percentage of total product revenue are shown in the table below.
Prior year amounts have been reclassified due to the consolidation of several
major customers.

                                     1999           1998           1997
                                     ----           ----           ----
         Customer A                   26%            30%            26%
         Customer B                   12%            11%            13%
         Customer C                    6%            14%            17%

         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.

                                      F-11
<PAGE>   70
                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

         Comparative product revenues as a percentage of sales in 1999, 1998 and
1997 were:
                                       1999          1998           1997
                                       ----          ----           ----
         HiGain/ETSI                    53%           63%            70%
         Subscriber Carrier             28%           23%            15%
         Campus                          9%            7%            11%
         Megabit Access                  2%            2%             2%
         Avidia                          2%            0%             0%
         OEM                             3%            2%             2%
         Royalty                         3%            3%             0%
                                       ---           ---            ---
         Total Revenues                100%          100%           100%
                                       ===           ===            ===

         Export sales represented 26%, 21% and 17% of product revenue during
1999, 1998 and 1997, respectively. Product sales by geographical region is
summarized as follows:
                                       1999          1998           1997
                                    ---------     ---------      ---------

         United States              $ 162,713     $ 217,308      $ 234,138
         Canada                        25,152        23,547         21,467
         Other international           31,067        33,522         26,512
                                    ---------     ---------      ---------
         Total product sales        $ 218,932     $ 274,377      $ 282,117
                                    =========     =========      =========

4.  SHORT-TERM INVESTMENTS

         Short-term investments as of December 31, 1999 and 1998 are summarized
as follows:
                                                     GROSS         GROSS
                                     UNREALIZED    UNREALIZED      FAIR
                         COST          GAINS         LOSSES        VALUE
                       --------      ----------    ----------    --------
                                          (IN THOUSANDS)
1999

     Municipal bonds   $105,525        $  7        $(482)        $105,050
                       ========        ====        =====         ========
1998

     Municipal bonds   $101,432        $602        $ (23)        $102,011
                       ========        ====        =====         ========

         There were no realized gains or losses for the years ended December 31,
1999 and 1998. For the year ended December 31, 1997 there was a realized gain of
$23,000. Unrealized holding (losses) gains on short-term investments, net of
tax, included in accumulated other comprehensive loss in stockholders' equity at
December 31, 1999 and 1998 were ($314,000) and $367,000, respectively.

         The amortized cost and estimated fair value of investments at December
31, 1999 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. The Company classifies short-term
investments as current assets as all such investments are available for current
operations.
                                                        COST         FAIR VALUE
                                                      --------       ----------
                                                            (IN THOUSANDS)

         Due in one year or less                      $ 49,719        $ 49,676
         Due after one year through three years         55,806          55,374
                                                      --------        --------
                                                      $105,525        $105,050
                                                      ========        ========

                                      F-12
<PAGE>   71

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

5. INVENTORIES

         Inventories consist of:

                                                          DECEMBER 31,
                                                     ---------------------
                                                      1999          1998
                                                     -------      --------
                                                        (IN THOUSANDS)

          Finished goods                             $16,013      $18,489
          Work in process                              7,686        1,647
          Purchased parts                             16,586       14,184
                                                     -------      -------
                                                     $40,285      $34,320
                                                     =======      =======

6.  PROPERTY AND EQUIPMENT

         Property and equipment consist of:

                                                           DECEMBER 31,
                                                     -----------------------
                                                       1999           1998
                                                     --------       --------
                                                          (IN THOUSANDS)

          Land                                       $  1,995       $     --
          Building                                      2,939             --
          Production and engineering equipment         27,632         22,169
          Computers, software, furniture and other     21,012         16,155
          Leasehold improvements                        6,405          4,129
                                                     --------       --------
                                                       59,983         42,453
          Less accumulated depreciation and
            amortization                              (33,461)       (22,971)
                                                     --------       --------
                                                     $ 26,522       $ 19,482
                                                     ========       ========

7. LONG-TERM INVESTMENTS

     ANDA Networks, Inc.

         In March 1999, the Company made a minority investment in ANDA Networks,
Inc., a California-based privately-held company which develops next generation
access systems. The Company purchased 2,500,000 shares of ANDA's Series C
Preferred Stock for an aggregate of $5.0 million. At December 31, 1999, the
Company's holdings represented approximately 5.3% of the total outstanding
stock.

     @Link Communications

         In July 1999, the Company made a minority investment in @Link
Communications ("@Link"), a Wisconsin-based privately-held Competitive Local
Exchange Carrier (CLEC) which provides xDSL-based data communications networking
services for businesses, internet service providers and network integrators. The
Company purchased 3,874,416 shares of @Link's Series A Convertible Preferred
Stock for an aggregate of $833,000. In December 1999, the Company purchased an
additional 2,582,944 shares of @Link's Series A Convertible Preferred Stock for
an aggregate of $556,000. The Company has committed to purchase an additional
5,165,888 shares for an aggregate of $1.1 million during 2000. At December 31,
1999, the Company's holdings represented approximately 2.3% of the total
outstanding stock.


                                      F-13

<PAGE>   72

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

     Analog and Digital Devices Telecommunications, Inc.

         In December 1999, the Company issued a note to Analog and Digital
Devices Telecommunications, Inc. ("ADDT"), a California-based privately-held
company that designs and manufactures modems used for the delivery of DSL
services. The Company issued ADDT a $2.0 million secured promissory note which
bears interest at prime (8.5% at December 31, 1999). The Company received a
warrant for the right to purchase up to 7.5% of ADDT shares for $2.0 million.
The Company committed to lend ADDT an additional $2.0 million on April 1, 2000.
At that time, the Company will receive a warrant for the right to purchase an
additional 7.5% of ADDT shares. Principal payment on the note will begin after
January 1, 2002, with the final payment occurring on or before December 16,
2004.

     E/O Networks

         In June 1996, the Company made a minority investment in E/O Networks of
Hayward, California ("E/O"). E/O supplied low-density fiber optic access
equipment to public carriers both domestically and internationally. The Company
purchased 545,000 shares of E/O's Series D Preferred Stock for an aggregate of
$3.0 million. In the fourth quarter of 1998, the Company recorded an impairment
adjustment of $1.5 million to reflect an impairment in its investment in E/O.

         During the second quarter of 1999, E/O filed for protection under
Chapter 11 of the U.S. Bankruptcy Act. Following notification of the bankruptcy
filing, the Company wrote-off its remaining $1.5 million investment in E/O
during the second quarter of 1999.

     Sourcecom Corporation

         In 1995 and 1996, the Company entered into certain agreements with
Sourcecom Corporation of Westlake, California ("Sourcecom"). The agreements
provided 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 invested $544,000 in
Sourcecom common and preferred stock.

         In the third quarter of 1997, Sourcecom filed for protection from
creditors under the U.S. Bankruptcy Act. In addition, Sourcecom sold all of its
assets to an unrelated third party for $8.0 million. Based upon the information
available, the Company recorded an impairment adjustment of $544,000 during the
third quarter of 1997 to reflect an impairment in its investment in Sourcecom. A
mutual release of all claims between Sourcecom and the Company was reached in
December 1997. Under the terms of the release, Sourcecom paid $2.6 million to
the Company to offset the loan made under the original agreements. In the fourth
quarter of 1997, the Company wrote off the balance of the note and associated
legal fees aggregating $200,000.

8.  ACCRUED EXPENSES

         Accrued expenses consist of:

                                                             DECEMBER 31,
                                                      -------------------------
                                                        1999             1998
                                                      -------           -------
                                                            (IN THOUSANDS)

          Accrued compensation and related expenses   $11,797           $ 9,343
          Accrued warranty                              3,971             7,413
          Deferred revenue                                --              3,500
          Other accrued expenses                        3,321             6,746
                                                      -------           -------
                                                      $19,089           $27,002
                                                      =======           =======


                                      F-14



<PAGE>   73

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

9.  INCOME TAXES

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

                                     1999          1998          1997
                                   --------       -------      --------
                                              (IN THOUSANDS)
         Current:
             Federal               $ (8,317)      $17,596      $ 28,822
             State                      287         2,724         5,859
             Foreign                  1,110         1,235         1,288
                                   --------       -------      --------
         Total current               (6,920)       21,555        35,969
                                   --------       -------      --------
         Deferred:
             Federal                   (654)          747        (5,129)
             State                   (2,126)          884        (1,031)
             Foreign                     --            --            --
                                   --------       -------      --------
         Total deferred              (2,780)        1,631        (6,160)
         Valuation allowance         (1,205)          380           497
                                   --------       -------      --------
         Total provision           $(10,905)      $23,566      $ 30,306
                                   ========       =======      ========

         The differences between the U.S. federal statutory income tax rate and
the Company's effective rate for the years ended December 31, 1999, 1998, and
1997 are as follows:

                                                 1999       1998      1997
                                                 ----       ----      ----
 U.S. federal statutory tax rate                 (35)%       35%       35%
 State taxes, net of federal tax                 (15)%        5%        4%
 Research and development credit                 (13)%       (3)%      (3)%
 Non-taxable interest income                     (16)%       (2)%      (1)%
 Merger expenses                                   0%         0%        1%
 Change in valuation allowance for
   deferred tax assets                           (14)%        1%        1%
 Tax benefit of capital losses previously
   considered non-deductible                     (50)%        0%        0%
 Other items, net                                 14%         1%        2%
                                                 ----       ---       ---
 Total provision                                (129)%       37%       39%
                                                =====       ===       ===

         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 of the Company's deferred tax assets are as follows:

                                                         DECEMBER 31,
                                                    ---------------------
                                                      1999         1998
                                                    --------     --------
                                                      (IN THOUSANDS)
Deferred tax assets:
  Inventory and related reserves                    $  4,898     $  6,978
  Warranty reserve                                     1,673        2,988
  Other reserves and accruals                          1,506        2,217
  Other                                                1,551        1,075
  Capital loss carryforwards                           5,555          600
  Net operating loss and credit carryforwards          3,070          965
                                                    --------     --------
Gross deferred tax assets                             18,253       14,823
Valuation allowance                                     (369)      (1,574)
                                                    --------     --------
Net deferred tax assets                             $ 17,884     $ 13,249
                                                    ========     ========


                                      F-15
<PAGE>   74

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

         In 1999, the Company recorded a $5.5 million tax benefit from the
recognition of previously incurred capital loss carryforwards and the reversal
of valuation allowances on certain deferred tax assets. The majority of the
benefit related to a capital loss incurred in 1995, which had previously been
unrecognized due to the uncertainty of generating capital gains under the
Company's current investment policies. Due to the Company's divestiture of its
microelectronics engineering group in the first quarter of 2000, the realization
of these capital losses is now assured. At December 31, 1999, the Company had
federal and state capital loss carryforwards for income tax purposes of
approximately $15.4 million and $3.0 million, respectively, the majority of
which will begin expiring in 2000. The Company also had federal net operating
loss carryforwards and research and development credit carryforwards of $430,000
and $76,000, respectively, which will expire beginning in 2011 and 2012. In
addition, the Company had state net operating loss and credit carryforwards of
$16.3 million and $2.0 million, respectively, which will begin to expire in 2008
and 2009. The federal net operating loss and tax credit carryforwards are
subject to separate return limitation year rules related to the Company's
acquisition of Avidia. The Company has established a valuation allowance of
$369,000 related to these carryforwards since the realization of the benefit
from some of these items is uncertain at the end of 1999.

10.  NOTE PAYABLE

         In May 1999, the Company assumed a $1.8 million note related to its
Tustin, California headquarters facility. The note bears interest at 8.25% and
is due December 1, 2005. The note is secured by a first Deed of Trust on the
facility. Monthly principal and interest payments are approximately $15,000,
with the remaining principal and interest payment of $1.5 million due on
December 1, 2005.

         The Company maintains an unsecured line of credit with a bank. The line
allows maximum borrowings of $5.0 million, including the issuance of letters of
credit and foreign exchange contracts. The line bears interest at the prime rate
(8.50% at December 31, 1999). At December 31, 1999, 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, 1999. The agreement expires May 1,
2000.

11.  COMMITMENTS AND CONTINGENCIES

         The Company has entered into several operating leases for its
facilities with varying terms. Future annual minimum lease payments under
non-cancelable operating leases are as follows:

           YEARS ENDING DECEMBER 31,                 (IN THOUSANDS)
           -------------------------                 --------------

                2000                                    $  1,143
                2001                                       1,144
                2002                                       1,147
                2003                                       1,202
                2004                                       1,223
                Thereafter                                   761
                                                        --------
                                                        $  6,620
                                                        ========

         Rent expense for the years ended December 31, 1999, 1998 and 1997
aggregated $1.4 million, $1.4 million and $1.3 million, respectively.

         The Company is involved from time to time in litigation incidental to
its business. The Company believes that none of its pending litigation matters,
individually or in the aggregate, will have a material adverse effect on its
financial position or results of operations.

12. STOCKHOLDERS' EQUITY

WARRANTS

         In 1996, Avidia granted warrants to certain stockholders which
converted in the Merger into the right to purchase 131,168 shares of the
Company's Common Stock at an aggregate exercise price of $495,000. Such warrants
were exercised in February 1997.


                                      F-16

<PAGE>   75

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

         In 1995, the Company granted a warrant for the purchase of 20,000
shares of its Common Stock at an exercise price of $5.00 per share in exchange
for services. The warrant had a net exercise provision which allowed for the
exercise price to be paid by tendering shares of the Company's Common Stock with
a fair market value equal to the exercise price. The warrant was exercised in
April 1998 using the net exercise provision. Accordingly, 15,046 shares of
Common Stock were issued. Another warrant for the purchase of 20,000 shares at
an exercise price of $6.25 per share was also issued in 1995 in exchange for
services. This warrant also had a net exercise provision which allowed for the
exercise price to be paid by tendering shares of the Company's Common Stock with
a fair market value equal to the exercise price. The warrant was exercised in
April 1999 using the net exercise provision. Accordingly, 10,384 shares of
Common Stock were issued.

PREFERRED STOCK

         Preferred stock consists of Series A Junior Participating Preferred
Stock ("Series A Preferred Stock"), 200,000 shares authorized (see below), and
other preferred stock, 1,800,000 shares authorized. There are no shares of
preferred stock issued and outstanding.

     Stockholder Rights Plan

         In December 1998, the Board of Directors adopted a Stockholder Rights
Plan in which preferred stock purchase rights were distributed as a dividend at
the rate of one Right for each share of Common Stock held as of the close of
business on December 14, 1998. The Rights will expire on December 14, 2008.

         Each Right entitles Stockholders to buy one ten-thousandth of a share
of a newly created series of preferred stock of the Company, Series A Preferred
Stock, at an Exercise Price of $55.00. The Rights will be exercisable only if a
person or group acquires 15% or more of the Company's Common Stock or announces
a tender offer the consummation of which would result in ownership by a person
or group of 15% or more of the Company's Common Stock.

         The Rights are exercisable for fractional shares of Series A Preferred
Stock rather than shares of Common Stock to avoid the Company having to reserve
a significant amount of its Common Stock for issuance upon exercise of the
Rights. The Series A Preferred Stock is designed such that each one
ten-thousandth of a share is the economic equivalent of one share of the
Company's Common Stock. If the Rights to purchase these fractional shares of
Series A Preferred Stock become exercisable by virtue of a person or group
acquiring 15% or more of PairGain's outstanding Common Stock, then each
Stockholder, other than the acquiror, is entitled to purchase, for $55.00, that
number of fractional shares of Series A Preferred Stock (or, in certain
circumstances, shares of the Company's Common Stock, property or other
securities of the Company) having a market value worth twice that amount, or
$110.00. If, after the Rights become exercisable, PairGain is acquired by
another company in a merger or other business combination transaction, or sells
50% or more of its assets or earnings power, the Rights entitle each PairGain
Stockholder to purchase, for $55.00, that number of the acquiring company's
common shares having a market value worth $110.00. Each scenario results in
substantial economic dilution to the acquiring entity.

         At any time on or prior to the close of business on the tenth business
day after the date of a public announcement that a person or group has acquired
beneficial ownership of 15% or more of the Company's Common Stock, the Rights
are redeemable for $.001 per Right at the option of the Board of Directors.


                                      F-17

<PAGE>   76

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

STOCK REPURCHASES

         On October 14, 1998 the Company announced that its Board of Directors
approved a plan to repurchase up to 7,000,000 shares, or approximately 10%, of
the Company's outstanding Common Stock. The timing and amount of any repurchase
is at the discretion of the Company's management. The Company's management
could, in the exercise of its judgment, decide to repurchase fewer shares than
authorized. Repurchased shares are subsequently cancelled. During 1999 and 1998,
the Company repurchased 400,000 shares and 1,000,000, respectively, at a cost of
approximately $3.7 million and $7.2 million, respectively, bringing the total
shares repurchased to 1,400,000 at a cost of approximately $10.9 million. On
February 20, 2000, the Company's Board of Directors adopted a resolution to
rescind the plan to repurchase shares of outstanding Common Stock. The Company
also repurchases shares for purposes of certain stock-based incentive plans.
(See Note 13)

13. STOCK-BASED INCENTIVE 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. Under the terms of the Plan, 24,191,400
shares of Common Stock have been reserved for issuance. In 1999, the Plan was
amended to require all option grants and direct stock issuances to be made with
exercise or issue prices not less than 100% of the fair market value of the
shares on the grant or issue date. Previously, the Plan had provided 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.

         Incentive options are granted at a price equal to 100% of the fair
market value at the date of grant 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 Plan vest over four years. 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 July 1998, the Plan was amended to include an automatic share
increase feature. Pursuant to the share increase feature, the number of shares
of Common Stock available for issuance under the Plan will automatically
increase by the number of shares of Common Stock repurchased by the Company on
the open market with the cash proceeds received by the Company from the exercise
of outstanding options under the Plan. Such share increases can not exceed
500,000 shares of Common Stock in any one calendar year. In 1998, 21,400 shares
were repurchased under the terms of the Plan at a cost of approximately
$300,000. During 1999, 370,000 shares were repurchased under the terms of the
Plan at a cost of approximately $3.9 million.

         In 1998, the Board of Directors approved stock option repricing
programs pursuant to which optionholders having options with exercise prices in
excess of $12.75 per share at August 5, 1998 and $7.03 per share at December 4,
1998 could elect to exchange their higher priced options for new stock options
with exercise prices of $12.75 and $7.03, the fair market values on those dates.
The higher priced options were cancelled and all vesting in those options was
forfeited by the optionholders. The new options vest monthly over a 48 month
period beginning on August 5, 1998 and December 4, 1998. A total of 3,648,283
and 4,127,597 options with exercise prices ranging from $13.63 to $30.00 per
share and $7.41 to $30.00 per share, respectively, were exchanged under these
programs. In 1999, the Plan was amended to eliminate the cancellation/regrant
provisions.


                                      F-18

<PAGE>   77

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

SHARES GRANTED OUTSIDE THE PLAN

         In December 1998, the Company granted a non-qualified option to
purchase 450,000 shares at a price of $7.00 per share outside of the Plan in
connection with the hiring of a new President and Chief Executive Officer. The
terms of this grant are identical to the terms of grants issued under the Plan.

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.

AVIDIA STOCK OPTION AND INCENTIVE AWARD PLAN

         In 1996, Avidia established the 1996 Stock Option and Incentive Award
Plan (the "Avidia Plan") which provides for the grant of any or all of the
following types of awards: (1) stock options, including incentive stock options
and non-qualified stock options, and (2) performance share awards. Under the
terms of the Avidia Plan, 232,521 shares of Common Stock have been reserved for
issuance to directors, employees, consultants, advisors and vendors of Avidia
and any related corporations. The majority of the stock options vest over a
four-year period, with 25% of the shares becoming exercisable on each of the
first four anniversaries of the grant date. The Board of Directors at its
discretion may grant accelerated vesting. The options expire ten years from the
date of the grant. During 1996, all of the options under the Avidia Plan were
granted at less than market value, which resulted in total compensation of
$285,000. This compensation is being amortized over the vesting period, and has
resulted in charges to earnings of $84,000, $77,000 and $76,000 in 1999, 1998
and 1997, respectively.


                                      F-19

<PAGE>   78

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

OPTION ACTIVITY

<TABLE>
<CAPTION>
                                                                                        WEIGHTED
                                                                       NUMBER OF        AVERAGE
                                                                        SHARES       EXERCISE PRICE
                                                                      ----------    ---------------
<S>                                                                   <C>           <C>
Outstanding, January 1, 1997
  (6,094,404 exercisable at a weighted average price of $2.15)        12,864,947         $ 6.59

Granted (weighted average fair value of $11.99)                        1,634,135         $19.72
Exercised                                                             (2,556,330)        $ 2.80
Cancelled                                                               (441,417)        $19.62
                                                                      ----------

Outstanding, December 31, 1997
  (6,608,473 exercisable at a weighted average price of $5.16)        11,501,335         $ 8.89

Granted (weighted average fair value of $7.03)                        10,744,480         $ 9.75
Exercised                                                             (1,907,226)        $ 2.37
Cancelled                                                             (8,206,250)        $16.59
                                                                      ----------

Outstanding, December 31, 1998
  (5,552,082 exercisable at a weighted average price of $3.67)        12,132,339         $ 5.42

Granted (weighted average fair value of $6.87)                         3,171,400         $ 9.32
Exercised                                                             (2,234,163)        $ 3.33
Cancelled                                                             (1,431,798)        $ 7.13
                                                                      ----------

Outstanding, December 31, 1999                                        11,637,778         $ 6.68
                                                                      ==========
</TABLE>

         The outstanding stock options primarily vest ratably over a four year
period. Stock options outstanding at December 31, 1999 are summarized as
follows:

<TABLE>
<CAPTION>
                                         OPTIONS OUTSTANDING                            OPTIONS EXERCISABLE
                         ---------------------------------------------------    -----------------------------------
                                                 WEIGHTED
                                                 AVERAGE
                          NUMBER OUTSTANDING     REMAINING        WEIGHTED      NUMBER EXERCISABLE      WEIGHTED
       RANGE OF                  AT            CONTRACTUAL        AVERAGE               AT               AVERAGE
   EXERCISE PRICES        DECEMBER 31, 1999        LIFE       EXERCISE PRICE    DECEMBER 31, 1999    EXERCISE PRICE
  -----------------       ------------------   -----------    --------------    -----------------    --------------
<S>                      <C>                  <C>             <C>               <C>                  <C>
    $0.04 - $0.07              1,226,808           2.5            $ 0.07              1,226,808          $ 0.07
    $0.25 - $3.44              1,012,788           4.6            $ 2.59              1,001,166          $ 2.61
    $4.00 - $7.00              2,436,427           7.7            $ 5.93              1,339,161          $ 5.44
    $7.03 - $8.44              5,302,916           8.7            $ 7.59              1,727,867          $ 7.39
    $8.50 - $16.00             1,482,839           9.0            $11.03                387,574          $11.82
   $16.88 - $27.25               176,000           7.5            $22.43                170,999          $22.32
                              ----------                                              ---------
    $0.04 - $27.25            11,637,778           7.5            $ 6.68              5,853,575          $ 5.32
                              ==========                                              =========
</TABLE>

         At December 31, 1999, 1,633,281 and 80,000 shares were available for
future grants under the 1993 Employee Stock Option Plan and 1996 Non-Employee
Directors Stock Option Plan, respectively.


                                      F-20

<PAGE>   79

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

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. Activity under the Purchase Plan is summarized as follows:

                                      WEIGHTED AVERAGE    WEIGHTED AVERAGE
          YEAR      SHARES ISSUED     PRICE PER SHARE     VALUE PER SHARE
          ----      -------------     ----------------    ----------------

          1999        265,162             $ 8.53             $10.03
          1998        144,029             $13.19             $15.51
          1997         57,922             $18.28             $21.50

         Under the provisions of the Purchase Plan, the Company may issue new
shares or issue shares acquired in open market purchases. During 1999, the
Company issued 265,162 new shares. At December 31, 1999, 348,672 shares were
reserved for future issuances under the Purchase Plan.

ADDITIONAL STOCK PLAN INFORMATION (SFAS NO. 123)

         As discussed in Note 1, the Company accounts 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.

         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.

         The Company's calculations were made using the Black-Scholes option
pricing model with the following weighted average assumptions:

<TABLE>
<CAPTION>
                                                              FOR OPTIONS GRANTED DURING:
                                                   ----------------------------------------------
                   ASSUMPTIONS                          1999             1998             1997
          --------------------------------         ---------------    -----------     -----------
<S>                                                <C>                <C>             <C>
          Expected life, following vesting         thirteen months    nine months     nine months
          Stock volatility                                91%             93%             71%
          Risk free interest rate                       5.73%           4.98%           6.22%
          Dividends during expected term                none            none            none
</TABLE>

         The Company's calculations are based on a single option valuation
approach and forfeitures are recognized as they occur. The expected life of
option grants is 61 months in 1999 and 57 months in both 1998 and 1997. The
computed fair values for stock-based compensation awards are $22.9 million,
$35.9 million (net of valuation credits for repriced options) and $20.5 million
in 1999, 1998 and 1997, respectively. If the fair values of the awards had been
amortized to expense over the vesting period of the awards, results would have
been as follows:

<TABLE>
<CAPTION>
                                                      1999        1998            1997
                                                   ---------     -------       -------
                                                         (IN THOUSANDS, EXCEPT
                                                          EARNINGS PER SHARE)
<S>                                                <C>           <C>           <C>
         Net income as reported                    $  2,423      $39,499       $47,637
         Pro forma net (loss) income               $(19,037)     $27,976       $38,361
         Pro forma (loss) earnings per share:
             Basic                                 $  (0.27)     $  0.40       $  0.56
             Diluted                               $  (0.27)     $  0.37       $  0.51
</TABLE>

                                      F-21
<PAGE>   80

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

         The impact of stock-based compensation awards granted prior to 1995 has
been excluded from the pro forma calculation; accordingly, the 1999, 1998 and
1997 pro forma adjustments may not be indicative of future period pro forma
adjustments, when the calculation will be applicable to all stock-based
compensation awards.

14.  EMPLOYEE BENEFIT PLANS

401(k) MATCHING CONTRIBUTION

         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. Employee deferrals
during 1999 were eligible for a matching contribution equal to fifty percent
(50%) of the employee's salary deferral to a maximum of $1,000. Employee
deferrals during 1998 were eligible for a matching contribution equal to fifty
percent (50%) of the employee's salary deferral, not to exceed $1,000 and not
less than $500 per employee. Employee deferrals during 1997 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 expense related to the
contributions was $502,000 in 1999, $464,000 in 1998 and $221,000 in 1997.

PROFIT SHARING

         In October 1996, the Company established a company-wide Profit Sharing
Plan for fiscal years beginning after December 31, 1996. Under the terms of the
Profit Sharing Plan, a pool equal to 2.5% of pre-tax income was established for
payments to be made on a pro rata basis, based on the amount of each
participant's base compensation. Plan participants include all employees in the
Company except those on an incentive compensation or sales commission plan who
are employed as of the date of the Profit Sharing payment. Payment is subject to
achieving a pre-determined threshold earnings per share level as established by
the Board of Directors and is to take place approximately one month after the
end of the year for which the Profit Sharing applies. There were no amounts
earned under the Profit Sharing Plan in 1999 or 1998. In 1997, $2.0 million was
earned under the Profit Sharing Plan.

MANAGEMENT DEFERRED COMPENSATION PLAN

         The Company established a Management Deferred Compensation Plan in
1996. The purpose of the plan is to provide a tax deferred capital accumulation
opportunity to senior management. Employees whose annual base salary is $100,000
or greater are eligible to participate. The minimum deferral is $5,000 per Plan
year (January 1 to December 31) and can be satisfied from salary, commission
and/or incentive compensation payments. Deferrals may be increased, decreased or
terminated for any subsequent years by filing an election by December 1 of the
prior year. The Company may make discretionary Company contributions at any time
as approved by the Compensation Committee of the Board of Directors. To date, no
Company contributions have been made to the Deferred Compensation Plan.

CHANGE IN CONTROL AGREEMENTS

         The Company has entered into agreements with 48 of its officers and
other key employees which will provide severance benefits in the event of
involuntary termination following a substantial change in ownership or control
of the Company. In the event of involuntary termination without cause within
eighteen months of a change of control, the agreements specify a salary
continuation period between nine and eighteen months (depending upon position),
acceleration of unvested stock options and continuation of life insurance
coverage during the salary continuation period. Participation in all other
benefit plans would cease upon termination.


                                      F-22

<PAGE>   81

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

15. OTHER COMPREHENSIVE INCOME (LOSS) AND ACCUMULATED OTHER COMPREHENSIVE
    INCOME (LOSS)

         The gross amount and related tax effects allocated to each component of
other comprehensive income (loss) consist of:

<TABLE>
<CAPTION>
                                                             YEAR ENDED DECEMBER 31,
                                -----------------------------------------------------------------------------------
                                           1999                        1998                        1997
                                --------------------------- --------------------------- ----------------------------
                                 GROSS    INCOME     NET     GROSS    INCOME     NET     GROSS    INCOME     NET
                                 AMOUNT    TAX     AMOUNT    AMOUNT    TAX      AMOUNT   AMOUNT     TAX     AMOUNT
                                ------------------ -------- ------------------ ------------------ -------- ---------
                                                                  (IN THOUSANDS)
<S>                             <C>        <C>     <C>      <C>        <C>     <C>       <C>        <C>     <C>
Foreign currency translation
  adjustments                   $  (974)   $  --   $  (974)  $(441)    $ --    $(441)    $(427)     $--     $(427)
Unrealized gains (losses)
  on securities:
  Unrealized holding
      gains (losses)
      arising during             (1,054)    (373)     (681)    462      170      292       (53)     (19)      (34)
      period
  Reclassification adjustment
      for gains (losses)
      included in net income         --       --        --     (12)      (5)      (7)       70       25        45
                                -------    -----   -------    ----     ----    -----     -----      ---    ------
  Net unrealized gains
      on securities              (1,054)    (373)     (681)    450      165      285        17        6        11
                                -------    -----   -------    ----     ----    -----     -----      ---    ------
Other comprehensive income
  (loss)                        $(2,028)   $(373)  $(1,655)   $  9     $165    $(156)    $(410)     $ 6    $ (416)
                                =======    =====   =======    ====     ====    =====     =====      ===    ======
</TABLE>

         The components of accumulated other comprehensive loss at December 31,
1999 and December 31, 1998 included foreign currency translation adjustments and
unrealized gains (losses) on securities.

<TABLE>
<CAPTION>
                                                   FOREIGN                            ACCUMULATED
                                                   CURRENCY      UNREALIZED GAINS        OTHER
                                                 TRANSLATION        (LOSSES) ON      COMPREHENSIVE
                                                  ADJUSTMENT        SECURITIES       INCOME (LOSS)
                                                 ----------- ------------------ -----------------
                                                                  (IN THOUSANDS)
<S>                                               <C>                   <C>             <C>
         Balance at January 1, 1997               $     --              $  71           $    71
         1997 Change                                  (427)                11              (416)
                                                  --------              -----           -------
         Balance at December 31, 1997                 (427)                82              (345)
         1998 Change                                  (441)               285              (156)
                                                  --------              -----           -------
         Balance at December 31, 1998                 (868)               367              (501)
         1999 Change                                  (974)              (681)           (1,655)
                                                   -------              -----           -------
         Balance at December 31, 1999              $(1,842)             $(314)          $(2,156)
                                                   =======              =====           =======
</TABLE>

                                      F-23

<PAGE>   82

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

16.  SETTLEMENT AGREEMENTS

     Harris Corporation

         In April 1998, Harris Corporation ("Harris") filed a complaint in
California Superior Court against the Company and others, alleging claims for
breach of contract, breach of the implied covenant of good faith and fair
dealing, breach of fiduciary duty, intentional or negligent interference of
contractual relations and prospective economic advantage and violation of
California Business and Professions Code Section 17200 et seq. These claims
related to an alleged agreement giving Harris the right to buy the Company's
Falcon 1A chipset and the impingement of this alleged agreement by the Company
in entering into a licensing agreement in March 1998 with respect to the Falcon
1A chipset. Under this licensing agreement, the Company granted a third party
the right to manufacture and sell the Falcon 1A chipset to the Company and
others. Harris's complaint sought specific performance, declaratory relief, an
accounting and unspecified compensatory and punitive damages. Harris's claim was
later amended to include a claim for fraud and the Company filed a
cross-complaint for declaratory relief.

         In May 1999, the Company reached an agreement with Harris to settle and
dismiss the complaints described above. Under the terms of the settlement, the
Company agreed to pay the sum of $1.5 million to Harris and both parties agreed
to dismiss their actions with prejudice. The settlement is included in general
and administrative expense for the year ended December 31, 1999.

     U.S. Attorney's Office and the SEC

         On September 2, 1999, the Company announced a tentative agreement with
the U.S. Attorney's office for failing to implement a system of internal
accounting controls and to maintain accurate books and records. The agreement
with the U.S. Attorney's office was finalized on November 8, 1999. In addition
to the agreement reached with the U.S. Attorney's office, the Company, its
Chairman and its then Chief Financial Officer also reached a settlement with the
SEC. These agreements relate to the 1995 loss of $15.8 million of the Company's
funds through its former money manager, S. Jay Goldinger, and his firm, Capital
Insight, Inc., the disclosures of such investments and the disclosure of the
loss incurred.

         Based upon these settlements, the Company paid $1.4 million for fines
and reimbursement of the government's cost of investigation. In addition, the
Company accrued $200,000 for other costs and expenses associated with the
settlement. These amounts are included in general and administrative expense in
the year ended December 31, 1999.

         The Company's Board of Directors authorized the settlement of all
outstanding claims with the U.S. Attorney's office and the SEC in the interest
of avoiding protracted litigation and in order to bring closure to these
matters.

     Termination of Joint Technology Development

         In November 1999, the Company announced its decision to sell its
microelectronics engineering group, designers of integrated circuits and
software for DSL applications. In this regard, the Company signed a Mutual
Release and Settlement Agreement with a third party to terminate a Memorandum of
Understanding between the two companies for a joint technology development. In
consideration of the settlement, the Company agreed to pay up to $3.5 million to
the other party. Of that amount, $2.5 million was paid in November 1999 and was
recorded in general and administrative expense for the year ended December 31,
1999. The additional payment of $1.0 million became due upon the signing of the
agreement to sell the microelectronics engineering group, which occurred on
February 24, 2000.


                                      F-24

<PAGE>   83

                           PAIRGAIN TECHNOLOGIES, INC.

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

17.  SUBSEQUENT EVENTS

         On January 21, 2000, the Company signed a definitive agreement with
GlobeSpan, Inc. ("GlobeSpan") for GlobeSpan to purchase the Company's
microelectronics engineering group. The purchase price was a combination of
3,243,591 shares of GlobeSpan common stock (adjusted to reflect a three-for-one
stock split as of February 29, 2000) and a $90.0 million subordinated
convertible promissory note. The sale of the microelectronics engineering group
to GlobeSpan closed on February 24, 2000. Based upon the closing sale price on
The Nasdaq Stock MarketSM on February 24, 2000, the value of stock the Company
received was approximately $255.7 million.

         On February 23, 2000, the Company and ADC Telecommunications, Inc., a
Minnesota corporation ("ADC"), announced that they had executed an Agreement and
Plan of Merger, dated as of February 22, 2000 (the "Merger Agreement"), by and
among PairGain, ADC and Roman Acquisition Corp., a Delaware corporation and
wholly-owned subsidiary of ADC ("Merger Sub"). Pursuant to the Merger Agreement,
Merger Sub will merge with and into PairGain and PairGain will survive the
merger as a wholly-owned subsidiary of ADC. As a result of the merger, each
share of PairGain's common stock issued and outstanding immediately prior to the
effective time of the merger (other than any shares owned by ADC or its
subsidiaries) will be automatically converted into the right to receive 0.43
shares of ADC common stock. The merger is expected to be treated as a
reorganization for federal income tax purposes and to be accounted for as a
pooling of interests. The consummation of the transaction is subject to a number
of conditions, including approval of the Merger Agreement by PairGain's
stockholders and receipt of applicable regulatory approvals.

         On March 1, 2000, the Company, through its wholly-owned subsidiary,
PairGain Canada, Inc., a Canadian corporation, entered into an Asset Purchase
Agreement with ABL Canada Inc., a Canadian corporation ("ABL"), under which the
Company agreed to purchase certain of ABL's assets, operations and business
related to ABL's SONET Multiplexing and Access Products. Under the Agreement,
the Company agreed to pay an aggregate of $10.4 million for the assets, which
will be paid at the closing of the transaction.

                                      F-25
<PAGE>   84

                           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, 1999:
 Allowance for doubtful accounts
   receivable                             $   900         $   42           $ --        $   42      $   900
 Allowance for estimated obsolete
   and excess inventories                  17,428            393             --         6,472       11,349
                                          -------         ------           ----        ------      -------
 Total                                    $18,328         $  435           $ --        $6,514      $12,249
                                          =======         ======           ====        ======      =======

 Year ended December 31, 1998:
 Allowance for doubtful accounts
   receivable                             $   955         $   28           $ --        $   83      $   900
 Allowance for estimated obsolete
   and excess inventories                  20,106          3,113             --         5,791       17,428
                                          -------         ------           ----       -------      -------
 Total                                    $21,061         $3,141           $ --       $ 5,874      $18,328
                                          =======         ======           ====       =======      =======

 Year ended December 31, 1997:
 Allowance for doubtful accounts
   receivable                             $   935         $   20           $ --       $    --      $   955
 Allowance for estimated obsolete
   and excess inventories                  14,656          8,935             --         3,485       20,106
                                          -------         ------           ----       -------      -------
 Total                                    $15,591         $8,955           $ --       $ 3,485      $21,061
                                          =======         ======           ====       =======      =======
</TABLE>


                                      S-1

<PAGE>   85

                                 EXHIBIT INDEX

         Exhibit
         Number                           Description
         -------                          -----------

         (q)2.1   Agreement and Plan of Merger, dated as of February 22, 2000,
                  among ADC Telecommunications, Inc., Roman Acquisition Corp.
                  and PairGain Technologies, Inc.

         (r)2.2   Asset Purchase Agreement, dated as of January 21, 2000,
                  between GlobeSpan, Inc. and PairGain Technologies, Inc.

         (a)3.1   Certificate of Incorporation of Registrant, a Delaware
                  corporation

         (g)3.2   Amendment to Certificate of Incorporation of PairGain
                  Technologies, Inc.

         (i)3.3   Amendment to Certificate of Incorporation of PairGain
                  Technologies, Inc.

         (a)3.4   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>   86

                           EXHIBIT INDEX (Continued)

          Exhibit
          Number                           Description
          -------                          -----------

         (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

         (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


<PAGE>   87


                           EXHIBIT INDEX (Continued)

         Exhibit
         Number                           Description
         -------                          -----------

         (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

         (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

         (k)10.43 Avidia Systems, Inc. 1996 Stock Plan (the "Avidia Plan")

         (k)10.44 Form of Incentive Stock Option Agreement pertaining to the
                  Avidia Plan

         (k)10.45 Form of Non-Qualified Stock Option Agreement pertaining to the
                  Avidia Plan

         (k)10.46 Form of Stock Option Assumption Agreement pertaining to the
                  Avidia Plan

         (l)10.47 PairGain Technologies, Inc. 1993 Option/Stock Issuance Plan as
                  amended (the "1993 Plan")

         (m)10.48 PairGain Technologies, Inc. 1993 Option/Stock Issuance Plan as
                  amended (the "1993 Plan")

         (n)10.49 Rights Agreement between PairGain Technologies, Inc. and U.S.
                  Stock Transfer Corporation as Rights Agent, dated as of
                  December 3, 1998

         (o)10.50 Form of Change in Control Agreement with Executive Officers
                  and Other Key Employees

         (p)10.51 PairGain Technologies, Inc. 1993 Option/Stock Issuance Plan as
                  amended (the "1993 Plan").

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

         21.1     Subsidiaries of the Registrant

         23.1     Consent of Deloitte & Touche LLP, Independent Auditors

         27.1     Financial Data Schedule


<PAGE>   88

                           EXHIBIT INDEX (Continued)



--------------------
(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.

(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.

(k)   Incorporated herein by reference to Exhibit number 99.1 to the Company's
      Registration Statement No. 333-26643 on Form S-8, as filed with the
      Commission on May 7, 1997.

(l)   Incorporated herein by reference to Exhibit number 99.1 to the Company's
      Registration Statement No. 333-33739 on Form S-8, as filed with the
      Commission on August 15, 1997.

(m)   Incorporated herein by reference to Exhibit number 99.1 to the Company's
      Registration Statement No. 333-60067 on Form S-8, as filed with the
      Commission on July 28, 1998.

(n)   Incorporated herein by reference to Exhibit number 1 to the Company's
      Registration Statement on Form 8-A, as filed with the Commission on
      December 15, 1998.

(o)   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, 1998, as filed with the Commission on March 29, 1999.

(p)   Incorporated herein by reference to Exhibit number 99.1 to the Company's
      Registration Statement No. 333-81947 on Form S-8, as filed with the
      Commission on June 30, 1999.

(q)   Incorporated herein by reference to the same Exhibit number to the
      Company's Current Report on Form 8-K ,as filed with the Commission on
      February 28, 2000.

(r)   Incorporated herein by reference to Exhibit number 2.1 to the Company's
      Current Report on Form 8-K ,as filed with the Commission on March 10,
      2000.