Spectral-amplitude-coding optical code-division multiple-access (OCDMA) systems are limited by interference between incoherent sources. A detailed analysis of this limit for a system with a balanced receiver is presented. Additional pulse-position modulation (PPM) coding is proposed as a method to improve the system performance beyond this limit. A simple and robust PPM decoding structure is proposed, and the performance analysis of the whole PPM-OCDMA system is presented. The interference-limited performance of the PPM-OCDMA system is found to be superior to that of the original system when the number of simultaneous users is of the order of the PPM word length or larger. In particular, for a PPM word length of two, an increase in spectral efficiency of up to 100% is possible with no change in the signaling rate, data rate, or bit-error rate (BER).