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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

                    (Mark One)

x  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the quarterly period ended October 1, 2004

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 0-16617

ALTERA CORPORATION

(Exact name of registrant as specified in its charter)

101 INNOVATION DRIVE

SAN JOSE, CALIFORNIA 95134

(Address of principal executive offices)(zip code)

408-544-7000

(Registrant’s telephone number, including area code)

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x    No ¨

Number of shares of common stock outstanding at October 29, 2004: 372,292,515

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ALTERA CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements.

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ALTERA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share amounts)

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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ALTERA CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

See accompanying notes to condensed consolidated financial statements.

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ALTERA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 – Organization and Basis of Presentation:

The accompanying unaudited condensed consolidated financial statements of Altera Corporation and subsidiaries, collectively referred to herein as “we”, “us”, or “our”, have been prepared by us in accordance with accounting principles generally accepted in the United States of America. This financial information reflects all adjustments which are, in the opinion of our management, of a normal recurring nature and necessary to present fairly the statements of financial position as of October 1, 2004 and January 2, 2004, results of operations for the three and nine months ended October 1, 2004 and October 3, 2003, and cash flows for the nine months ended October 1, 2004 and October 3, 2003. The January 2, 2004 balance sheet was derived from our audited financial statements included in our 2003 Annual Report on Form 10-K. All significant intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 period. Actual results could differ from those estimates, and material effects on our operating results and financial position may result.

These condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended January 2, 2004 included in our Annual Report on Form 10-K, as filed on March 15, 2004 with the Securities and Exchange Commission, or SEC. The results of operations for the three and nine months ended October 1, 2004 are not necessarily indicative of the results to be expected for any future period.

Note 2 – Balance Sheet Details:

One balance sheet reclassification has been made to prior period balances in order to conform to the current period’s presentation. We reclassified $23.6 million from income taxes payable to other current assets to reflect an income tax receivable that was received subsequent to the quarter end in connection with the settlement of an income tax examination (see Note 9 – Income Taxes).

Inventories at October 1, 2004 and January 2, 2004 were comprised of the following (in thousands):

We realized gross margin benefits of $3.3 million for the three months ended October 1, 2004 and $11.3 million for the nine months ended October 1, 2004, resulting from the sale of inventory previously written down in 2001. These benefits were $7.6 million and $25.9 million for the three and nine months ended October 3, 2003.

As of October 1, 2004, the book value of the inventory written down in 2001 was zero while the cost basis was $17.0 million. The cost basis was comprised of $11.7 million of raw materials and work in process inventory and $5.3 million of finished goods inventory.

We have entered into business arrangements with certain distributors to advance cash to defray their working capital costs associated with servicing our end customers. These arrangements are set forth in legal agreements and these advances are unsecured, bear no interest and are due upon demand. These advances

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consist of two components. The first component is an advance of anticipated price discounts and is included as a reduction to deferred income and allowances on sales to distributors. Such advance totaled $53.7 million at October 1, 2004 and $29.1 million at January 2, 2004. The second component is, in substance, an arrangement to finance distributors’ accounts receivable and inventory and is classified as other current assets and totaled $43.5 million at October 1, 2004 and $20.6 million at January 2, 2004.

Property and equipment at October 1, 2004 and January 2, 2004 were comprised of the following (in thousands):

Note 3 – Comprehensive Income:

The components of comprehensive income were as follows (in thousands):

Accumulated other comprehensive (loss) income presented in the accompanying condensed consolidated balance sheets consists of the accumulated unrealized (loss) gain on investments, net of tax.

Note 4 – Income Per Share:

In accordance with Statement of Financial Accounting Standards No. 128, or SFAS No. 128, “Earnings Per Share,” we compute basic income per share by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period (excluding the dilutive effect of stock options and restricted stock). Diluted income per share reflects the dilution of potential common shares outstanding during the period. In computing diluted income per share, we adjust share count by assuming that all in-the-money options are exercised and that we repurchase shares with the proceeds of these hypothetical exercises along with the tax benefit resulting from the hypothetical option exercises. We further assume that any unamortized deferred stock-based compensation is also used to repurchase shares. In determining the hypothetical shares repurchased, we use the average stock price for the period.

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Diluted income per share excludes out-of-the-money stock options and unvested restricted stock totaling 37.6 million shares for the three months ended October 1, 2004 and 20.5 million shares for the three months ended October 3, 2003, as their effect is anti-dilutive. Anti-dilutive stock options and unvested restricted stock totaled 30.8 million shares for the nine months ended October 1, 2004 and 37.9 million for the nine months ended October 3, 2003. While these options are currently anti-dilutive, they could be dilutive in the future. A reconciliation of basic and diluted income per share is presented below (in thousands, except per share amounts):

Note 5 – Deferred Income Taxes and Other Assets, Net:

Our deferred income taxes and other assets consisted primarily of the non-current portion of deferred tax assets of $40.8 million at October 1, 2004 and $34.1 million at January 2, 2004, and acquired intangible assets which are amortized on a straight-line basis over their estimated useful lives. Our acquired intangible assets were comprised of the following (in thousands):

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Amortization of total acquired intangible assets was $0.6 million for the three months ended October 1, 2004 and was $2.4 million for the three months ended October 3, 2003. Amortization of acquired intangible assets was $3.8 million for the nine months ended October 1, 2004 and was $5.7 million for the nine months ended October 3, 2003. The estimated future amortization expense of acquired intangible assets as of October 1, 2004 was as follows (in thousands):

Note 6 – Indemnification and Product Warranty:

We indemnify certain customers, distributors, suppliers, and subcontractors for attorney fees and damages and costs awarded against these parties in certain circumstances in which our products are alleged to infringe third party intellectual property rights, including patents, trade secret, trademarks, or copyrights. In all cases, there are limits on and exceptions to our potential liability for indemnification relating to intellectual property infringement claims. We cannot estimate the amount of potential future payments, if any, that we might be required to make as a result of these agreements. To date, we have not paid any claim or been required to defend any action related to our indemnification obligations, and accordingly, we have not accrued any amounts for such indemnification obligations. However, we may record charges in the future as a result of these indemnification obligations.

We generally warrant our products against defects in materials and workmanship and non-conformance to our specifications for varying lengths of time. If there is a material increase in customer claims compared with our historical experience, or if costs of servicing warranty claims are greater than expected, we may record a charge against cost of sales.

The following table summarizes the activity for the nine months ended October 1, 2004 and October 3, 2003 related to our product warranty liability, which was included in accrued liabilities in our consolidated balance sheets.

Note 7 – Common Stock Repurchases:

In September 2004, our Board of Directors approved an increase in the shares authorized for repurchase from 78.0 million shares to 88.0 million shares. Share repurchase activities for the three and nine months ended October 1, 2004 and October 3, 2003 were as follows:

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Since the inception of our repurchase program in 1996 through October 1, 2004, we have repurchased a total of 66.1 million shares of our common stock for an aggregate cost of $1.4 billion. All shares were retired upon acquisition. At October 1, 2004, 21.9 million shares remained authorized for repurchases under the plan.

In the fourth quarter, we entered into an agreement pursuant to SEC Rule 10b5-1 under which we have authorized a third party broker to repurchase shares on our behalf during our normal blackout period according to predetermined trading instructions. In addition, we may repurchase shares of our common stock under the guidelines of SEC Rule 10b-18.

Note 8 – Stock-Based Compensation Plans:

We currently have three stock-based compensation plans, which are described below. We account for stock-based compensation using the intrinsic value method prescribed in APB No. 25, “Accounting for Stock Issued to Employees” as allowed under SFAS No. 123.

Stock Option Plans

Our stock option program is a broad-based, long-term retention program intended to attract, motivate, and retain talented employees as well as align stockholder and employee interests. We currently grant stock options under two plans: the 1996 Stock Option Plan, which provides for the periodic issuance of stock options to our employees, and the 1998 Director Stock Option Plan, which provides for the periodic issuance of stock options to members of our Board of Directors who are not employees. The majority of the options granted under these plans generally vest over four years. All options have a maximum term of ten years. On May 11, 2004, our stockholders approved an amendment to our 1996 Stock Option Plan to increase the number of shares reserved for issuance from 74.0 million shares to 86.0 million shares. As of October 1, 2004, 14.0 million shares were available for future grants. The 1998 Director Stock Option Plan had 680,000 shares reserved for issuance and 164,167 shares were available for future grants.

Employee Stock Purchase Plan

On May 11, 2004, our stockholders approved an amendment to our 1987 Employee Stock Purchase Plan to increase the number of shares reserved for issuance from 17.7 million shares to 18.7 million shares. As of the end of our fiscal third quarter of 2004, 3.2 million shares were available for future issuances under that plan. Sales under the Employee Stock Purchase Plan were 414,055 shares of common stock at an average price of $16.67 for the nine months ended October 1, 2004, and 567,328 shares of common stock at an average price of $10.56 per share for the nine months ended October 3, 2003.

Pro Forma Net Income and Net Income Per Share

The fair value of each option grant, as defined by SFAS No. 123, is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions. However, options granted under our stock option plans are not freely tradable, or fully transferable, and have vesting restrictions. The Black-Scholes model also requires highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the fair value.

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As required by SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure”, the following table illustrates the effect on our net income and net income per share if we had recorded compensation costs based on the estimated grant date fair value defined by SFAS No. 123 for all granted stock-based awards (in thousands, except per share amounts):

Note 9 – Income Taxes:

We are currently under examination by various taxing authorities. Although the outcome of any tax audit is uncertain, we believe we have adequately provided in our financial statements for any additional taxes that we may be required to pay as a result of such examinations. If the payment ultimately proves to be unnecessary, the reversal of these tax reserves would result in tax benefits being recognized in the period we determine such reserves are no longer necessary. However, if an ultimate tax assessment exceeds our estimate of tax liabilities, an additional charge to expense will result.

In the third quarter of 2004, an examination by the Hong Kong Inland Department of Revenue (“IRD”) of the tax returns of our wholly owned subsidiary, Altera International Limited, was concluded. An overall settlement was reached with the IRD covering fiscal years 1997 through 2003. During the quarter ended October 1, 2004, we recognized an income tax benefit of $17.1 million in our statement of income primarily as a result of this settlement.

Note 10 – Recent Accounting Pronouncements:

In March 2004, the Financial Accounting Standards Board (FASB) approved the consensus reached on the Emerging Issues Task Force (EITF) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-1 provides guidance for identifying impaired investments and new disclosure requirements for investments that are deemed to be temporarily impaired. On September 30, 2004, the FASB issued a final staff position (FSP) EITF Issue 03-1-1 that delays the effective date for the measurement and recognition guidance included in paragraphs 10 through 20 of EITF 03-1. Quantitative and qualitative disclosures required by EITF 03-1 remain effective for Altera’s fiscal year ending 2004. We do not believe the impact of adoption of this EITF consensus will be significant to our overall results of operations or financial position.

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The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained in “Risk Factors” below and elsewhere in this report, contains forward-looking statements, which are provided under the “safe harbor” protection of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are generally written in the future tense and/or are preceded by words such as “will,” “may,” “should,” “could,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan,” or other similar words. Forward-looking statements include statements regarding (1) the commercial success of our new products; (2) trends in future sales; (3) our research and development efforts; (4) the benefits to gross margin from the sale of previously written-down inventory; and (5) our effective tax rate..

Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. The forward-looking statements contained in this report are based on information that is currently available to us and expectations and assumptions that we deem reasonable at the time the statements were made. We do not undertake any obligation to update any forward-looking statements in this report or in any of our other communications, except as required by law. All such forward-looking statements should be read as of the time the statements were made and with the recognition that these forward-looking statements may not be complete or accurate at a later date.

Many factors may cause actual results to differ materially from those expressed or implied by the forward-looking statements contained in this report. These factors include, but are not limited to, those risks described below under “Risk Factors” and those risks described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended January 2, 2004.

CRITICAL ACCOUNTING ESTIMATES

The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires our management to make judgments and estimates that affect the amounts reported in our financial statements and accompanying notes. Our management believes that we consistently apply these judgments and estimates and the financial statements and accompanying notes fairly represent all periods presented. However, any errors in these judgments and estimates may have a material impact on our statement of operations and financial conditions. Critical accounting estimates, as defined by the Securities and Exchange Commission, are those that are most important to the portrayal of our financial condition and results of operations and require our management’s most difficult and subjective judgments and estimates of matters that are inherently uncertain. Our critical accounting estimates include those regarding (1) revenue recognition; (2) valuation of inventories; and (3) taxes. For a discussion of the critical accounting estimates, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Estimates” in our Annual Report on Form 10-K for the year ended January 2, 2004.

RESULTS OF OPERATIONS

Sales

We design, manufacture, and market high-performance, high-density programmable logic devices, or PLDs; low-cost, masked programmed HardCopy^® structured ASIC devices; pre-defined design building blocks known as intellectual property, or IP, cores; and associated development tools. Our PLDs, which consist of field-programmable gate arrays, or FPGAs, and complex programmable logic devices, or CPLDs, are semiconductor integrated circuits that are manufactured as standard chips that our customers program to perform desired logic functions within their electronic systems. FPGAs, which represented 70% of our sales for the three months ended October 1, 2004 and 68% for the nine months ended October 1, 2004, consist of our Stratix^®, Stratix GX, Stratix II, Cyclone™, APEX™, APEX II, FLEX^®, ACEX^®, Excalibur™, and Mercury™ families, and CPLDs, which represented 22% and 24% of our total sales during the same periods, consist of our MAX^®, MAX II, and Classic™ families. Our products serve a wide range of markets, including communications, computer and storage, consumer, and industrial market segments.

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We classify our products into three categories: New, Mainstream, and Mature and Other Products. During the fourth quarter of 2003, we updated our product categories, and all prior period data have been adjusted to reflect the following compositions:

Sales during the three months ended October 1, 2004 were $264.6 million compared to $209.4 million for the three months ended October 3, 2003, representing a 26% increase in sales year-over-year. The increase was driven primarily by the sales of New Products which increased 212% year-over-year predominantly due to higher sales of our Stratix and Cyclone families. FPGA sales accounted for 70% of total sales and grew 33% year-over-year, driven predominantly by increased sales of our Stratix and Cyclone families. CPLD sales accounted for 22% of total sales and increased 6% compared to the same period a year ago, driven primarily by increases in sales of our MAX 3000A family. Sales during the nine months ended October 1, 2004 were $776.5 million compared to $609.8 million for the nine months ended October 3, 2003, representing a 27% increase in sales year-over-year. These increases for the three and nine month periods were primarily due to higher unit sales in our New and Mainstream product categories, partially offset by routine declines in average unit selling prices in our Mainstream and Mature and Other categories.

Sales decreased 2% sequentially in the third quarter of 2004 due to lower end market demand especially in Europe. Despite the overall decrease, New Products continue to grow with a 25% sequential gain driven predominantly by the Stratix and Cyclone families as a number of customer programs entered volume production and prototyping activity continued to be strong.

Sales by Product Category

Sales by product category, as a percentage of total sales, as well as year-over-year and sequential change, were as follows:

We expect that sales of the Stratix and Cyclone families will continue to increase over time as customer adoption of our New Products continues to be strong, and customers ramp their programs into volume production.

Sales by Market Segment

The following market segment data is derived from data that is provided to us by our distributors and end customers. With a broad base of customers, who in some cases manufacture end products spanning multiple market segments, the assignment of revenue to a market segment requires the use of estimates, judgment, and extrapolation. As such, actual results may differ from those reported.

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Sales by market segment, as a percentage of total sales, as well as year-over-year and sequential change, were as follows:

In absolute dollars, sales in all four market segments provided growth for the three and nine months ended October 1, 2004 compared to the same periods a year ago as a result of increased usage of PLDs. Sales in the Communications market segment had the largest growth year-over-year driven primarily by increased penetration in the wireless subsegment.

While we expect that Communications will remain our largest market segment, we anticipate that the Industrial and Consumer market segments will continue to contribute significantly to our future growth. For the three and nine months ended October 1, 2004 and October 3, 2003, no single end customer provided more than 10% of our sales.

Sales by Geography

The following table is based on the geographic location of the original equipment manufacturers or the distributors who purchased our products. For sales to our distributors, their geographic locations may be different from the geographic locations of the ultimate end users. Sales by geography, as a percentage of total sales, as well as year-over-year and sequential change, were as follows:

In absolute dollars, sales increased year-over-year in all geographies, but most significantly in the international geographies. The percentage of total sales represented by international locations increased year-over-year due to increased sales to end customers as well as the transfer of end customers’ business from North America to Asia Pacific. We expect that sales will continue to transfer from North America.

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Gross Margin

The year-over-year increase in gross margin was primarily due to yield enhancements especially in newer products, as well as overall declines in material and subcontractor costs. Gross margin included benefits resulting from the sale of inventory previously written down in 2001. We anticipate such gross margin benefit will continue to decline over time.

As of October 1, 2004, the book value of the inventory written down in 2001 was zero while the cost basis was $17.0 million. The cost was comprised of $11.7 million of raw materials and work in process inventory and $5.3 million of finished goods inventory.

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Research and Development

Selling, general, and administrative expenses primarily include salary expenses related to sales, marketing, and administrative personnel, commissions and incentives, depreciation, legal, advertising, facilities, and travel expenses.

Selling, general, and administrative expenses increased $6.7 million, or 14%, for the three months ended October 1, 2004 over the same period a year ago. The increase was primarily attributable to higher spending on labor costs, higher spending on commissions and incentives, and increased outside consulting expenses related to the initial adoption of Section 404 of the Sarbanes Oxley Act of 2002. Selling, general and administrative expenses increased $19.5 million, or 14%, for the nine months ended October 1, 2004 over the same period a year ago. The increase was primarily attributable to higher spending on labor and benefit costs, commissions and incentives, consulting and travel expenses.

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Interest and Other Income, Net

Interest and other income consists mainly of interest income generated from investments in high-quality fixed income securities. Interest and other income during the three months ended October 1, 2004 remained relatively flat compared to the same period a year ago. The increase in interest and other income during the nine months ended October 1, 2004 compared to the same period a year ago was primarily due to a recognized loss of $3.1 million in the second quarter of 2003, partially offset by a decrease in interest income due to lower investment yields in 2004.

Provision for Income Taxes

Our effective tax rate for the three months ended October 1, 2004 was 3%, compared with 27% for the three months ended October 3, 2003. Our effective income tax rate for the nine months ended October 1, 2004 was 16%, compared with 27% for the nine months ended October 3, 2003.

An income tax benefit, primarily related to a settlement with the Hong Kong Inland Revenue Department for the tax years 1997 to 2003, contributed to a 20 percentage point rate decrease in our effective tax rate for the three months ended October 1, 2004, and a 7 percentage point rate decrease for the nine months ended October 1, 2004. The remaining decrease in our effective tax rate over the prior periods is due to a favorable change in the geographic mix of income, partially offset by smaller benefits from tax-exempt income and research and development tax credits. We expect our effective tax rate to return to 23% in the fourth quarter.

Financial Condition, Liquidity, and Capital Resources

We ended the third quarter of 2004 with $1.1 billion of cash, cash equivalents, and short-term investments available to finance our operating activities and future growth. We currently use cash generated from operations to support our operating activities, capital expenditures, and acquisitions and investments. We also use our available cash for repurchases of our common stock under our stock repurchase program. As of October 1, 2004, we had no borrowings.

Cash provided by operating activities was $259.1 million for the nine months ended October 1, 2004. Our positive cash flows from operating activities were primarily attributable to net income, adjusted for non-cash items. Working capital uses of cash included increases in inventories and cash advances to distributors. Working capital sources of cash included a decrease in accounts receivable primarily due to timing of shipments and customer payments, and an increase in accounts payable and accrued liabilities.

Cash provided by investing activities was $237.1 million for the nine months ended October 1, 2004, and consisted primarily of proceeds from the maturity and sale of investments, net of purchases, of $254.7 million. We also spent $15.8 million to purchase property and equipment for the nine months ended October 1, 2004.

Cash used for financing activities of $137.2 million resulted from repurchases of our common stock of $163.7 million, which was partially offset by net proceeds of $26.5 million from the issuance of our common stock to employees through various stock option plans. We expect that we will continue to use a portion of our available capital to repurchase shares.

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We believe our current cash and cash equivalents, investments and cash generated from operations will satisfy our working capital requirements for the foreseeable future.

Purchase Commitments and Contractual Obligations

We depend entirely upon subcontractors to manufacture our silicon wafers and provide assembly and test services. Due to lengthy subcontractor lead times, we must order these materials and services from these subcontractors well in advance, and if the subcontractor has commenced production to satisfy our order, we are ultimately obligated to pay for the materials and services. As of October 1, 2004, we had less than $100.0 million of outstanding purchase commitments to such subcontractors. We expect to receive and pay for these materials and services within the next four to six months.

We also lease facilities under non-cancelable lease agreements expiring at various times through 2010. There had been no significant changes to our operating lease obligations since our 2003 fiscal year end. We also enter into various non-cancelable contracts to acquire goods and services in the normal course of business.

Impact of Currency Translation and Inflation

We purchase the majority of our materials and services in U.S. dollars and sell our products to OEMs and distributors in U.S. dollars. As of October 1, 2004, we had no open forward contracts; however, we may enter into contracts from time to time to hedge foreign exchange exposure. We have, in the past, entered into forward contracts to hedge against currency fluctuations associated with contractual commitments denominated in foreign currencies.

Common Stock Repurchases

In September 2004, our Board of Directors approved an increase in the shares authorized for repurchase from 78.0 million shares to 88.0 million shares. Share repurchase activities for the three and nine months ended October 1, 2004 and October 3, 2003 were as follows: