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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended September 30, 2004

For the transition period from              to             

0-23270

Commission File Number

Dominion Homes, Inc.

(Exact name of registrant as specified in its charter)

5000 Tuttle Crossing Blvd, Dublin, Ohio

(Address of principal executive offices)

43016-5555

(Zip Code)

(614) 356-5000

(Registrant’s Telephone Number, Including Area Code)

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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 common shares outstanding as of November 9, 2004: 8,206,515

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

Dominion Homes, Inc.

Consolidated Balance Sheets

(In thousands, except share information)

The accompanying notes are an integral part of the consolidated financial statements.

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Dominion Homes, Inc.

Consolidated Statements of Operations

(In thousands, except share and per share amounts)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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Dominion Homes, Inc.

Consolidated Statement of Changes in Shareholders’ Equity

(In thousands)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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Dominion Homes, Inc.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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DOMINION HOMES, INC.

Notes to the Consolidated Financial Statements

(Unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements of Dominion Homes, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The December 31, 2003 balance sheet data were derived from audited financial statements but do not include all disclosures required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with the December 31, 2003 audited annual financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2003.

The financial information included herein reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results of operations to be expected for the full year.

2. Stock-Based Compensation

The Company has elected to follow the intrinsic value method to account for compensation expense related to the award of stock options and to furnish the pro forma disclosures required under SFAS No. 123, “Accounting for Stock-Based Compensation.” Because the Company’s stock option awards are granted at prices not less than the fair-market value of the shares at the date of grant, no compensation expense is recognized for these awards. Compensation expense related to restricted share awards is determined at the date of grant, recorded as unearned compensation expense, updated periodically for changes in fair value and amortized over the vesting period of the awarded shares. The unearned compensation expense related to such awards was $3.2 million at September 30, 2004 and is reflected as a reduction of shareholders’ equity.

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Had compensation cost for stock options been determined based on the fair value of awards at the grant dates, the Company’s net income and earnings per share for the three months and nine months ended September 30, would have been reduced to the pro forma amounts indicated below:

3. Capitalized Interest

The Company capitalizes the cost of interest related to: (1) construction costs incurred during the construction period of homes and (2) costs incurred while developing land. Capitalized interest related to the construction costs of homes and land development is included in interest expense in the period in which the home is closed. Capitalized interest related to land under development and construction in progress was $3.9 million and $3.4 million at September 30, 2004 and 2003, respectively. The summary of total interest is as follows:

4. Note Payable, Banks

On June 30, 2004, the Company amended the Second Amended and Restated Credit Agreement, which evidences its Senior Unsecured Revolving Credit Facility (the “Facility”) to increase the maximum lending amount from $250.0 million to $300.0 million. No other changes were made to the Facility. The Facility terminates on May 31, 2007 unless extended by mutual agreement. See Note 7, Note Payable, Banks, to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

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As of September 30, 2004, the Company was in compliance with the Facility covenants and had $60.8 million available under the Facility, after adjustment for borrowing base limitations and giving effect to the increased lending amount described above. Borrowing availability under the Facility could increase depending on the Company’s utilization of the proceeds of borrowings under the Facility.

5. Derivative Instruments and Hedging Activities

The Facility provides for a variable rate of interest on borrowings. The variable rate is the three month LIBOR rate plus a variable margin rate that ranges from 1.75% to 2.5% and is based on the Company’s interest coverage ratio. The margin rate was 1.75% for the three months ended September 30, 2004. In order to reduce exposure to increasing interest rates, the Company has entered into interest rate swap contracts that fix the interest rate on a portion of the borrowings under the Facility. The Company has designated the swap contracts as cash flow hedges as described in Note 10, Derivative Instruments and Hedging Activities, to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. At September 30, 2004, the Company had fixed the interest rate on $130 million of borrowings with interest rates that range between 2.5% and 5.6%, plus the variable margin rate. The interest rate swaps mature between January 12, 2005 and September 9, 2008. The related fair value of the interest rate swaps at September 30, 2004, was a loss of approximately $109,000 which is recorded through other comprehensive income. The weighted average interest rates for borrowings under the Facility for the three months ended September 30, 2004 and 2003 were 4.7% and 6.2%, respectively. These rates include the cost of the interest rate swaps.

6. Earnings per Share

A reconciliation of the weighted average common shares used in basic and diluted earnings per share calculations is as follows:

7. Warranty Costs

The Company provides a two-year limited warranty on materials and workmanship and a thirty-year warranty against major structural defects. An estimated amount of warranty cost is provided for each home at the date of closing based on historical warranty experience.

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A reconciliation of the changes in the warranty liability for the three and nine months ended September 30 is as follows:

8. Income Taxes

The Company provides for income taxes in interim periods based on its annual effective tax rate. The estimated annual effective tax rate used to determine the tax expense was 41.8% for the third quarter of 2004 and 40.2% for the third quarter of 2003.

9. Legal Proceedings

The Company is involved in various legal proceedings that arise in the ordinary course of business, some of which are covered by insurance. In the opinion of the Company’s management, there are no currently pending proceedings that will have a material adverse effect on the Company’s financial condition or results of operations.

10. Adoption of Accounting Pronouncement

Effective January 1, 2004, the Company adopted FASB Interpretation No. 46R (“FIN 46R”), which requires existing unconsolidated variable interest entities acquired before February 1, 2003 to be consolidated by their primary beneficiaries, if the entities do not effectively disperse risks among the parties involved.

The Company has evaluated all of its existing joint venture agreements, and has determined that none of the joint ventures are variable interest entities. Therefore, the Company has not consolidated any of its joint venture agreements pursuant to the requirements of FIN 46R. The Company has evaluated its land option contracts and determined that it is the primary beneficiary of certain of these option contracts. Although the Company does not have legal title to the land subject to the option contracts, for those land option contracts for which the Company is the primary beneficiary, the Company is required to consolidate the land subject to the option contracts. The consolidation of the land subject to these option contracts had the effect of increasing real estate inventories by $11.9 million with a corresponding increase to accrued liabilities in the accompanying balance sheet as of September 30, 2004. The liabilities represent the difference between the exercise price of the land option contracts and the Company’s deposits. The Company’s maximum exposure to loss on the consolidated $11.9 million of land is limited to letters of credit of approximately $6.2 million at September 30, 2004.

The Company has evaluated its interests in Alliance Title Agency, Ltd. (“Alliance”) and, based on this evaluation, the Company consolidated Alliance effective January 1, 2004. There were assets of $768,000 related to Alliance included in the Consolidated Balance Sheets at September 30, 2004. The Company’s maximum exposure to loss in this entity is limited to the

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amount invested, which is approximately $227,000 at September 30, 2004. Alliance is an Ohio limited liability company of which the Company owns 49.9%, the maximum allowable under Ohio law, and provides title insurance for most of the Company’s home closings in Ohio.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a leading builder of high-quality homes in Central Ohio (the Columbus Metropolitan Statistical Area), Louisville, Kentucky and Lexington, Kentucky. Our customer-driven focus targets entry-level and move-up buyers. We offer a variety of homes that are differentiated by price, size, standard features and available options. Our homes range in price from approximately $100,000 to more than $350,000 and in size from approximately 1,000 to 3,500 square feet. We believe our success has resulted, in part, from our ability to provide a wide-range of communities and home designs that entry-level and move-up buyers find appealing and can afford.

On October 14, 2004, our President and Chief Operating Officer, Jon M. Donnell, resigned effective October 31, 2004 in order to pursue other opportunities. On November 1, 2004 our Chairman and Chief Executive Officer, Douglas G. Borror, assumed the title of President. There are currently no plans to replace Mr. Donnell, who served the Company well over the last nine and a half years.

Our third quarter 2004 revenues increased 6% to $162.6 million from $153.2 million for the third quarter of 2003. Higher costs of real estate sold and increased selling, general and administrative expenses offset the third quarter 2004 sales gain, resulting in an 18% decline in net income to $7.5 million, compared to the third quarter 2003 net income of $9.1 million. Diluted earnings per share decreased 19% to $0.91 for the third quarter of 2004 compared to $1.13 per diluted share for the third quarter of 2003.

The increase in revenues was due to an 11%, or $18,700, increase in the average price of homes delivered, offset by the delivery of 24 fewer homes. This increase in the average delivery price was primarily due to delivering more of our larger, more expensive Tradition Series of homes compared to the same period the previous year. Third quarter 2004 revenues also include $3.5 million from the sale of 21 model homes that we leased back for use as sales models. There were no model homes sold and leased back for use as sales models during the third quarter of 2003. Gross profit margin declined to 22.3% from 24.0% principally due to higher building material costs and financial incentives to reduce the number of inventory homes. Our investment in inventory homes at September 30, 2004 has been reduced to 219 homes, with an aggregate investment of $20.0 million, from 290 homes, with an aggregate investment of $29.2 million, on June 30, 2004.

Selling, general and administrative expenses increased $1.6 million for the third quarter of 2004 to $21.0 million from $19.4 million for the third quarter of 2003, and remained approximately the same as a percentage of revenues compared to the third quarter of 2003. This increase was principally due to additional expenses associated with the growth in the number of our communities, the expansion of our mortgage financing services subsidiary and costs associated with the testing and documentation of internal controls required by the Sarbanes-Oxley Act.

Sales demand in the Midwest region slowed in recent months and, as a result, our third quarter 2004 homes sales are down 16.7% compared to the same quarter homes sales the previous year. Our backlog on September 30, 2004 represented 36.3% fewer sales contracts than at September 30, 2003, however, the average sales price of homes in backlog increased 3.7% over the prior year’s. We are evaluating our cost structure and land position to adapt to lower expected revenues in future periods.

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Safe Harbor Statement under the Private Securities Litigation Act of 1995

We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). This Quarterly Report on Form 10-Q contains various “forward–looking statements” within the meaning of the PSLRA and other applicable securities laws. Such statements can be identified by the use of the forward-looking words “anticipate,” “estimate,” “project,” “believe,” “intend,” “expect,” “hope” or similar words. These statements discuss future expectations, contain projections regarding future developments, operations or financial conditions, or state other forward-looking information. These forward-looking statements involve various important risks, uncertainties and other factors which could cause our actual results for 2004 and beyond to differ materially from those expressed in the forward-looking statements. Certain of these important factors are described in our Annual Report on Form 10-K for the year ended December 31, 2003 and include the following risks and uncertainties:

In addition, domestic terrorist attacks and the threat or the escalation of the United States’ involvement in international armed conflict may also adversely affect general economic conditions, consumer confidence and the homebuilding markets.

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Seasonality and Variability in Quarterly Results

Historically, we have experienced significant seasonality and quarter-to-quarter variability in our homebuilding activity. Typically, closings and related revenues increase in the second half of the year. We believe this seasonality reflects the tendency of home buyers to shop for a new home in the spring with the goal of closing in the fall or winter. Weather conditions can also accelerate or delay the scheduling of closings. During 2004, we expect second half closings to be approximately the same as first half closings due to the lower number of home sales during the second and third quarters of 2004. The following table sets forth certain data for each of the last eight quarters:

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Results of Operations

The following table sets forth, for the periods indicated, certain items from our Consolidated Statements of Operations expressed as percentages of total revenues, as well as certain operating data:

We include a home in “sales contracts” for purposes of the foregoing table when a home buyer signs our standard sales contract, which requires a deposit and generally has no contingencies other than for buyer financing or for the sale of an existing home, or both. We recognize revenue and cost of real estate sold at the time of closing. “Closings” or “deliveries” occur when we convey the deed to the home buyer. We include a home in “backlog” when a home buyer signs our standard sales contract, but the closing has not occurred as of the end of the period.

Homes included in “sales contracts” in the foregoing table are net of cancellations. Most cancellations occur when home buyers cannot qualify for financing. While most cancellations occur prior to the start of construction, some cancellations occur during the construction process.

We annually incur a substantial amount of indirect construction costs, which are essentially fixed in nature. For purposes of quarterly financial reporting, we capitalize these costs to real estate inventories based on the ratio of estimated annual indirect costs to direct construction costs to be incurred. Thus, variations in construction activity cause fluctuations in interim and annual gross profits.

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Third Quarter 2004 Compared to Third Quarter 2003

Revenues. Our revenues for the third quarter of 2004 increased by 6.2% to $162.6 million from the delivery of 820 homes compared to revenues for the third quarter of 2003 of $153.2 million from the delivery of 844 homes. Third quarter 2004 revenues include $3.5 million from the sale of 21 model homes that we leased back for use as sales models. There were no model homes sold and leased back for use as sales models during the third quarter of 2003. Revenues increased due to a 10.5% increase in the average price of delivered homes, which increased to $196,300 from $177,600, offset by the delivery of 24 fewer homes. The average price of delivered homes increased due to delivering a larger number of our more expensive Tradition Series of homes and fewer of our first-time home buyer series of homes than during the comparable quarter in 2003.

Included in revenues are other revenues, consisting principally of fees from our mortgage financing services subsidiary. These other revenues amounted to $2.5 million for the third quarter of 2004 and $3.3 million for the third quarter of 2003. The decrease in other revenues is principally due to our home buyers using a higher percentage of third party mortgage lenders during the third quarter of 2004 than the third quarter of 2003.

Gross Profit. Our gross profit margin for the third quarter of 2004 decreased to 22.3% from 24.0% for the third quarter of 2003. This margin decrease was principally due to increases in building material costs and financial incentives offered on inventory homes.

Selling, General and Administrative Expenses. Our selling, general and administrative expenses for the third quarter of 2004 increased 7.9% to $21.0 million from $19.4 million for the third quarter of 2003 and represented 12.9% and 12.7%, respectively of revenues for the third quarter of 2004 and 2003. This increase was primarily due to additional expenses associated with the growth in the number of our communities, the expansion of our mortgage financing services subsidiary and costs associated with the testing and documentation of internal controls required by the Sarbanes-Oxley Act.

Interest Expense. Our interest expense was $2.4 million for the third quarter of 2004 compared to $2.0 million for the third quarter of 2003. The average borrowings under our bank credit facility (the “Facility”) increased to $194.6 million for the third quarter of 2004 compared to $111.8 million for the third quarter of 2003. Average borrowings under the Facility increased principally due to the acquisition of additional land. The weighted average rate of interest on total borrowings decreased to 4.7% for the third quarter of 2004 compared to 6.2% for the third quarter of 2003.

Provision for Income Taxes. Our income tax expense for the third quarter of 2004 decreased to $5.4 million from $6.1 million for the third quarter of 2003. Our estimated annual effective tax rate used to determine tax expense was 41.8% for the third quarter of 2004 and 40.2% for 2003.

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First Nine Months 2004 Compared to First Nine Months 2003

Revenues. Our revenues for the first nine months of 2004 increased by 7.4% to $426.5 million from the delivery of 2,232 homes, compared to revenues for the first nine months of 2003 of $397.1 million from the delivery of 2,177 homes. Revenues include $3.5 million from the sale of 21 model homes that we leased back for use as sales models. There were no model homes sold and leased back for use as sales models during the third quarter of 2003. The increase in revenues was primarily due to the delivery of 55 additional homes during the first nine months of 2004 and an increase in the average price of delivered homes to approximately $188,500 from $178,500.

Included in revenues are other revenues, consisting primarily of revenues from our mortgage financing services subsidiary. These other revenues amounted to $6.7 million during the first nine months of 2004 compared to $8.5 million for the first nine months of 2003. The decrease in other revenues is principally due to our home buyers using a higher percentage of third party mortgage lenders during the first nine months of 2004 than the first nine months of 2003.

Gross Profit. Our gross profit margin for the first nine months of 2004 decreased to 22.8% from 23.9% for the first nine months of 2003. This decrease was primarily due to increased building material costs, financial incentives offered on inventory homes, offset by a reduction in warranty expense.

Selling, General and Administrative Expenses. Our selling, general and administrative expenses for the first nine months of 2004 increased by 14.0% to $59.8 million from $52.4 million. This $7.4 million increase was due to the increased variable expense associated with delivering more homes, investments in personnel and other expenses that were incurred to increase the number of communities in Central Ohio and Louisville, Kentucky, the start-up of our Lexington, Kentucky market, the expansion of our mortgage financing services subsidiary, testing and documentation of internal controls required by the Sarbanes-Oxley Act and the replacement of our Chief Financial Officer.

Interest Expense. Our interest expense for the first nine months of 2004 increased to $6.2 million from $5.7 million for the first nine months of 2003. The average borrowing under the Facility increased to $183.2 million for the first nine months of 2004 from $109.5 million for the first nine months of 2003. Average borrowings under the facility increased principally due to the acquisition of additional land. The weighted average rate of interest on total borrowings for the first nine months of 2004 was 4.6% compared to 6.6% for the first nine months of 2003.

Provision for Income Taxes. Our income tax expense for the first nine months of 2004 decreased to $12.1 million from $14.8 million for the first nine months of 2003. Our estimated effective tax rate decreased to 38.7% for the first nine months of 2004 from 39.9% for the first nine months of 2003 as a result of expected tax benefits from tax planning strategies.

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Liquidity and Capital Resources

Historically, our capital needs have depended on sales volume, asset turnover, land acquisition and inventory levels. Our traditional sources of capital have been internally generated cash, bank borrowings and seller financing. At times, we have sold our common shares in the public market. We have incurred indebtedness in the past and expect to incur indebtedness in the future to fund operations and investment in land. We expect the cash flow from sales in backlog and funds from the Facility to allow us to meet short-term cash obligations of the Company. The primary reasons that we could require additional capital are expansion in existing markets, expansion into new markets, expansion of our mortgage financing services subsidiary, or purchase of a homebuilding company. We believe the current borrowing capacity and anticipated cash flows from operations are sufficient to meet liquidity needs of the Company for the foreseeable future.

Sources and Uses of Cash for the First Nine Months of 2004 Compared to the First Nine Months of 2003

During the first nine months of 2004, we generated $32.9 million of cash flow from operations before expenditures on real estate inventories of $87.7 million. The $87.7 million increase in real estate inventories consisted of a $96.7 million increase in land and land development and other building material inventories and a decrease of $9.0 million in homes under construction. We invested significantly in land and land development to expand our presence in Central Ohio and Louisville, Kentucky and to enter the Lexington, Kentucky market. We used cash from operations together with borrowings under our Facility to finance the increase in real estate inventories.

During the first nine months of 2003, we generated $34.9 million of cash flow from operations before expenditures on real estate inventories of $38.8 million. The $38.8 million increase in real estate inventories consisted of a $8.4 million increase in land and land development and other building material inventories and $30.4 million in homes under construction. We also utilized $7.8 million of cash to fund the construction of our new office building, to purchase other property and equipment and to repurchase common shares valued at $1.8 million. Proceeds under our Facility were used to finance our cash requirements.

Real Estate Inventories

We develop approximately 90% of the communities in which we build homes and generally do not purchase land for resale. We generally attempt to maintain a land inventory that is sufficient to meet our anticipated lot needs for the next three to six years. We are currently evaluating our land holdings and may sell some of our land to third parties in order to better meet our expected land needs based on the slowdown in home sales.

On September 30, 2004, we owned lots or land that we estimate could be developed into 15,088 lots, including 2,645 lots in Kentucky. During the first nine months of 2004, we exercised options to purchase lots or unimproved land that could be developed into 7,329 lots, including 1,494 lots in Kentucky.

At September 30, 2004, we controlled, through option agreements or contingent contracts, land that we estimate could be developed into 7,307 additional lots, including 836 lots in Kentucky. We hold additional contingent agreements for land that may allow us to develop additional lots that are not included in these totals. However, based on our land review process, we have concluded that it is unlikely that all of the contingencies contained in these other

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agreements will be satisfied in the near future. Consequently, we did not consider these contingent agreements when estimating the total amount of land or number of lots that we potentially may control. The option agreements that we determined were more than likely to have contingencies that will be satisfied expire at various dates through 2015. We decide whether to exercise any particular option or otherwise acquire additional land based upon our assessment of a number of factors, including our existing land inventory at the time, the status of purchase contingencies and our evaluation of the future demand for our homes.

Our real estate inventories at September 30, 2004 were $415.4 million, consisting of $302.3 million of land and land under development, $108.3 million of homes under construction and other inventories of $4.8 million.

The following table sets forth our land inventory as of September 30, 2004:

On September 30, 2004, we had 219 single-family inventory homes in various stages of construction, representing an aggregate investment of $20.0 million, compared to 202 inventory homes in various stages of construction, representing an aggregate investment of $15.4 million on September 30, 2003. We do not include inventory homes in sales or backlog.

Contractual Obligations

Note Payable Banks. On December 3, 2003, we entered into a Second Amended and Restated $250.0 million Senior Unsecured Revolving Credit Facility (the “Facility”) that terminates on May 31, 2007 unless extended by mutual agreement. On June 30, 2004, we amended the Facility to increase the maximum lending amount from $250.0 million to $300.0 million. For a more detailed description of the Facility, including restrictions on our business activities, see Note 7, Note Payable, Banks, to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2003.

The Facility provides for a variable rate of interest on our borrowings. The variable rate is the three month LIBOR rate plus a variable margin that ranges from 1.75% to 2.5%, is based on our interest coverage ratio and is determined quarterly. At September 30, 2004, we had fixed the interest rate on $130 million of our borrowings under the Facility by entering into interest rate swap contracts. Additional information regarding the interest rate swap contracts we have entered into is set forth under the heading “Quantitative and Qualitative Disclosures About Market Risk” in Item 3 below.

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As of September 30, 2004, we were in compliance with the Facility covenants and had $60.8 million available under the Facility, after adjustment for borrowing base limitations and giving effect to the increased lending amount described above. Borrowing availability under the Facility could increase, depending on our use of the proceeds from borrowings under the Facility.

Seller Financing. We hold land for development that was partially financed with seller provided term debt with an outstanding balance of $7.6 million at September 30, 2004. We expect to repay $2.8 million of this debt during 2004, $4.0 million during 2005 and $850,000 during 2007.

Capital and Operating Leases. We believe the best use of our Facility is to finance direct investments in our homebuilding operations. Assets that support our homebuilding operations are generally financed through capital and operating lease obligations. These assets include office facilities, model homes, vehicles and equipment. We analyze each lease and determine whether the lease is a capital lease, in which case the asset and related obligation is included on our balance sheet, or an operating lease, in which case the asset and obligation is not included on our balance sheet. We do not retain a residual financial interest in leased assets. Our capital lease obligations were $1.4 million at September 30, 2004. We believe our operating leases are properly classified as off balance sheet transactions. Our minimum rental commitment under such non-cancelable operating leases was $18.4 million at September 30, 2004. For further information on our leases, see Note 9, Operating Lease Commitments and Note 12, Related Party Transactions, to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2003.

Land Purchase Commitments. On September 30, 2004, we had commitments to purchase residential lots and unimproved land at an aggregate cost of $942,000, net of approximately $50,000 in good faith deposits. We intend to purchase this land within the next year.

The following is a summary of our contractual obligations at September 30, 2004:

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Off Balance Sheet Arrangements

Performance Bonds and Irrevocable Letters of Credit. We are liable for performance bonds of $50.1 million and irrevocable letters of credit of $8.9 million at September 30, 2004. These instruments were issued to municipalities and other individuals to ensure performance and completion of certain land development activities and as collateral for contingent land purchase commitments. We do not anticipate incurring any liability with respect to these instruments.

Variable Interest Entities. We selectively enter into joint ventures with other homebuilders to own and develop communities. The participants in the joint ventures acquire substantially all of the lots developed by the joint ventures and fund the development costs of the joint ventures. In certain cases, we may be liable under debt commitments within the particular joint venture. As of September 30, 2004, we were party to one joint venture that finances its own development activities. We have guaranteed the obligations under the joint venture’s loan agreement up to $1.2 million, representing our one-half interest. At September 30, 2004, the joint venture had no loans outstanding under this loan agreement.

Under certain circumstances, joint ventures may qualify as variable interest entities that are required to be consolidated with our financial statements. We have evaluated all of our existing joint venture agreements and we have determined that none of our joint ventures are variable interest entities.

We continually evaluate our land option and contingent purchase contracts to purchase unimproved land and developed lots. Cancelable contractual obligations consist of options under which we have the right, but not the obligation, to purchase land and contingent purchase contracts are contracts under which our obligation to purchase land is subject to the satisfaction of zoning, utility, environmental, title or other contingencies. On September 30, 2004, we had $79.2 million of cancelable contractual obligations for which we had determined it is reasonably likely that we will execute the land or lot purchase. Our combined good faith deposits and letters of credit on these contracts were $3.9 million at September 30, 2004. Assuming that the contingencies are actually satisfied and that no other significant obstacles to development arise, we expect to purchase most of the residential lots and unimproved land that are subject to these cancelable contractual obligations. We expect to fund our land acquisition and development obligations from internally generated cash and from the borrowing capacity under our Facility. We are in the process of evaluating an additional $98.5 million of cancelable contractual obligations for which we have not yet determined whether it is reasonably likely that we will execute the land or lot purchase. On September 30, 2004, good faith deposits on these contracts were $2.4 million.

We have also evaluated our land option contracts in order to determine if we are the primary beneficiary of these contracts. We have determined that we are the primary beneficiary of certain of these contracts. Although we do not have legal title to the land subject to the option contracts, for those option contracts for which we are the primary beneficiary we are required to consolidate in the financial statements the land subject to the option contracts. The consolidation of the land subject to these option contracts had the effect of increasing real estate inventories by $11.9 million with a corresponding increase to accrued liabilities in the accompanying balance sheet as of September 30, 2004. The liabilities represent the difference between the exercise price of the land option contracts and our letters of credit.

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We own a 49.9% interest in a title insurance agency, Alliance Title Agency, Ltd. (“Alliance”), which provides title insurance for most of our home deliveries in Ohio. Our maximum exposure to loss in Alliance is limited to the amount invested, which is approximately $227,000 at September 30, 2004. We have determined that Alliance is a variable interest entity and have consolidated Alliance effective January 1, 2004.

In 1997, we entered into an agreement with an unaffiliated third party to sell and lease back certain model homes used as sales models. This agreement was amended September 10, 2004, at which time 21 model homes were sold and leased back for use as sales models. On September 30, 2004, we had 21 model homes subject to a one-year lease and six model homes subject to a month to month lease under this agreement. We have determined that these leases are not with a variable interest entity and rental obligations are properly classified as operating leases in our schedule of contractual obligations.

The following is a summary of our commercial commitments under off balance sheet arrangements at September 30, 2004 (in thousands):

Alliance Title Agency

Alliance is an Ohio limited liability company which is licensed under Ohio insurance laws to conduct a title insurance agency business in Ohio. Alliance provides title insurance and other closing related services for most of the Company’s home closings in Central Ohio. As of December 31, 2003, the Company owned 49.9% of the membership interests in Alliance, the maximum percentage allowable under Ohio law, and CC, I Ltd. (“CCI”), an Ohio limited liability company owned by Denis G. Connor and Chicago Title Agency of Central Ohio, Inc., owned the remaining 50.1%. Effective January 1, 2004, the Company assigned and contributed a 30.1% membership interest in Alliance to the Dominion Homes – Borror Family Foundation (the “Foundation”), an Ohio nonprofit corporation formed by the Company, and simultaneously exercised its right to purchase a 30.1% membership interest in Alliance from CCI at a cost of $11,667 which was determined in accordance with an existing operating agreement between the parties. After the completion of these transactions, the membership interests of Alliance are owned as follows: 49.9% by the Company (the maximum ownership interest allowed under Ohio law); 20.0% by CCI; and 30.1% by the Foundation.

The Foundation has applied to be treated as a tax exempt organization under Section 501(c)(3) of the Internal Revenue Code (the “Code”). In the event that the Foundation’s application for tax exempt treatment is denied, however, the Company has an option to rescind the transactions described above, effectively restoring the ownership of membership interests in Alliance to that existing on December 31, 2003.

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As part of its application for tax exempt treatment, the Foundation has requested to be recognized as a “supporting organization” of the Columbus Foundation, an Ohio nonprofit corporation, under Section 509(a)(3) of the Code. The Foundation was formed exclusively for charitable, educational, scientific and religious purposes and for the exclusive benefit and to carry out the purposes of the Columbus Foundation. It is anticipated that the Company’s involvement with the Foundation and the Foundation’s charitable activities will reflect favorably on the Company and its presence in the Central Ohio market. The Columbus Foundation has the right to appoint three individuals to the Foundation’s board of directors. The Company has the right to appoint the remaining two individuals and has appointed Douglas G. Borror, its Chairman and Chief Executive Officer, and Denis G. Connor to the Foundation’s board of directors. The Foundation also has a non-exclusive, non-transferable license to use the “Dominion” trademark in connection with its philanthropic activities supporting The Columbus Foundation.

Inflation and Other Cost Increases

We are not always able to reflect all of our cost increases in the prices of our homes because competitive pressures and other factors sometimes require us to maintain or discount those prices. While we attempt to maintain costs with subcontractors from the date a sales contract with a customer is accepted until the date construction is completed, we may incur unanticipated costs which cannot be passed on to the customer. For example, delays in construction of a home can cause the mortgage commitment to expire and can require us, if mortgage interest rates have increased, to pay significant amounts to the mortgage lender to extend the original mortgage interest rate. During periods of high construction activities, we may incur additional costs to obtain subcontractors when certain trades are not readily available, which can result in lower gross profits. In addition, periods of rapid price increases in the cost of materials can result in lower gross profits.

Recently Issued Accounting Pronouncements

Effective January 1, 2004, we adopted FASB Interpretation No. 46R (“FIN 46R”), which requires existing unconsolidated variable interest entities acquired before February 1, 2003 to be consolidated by their primary beneficiaries, if the entities do not effectively disperse risks among the parties involved. Our adoption of this pronouncement is discussed under the heading “Off Balance Sheet Arrangements” contained herein.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As of September 30, 2004, we were a party to twelve interest rate swap contracts with an aggregate notional amount of $130 million, as reflected in the table below. We enter into swap contracts to minimize earnings fluctuations caused by interest rate volatility associated with our variable rate debt. The swap contracts allow us to have variable rate borrowings and to select the level of fixed rate debt for the Company as a whole. Under the swap contracts, we agree with other parties to exchange, at specified intervals, the difference between fixed rate and floating rate amounts calculated by reference to an agreed notional amount. Our intention is to maintain approximately 50% of our debt on a fixed interest rate basis. At any time, this percentage may be more or less depending on specific circumstances. At September 30, 2004, our level of the fixed

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rate debt under the Facility, after considering the effect of the interest rate swaps, was approximately 68% of total borrowings under the Facility. We do not enter into derivative financial instrument transactions for speculative purposes. The swap contracts are more fully described below: