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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period
ended March 31, 2005 or o
    
    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: 000-50360 DIRECT GENERAL CORPORATION 
  Tennessee
    
    62-1564496(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)1281 Murfreesboro Road, Nashville, TN
    
    37217(Address of principal executive offices)
    
    (Zip Code)
 (615) 399-0600
(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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes þ No o Indicate the number of shares outstanding of each of the issuers classes of common stock, as
of the latest practicable date: 21,745,097 shares of common stock, no par value, at May 9, 2005.




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TABLE OF CONTENTS  PART IFINANCIAL INFORMATIONItem 1. Financial StatementsItem 2. Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPART II OTHER INFORMATIONItem 1. Legal ProceedingsItem 2. Unregistered Sales of Equity Securities and Use of ProceedsItem 6. ExhibitsSIGNATURESEX-31.1  SECTION 302 CERTIFICATION OF THE CEOEX-31.2  SECTION 302 CERTIFICATION OF THE CFOEX-32.1  SECTION 906 CERTIFICATION OF THE CEOEX-32.2  SECTION 906 CERTIFICATION OF THE CFO    Table of Contents  
 PART IFINANCIAL INFORMATION 
 Item 1. Financial Statements. DIRECT GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) Three Months EndedMarch 31,2005
    
    
    2004(In thousands, except per share amounts)RevenuesPremiums earned
    
    $
    101,913
    
    
    $
    83,007Finance income
    
    
    12,171
    
    
    
    12,761Commission and service fee income
    
    
    14,267
    
    
    
    13,495Net investment income
    
    
    3,329
    
    
    
    2,276Net realized gains on securities and other
    
    
    31
    
    
    
    69Total revenues
    
    
    131,711
    
    
    
    111,608ExpensesInsurance losses and loss adjustment expenses
    
    
    75,882
    
    
    
    60,825Selling, general and administrative costs
    
    
    32,784
    
    
    
    25,240Interest expense
    
    
    1,310
    
    
    
    1,352Total expenses
    
    
    109,976
    
    
    
    87,417Income before income taxes
    
    
    21,735
    
    
    
    24,191Income tax expense
    
    
    8,152
    
    
    
    9,173Net income
    
    
    13,583
    
    
    
    15,018Net income available to common shareholders
    
    $
    13,583
    
    
    $
    15,018Earnings per ShareBasic earnings per common share
    
    $
    0.61
    
    
    $
    0.70Diluted earnings per common share
    
    $
    0.61
    
    
    $
    0.67
 See notes to condensed consolidated financial statements. 2




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)March 31,
    
    
    December 31,2005
    
    
    2004(In thousands)AssetsInvestments:Debt securities available-for-sale at fair value (amortized cost
$337,091 and $334,770 at March 31, 2005 and December 31, 2004,
respectively)
    
    $
    331,728
    
    
    $
    334,816Short-term investments
    
    
    2,022
    
    
    
    1,663Total investments
    
    
    333,750
    
    
    
    336,479Cash and cash equivalents
    
    
    117,719
    
    
    
    70,988Finance receivables, net
    
    
    256,687
    
    
    
    214,180Reinsurance balances receivable
    
    
    34,832
    
    
    
    35,671Prepaid reinsurance premiums
    
    
    31,208
    
    
    
    29,544Deferred policy acquisition costs
    
    
    14,771
    
    
    
    12,666Income taxes recoverable
    
    
    
    
    
    
    7,177Deferred income taxes
    
    
    22,705
    
    
    
    20,040Property and equipment
    
    
    16,471
    
    
    
    15,823Goodwill, net
    
    
    26,943
    
    
    
    22,188Other assets
    
    
    23,597
    
    
    
    22,696Total assets
    
    $
    878,683
    
    
    $
    787,452Liabilities and Shareholders EquityLoss and loss adjustment expense reserves
    
    $
    122,728
    
    
    $
    124,858Unearned premiums
    
    
    266,376
    
    
    
    223,303Reinsurance balances payable and funds held
    
    
    37,657
    
    
    
    33,996Accounts payable and accrued expenses
    
    
    15,323
    
    
    
    11,949Income taxes payable
    
    
    673
    
    
    
    Notes payable
    
    
    173,286
    
    
    
    135,626Capital lease obligations
    
    
    3,460
    
    
    
    3,772Other liabilities
    
    
    14,167
    
    
    
    8,867Total liabilities
    
    
    633,670
    
    
    
    542,371Shareholders equityCommon stock, no par; authorized shares  100,000.0; issued shares 
21,997.5 and 22,360.0 at March 31, 2005 and December 31, 2004,
respectively
    
    
    99,791
    
    
    
    109,163Retained earnings
    
    
    148,869
    
    
    
    136,178Accumulated other comprehensive (loss) income:Net unrealized (depreciation) appreciation on investment securities
    
    
    (3,486
    )
    
    
    30Net loss on cash flow hedge
    
    
    (161
    )
    
    
    (290
    )Total shareholders equity
    
    
    245,013
    
    
    
    245,081Total liabilities and shareholders equity
    
    $
    878,683
    
    
    $
    787,452
 See notes to condensed consolidated financial statements. 3




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) Three Months Ended March 31,2005
    
    
    2004(In thousands)Operating activitiesNet income
    
    $
    13,583
    
    
    $
    15,018Adjustments to reconcile net income to net cash provided by operating activities:Net realized gains on securities and other
    
    
    (31
    )
    
    
    (69
    )Depreciation and amortization
    
    
    1,616
    
    
    
    1,331Deferred income taxes
    
    
    (841
    )
    
    
    (1,983
    )Changes in operating assets and liabilities:Finance receivables
    
    
    (42,507
    )
    
    
    (52,513
    )Reinsurance balances receivable
    
    
    839
    
    
    
    (7,614
    )Prepaid reinsurance premiums
    
    
    (1,664
    )
    
    
    309Deferred policy acquisition costs
    
    
    (2,105
    )
    
    
    (667
    )Income taxes recoverable/payable
    
    
    7,850
    
    
    
    7,595Loss and loss adjustment expense reserves
    
    
    (2,130
    )
    
    
    714Unearned premiums
    
    
    43,073
    
    
    
    54,051Reinsurance balances payable and funds held
    
    
    3,661
    
    
    
    6,321Accounts payable and accrued expenses
    
    
    3,374
    
    
    
    (690
    )Other
    
    
    4,400
    
    
    
    (4,608
    )Net cash provided by operating activities
    
    
    29,118
    
    
    
    17,195Investing activitiesProceeds from sales and maturities of debt securities available-for-sale
    
    
    22,132
    
    
    
    54,504Purchase of debt securities available-for-sale
    
    
    (24,766
    )
    
    
    (67,775
    )Payable for securities
    
    
    625
    
    
    
    8,680Net purchases of short-term investments
    
    
    (359
    )
    
    
    (309
    )Purchase of property and equipment, net
    
    
    (2,220
    )
    
    
    (1,678
    )Purchase of insurance agency assets
    
    
    (4,799
    )
    
    
    Purchase of life insurance company
    
    
    
    
    
    
    (7,330
    )Net cash used in investing activities
    
    
    (9,387
    )
    
    
    (13,908
    )Financing activitiesRepurchase of common stock
    
    
    (9,999
    )
    
    
    Issuance of common stock
    
    
    543
    
    
    
    425Net proceeds from borrowings
    
    
    37,800
    
    
    
    28,000Payment of principal on borrowings
    
    
    (452
    )
    
    
    (404
    )Payment of dividends on common stock
    
    
    (892
    )
    
    
    (861

    )Net cash provided by financing activities
    
    
    27,000
    
    
    
    27,160Net increase in cash and cash equivalents
    
    
    46,731
    
    
    
    30,447Cash and cash equivalents at beginning of period
    
    
    70,988
    
    
    
    87,342Cash and cash equivalents at end of period
    
    $
    117,719
    
    
    $
    117,789
 See notes to condensed consolidated financial statements. 4




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) 1. Nature of Operations Direct General Corporation, headquartered in Nashville, Tennessee, is a financial services
holding company whose principal operating subsidiaries provide non-standard personal automobile
insurance, term life insurance, premium finance and other consumer products and services primarily
on a direct basis and primarily in the southeastern United States. Direct General Corporation owns
four property/casualty insurance companies, two life/health insurance companies, two premium
finance companies, thirteen insurance agencies, two administrative service companies and one
company that provides non-insurance consumer products and services. 2. Basis of Presentation The unaudited condensed consolidated financial statements included herein have been prepared
pursuant to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States (GAAP) have been
condensed or omitted pursuant to such rules and regulations. The unaudited condensed consolidated
financial statements reflect all normal recurring adjustments which were, in the opinion of
management, necessary for a fair statement of the results for the interim periods presented. The
results of operations for the period ended March 31, 2005 are not necessarily indicative of the
results that may be expected for the full year. These unaudited condensed consolidated financial
statements and the notes thereto should be read in conjunction with the Companys audited financial
statements and accompanying notes included in the Companys Annual Report on Form 10-K for the year
ended December 31, 2004. 3. Acquisitions During January 2005, the Company acquired certain assets of All American General Agency, Inc.,
operating primarily under the name AMCO, and the assets of two other insurance agencies,
collectively operating through 82 sales offices in the state of Texas. The assets acquired
included customer records and renewal rights and the operating assets of the sales offices used to
conduct their agency business. The total purchase price, the majority of which is recorded as
goodwill, was $5,380,000 and may be increased by a future contingent payment of up to $500,000.
The acquisition of the 82 sales offices increased the Companys future minimum lease commitments
having an initial or remaining term of more than one year by approximately $3.1 million. 4. Common Stock Repurchase On January 31, 2005, the Company announced that its Board of Directors approved the repurchase
of up to $20,000,000 of its outstanding common stock. As of March 31, 2005, the Company had
repurchased 493,350 shares of its outstanding common stock for an aggregate price of approximately
$10,000,000. 5. Notes Payable The Company maintains a revolving credit facility with a consortium of banks to fund the
working capital of the Companys premium finance operations. On July 1, 2004, the Company renewed
its $190.0 million revolving credit facility under substantially similar terms and extended its
maturity for an additional three-year period to June 30, 2007. As of March 31, 2005, the amount
outstanding under the facility was $173.0 million. The Company also has a $30.0 million revolving
credit facility available to support its operations and strategic initiatives. No amounts were
outstanding under this facility as of March 31, 2005. 5




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6. Earnings Per Share The following table sets forth the computation of basic and diluted earnings per share: Three Months Ended March 31,2005
    
    
    2004(In thousands, except per share amounts)Numerator:Net income available to common shareholders
    
    $
    13,583
    
    
    $
    15,018Denominator:Weighted average common shares outstanding
    
    
    22,272.3
    
    
    
    21,503.0Dilutive stock options
    
    
    125.6
    
    
    
    834.1Weighted average common shares outstanding
for purposes of computing diluted earnings
per common share
    
    
    22,397.9
    
    
    
    22,337.1Basic earnings per common share
    
    $
    0.61
    
    
    $
    0.70Diluted earnings per common share
    
    $
    0.61
    
    
    $
    0.67
 7. Stock Options The Company follows the provisions of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, to account for its stock option activity in the
financial statements. The Company generally grants employee stock options at an exercise price
equal to the market price at the date of grant. Employee stock options granted at less than the
market price at the date of grant and options granted to non-employees are expensed. During the
first quarter of 2005, the Company recorded $84,000 of expense related to options granted to both
employees and non-employees to purchase 115,000 shares at an exercise price of $31.00 per share
that was less than the current market price at the time of grant. If the Company had elected to recognize stock compensation expense based on the fair value of
stock options at the grant date, as prescribed by SFAS 123, net income available to common
shareholders and basic and diluted earnings per share would have been reported as presented in the
following table. Three Months Ended March 31,2005
    
    
    2004(In thousands, except per share amounts)Net income available to common
shareholders, as reported
    
    $
    13,583
    
    
    $
    15,018Deduct: Total stock-based employee
compensation expense determined
under the fair value based method,
net of related tax effects
    
    
    (218
    )
    
    
    (252
    )Net income available to common
shareholders, pro forma
    
    $
    13,365
    
    
    $
    14,766Income for purposes of computing
diluted earnings per share common,
as reported
    
    $
    13,583
    
    
    $
    15,018Deduct: Total stock-based employee
compensation expense determined
under the fair value based method,
net of related tax effects
    
    
    (218
    )
    
    
    (252
    )Income for purposes of computing
diluted earnings per share common,
pro forma
    
    $
    13,365
    
    
    $
    14,766
 6




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Three Months Ended March 31,2005
    
    
    2004(In thousands, except per share amounts)Earnings per shareBasic  as reported
    
    $
    0.61
    
    
    $
    0.70Basic  pro forma
    
    $
    0.60
    
    
    $
    0.69Diluted  as reported
    
    $
    0.61
    
    
    $
    0.67Diluted  pro forma
    
    $
    0.60
    
    
    $
    0.66
 8. Contingencies The Company is named as defendant in various legal actions arising in the ordinary course of
business. During the first quarter of 2005, the Company and certain of our officers and directors
were named as defendants in six purported securities class action lawsuits and six shareholder
derivative class actions. The Company intends to vigorously defend each of these lawsuits.
However, all litigation is unpredictable and the ultimate outcome of these cases is uncertain.
These matters are in their early procedural stages, and thus the Company is unable to predict the
likelihood or range of our potential liability or the potential financial impact on our future
operations, if we are not able to successfully defend these cases. 9. Subsequent Events In April 2005, the Company signed a purchase agreement to acquire a property and casualty
company the assets of which consist of licenses to conduct property and casualty business in 38
states and the District of Columbia and debt securities. The proposed acquisition is pending
regulatory approval. The purchase price is estimated to be $10.3 million of which approximately
$4.3 million is expected to be allocated to the value of the licenses and recorded as goodwill. 10. Recent Accounting Pronouncements The Company periodically reviews recent accounting pronouncements issued by the Financial
Accounting Standards Board, American Institute of Certified Public Accountants, Emerging Issues
Task Force, and Staff Accounting Bulletins issued by the United States Securities and Exchange
Commission to determine the potential impact on the Companys financial statements. Based on its
most recent review, the Company has determined that the majority of these recently issued
accounting standards either do not apply to the Company or will not have a material impact on its
financial statements. However, in December 2004, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, which will
affect the manner in which the Company accounts for its share-based payment arrangements, including
stock options. Accordingly, effective January 1, 2006, the Company will be required to expense the
cost resulting from all share-based payment arrangements in its financial statements. The Company
is currently in the process of determining the impact this standard will have on its financial
statements. 7




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations. This Managements Discussion and Analysis of Financial Condition and Results of Operations
should be read in conjunction with the Companys discussion presented under the caption
Managements Discussion and Analysis of Financial Condition and Results of Operations that is
available in the Annual Report onForm 10-Kfor the year ended December 31, 2004 filed with the
Securities and Exchange Commission. Overview of Operating Results Net income decreased 9.3% to $13.6 million or $0.61 per share, on a diluted basis, for the
three months ended March 31, 2005, as compared to net income of $15.0 million or $0.67 per share,
on a diluted basis, in the first quarter of 2004. The annualized return on average equity was 22%
during the first quarter, which exceeds our stated long-term objective of 20%. The first quarter
results included a slightly higher loss ratio and higher expense ratios. The higher expense ratio
was impacted by an increase in operating expenses of approximately $2.4 million from our expansions
in Texas, Missouri and Virginia, as compared to the prior year quarter. The increases in costs
were partially offset by a $1.0 million increase in net investment income. For the quarter, gross
premiums written decreased 4.6% to $161.3 million from $169.0 million in the same period in 2004,
including a decrease of approximately $2.2 million associated with the reduction in premiums in the
Miami, Florida market. We experienced an increase in renewal policies over the prior year
quarter, which partially offset the decrease in new business policies. Summary of Key Measures of Financial Results The table below summarizes certain operating results and key measures we use in monitoring and
evaluating our operations. The information provided is intended to summarize and supplement
information contained in our consolidated financial statements and to assist the reader in gaining
a better understanding of our results of operations. Three Months EndedMarch 31,%($ in millions)
    
    2005
    
    
    2004
    
    
    Change(Unaudited)Selected Financial DataGross premiums written
    
    $
    161.3
    
    
    $
    169.0
    
    
    
    (4.6
    )Ancillary income
    
    
    26.5
    
    
    
    26.3
    
    
    
    0.8Net investment income
    
    
    3.3
    
    
    
    2.3
    
    
    
    43.5Gross revenues
    
    $
    191.1
    
    
    $
    197.6
    
    
    
    (3.3
    )Ceded premiums written
    
    
    (18.0
    )
    
    
    (31.7
    )
    
    
    (43.2
    )Change in net unearned premiums
    
    
    (41.4
    )
    
    
    (54.3
    )
    
    
    (23.8
    )Total revenues
    
    $
    131.7
    
    
    $
    111.6
    
    
    
    18.0Net income
    
    $
    13.6
    
    
    $
    15.0
    
    
    
    (9.3
    )Key Financial RatiosLoss ratio  net
    
    
    74.5
    %
    
    
    73.3
    %Expense ratio  net
    
    
    7.5
    %
    
    
    0.4
    %Combined ratio  net
    
    
    82.0
    %
    
    
    73.7
    %Ancillary income to net operating expenses
    
    
    77.7
    %
    
    
    98.7
    %
 Explanation of Key Measurers We evaluate our operations by monitoring key measures of growth and profitability. We measure
our growth by examining our gross revenues, which is comprised of gross premiums written and
revenues from all other sources produced through our distribution system. We generally measure our
operating results by examining our net income, return on equity, and our loss, expense and combined
ratios. In addition, we evaluate our performance by comparing the level of our ancillary income to
premiums earned and to operating expenses. The following provides further explanation of the key
measures that we use to evaluate our results: Gross Premiums Written. Gross premiums written is the sum of direct premiums written and
assumed premiums written. Direct premiums written is the sum of the total policy premiums, net of
cancellations, associated with policies underwritten and issued by our insurance subsidiaries.
Assumed premiums written is the sum of total premiums associated with the insurance risk
transferred 8




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to us by other insurance companies pursuant to reinsurance contracts. We use gross premiums
written, which excludes the impact of premiums ceded to reinsurers, as a measure of the underlying
growth of our insurance business from period to period. Net Premiums Written.Net premiums written is the sum of direct premiums written and assumed
premiums written less ceded premiums written. Ceded premiums written is the portion of our direct
and assumed premiums that we transfer to our reinsurers in accordance with the terms of our
reinsurance contracts based upon the risks they accept. We use net premiums written, primarily in
relation to gross premiums written, to measure the amount of business retained after cessions to
reinsurers. Gross Revenues (a non-GAAP financial measure).Gross revenues are the sum of gross premiums
written plus ancillary income (finance income and commission and service fee income) and net
investment income (excluding net realized gains (losses) on securities). We use gross revenues as
the primary measure of the underlying growth of our revenue streams from period to period. Gross
revenues are reconciled to total revenues in the Managements Discussion and Analysis of Financial
Condition and Results of Operations  Results of Operations. Loss Ratio. Loss ratio is the ratio (expressed as a percentage) of losses and loss adjustment
expenses incurred to premiums earned and measures the underwriting profitability of a companys
insurance business. Loss ratio generally is measured on both a gross (direct and assumed) and net
(gross less ceded) basis. We use the gross loss ratio as a measure of the overall underwriting
profitability of the insurance business we write and to assess the adequacy of our pricing. Our
net loss ratio is meaningful in evaluating our financial results, which are net of ceded
reinsurance, as reflected in our consolidated financial statements. Our loss ratios are generally
calculated in the same way for GAAP and statutory accounting purposes. Expense Ratio. Expense ratio is the ratio (expressed as a percentage) of net operating
expenses to premiums earned and measures a companys operational efficiency in producing,
underwriting and administering its insurance business. For statutory accounting purposes,
operating expenses of an insurance company exclude investment expenses, and are reduced by other
income. There is no such industry definition for determining an expense ratio for GAAP purposes.
As a result, we apply the statutory definition to calculate our expense ratio on a GAAP basis. We
reduce our operating expenses by ancillary income (excluding net investment income and realized
gains (losses) on securities) to calculate our net operating expenses. Due to our historically
high levels of reinsurance, we calculate our expense ratio on both a gross basis (before the effect
of ceded reinsurance) and a net basis (after the effect of ceded reinsurance). Although the net
basis is meaningful in evaluating our financial results that are net of ceded reinsurance, as
reflected in our consolidated financial statements, we believe that the gross expense ratio more
accurately reflects the operational efficiency of the underlying business and is a better measure
of future trends. Combined Ratio. Combined ratio is the sum of the loss ratio and the expense ratio and
measures a companys overall underwriting profit. If the combined ratio is at or above 100, an
insurance company cannot be profitable without investment income (and may not be profitable if
investment income is insufficient). We use the GAAP combined ratio in evaluating our overall
underwriting profitability and as a measure for comparison of our profitability relative to the
profitability of our competitors. Ancillary Income Measures.We have developed measures of our ability to generate ancillary
income (finance income and commission and service fee income) that reflect the differences between
our business model and those used by our competitors. We measure our ancillary income as a
percentage of premiums earned and as a percentage of our operating expenses. We believe that most
of our competitors only achieve point of sale contact through an independent agent and are
therefore typically unable to generate significant amounts of ancillary income. Seasonality. The months of February and March generally represent some of the highest premium
production months of the year as many of our customers have more disposable cash as a result of
income tax refunds. As a result, gross premiums written are generally the highest during the first
quarter of the year. Typically, the Company generally experiences its lowest level of gross
premiums written during the second quarter of the year as cancellations on the business written in
the first quarter occur. Since the majority of our business is financed, finance receivables and
unearned premiums increase during the first quarter. In addition, there are corresponding
increases in notes payable and cash as our premium finance subsidiaries draw on the revolving line
of credit with our banks to settle balances due to our insurance subsidiaries. Since these
settlements occur at the end of the month, our insurance subsidiaries hold a high level of cash
that has yet to be permanently invested in the long term portfolio. 9




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Results of Operations Revenues Premiums The following table presents our gross premiums written in our major markets and provides a
summary of gross, ceded and net premiums written and earned for the periods presented: Three Months EndedMarch 31,%($ in millions)
    
    2005
    
    
    2004
    
    
    Change(Unaudited)Gross premiums writtenFlorida
    
    $
    78.1
    
    
    $
    83.9
    
    
    
    (6.9
    )Tennessee
    
    
    22.3
    
    
    
    23.4
    
    
    
    (4.7
    )Georgia
    
    
    10.6
    
    
    
    12.3
    
    
    
    (13.8
    )Louisiana
    
    
    11.8
    
    
    
    12.5
    
    
    
    (5.6
    )Mississippi
    
    
    10.0
    
    
    
    10.1
    
    
    
    (1.0
    )Texas
    
    
    8.5
    
    
    
    7.0
    
    
    
    21.4All other states
    
    
    20.0
    
    
    
    19.8
    
    
    
    1.0Gross premiums written
    
    $
    161.3
    
    
    $
    169.0
    
    
    
    (4.6
    )Ceded premiums written
    
    
    (18.0
    )
    
    
    (31.7
    )
    
    
    (43.2
    )Net premiums written
    
    $
    143.3
    
    
    $
    137.3
    
    
    
    4.4Gross premiums earned
    
    $
    118.2
    
    
    $
    115.0
    
    
    
    2.8Ceded premiums earned
    
    
    (16.3
    )
    
    
    (32.0
    )
    
    
    (49.1
    )Net premiums earned
    
    $
    101.9
    
    
    $
    83.0
    
    
    
    22.8Net premiums written to gross premiums written
    
    
    88.8
    %
    
    
    81.2
    %Gross premiums earned to gross premiums written
    
    
    73.3
    %
    
    
    68.0
    %Net premiums earned to net premiums written
    
    
    71.1
    %
    
    
    60.5
    %
 Gross premiums written decreased $7.7 million or 4.6% for the three months ended March 31,
2005 compared to the first quarter of 2004. For the first quarter of 2005, gross premiums written
from the sale of our core non-standard automobile insurance business decreased 5.5% to $154.0
million while gross premiums written from the sale of our term life insurance business increased
21.7% to $7.3 million as compared to the first quarter of 2004. Gross premiums earned, a function
of gross premiums written over the current and prior periods, increased 2.8% to $118.2 million in
first quarter of 2005 versus the same period in 2004. The decrease in gross premiums written included a decrease of approximately $2.2 million
related to our decision, in October 2004, to cease writing new business policies in the Miami,
Florida market. Overall, new business policies issued decreased by approximately 7%, which
included the decrease in Miami new business that was partially offset by a 20% increase in renewal
policies issued. We believe that the majority of the decrease in new business policies, outside
Miami, was related to the increased competition for this business as reflected by the volume of
calls to our Baton Rouge call center being down from the same period in 2004. However, we have
seen an increase in the conversion rate of quotes to policies issued, which partially offset the
decline in call volume. We believe that the number of nonstandard and standard automobile insurers that heavily use
both television and radio advertising media have substantially increased in recent months, which
contributed to our reduced call volume. We believe that this increased competition for media
advertising has impacted the effectiveness of our advertising approach that has historically
focused on a saturation of daytime network television complemented by yellow-page advertising. We
also believe that a number of larger, national carriers that have predominantly operated in the
standard market, are having some success in attracting a portion of our customer base as they have
directly or indirectly expanded their target market to include a portion of the nonstandard market
through their increased media advertising. One of the trends that we are closely monitoring is our
mix of full coverage business, which includes physical damage coverage, as opposed to liability
only policies. In certain states, particularly North and South Carolina, we have started to see a
decline in the percentage of full coverage business, which we believe may be indicative of a
portion of our customer base moving to the standard carriers. 10




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Consistent with our ongoing review of rates by coverage and state, we plan to make minor
adjustment to our rates in certain states in an effort to improve our new business growth and
stabilize our mix of full coverage versus liability only business. In response to the increased
competition, we have recently hired a national advertising company to assist us in developing new
marketing strategies to address the changing competitive landscape in many of our existing markets.
We initially expect to test these new strategies in Tennessee and, if they are successful, we plan
to implement them in our other existing states shortly thereafter. Gross premiums written in Texas increased 21.4% over the first quarter of 2004 largely as a
result of our advertising campaigns and the increase in the number of sales offices in this market.
In March 2005, we began issuing twelve-month policies in some of our Texas offices. We expect to
continue to convert our monthly policies in Texas to annual policies over the remainder of the
year. We have started to see a positive impact from our advertising programs in Texas, and our new
advertising firm is helping us develop a campaign to specifically target the Hispanic market in
Texas. The growth in net premiums written and earned is a function of gross premiums written and
earned less ceded premiums written and earned. We continued to increase our retention of our
business during the first quarter of 2005 and, as a result, the ratio of net premiums written to
gross premiums written increased to 88.8% as compared to 81.2% in the first quarter of 2004. We
expect to retain 88% to 90% of our gross premiums written in 2005. We are actively pursuing a number of initiatives to increase our gross revenues. In addition
to our new advertising efforts, we are also exploring the possibility of offering our products
through alternative distribution channels, including over the Internet and to customers who prefer
to operate through the mail. We have been experimenting with Internet sales over the past year in
Florida, and we are working to expand this channel in several other states. We also continue to
evaluate new insurance products that we believe will be attractive to our customers including
renters, homeowners (including mobile homeowners), motorcycle, boat, and personal watercraft
policies. In order to facilitate the future expansion of our Direct General business model into
additional states, we recently entered into an agreement to acquire a property and casualty shell
insurance company with licenses in 38 states and the District of Columbia. This acquisition, which
is currently pending regulatory approval, will provide us with a property and casualty insurance
license in these states. The acquisition of these licenses will provide us a valuable tool that
will allow us to more efficiently move into new markets. As a result of these growth initiatives
and the additional initiatives we expect to introduce during the second quarter and the remainder
of the 2005, we are optimistic that our gross revenues should increase during the second half of
the year; however, growth is expected to be flat or down slightly throughout the second quarter of
2005. Ancillary Income Ancillary income for the three months ended March 31, 2005 increased 0.8% to $26.5 million
compared to the corresponding period in 2004. The majority of this increase was attributable to
the success of our Direct prepaid Visa® debit card. We issued more than 57,000 cards during the
quarter and revenues from the product were $0.6 million. The increase in revenues from the debit
card was largely offset by a $0.6 million reduction in finance income primarily as a result of a
decrease in down payments. We expect that the reduction in down payments could negatively impact
the level of finance income to gross premiums earned in certain states; however, finance income
should be positively impacted from our growth in Texas as we convert more of our Texas policies
from monthly policies to annual policies and finance them through our premium finance company. The ratio of ancillary income to gross premiums earned was 22.4% and 22.9% for the first
quarter of 2005 and 2004, respectively, while the ratio of ancillary income to operating expenses
decreased to 77.7% in the 2005 period from 98.7% in the 2004 period. Because operating expenses
are net of ceded reinsurance commissions received and we have been reducing our level of
reinsurance, our net operating expenses have increased resulting in a lower ratio of ancillary
income to operating expenses. Net Investment Income Net investment income was $3.3 million for the three months ended March 31, 2005 compared to
$2.3 million for the first quarter of 2004. The increase was due primarily to an increase in
average invested assets and a slightly higher investment yield as a result of the increasing
interest rate environment and slightly longer portfolio duration. Average invested assets
increased 24.0% to $329.5 million in the first quarter of 2005 from $265.7 million in the first
quarter of 2004. The average investment yield increased to 4.0% in the first quarter of 2005 from
3.5% in the corresponding period in 2004. Realized Gains on Securities and Other We realized no gross gains and gross losses of $0.3 million on the sale of securities for the
three months ended March 31, 2005. Comparatively, we realized gross gains on debt securities of
$0.2 million and gross losses of $0.2 million for the comparable period in 2004. There was no
impact on realized losses attributable to adjustments for other than temporary impairment of
securities still held during these periods. 11




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##### Table of Contents



In the first quarter of 2005, we also realized gross gains of $0.4 million and gross losses of
$0.5 million on closed contracts in our trading portfolio. The trading portfolio primarily
consists of futures contracts, swaps, and other derivative instruments. This represents a
speculative investment and does not represent a hedge; accordingly, all open contracts are marked
to market with the change in market values included in net realized gains on securities and other
in our condensed consolidated statement of operations. During the quarter, the market value on
open contracts increased by $0.4 million, which was included in net realized gains on securities
and other. As of March 31, 2005, we had open contracts with gross unrealized gains of $0.5
million and gross unrealized losses of $0.2 million. Expenses Insurance Losses and Loss Adjustment Expenses Insurance losses and loss adjustment expenses increased to $75.9 million for the three months
ended March 31, 2005 from $60.8 million for the same period in 2004. The majority of this increase
was related to the increase in net premiums earned. Net loss ratios for the first quarter of 2005
and 2004 were 74.5% and 73.3%, respectively. The Companys quarterly analysis of reserves resulted
in an increase to prior year reserves of $0.8 million, which increased the net loss ratio by 0.8
points in the first quarter of 2005. The increase in prior period reserves was primarily
associated with the last two accident quarters of 2004 and was a result of an increase in the
expected average ultimate payments on personal injury protection PIP claims in Florida and
increases in expected frequency and severity of physical damage claims, primarily in Tennessee and
Georgia. The increase was partially offset by redundancy in bodily injury reserves for Tennessee
and Louisiana, as a result of a decrease in estimates of ultimate expected frequency. During the
first quarter of 2004, the Companys development on prior years reserves increased the net loss
ratio by 0.4 points. The net loss ratios, excluding the impact of the adjustments to prior years
reserves, were 73.7% and 72.9% for the three months ended March 31, 2005 and 2004, respectively.
During the first quarter of 2005, losses from hail storms that primarily hit Mississippi, Florida,
and Georgia increased the Companys loss ratio by 0.5 points. The impact of catastrophic losses in
the first quarter of 2004 was minimal. Our first quarter actuarial review indicated some improvement in the PIP loss ratio in Florida
for accidents that occurred during the first quarter of 2005, primarily as a result of our
decision, in October 2004, to stop writing new business policies in the Miami market. Since
October 2004, the number of exposures in this market has decreased nearly 40% and the exposures
should continue to decrease over the next two quarters. However, we continue to be cautious about
PIP frequency trends increasing in other areas of the state, which could indicate increasing fraud
activity. Accordingly, we are closely tracking our PIP frequency trends throughout the State,
especially in larger metropolitan areas such as Tampa and Ft. Lauderdale, where the most recent
data reflects an increase in reported claims frequency. As in the past, our claims staff continues
to actively identify and refer suspicious claims to our special investigations unit to detect
potential fraud. Operating Expenses Operating expenses increased 28.2% to $34.1 million for the three months ended March 31, 2005,
compared to $26.6 million for the same period of 2004. This increase in operating expenses was
higher than the 18.0% increase in total revenues primarily as a result of the increased operating
costs associated with the acquisition of the 65 AMCO sales offices and 17 other franchisee sales
offices in Texas and the additional salary, rent, and advertising costs associated with our
expansion in Missouri and Virginia. Collectively, the operating expenses associated with our
expansions represented an increase of approximately $2.4 million over the first quarter of 2004.
The increase in operating expenses also reflected a $3.4 million reduction in ceded reinsurance
commissions received to $2.3 million in the first quarter of 2005 as compared to the same period in
2004. As a result of the increase in operating costs associated with our expansions in Texas,
Missouri, and Virginia and the slower than anticipated growth in the first half of 2005, we expect
that our expense ratio will be in the 7% to 8% range for the year. Income Taxes Our effective tax rates were 37.5% and 37.9% for the three-month periods ended March 31, 2005
and 2004, respectively. The slight decrease in our effective tax rate is primarily due to
strategies we implemented to reduce our state income taxes. 12




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##### Table of Contents



Financial Condition Liquidity and Capital Resources Sources and Uses of Funds We are organized as a holding company system with all of our operations being conducted by our
wholly-owned insurance, premium finance, agency, administrative and consumer product subsidiaries.
Accordingly, Direct General Corporation receives cash through loans from banks, issuance of equity
securities, subsidiary dividends and other transactions. We may use the proceeds from these sources
to contribute to the capital of our insurance subsidiaries and premium finance company in order to
support premium growth, to repurchase our common stock, to retire our outstanding indebtedness, to
pay interest, dividends, and taxes, and for other business purposes. Our operating subsidiaries primary sources of funds are premiums received, finance income,
commission and service fee income, investment income, borrowings under credit facilities and
proceeds from the sale and redemption of investments. Funds are used to pay claims and operating
expenses, to pay interest and principal repayments under the terms of our indebtedness for borrowed
money, to purchase investments and to pay dividends to Direct General Corporation. We had positive
cash flow from operations of approximately $29.1 million and $17.2 million in the first three
months of 2005 and 2004, respectively. We expect our cash flows to be positive in both the
short-term and reasonably foreseeable future. Financing and Capital During the first quarter of 2005, we repurchased 493,350 shares of our common stock for an
aggregate price of approximately $10.0 million. Subsequent to the end of the quarter, we
repurchased an additional 252,353 shares for approximately $5.0 million and, under our current
plan, expect to repurchase $5.0 million more prior to the end of the second quarter. During the
first quarter of 2005, we also paid a common stock dividend totaling $0.9 million. As of March 31, 2005, the maximum aggregate amount available under our revolving credit
agreement used to support our premium finance operations was $190.0 million and the amount
outstanding was $173.0 million. We believe that this facility, which matures on June 30, 2007, is
sufficient to support our premium finance operations through the end of the year. Later in the
year, we plan to reevaluate the size of the facility based on our growth expectations for 2006. Reinsurance The increased capitalization of our insurance subsidiaires has enabled us to continue to
reduce our quota share cession percentage. As a result, we ceded 11.2% of our gross premiums
written to reinsurers in the three months ended March 31, 2005 as compared to 18.8% in the first
quarter of 2004. Our quota share reinsurance agreement for 2005 also provides for adjustments to
the cession percentage during the year. We plan to cede between 10% and 12% of our gross premiums
written to reinsurers during 2005. Investments Debt securities. Our investment portfolio primarily consists of debt securities, all
classified as available-for-sale and carried at market value with unrealized gains and losses
reported in our financial statements as a separate component of shareholders equity on an
after-tax basis. As of March 31, 2005, our investment portfolio of $331.7 million included $5.4
million in net unrealized losses. The effective duration of our investment portfolio was 4.4
years at March 31, 2005. As of March 31, 2005, our investment portfolio included gross unrealized gains of $1.2 million
and gross unrealized losses of $6.6 million. During the quarter, net unrealized losses on our
investment portfolio increased by $5.4 million, which is included in accumulated other
comprehensive income, net of applicable taxes, in the stockholders equity section of the balance
sheet. Our quarterly procedures include an examination of our investment portfolio for evidence of
impairment. The assessment of whether such impairment has occurred is based on managements
evaluation, on an individual security basis, of the underlying reasons for the decline in fair
value. In such cases, changes in fair value are discussed with our investment advisors and
evaluated to determine the extent to which such changes are attributable to interest rates,
market-related factors other than interest rates, as well as financial conditions, business
prospects and other fundamental factors specific to the issuer. Declines attributable to issuer
fundamentals are reviewed in further detail. When one of our securities has a decline in fair value
that is determined to be other than temporary, we reduce the carrying value of such security to its
current fair value as required by GAAP. Based upon our analysis, we believe that we will recover all contractual principle and
interest payments related to those securities that currently reflect unrealized losses and that we
have the ability to hold these securities until they mature or recover in value. Should either of
these beliefs change with regard to a particular security, a charge for impairment would likely be
required. 13




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##### Table of Contents



While it is not possible to accurately predict if or when a specific security will become
impaired, charges for other than temporary impairment could be material to our results of
operations in a future period. Management believes it is not likely that future impairment charges
will have a significant effect on our liquidity. The following table shows the composition by our internal industry classification of the
amortized cost, gross unrealized gains, gross unrealized losses and fair value of debt securities
available-for-sale as of March 31, 2005: Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    Fair($ in millions)
    
    Cost
    
    
    Gains
    
    
    Losses
    
    
    ValueU.S. Treasury securities and
obligations of U.S. government
corporations and agencies
    
    $
    51.7
    
    
    $
    0.1
    
    
    $
    1.2
    
    
    $
    50.6Obligations of states and
political subdivisions
    
    
    65.0
    
    
    
    0.7
    
    
    
    0.5
    
    
    
    65.2Corporate debt securitiesBanks and financial institutions
    
    
    77.7
    
    
    
    0.1
    
    
    
    1.8
    
    
    
    76.0Credit cards and auto loans
    
    
    62.6
    
    
    
    
    
    
    
    1.4
    
    
    
    61.2Industrial
    
    
    47.1
    
    
    
    0.1
    
    
    
    1.0
    
    
    
    46.2Telecommunications
    
    
    18.0
    
    
    
    0.1
    
    
    
    0.4
    
    
    
    17.7Utilities and Electric Services
    
    
    15.0
    
    
    
    0.1
    
    
    
    0.3
    
    
    
    14.8Corporate debt securities
    
    
    220.4
    
    
    
    0.4
    
    
    
    4.9
    
    
    
    215.9Total
    
    $
    337.1
    
    
    $
    1.2
    
    
    $
    6.6
    
    
    $
    331.7
 The amortized cost and fair value of debt securities available-for-sale as of March 31, 2005,
by contractual maturity, is shown below: ($ in millions)
    
    Amortized Cost
    
    
    Fair ValueYears to maturity:One or less
    
    $
    6.7
    
    
    $
    6.8After one through five
    
    
    158.5
    
    
    
    155.6After five through ten
    
    
    108.1
    
    
    
    106.4After ten
    
    
    63.8
    
    
    
    62.9Total
    
    $
    337.1
    
    
    $
    331.7
 The Securities Valuation Office of the National Association of Insurance Commissioners
(NAIC) evaluates the bond investments of insurers for regulatory reporting purposes and assigns
securities to one of six investment categories called NAIC designations. The NAIC designations
parallel the credit ratings of the Nationally Recognized Statistical Rating Organizations for
marketable bonds. NAIC designations 1 and 2 include bonds considered to be investment grade, rated
BBB- or higher by Standard & Poors (S&P). NAIC designations 3 through 6 include bonds
considered below investment grade, rated BB+ or lower by S&P. All of the debt securities in our
portfolio were rated investment grade by the NAIC and S&P as of March 31, 2005. Investment grade
securities generally bear lower yields and lower degrees of risk than those that are unrated or are
rated non-investment grade. The quality distribution of our investment portfolio as of March 31, 2005 was as follows: ($ in millions)NAIC
    
    S&P
    
    Amortized
    
    
    
    
    
    
    % of FairRating
    
    Rating
    
    Cost
    
    
    Fair Value
    
    
    Value1
    
    AAA
    
    $
    130.8
    
    
    $
    128.8
    
    
    
    38.8
    %1
    
    AA
    
    
    34.7
    
    
    
    34.4
    
    
    
    10.4
    %1
    
    A
    
    
    99.3
    
    
    
    97.6
    
    
    
    29.4
    %2
    
    BBB
    
    
    34.5
    
    
    
    33.8
    
    
    
    10.2
    %1
    
    Agency
    
    
    37.8
    
    
    
    37.1
    
    
    
    11.2
    %$
    337.1
    
    
    $
    331.7
    
    
    
    100.0
    %
 We evaluate the risk versus reward tradeoffs of investment opportunities, measuring their
effects on the stability, diversity, overall quality and liquidity of our investment portfolio.
The primary market risk exposure to our debt securities portfolio is interest rate risk, which is
limited by managing duration to a defined range of three to four years. Interest rate risk
includes the risk from 14




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##### Table of Contents



movements in the underlying market rate and in credit spreads of the respective sectors of
debt securities held in our portfolio. The fair value of our fixed maturity portfolio is directly
impacted by changes in market interest rates. The following table provides information about our investments that are sensitive to interest
rate risk and provides estimates of expected changes in fair value based upon a 100 basis-point
increase and decrease in market interest rates as of March 31, 2005: -100 Basis Point
    
    
    
    
    
    
    +100 Basis Point($ in millions)
    
    Change
    
    
    Fair Value
    
    
    ChangeDebt securities, available for sale
    
    $
    346.3
    
    
    $
    331.7
    
    
    $
    317.2
 Short-term investments.We have a managed trading account with a commodities trading company
and, as of March 31, 2005, the total fair value of open trades in this account was a $0.3 million
gain, which represents less than 1% of our entire investment portfolio. We invest in commodities,
primarily cattle futures and swaps. U.S. Treasury securities of $1.7 million, included in
short-term investments and cash of $1.4 million, included in cash and cash equivalents, are held as
collateral for this account. We recognized a net realized loss of $0.1 million on closed
contracts and a $0.4 million gain on open contracts during the first quarter of 2005. Because this
is a speculative investment and not a hedge, both the realized gains on closed contracts and the
change in the fair value of open contracts are reported as net realized gains on securities and
other in our consolidated statement of operations. Cash and cash equivalents. Our balance in cash and cash equivalents was $117.7 million as of
as of March 31, 2005, which was 65.8% higher than the balance of cash held at December 31, 2004.
The increase was primarily attributable to the seasonality of the business. Forward-Looking Statements This report contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. All statements made in the report, other than statements of historical fact, are
forward-looking statements. You can identify these statements from our use of the words may,
should, could, potential, continue, plan, forecast, estimate, project, believe,
intend, anticipate, expect, target, is likely, will, or the negative of these terms,
and similar expressions. These statements are made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. These forward-looking statements may include,
among other things:  
    statements and assumptions relating to future growth, earnings, earnings per
share and other financial performance measures, as well as managements short-term and
long-term performance goals;
    statements relating to the anticipated effects on results of operations or
financial condition from recent and expected developments or events;
    statements relating to our business and growth strategies; and
    any other statements or assumptions that are not historical facts. We believe that our expectations are based on reasonable assumptions. However, these
forward-looking statements involve known and unknown risks, uncertainties and other important
factors that could cause our actual results, performance or achievements, or industry results, to
differ materially from our expectations of future results, performance or achievements expressed or
implied by these forward-looking statements. In addition, our past results of operations do not
necessarily indicate our future results. We discuss these and other uncertainties in the Business
 Risks Related to our Business section of the Annual Report on Form 10-K for the year ended
December 31, 2004 filed with the Securities and Exchange Commission on March 16, 2005. You should not place undue reliance on any forward-looking statements. These statements speak
only as of the date of this report. Except as otherwise required by applicable laws, we undertake
no obligation to publicly update or revise any forward-looking statements or the risk factors
described in this report, whether as a result of new information, future events, changed
circumstances or any other reason after the date of this report. 15




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk. Please see the caption Financial Condition  Liquidity and Capital Resources in Part I 
FINANCIAL INFORMATION, Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations of this report for a description of our quantitative and qualitative
disclosures about market risks. 
 Item 4. Controls and Procedures. Our management, with the participation of our chief executive officer and chief financial
officer, has evaluated the effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this
report. Based on that evaluation, the chief executive officer and chief financial officer have
concluded that our disclosure controls and procedures are effective to ensure that material
information relating to us and our consolidated subsidiaries is made known to such officers by
others within these entities, particularly during the period this quarterly report was prepared, in
order to allow timely decisions regarding required disclosure. There have not been any changes in
our internal control over financial reporting during the period covered by this report that have
materially affected, or are reasonably likely to materially affect, our internal control over
financial reporting. 16




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##### Table of Contents



PART II OTHER INFORMATION 
 Item 1. Legal Proceedings. We and our subsidiaries are named from time to time as defendants in various legal actions
that are incidental to our business and arise out of or are related to claims made in connection
with our insurance policies, claims handling, premium finance agreements and other contracts, and
employment related disputes. The plaintiffs in some of these lawsuits have alleged bad faith or
extracontractual damages and some have claimed punitive damages. We believe that the resolution of
these legal actions will not have a material adverse effect on our financial position or results of
operations. In the first quarter of 2005, we, and certain of our officers and directors were named as
defendants in six putative class action lawsuits filed in the United States District Court for the
Middle District of Tennessee. These cases have been consolidated and Lead Plaintiffs have been
appointed. Lead Plaintiffs allege that we and certain of our officers and directors made false and
misleading statements with respect to liabilities that had been recorded for unpaid losses and loss
adjustment expenses. Lead Plaintiffs generally contend that certain legislation in Florida which
became effective in October 2003 negatively impacted our business by increasing our liability and
risk of litigation and that we failed to timely strengthen our loss reserves to account for this
alleged increased risk. Lead Plaintiffs further assert that certain officers and directors sold
shares of our stock while they knew of the allegedly negative impact of the legislation but before
the reserves were strengthened. Lead Plaintiffs seek to recover damages on behalf of all
purchasers of our stock during a class period to be determined and attorneys fees on behalf of
themselves and others similarly situated. Also in the first quarter of 2005, we, our directors and certain of our officers were named in
three shareholder derivative actions filed in the United States District Court for the Middle
District of Tennessee, which have been consolidated, and three shareholder derivative actions filed
in the Chancery Court for the State of Tennessee. These actions assert various claims for breaches
of fiduciary duties based upon the same alleged misleading statements and allegations that form the
basis of the putative class action described above. We intend to vigorously defend these actions. These actions are still in the early procedural
stages and the ultimate outcome of these cases is uncertain. In addition to legal actions that are incidental to our business, one or more of our
subsidiaries has been named as a defendant in a number of currently pending putative class action
lawsuits. For descriptions of these legal actions, please see the caption Business  Legal
Proceeding included in our Annual Report on Form 10-K for the year ended December 31, 2004 (Form
10-K) filed with the Securities and Exchange Commission (SEC) on March 16, 2005 and our periodic
reports filed with the SEC under the Securities Exchange Act of 1934 since the filing of our Form
10-K. 17




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. The following table summarizes our common stock repurchase activity for the three-month period
ended March 31, 2005 and the approximate value of shares of common stock that may yet be
repurchased. Issuer Purchases of Equity Securities Total number of
    
    
    Approximate dollarshares purchased as
    
    
    value of share that mayTotal number of
    
    
    Average price
    
    
    part of publicly
    
    
    yet be purchasedPeriod
    
    shares purchased
    
    
    paid per share
    
    
    announced program
    
    
    under the programJanuary 1 to January 31
    
    
    0
    
    
    $
    0.00
    
    
    
    0
    
    
    $
    20,000,000February 1 to February 28
    
    
    283,646
    (1)
    
    $
    19.79
    (2)
    
    
    282,400
    
    
    $
    14,411,711March 1 to March 31
    
    
    210,950
    
    
    $
    20.83
    
    
    
    210,950
    
    
    $
    10,018,327Total
    
    
    494,596
    (1)
    
    $
    20.23
    (2)
    
    
    493,350
    
    
    $
    10,018,327
   (1)
    Includes 1,246 shares of our common stock tendered as payment of the exercise price
of options exercised during this period.(2)
    The shares of common stock tendered as payment of the exercise price of the options
were valued at $25,082 which was the fair market value on the date of exercise. 
 Item 6. Exhibits.  31.1
    Rule 13a-14(a) Certifications of CEO (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002).31.2
    Rule 13a-14(a) Certifications of CFO (pursuant to Section 302 of the Sarbanes-Oxley Act of 2002).32.1
    Rule 1350 Certifications of CEO (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002).32.2
    Rule 1350 Certifications of CFO (pursuant to Section 906 of the Sarbanes-Oxley Act of 2002). 18




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##### Table of Contents



SIGNATURES   
 Pursuant to the requirements 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. DIRECT GENERAL CORPORATION(Registrant)
 May 10, 2005
    
    
    
    By:
    
    /s/ William C. Adair, Jr.Date
    
    
    
    
    
    (Signature)Name:
    
    William C. Adair, Jr.Title:
    
    Chairman and Chief Executive OfficerMay 10, 2005
    
    
    
    By:
    
    /s/ Barry D. ElkinsDate
    
    
    
    
    
    (Signature)Name:
    
    Barry D. ElkinsTitle:
    
    Senior Vice President and Chief Financial Officer