##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
  þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For
the quarterly period ended March 31, 2006
 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)
 
 þ o
  o þ o
  o þ




---



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 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 31,2006
    
    
    2005(In thousands, except per share amounts)RevenuesPremiums earned
    
    $
    101,888
    
    
    $
    101,913Finance income
    
    
    11,763
    
    
    
    12,171Commission and service fee income
    
    
    14,053
    
    
    
    14,267Net investment income
    
    
    4,124
    
    
    
    3,329Net realized (losses) gains on securities and other
    
    
    (1,015
    )
    
    
    31Total revenues
    
    
    130,813
    
    
    
    131,711ExpensesInsurance losses and loss adjustment expenses
    
    
    77,217
    
    
    
    75,882Selling, general and administrative costs
    
    
    36,206
    
    
    
    32,784Interest expense
    
    
    2,678
    
    
    
    1,310Total expenses
    
    
    116,101
    
    
    
    109,976Income before income taxes
    
    
    14,712
    
    
    
    21,735Income tax expense
    
    
    5,552
    
    
    
    8,152Net income
    
    $
    9,160
    
    
    $
    13,583Earnings per ShareBasic earnings per common share
    
    $
    0.45
    
    
    $
    0.61Diluted earnings per common share
    
    $
    0.45
    
    
    $
    0.61
  2




---



##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (Unaudited)March 31,
    
    
    December 31,2006
    
    
    2005(In thousands)AssetsInvestments:Debt securities available-for-sale at fair value
(amortized cost $395,760 and $395,159 at March 31,
2006 and December 31, 2005, respectively)
    
    $
    384,590
    
    
    $
    388,032Short-term investments
    
    
    3,173
    
    
    
    3,688Total investments
    
    
    387,763
    
    
    
    391,720Cash and cash equivalents
    
    
    111,022
    
    
    
    64,527Finance receivables, net
    
    
    263,762
    
    
    
    214,796Reinsurance balances receivable
    
    
    23,060
    
    
    
    27,083Prepaid reinsurance premiums
    
    
    12,025
    
    
    
    24,440Goodwill and other tangible assets, net
    
    
    31,621
    
    
    
    31,621Deferred policy acquisition costs
    
    
    20,264
    
    
    
    13,804Income taxes recoverable
    
    
    719
    
    
    
    4,692Deferred income taxes
    
    
    22,611
    
    
    
    21,915Property and equipment, net
    
    
    17,531
    
    
    
    18,346Other assets
    
    
    26,832
    
    
    
    28,068Total assets
    
    $
    917,210
    
    
    $
    841,012Liabilities and Shareholders EquityLoss and loss adjustment expense reserves
    
    $
    132,517
    
    
    $
    131,408Unearned premiums
    
    
    263,659
    
    
    
    214,715Reinsurance balances payable and funds held
    
    
    20,228
    
    
    
    32,024Accounts payable and accrued expenses
    
    
    17,587
    
    
    
    12,550Notes payable
    
    
    179,337
    
    
    
    153,009Debentures payable
    
    
    41,238
    
    
    
    41,238Capital lease obligations
    
    
    2,291
    
    
    
    2,636Payable for securities
    
    
    495
    
    
    
    3,187Other liabilities
    
    
    15,795
    
    
    
    12,713Total liabilities
    
    
    673,147
    
    
    
    603,480Shareholders equityCommon stock, no par; authorized shares  100,000.0;
issued shares  20,347.7 and 20,339.2 at March 31,
2006 and December 31, 2005, respectively
    
    
    70,048
    
    
    
    69,700Retained earnings
    
    
    180,126
    
    
    
    171,780Accumulated other comprehensive (loss) income:Net unrealized depreciation on investment securities
    
    
    (7,260
    )
    
    
    (4,633
    )Net gain on cash flow hedge
    
    
    1,149
    
    
    
    685Total shareholders equity
    
    
    244,063
    
    
    
    237,532Total liabilities and shareholders equity
    
    $
    917,210
    
    
    $
    841,012
  3




---



##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 Three Months Ended March 31,2006
    
    
    2005(In thousands)Operating activitiesNet income
    
    $
    9,160
    
    
    $
    13,583Adjustments to reconcile net income to net cash provided by operating activities:Net realized losses (gains) on securities and other
    
    
    1,015
    
    
    
    (31
    )Depreciation and amortization
    
    
    2,294
    
    
    
    1,616Deferred income taxes
    
    
    469
    
    
    
    (841
    )Changes in operating assets and liabilities:Finance receivables, net
    
    
    (48,966
    )
    
    
    (42,507
    )Reinsurance balances receivable
    
    
    4,023
    
    
    
    839Prepaid reinsurance premiums
    
    
    12,415
    
    
    
    (1,664
    )Deferred policy acquisition costs
    
    
    (6,460
    )
    
    
    (2,105
    )Income taxes recoverable/payable
    
    
    3,973
    
    
    
    7,850Loss and loss adjustment expense reserves
    
    
    1,109
    
    
    
    (2,130
    )Unearned premiums
    
    
    48,944
    
    
    
    43,073Reinsurance balances payable and funds held
    
    
    (11,796
    )
    
    
    3,661Accounts payable and accrued expenses
    
    
    5,037
    
    
    
    3,374Other
    
    
    5,359
    
    
    
    4,400Net cash provided by operating activities
    
    
    26,576
    
    
    
    29,118Investing activitiesProceeds from sales and maturities of debt securities available-for-sale
    
    
    22,205
    
    
    
    22,132Purchase of debt securities available-for-sale
    
    
    (23,710
    )
    
    
    (24,766
    )Payable for securities
    
    
    (2,692
    )
    
    
    625Net purchases of short-term investments
    
    
    (198
    )
    
    
    (359
    )Purchase of property and equipment, net
    
    
    (879
    )
    
    
    (2,220
    )Purchase of insurance agency assets
    
    
    
    
    
    
    (4,799
    )Net cash used in investing activities
    
    
    (5,274
    )
    
    
    (9,387
    )Financing activitiesRepurchase of common stock
    
    
    
    
    
    
    (9,999
    )Issuances of common stock
    
    
    23
    
    
    
    543Net proceeds from borrowings
    
    
    27,000
    
    
    
    37,800Payment of principal on borrowings
    
    
    (1,016
    )
    
    
    (452
    )Payment of dividends on common stock
    
    
    (814
    )
    
    
    (892
    )Net cash provided by financing activities
    
    
    25,193
    
    
    
    27,000Net increase in cash and cash equivalents
    
    
    46,495
    
    
    
    46,731Cash and cash equivalents at beginning of period
    
    
    64,527
    
    
    
    70,988Cash and cash equivalents at end of period
    
    $
    111,022
    
    
    $
    117,719
  4




---



##### Table of Contents



DIRECT GENERAL CORPORATION AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 1. Nature of Operations
  2. Basis of Presentation
  3. Notes Payable
  4. Earnings Per Share
  Three Months Ended March 31,2006
    
    
    2005(In thousands, except per share amounts)Numerator:Net income
    
    $
    9,160
    
    
    $
    13,583Denominator:Weighted average common shares outstanding
    
    
    20,343.4
    
    
    
    22,272.3Dilutive stock options
    
    
    41.3
    
    
    
    125.6Weighted average common shares
outstanding for purposes of computing
diluted earnings per common share
    
    
    20,384.7
    
    
    
    22,397.9Basic earnings per common share
    
    $
    0.45
    
    
    $
    0.61Diluted earnings per common share
    
    $
    0.45
    
    
    $
    0.61
 5




---



##### Table of Contents



5. Stock Options
     Three MonthsendedMarch 31, 2005(in thousands,except pershare amounts)Net income, as reported
    
    $
    13,583Deduct: Total stock-based employee compensation expense determined under the
fair value based method, net of
related tax effects
    
    
    (218
    )Net income, pro forma
    
    $
    13,365Income for purposes of computing diluted earnings per share common, as reported
    
    $
    13,583Deduct: Total stock-based employee compensation expense
determined under fair value based method, net of related
tax effects
    
    
    (218
    )Income for purposes of computing diluted earnings per share common, pro forma
    
    $
    13,365Earnings per shareBasic  as reported
    
    $
    0.61Basic  pro forma
    
    $
    0.60Diluted  as reported
    
    $
    0.61Diluted  pro forma
    
    $
    0.60
  Number ofSharesOptions outstanding January 1, 2006 (385,300 exercisable)
    
    
    970,700Granted
    
    
    20,000Exercised
    
    
    8,500Forfeited
    
    
    18,000Options outstanding March 31, 2006 (377,700 exercisable)
    
    
    964,200
 6




---



##### Table of Contents



2006
    
    2005Expected option term
    
    5 years
    
    5 yearsAnnualized volatility rate
    
    
    21.0
    %
    
    
    31.5
    %Risk-free rate of return
    
    
    4.57
    %
    
    
    4.12
    %Fair value at the date of grant (weighted-average)
    
    $
    15.57
    
    
    $
    18.06Dividend yield
    
    
    0.77
    %
    
    
    0.66
    %Black-Scholes value
    
    
    26.0
    %
    
    
    32.9
    %
 6. Comprehensive Income
  7. Contingencies
  8. Recent Accounting Pronouncements
  7




---



##### Table of Contents



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 on Form 10-K for the year ended December 31, 2005 filed with the
Securities and Exchange Commission.
 Overview of Operating Results
  Summary of Key Measures of Financial Results
  Three Months EndedMarch 31,%($ in millions)
    
    2006
    
    2005
    
    Change(Unaudited)Selected Financial DataGross premiums written
    
    $
    160.6
    
    
    $
    161.3
    
    
    
    (0.4
    )Ancillary income
    
    
    25.8
    
    
    
    26.5
    
    
    
    (2.6
    )Net investment income
    
    
    4.1
    
    
    
    3.3
    
    
    
    24.2Gross revenues
    
    $
    190.5
    
    
    $
    191.1
    
    
    
    (0.3
    )Ceded premiums written
    
    
    2.6
    
    
    
    (18.0
    )
    
    
    (114.4
    )Change in net unearned premiums
    
    
    (61.3
    )
    
    
    (41.4
    )
    
    
    (48.1
    )Net realized losses on securities and other
    
    
    (1.0
    )
    
    
    
    
    
    NMTotal revenues
    
    $
    130.8
    
    
    $
    131.7
    
    
    
    (0.7
    )Net income
    
    $
    9.2
    
    
    $
    13.6
    
    
    
    (32.4
    )Key Financial RatiosLoss ratio  net
    
    
    75.8
    %
    
    
    74.5
    %Expense ratio  net
    
    
    12.8
    %
    
    
    7.5
    %Combined ratio  net
    
    
    88.6
    %
    
    
    82.0
    %Ancillary income to net operating expenses
    
    
    66.4
    %
    
    
    77.5
    %
 Explanation of Key Measurers
  Gross Premiums Written
 8




---



##### Table of Contents



Net Premiums Written.
 Gross Revenues (a non-GAAP financial measure).
 Loss Ratio
 Expense Ratio
 Combined Ratio
 Ancillary Income Measures.
 Seasonality
 9




---



##### Table of Contents



Results of Operations
 Revenues
 Premiums
  Three Months EndedMarch 31,%($ in millions)
    
    2006
    
    2005
    
    Change(Unaudited)Gross premiums writtenFlorida
    
    $
    71.0
    
    
    $
    78.1
    
    
    
    (9.1
    )Tennessee
    
    
    19.7
    
    
    
    22.3
    
    
    
    (11.7
    )Georgia
    
    
    11.3
    
    
    
    10.6
    
    
    
    6.6Louisiana
    
    
    8.8
    
    
    
    11.8
    
    
    
    (25.4
    )Texas
    
    
    14.9
    
    
    
    8.5
    
    
    
    75.3Mississippi
    
    
    11.2
    
    
    
    10.0
    
    
    
    12.0All other states
    
    
    23.7
    
    
    
    20.0
    
    
    
    18.5Gross premiums written
    
    $
    160.6
    
    
    $
    161.3
    
    
    
    (0.4
    )Ceded premiums written
    
    
    2.6
    
    
    
    (18.0
    )
    
    
    (114.4
    )Net premiums written
    
    $
    163.2
    
    
    $
    143.3
    
    
    
    13.9Gross premiums earned
    
    $
    111.7
    
    
    $
    118.2
    
    
    
    (5.5
    )Ceded premiums earned
    
    
    (9.8
    )
    
    
    (16.3
    )
    
    
    (39.9
    )Net premiums earned
    
    $
    101.9
    
    
    $
    101.9Net premiums written to gross premiums written
    
    
    101.6
    %
    
    
    88.8
    %Gross premiums earned to gross premiums written
    
    
    69.6
    %
    
    
    73.3
    %Net premiums earned to net premiums written
    
    
    62.4
    %
    
    
    71.1
    %
     10




---



##### Table of Contents



Ancillary Income
 ®
  Net Investment Income
  Realized Gains on Securities and Other
   Expenses
 Insurance Losses and Loss Adjustment Expenses
   11




---



##### Table of Contents



Operating Expenses
  Stock Options
  Income Taxes
  12




---



##### Table of Contents



Financial Condition
 Liquidity and Capital Resources
 Sources and Uses of Funds
   Financing and Capital
   Reinsurance
  Investments
 Debt securities
   13




---



##### Table of Contents



Gross
    
    Gross Unrealized LossesAmortized
    
    Unrealized
    
    Less than
    
    Greater than
    
    Fair($ in millions)
    
    Cost
    
    Gains
    
    12 months
    
    12 months
    
    ValueU.S. Treasury securities and
obligations of U.S. government
corporations and agencies
    
    $
    70.3
    
    
    $
    
    
    
    $
    0.9
    
    
    $
    1.3
    
    
    $
    68.1Obligations of states and
political subdivisions
    
    
    71.3
    
    
    
    0.2
    
    
    
    0.3
    
    
    
    0.6
    
    
    
    70.6Corporate debt securitiesBanks and financial institutions
    
    
    96.7
    
    
    
    
    
    
    
    0.9
    
    
    
    2.5
    
    
    
    93.3Credit cards and auto loans
    
    
    78.4
    
    
    
    0.1
    
    
    
    0.7
    
    
    
    1.2
    
    
    
    76.6Industrial
    
    
    47.7
    
    
    
    
    
    
    
    0.4
    
    
    
    1.5
    
    
    
    45.8Telecommunications
    
    
    15.9
    
    
    
    
    
    
    
    0.1
    
    
    
    0.5
    
    
    
    15.3Utilities and Electric Services
    
    
    15.5
    
    
    
    
    
    
    
    0.1
    
    
    
    0.5
    
    
    
    14.9Corporate debt securities
    
    
    254.2
    
    
    
    0.1
    
    
    
    2.2
    
    
    
    6.2
    
    
    
    245.9Total
    
    $
    395.8
    
    
    $
    0.3
    
    
    $
    3.4
    
    
    $
    8.1
    
    
    $
    384.6
  ($ in millions)
    
    Amortized Cost
    
    Fair ValueYears to maturity:One or less
    
    $
    12.6
    
    
    $
    12.5After one through five
    
    
    178.3
    
    
    
    173.8After five through ten
    
    
    120.2
    
    
    
    116.0After ten
    
    
    84.7
    
    
    
    82.3Total
    
    $
    395.8
    
    
    $
    384.6
   ($ in millions)NAIC
    
    S&P
    
    Amortized
    
    
    
    
    
    % of FairRating
    
    Rating
    
    Cost
    
    Fair Value
    
    Value1
    
    AAA
    
    $
    156.6
    
    
    $
    153.0
    
    
    
    39.8
    %1
    
    AA
    
    
    32.4
    
    
    
    31.8
    
    
    
    8.3
    %1
    
    
    A
    
    
    
    102.6
    
    
    
    99.1
    
    
    
    25.8
    %2
    
    BBB
    
    
    34.9
    
    
    
    33.6
    
    
    
    8.7
    %1
    
    Agency
    
    
    69.3
    
    
    
    67.1
    
    
    
    17.4
    %$
    395.8
    
    
    $
    384.6
    
    
    
    100.0
    %
  14




---



##### Table of Contents



-100 Basis Point
    
    
    
    
    
    +100 Basis Point($ in millions)
    
    Change
    
    Fair Value
    
    ChangeDebt securities, available for sale
    
    $
    401.1
    
    
    $
    384.6
    
    
    $
    368.1
 Short-term investments.
 Cash and cash equivalents
 15




---



##### Table of Contents



Forward-Looking Statements
  
    
    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.
   
 Item 3. Quantitative and Qualitative Disclosures About Market Risk.
  
 Item 4. Controls and Procedures.
  16




---



##### Table of Contents



PART II  OTHER INFORMATION
 
 Item 1. Legal Proceedings.
   
 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).
 17




---



##### Table of Contents



SIGNATURES
  DIRECT GENERAL CORPORATION(Registrant)May 9, 2006
    
    
    
    By:
    
    /s/ William C. Adair, Jr.Date
    
    
    
    
    
    (Signature)Name: William C. Adair, Jr.Title: Chairman and Chief Executive OfficerMay 9, 2006
    
    
    
    By:
    
    /s/ J. Todd HagelyDate
    
    
    
    
    
    (Signature)Name: J. Todd HagelyTitle: Senior Vice President and Chief Financial Officer
 18