##### Table of Contents



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 June 30, 2004
 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
incorporation or organization)
    
    (I.R.S. Employer Identification No.)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  o     No  þ Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date: 22,349,246 shares of common
stock, no par value, at August 6, 2004.




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TABLE OF CONTENTS  PART IFINANCIAL INFORMATIONItem 1. Financial Statements.Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.Item 3. Quantitative and Qualitative Disclosures About Market Risk.Item 4. Controls and Procedures.PART II OTHER INFORMATIONItem 1. Legal Proceedings.Item 6. Exhibits and Reports on Form 8-K.SIGNATURESEX-31.1  SECTION 302 CEO CERTIFICATIONEX-31.2  SECTION 302 CFO CERTIFICATIONEX-32.1  SECTION 906 CEO CERTIFICATIONEX-32.2  SECTION 906 CFO CERTIFICATION    Table of Contents  
 PART IFINANCIAL INFORMATION 
 Item 1. Financial Statements. DIRECT GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands  except per share amounts)RevenuesPremiums earned
    
    $
    93,297
    
    
    $
    53,776
    
    
    $
    176,304
    
    
    $
    101,451Finance income
    
    
    12,702
    
    
    
    11,220
    
    
    
    25,463
    
    
    
    22,447Commission and service fee income
    
    
    11,980
    
    
    
    7,499
    
    
    
    25,475
    
    
    
    15,998Net investment income
    
    
    2,621
    
    
    
    1,550
    
    
    
    4,897
    
    
    
    2,931Net realized gains (losses) on securities and other
    
    
    (9
    )
    
    
    1,655
    
    
    
    60
    
    
    
    1,921Total revenues
    
    
    120,591
    
    
    
    75,700
    
    
    
    232,199
    
    
    
    144,748ExpensesInsurance losses and loss adjustment expenses
    
    
    68,262
    
    
    
    40,191
    
    
    
    129,087
    
    
    
    74,989Selling, general and administrative costs
    
    
    25,148
    
    
    
    17,651
    
    
    
    50,388
    
    
    
    34,982Interest expense
    
    
    1,539
    
    
    
    1,805
    
    
    
    2,891
    
    
    
    3,372Total expenses
    
    
    94,949
    
    
    
    59,647
    
    
    
    182,366
    
    
    
    113,343Income before income taxes
    
    
    25,642
    
    
    
    16,053
    
    
    
    49,833
    
    
    
    31,405Income tax expense
    
    
    9,624
    
    
    
    5,919
    
    
    
    18,797
    
    
    
    11,461Net income
    
    
    16,018
    
    
    
    10,134
    
    
    
    31,036
    
    
    
    19,944Preferred stock dividends  Series B
    
    
    
    
    
    
    141
    
    
    
    
    
    
    
    281Net income available to common shareholders
    
    $
    16,018
    
    
    $
    9,993
    
    
    $
    31,036
    
    
    $
    19,663Earnings per ShareBasic earnings per common share
    
    $
    0.72
    
    
    $
    0.82
    
    
    $
    1.42
    
    
    $
    1.62Diluted earnings per common share
    
    $
    0.70
    
    
    $
    0.58
    
    
    $
    1.37
    
    
    $
    1.14
 See notes to condensed consolidated financial statements. 2




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)June 30,
    
    December 31,2004
    
    2003(In thousands)AssetsInvestments:Debt securities available-for-sale at fair value (amortized cost
$298,150 and $263,929 at June 30, 2004 and December 31, 2003,
respectively)
    
    $
    293,871
    
    
    $
    264,998Short-term investments
    
    
    2,038
    
    
    
    1,322Total investments
    
    
    295,909
    
    
    
    266,320Cash and cash equivalents
    
    
    95,681
    
    
    
    87,342Finance receivables, net
    
    
    236,302
    
    
    
    201,271Reinsurance balances receivable
    
    
    48,471
    
    
    
    57,472Prepaid reinsurance premiums
    
    
    44,902
    
    
    
    56,397Deferred policy acquisition costs
    
    
    12,366
    
    
    
    11,432Income taxes recoverable
    
    
    4,366
    
    
    
    Deferred income taxes
    
    
    22,621
    
    
    
    18,539Property and equipment
    
    
    14,460
    
    
    
    13,775Goodwill, net
    
    
    22,188
    
    
    
    20,840Other assets
    
    
    23,170
    
    
    
    17,766Total assets
    
    $
    820,436
    
    
    $
    751,154Liabilities and Shareholders EquityLoss and loss adjustment expense reserves
    
    $
    116,629
    
    
    $
    112,618Unearned premiums
    
    
    248,636
    
    
    
    213,250Reinsurance balances payable and funds held
    
    
    49,529
    
    
    
    62,223Accounts payable and accrued expenses
    
    
    12,838
    
    
    
    13,105Income taxes payable
    
    
    
    
    
    
    2,369Notes payable
    
    
    152,690
    
    
    
    148,946Capital lease obligations
    
    
    4,063
    
    
    
    4,556Payable for securities
    
    
    1,569
    
    
    
    Other liabilities
    
    
    14,000
    
    
    
    16,692Total liabilities
    
    
    599,954
    
    
    
    573,759Shareholders equityCommon stock, no par; authorized shares  100,000.0; issued shares 
22,349.2 and 21,350.6 at June 30, 2004 and December 31, 2003,
respectively
    
    
    108,769
    
    
    
    91,853Retained earnings
    
    
    115,018
    
    
    
    85,735Accumulated other comprehensive income (loss):Net unrealized (depreciation) appreciation on investment securities
    
    
    (2,781
    )
    
    
    695Net loss on cash flow hedge
    
    
    (524
    )
    
    
    (888
    )Total shareholders equity
    
    
    220,482
    
    
    
    177,395Total liabilities and shareholders equity
    
    $
    820,436
    
    
    $
    751,154
 See notes to condensed consolidated financial statements. 3




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DIRECT GENERAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) Six Months Ended June 30,2004
    
    2003(In thousands)Operating activitiesNet income
    
    $
    31,036
    
    
    $
    19,944Adjustments to reconcile net income to net cash provided by operating activities:Net realized gains on securities and other
    
    
    (60
    )
    
    
    (1,921
    )Depreciation and amortization
    
    
    2,675
    
    
    
    2,341Deferred income taxes
    
    
    (2,406
    )
    
    
    (4,256
    )Changes in operating assets and liabilities:Finance receivables
    
    
    (35,031
    )
    
    
    (37,057
    )Reinsurance balances receivable
    
    
    9,001
    
    
    
    (1,736
    )Prepaid reinsurance premiums
    
    
    11,495
    
    
    
    (19,850
    )Deferred policy acquisition costs
    
    
    (934
    )
    
    
    (688
    )Income taxes recoverable/payable
    
    
    (6,735
    )
    
    
    (2,459
    )Loss and loss adjustment expense reserves
    
    
    4,011
    
    
    
    14,558Unearned premiums
    
    
    35,386
    
    
    
    42,347Reinsurance balances payable and funds held
    
    
    (12,694
    )
    
    
    13,690Accounts payable and accrued expenses
    
    
    (315
    )
    
    
    (964
    )Other
    
    
    (4,486
    )
    
    
    6,307Net cash provided by operating activities
    
    
    30,943
    
    
    
    30,256Investing activitiesProceeds from sales and maturities of debt securities available-for-sale
    
    
    85,104
    
    
    
    49,948Purchase of debt securities available-for-sale
    
    
    (116,235
    )
    
    
    (98,489
    )Payable for securities
    
    
    1,569
    
    
    
    Net (purchases) sales of short-term investments
    
    
    (716
    )
    
    
    2,745Purchase of property and equipment, net
    
    
    (3,297
    )
    
    
    (1,698
    )Purchase of life insurance company
    
    
    (7,330
    )
    
    
    Net cash used in investing activities
    
    
    (40,905
    )
    
    
    (47,494
    )Financing activitiesIssuances of common stock
    
    
    16,804
    
    
    
    Proceeds from borrowings
    
    
    4,066
    
    
    
    45,218Payment of principal on borrowings
    
    
    (815
    )
    
    
    (3,354
    )Payment of stock dividends
    
    
    (1,754
    )
    
    
    (281
    )Net cash provided by financing activities
    
    
    18,301
    
    
    
    41,583Net increase in cash and cash equivalents
    
    
    8,339
    
    
    
    24,345Cash and cash equivalents at beginning of period
    
    
    87,342
    
    
    
    87,027Cash and cash equivalents at end of period
    
    $
    95,681
    
    
    $
    111,372
 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 throughout most of 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
three and six months ended June 30, 2004 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, 2003. Effective August 11, 2003, the Company effected a stock split pursuant to
which each outstanding share of the Companys common stock became 12 new shares
of common stock. The Company has adjusted all share and per share amounts in
the accompanying financial statements to reflect the 12 for 1 split. 3. Acquisitions On January 30, 2004, the Company acquired an inactive life insurance
company for a total purchase price of $7.3 million of which approximately $1.3
million was attributable to goodwill. The assets of this life insurance
company consist of licenses to conduct life and/or accident and health
insurance business in 43 states and the District of Columbia and debt
securities. 4. Secondary Offering On March 23, 2004, the Company completed a secondary offering whereby
selling shareholders sold 3,314,015 shares of the Companys common stock. As a
result of the exercise of the over-allotment option by the underwriters of the
secondary offering, the Company issued and sold an additional 497,102 common
shares in April 2004, which resulted in net proceeds to the Company (after
deducting issuance costs) of approximately $16.0 million. 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 million revolving credit facility
under substantially similar terms and extended its maturity for an additional
three-year period to June 30, 2007. As of June 30, 2004, the amount
outstanding under the facility was $152.0 million. 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
    
    Six months endedJune 30
    
    June 302004
    
    2003
    
    2004
    
    2003(In thousands, except per share amounts)Numerator:Net income available to common shareholders
    
    $
    16,018
    
    
    $
    9,993
    
    
    $
    31,036
    
    
    $
    19,663Dividends paid to preferred shareholders
    
    
    
    
    
    
    261
    
    
    
    
    
    
    
    521Income for purposes of computing diluted
earnings per common share
    
    $
    16,018
    
    
    $
    10,254
    
    
    $
    31,036
    
    
    $
    20,184Denominator:Weighted average common shares outstanding
    
    
    22,239.2
    
    
    
    12,119.1
    
    
    
    21,871.1
    
    
    
    12,119.1Dilutive stock options
    
    
    602.5
    
    
    
    310.7
    
    
    
    718.1
    
    
    
    310.7Dilutive preferred stock
    
    
    
    
    
    
    5,264.0
    
    
    
    
    
    
    
    5,264.0Weighted average common shares outstanding
for purposes of computing diluted earnings
per common share
    
    
    22,841.7
    
    
    
    17,693.8
    
    
    
    22,589.2
    
    
    
    17,693.8Basic earnings per common share
    
    $
    0.72
    
    
    $
    0.82
    
    
    $
    1.42
    
    
    $
    1.62Diluted earnings per common share
    
    $
    0.70
    
    
    $
    0.58
    
    
    $
    1.37
    
    
    $
    1.14
 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 and, therefore, under APB 25, no compensation expense is
recorded. The Company follows the disclosure provisions of Statement of
Financial Accounting Standards (SFAS) 123, Accounting for Stock-Based
Compensation. 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 disclosed in the following table in
accordance with SFAS 148, Accounting for Stock-Based Compensation-Transition
and Disclosure: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except per share amounts)Net income
available to
common
shareholders, as
reported
    
    $
    16,018
    
    
    $
    9,993
    
    
    $
    31,036
    
    
    $
    19,663Deduct: Total
stock-based
employee
compensation
expense
determined under
the fair value
based method,
net of related
tax effects
    
    
    (188
    )
    
    
    (11
    )
    
    
    (440
    )
    
    
    (30
    )Net income
available to
common
shareholders,
pro forma
    
    $
    15,830
    
    
    $
    9,982
    
    
    $
    30,596
    
    
    $
    19,633Income for
purposes of
computing
diluted earnings
per share
common, as
reported
    
    $
    16,018
    
    
    $
    10,254
    
    
    $
    31,036
    
    
    $
    20,184Deduct: Total
stock-based
employee
compensation
expense
determined under
the fair value
based method,
net of related
tax effects
    
    
    (188
    )
    
    
    (11
    )
    
    
    (440
    )
    
    
    (30
    )Income for
purposes of
computing
diluted earnings
per share
common, pro
forma
    
    $
    15,830
    
    
    $
    10,243
    
    
    $
    30,596
    
    
    $
    20,154
 6




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Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands, except per share amounts)Earnings per shareBasic  as reported
    
    $
    0.72
    
    
    $
    0.82
    
    
    $
    1.42
    
    
    $
    1.62Basic  pro forma
    
    $
    0.71
    
    
    $
    0.82
    
    
    $
    1.40
    
    
    $
    1.62Diluted  as reported
    
    $
    0.70
    
    
    $
    0.58
    
    
    $
    1.37
    
    
    $
    1.14Diluted  pro forma
    
    $
    0.69
    
    
    $
    0.58
    
    
    $
    1.35
    
    
    $
    1.14Weighted average common shares
    
    
    22,239.2
    
    
    
    12,119.1
    
    
    
    21,871.1
    
    
    
    12,119.1Fully diluted shares
    
    
    22,841.7
    
    
    
    17,693.8
    
    
    
    22,589.2
    
    
    
    17,693.8
 8. Recent Accounting Pronouncements The Company continually evaluates the impact of new accounting
pronouncements and based on this analysis, the Company does not expect recently
issued accounting standards to have a material impact on the Companys results
of operations, financial condition, or cash flows. 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, 2003 filed with the
Securities and Exchange Commission. Overview We are a provider of non-standard personal automobile insurance, premium
finance and other insurance and non-insurance products and services. Our
operations are concentrated in the southeastern part of the United States. Our
business model integrates our insurance, premium finance and agency
subsidiaries under one organization. Our model also emphasizes the
distribution of our products and services through neighborhood sales offices
staffed by salaried employee-agents as opposed to commissioned agents. The
expansion of our neighborhood sales offices in selected states includes the use
of independent insurance agencies, which we generally have options to acquire
in the future. Measurement of Results 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 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. 8




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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. Results of Operations 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. (Unaudited)
    
    (Unaudited)Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,($ in millions)
    
    2004
    
    2003
    
    % Change
    
    2004
    
    2003
    
    % ChangeSelected Financial DataGross premiums written
    
    $
    101.8
    
    
    $
    87.9
    
    
    
    15.8
    
    
    $
    270.8
    
    
    $
    228.5
    
    
    
    18.5Ancillary income
    
    
    24.7
    
    
    
    18.7
    
    
    
    32.1
    
    
    
    50.9
    
    
    
    38.4
    
    
    
    32.6Net investment income
    
    
    2.6
    
    
    
    1.5
    
    
    
    73.3
    
    
    
    4.9
    
    
    
    3.0
    
    
    
    63.3Gross revenues
    
    $
    129.1
    
    
    $
    108.1
    
    
    
    19.4
    
    
    $
    326.6
    
    
    $
    269.9
    
    
    
    21.0Ceded premiums written
    
    
    (16.0
    )
    
    
    (39.9
    )
    
    
    (59.9
    )
    
    
    (47.6
    )
    
    
    (104.6
    )
    
    
    (54.5
    )Change in net unearned premiums
    
    
    7.5
    
    
    
    5.8
    
    
    
    29.3
    
    
    
    (46.9
    )
    
    
    (22.5
    )
    
    
    108.4Net realized gains on investments
    
    
    
    
    
    
    1.7
    
    
    NM
    
    
    0.1
    
    
    
    1.9
    
    
    
    (94.7
    )Total revenues
    
    $
    120.6
    
    
    $
    75.7
    
    
    
    59.3
    
    
    $
    232.2
    
    
    $
    144.7
    
    
    
    60.5Net income
    
    $
    16.0
    
    
    $
    10.1
    
    
    
    58.4
    
    
    $
    31.0
    
    
    $
    19.9
    
    
    
    55.8Key Financial RatiosLoss ratio  net
    
    
    73.2
    %
    
    
    74.7
    %
    
    
    
    
    
    
    73.2
    %
    
    
    73.9
    %Expense ratio  net
    
    
    2.2
    %
    
    
    1.4
    %
    
    
    
    
    
    
    1.3
    %
    
    
    (0.1
    %)Combined ratio  net
    
    
    75.4
    %
    
    
    76.1
    %
    
    
    
    
    
    
    74.5
    %
    
    
    73.8
    %Ancillary income to gross premiums earned
    
    
    20.5
    %
    
    
    19.0
    %
    
    
    
    
    
    
    21.6
    %
    
    
    20.6
    %Ancillary income to net operating expenses
    
    
    92.5
    %
    
    
    95.9
    %
    
    
    
    
    
    
    95.5
    %
    
    
    100.0
    %
 Overview of Operating Results Net income increased 58.4% to $16.0 million or $0.70 per share, on a
diluted basis, for the three months ended June 30, 2004 and 55.8% to $31.0
million or $1.37 per share, on a diluted basis, for the six months ended June
30, 2004 compared to the same periods in 2003. The increase in net income was
primarily attributable to continued growth in premiums written and earned,
growth in ancillary income and a decrease in the loss ratio. Gross revenues
increased 19.4% and 21.0% for the three and six months ended June 30, 2004,
respectively, compared to the same periods in 2003. Approximately $3.6 million
of the increase in net income for the second quarter was attributable to the
Cash Register agency offices that were acquired in November 2003. The
operating expenses associated with these offices decreased by $3.8 million as a
variable (commissioned based) cost structure was replaced by the largely fixed
cost structure provided by our business model. In addition, these offices
generated total revenues of $1.9 million primarily from the sale of ancillary
insurance products which, prior to our acquisition, remained with the agency.
These favorable trends were partially offset by an increase in operating
expenses and a reduction in net realized gains on securities and other. Net
realized gains, after tax, were insignificant for the three months and six
months ended June 30, 2004, but were $1.1 million and $1.2 million or $0.06 and
$0.07 per diluted share for the three and six months ended June 30, 2003,
respectively. 9




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##### Table of Contents



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: (Unaudited)
    
    (Unaudited)Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,($ in millions)
    
    2004
    
    2003
    
    % Change
    
    2004
    
    2003
    
    % ChangeGross premiums writtenFlorida
    
    $
    52.2
    
    
    $
    46.7
    
    
    
    11.8
    
    
    $
    136.1
    
    
    $
    117.6
    
    
    
    15.7Tennessee
    
    
    13.6
    
    
    
    13.2
    
    
    
    3.0
    
    
    
    37.0
    
    
    
    34.1
    
    
    
    8.5Georgia
    
    
    6.7
    
    
    
    5.0
    
    
    
    34.0
    
    
    
    19.0
    
    
    
    16.9
    
    
    
    12.4Louisiana
    
    
    6.1
    
    
    
    5.8
    
    
    
    5.2
    
    
    
    18.6
    
    
    
    16.3
    
    
    
    14.1Texas
    
    
    8.0
    
    
    
    3.6
    
    
    
    122.2
    
    
    
    15.0
    
    
    
    5.4
    
    
    
    177.8Mississippi
    
    
    5.0
    
    
    
    4.0
    
    
    
    25.0
    
    
    
    15.1
    
    
    
    12.4
    
    
    
    21.8All other states
    
    
    10.2
    
    
    
    9.6
    
    
    
    6.3
    
    
    
    30.0
    
    
    
    25.8
    
    
    
    16.3Gross premiums written
    
    $
    101.8
    
    
    $
    87.9
    
    
    
    15.8
    
    
    $
    270.8
    
    
    $
    228.5
    
    
    
    18.5Ceded premiums written
    
    
    (16.0
    )
    
    
    (39.9
    )
    
    
    (59.9
    )
    
    
    (47.6
    )
    
    
    (104.6
    )
    
    
    (54.5
    )Net premiums written
    
    $
    85.8
    
    
    $
    48.0
    
    
    
    78.8
    
    
    $
    223.2
    
    
    $
    123.9
    
    
    
    80.1Gross premiums earned
    
    $
    120.4
    
    
    $
    98.4
    
    
    
    22.4
    
    
    $
    235.4
    
    
    $
    186.2
    
    
    
    26.4Ceded premiums earned
    
    
    (27.1
    )
    
    
    (44.7
    )
    
    
    (39.4
    )
    
    
    (59.1
    )
    
    
    (84.8
    )
    
    
    (30.3
    )Net premiums earned
    
    $
    93.3
    
    
    $
    53.7
    
    
    
    73.7
    
    
    $
    176.3
    
    
    $
    101.4
    
    
    
    73.9Net premiums written to gross premiums written
    
    
    84.3
    %
    
    
    54.6
    %
    
    
    
    
    
    
    82.4
    %
    
    
    54.2
    %Gross premiums earned to gross premiums written
    
    
    118.3
    %
    
    
    111.9
    %
    
    
    
    
    
    
    86.9
    %
    
    
    81.5
    %Net premiums earned to net premiums written
    
    
    108.7
    %
    
    
    111.9
    %
    
    
    
    
    
    
    79.0
    %
    
    
    81.8
    %
 Gross premiums written increased $13.9 million or 15.8% and $42.3 million
or 18.5% for the three and six months ended June 30, 2004, respectively,
compared to the same periods in 2003. The increase in gross premiums written
reflected growth primarily from renewal policies in our existing states and new
business growth in our expansion state of Texas. The premium growth in our
existing states also included increases in new business policies in Georgia in
conjunction with some modifications to our payment plans implemented after the
second quarter of 2003 and Georgias efforts to reduce its number of uninsured
motorists. We also continue to build market share in Mississippi and South
Carolina. There was minimal impact from rate changes in our existing states.
Gross written premiums from the sale of our core non-standard automobile
insurance business increased 14.7% and 17.6% for the three and six month
periods ended June 30, 2004, respectively, while gross premiums written from
the sale of our term life insurance business increased 54.2% to $3.7 million
and 49.2% to $9.7 million for the first three and six months of 2004,
respectively. The Cash Register agency offices, which were acquired in
November 2003, have produced $1.2 million of life premiums for us through the
first six months of 2004. These offices did not sell our life product prior to
the acquisition. Gross premiums earned, a function of gross premiums written
over the current and prior periods, increased 22.4% and 26.4% in the three and
six months ended June 30, 2004, respectively, as compared to the same periods
in 2003. In early August, we commenced our initial advertising campaign in Texas,
which involves the co-branding of Direct and the Texas independent agency
network that we have an option to acquire the assets of at the end of 2004. We
have also begun to install our agency systems into some of the independent
agency offices in Texas in anticipation of our acquisition of these offices at
the end of the year. In addition to Texas, we are proceeding with our
expansion into Missouri and Virginia. We are currently negotiating leases for
sales office space in both states and expect to begin operations in the fourth
quarter of 2004. The growth in net premiums written and earned is a function of gross
premiums written and earned less ceded premiums written and earned. The ratio
of net premiums written to gross premiums written increased to 84.3% and 82.4%
for the three and six months ended June 30, 2004. Comparatively, this ratio
was only 54.6% and 54.2% for the corresponding periods in 2003, which was prior
to the infusion of additional capital into our insurance subsidiaries from the
proceeds raised in our initial public offering in the third quarter of 2003.
We expect to retain approximately 85% of our gross premiums written in 2004. 10




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##### Table of Contents



Ancillary Income Ancillary income for the three and six months ended June 30, 2004 was
$24.7 million and $50.9 million, respectively, which represents an increase of
32.1% and 32.6%, respectively, compared to the corresponding periods in 2003.
Commission and service fee income on products sold by the Cash Register agency
offices, which were acquired in the fourth quarter of 2003, represented
approximately $1.7 million and $3.3 million of the increase over the prior year
quarter and year to date, respectively. During the second quarter of 2004,
sales of ancillary insurance products increased, while premium finance income
grew largely as a result of an increase in average finance receivables
outstanding. The increase in finance income will not correspond
proportionately with the increase in premiums earned since, in Texas, we are
currently only issuing one-month policies and are not financing premiums. The ratio of ancillary income to gross premiums earned was 20.5% and 19.0%
for the second quarter of 2004 and 2003, respectively, while the ratio of
ancillary income to operating expenses decreased slightly to 92.5% in the 2004
period from 95.9% in the 2003 period. For the six months ended June 30, 2004
and 2003, the ratio of ancillary income to gross premiums earned was 21.6% and
20.6%, respectively, and the ratio of ancillary income to operating expenses
was 95.6% and 100.0%, respectively. The increase in ancillary income as a
percentage of gross premiums earned is largely attributable to the increase in
ancillary income produced by the Cash Register offices. The decline in the
ratio of ancillary income to operating expenses is primarily associated with
the increased retention of the business. 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 increased to $2.6 million from $1.5 million for the
three months ended June 30, 2004 compared to the same period of 2003. The
increase was due primarily to an increase in invested assets partially offset
by a decrease in investment yields. For the six months ended June 30, 2004,
net investment income increased to $4.9 million from $3.0 million in the
corresponding period in 2003. The return on the portfolio for the six months
ended June 30, 2004 and 2003 was 1.8% and 2.0%, respectively. Average invested
assets increased 89.2% to $280.4 million in the first six months of 2004 from
$148.2 million in the first six months of 2003. Realized Gains (Losses) on Securities Net realized losses on securities were insignificant for the three months
ended June 30, 2004 as compared to net realized gains of $1.7 million in the
corresponding period in 2003. We realized gross gains of $0.1 million and $0.2
million and gross losses of $0.6 million and $0.7 million on the sale of
securities for the three and six month periods ended June 30, 2004,
respectively. The majority of these gains and losses were attributable to the
sale of selected securities in favor of securities that offered more attractive
yields and income potential. Comparatively, we realized gross gains of $1.7
million and $1.9 million for the three and six month periods ended June 30,
2003, respectively, with no gross realized losses during either period. The
prior year to date gross gains were primarily attributable to the sale of
certain securities as we repositioned our bond portfolio based on our
investment guidelines for changes in market conditions and other factors.
Approximately $1.2 million of the gains during the second quarter of 2003 were
precipitated by our decision to reduce our investment in Georgia municipal
obligations. There was no impact on realized losses attributable to
adjustments for other than temporary impairment of securities still held during
these periods. In the three and six month periods ended June 30, 2004, we also realized
gross gains of $0.9 million and $1.4 million and gross losses of $0.8 million
and $1.6 million, respectively, 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 consolidated statement of operations. For the three and six
months ended June 30, 2004, the market value on open contracts increased by
$0.4 million and $0.7 million, respectively, which was included in net realized
gains on securities and other. As of June 30, 2004, we had open contracts with
gross unrealized gains of $0.4 million and gross unrealized losses of $0.1
million. Expenses Insurance Losses and Loss Adjustment Expenses Insurance losses and loss adjustment expenses increased to $68.3 million
for the three months ended June 30, 2004 from $40.2 million for the same period
in 2003. Net loss ratios for the second quarter of 2004 and 2003 were 73.2%
and 74.7%, respectively. The Companys quarterly analysis of reserves resulted
in an increase to the reserves for prior accident quarters of $0.7 million or
0.7 points in the second quarter of 2004. During the quarter, we strengthened
prior year reserves, primarily associated with the personal injury protection
coverage in Florida, by approximately $2.0 million and reduced reserves
associated with accidents 11




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##### Table of Contents



occurring in the first quarter of 2004 by approximately $1.3 million due
to lower than expected frequency trends for property and physical damage
coverages primarily in Florida. In comparison, the loss ratio for the second
quarter of 2003 was increased by approximately 2.2 points of weather related
losses and by 0.5 points of adverse reserve development. The impact of weather
related losses in the second quarter of 2004 was minimal. For the six months ended June 30, 2004, insurance losses and loss
adjustment expenses increased to $129.1 million from $75.0 million in the
corresponding 2003 period and the net loss ratios were 73.2% and 73.9%,
respectively. Our year to date loss ratio was adversely impacted by
approximately 1.3 points due to the strengthening of prior year reserves. The
impact of catastrophic losses for the first six months of 2004 was minimal.
For the six months ended June 30, 2003, the loss ratio included approximately
1.2 points of weather related losses that were partially offset by 0.5 points
of favorable development on prior years reserves. Overall, for the first six months of 2004, our countrywide frequency and
severity trends were relatively flat for the personal injury protection and
property damage coverages as compared to 2003; however, we have seen a slight
improvement in the frequency for the bodily injury and physical damage
coverages. We have been closely monitoring increases in claims frequency,
particularly in the personal injury protection coverage in the Miami, Florida
market over the past few quarters. These trends appear to have stabilized and
we are starting to see the benefits from the rate increases that we implemented
in October 2003 and May 2004. The loss ratio for our Texas business continues
to be slightly better than our countrywide average for our existing states. Operating Expenses Operating expenses increased 36.9% to $26.7 million for the three months
ended June 30, 2004, compared to $19.5 million for the same period of 2003.
This increase in operating expenses was substantially lower than the 59.3%
increase in total revenues primarily as a result of the reduction in operating
costs associated with the acquisition of Cash Register agency offices in
Florida. Operating expenses for the quarter reflected a $3.8 million reduction
in selling, general and administrative costs associated with the Cash Register
business as the cost structure for this business was converted from a variable
structure with commissioned independent agents to the largely fixed cost
structure provided by our business model. The increase in operating costs
compared to the second quarter of 2003 was driven by a reduction in ceded
reinsurance commissions received of $5.5 million and a $5.5 million increase in
other operating costs primarily associated with corporate insurance and
employee health insurance costs, our growth in Texas and increased premium
volumes in our existing states. For the six months ended June 30, 2004, operating expenses increased 38.8%
to $53.3 million from $38.4 million in the comparable period in 2003. The
increase in operating expenses was primarily attributable to a $10.9 million
reduction in ceded reinsurance commissions received and other increases in
operating costs associated with increased premium volumes totaling $10.4
million, which were partially offset by a $6.4 million reduction in operating
costs associated with the Cash Register agency offices. Income Taxes Our effective tax rates were 37.5% and 36.9% for the three month periods
ended June 30, 2004 and 2003, respectively. The effective tax rates for the
six months ended June 30, 2004 and 2003 were 37.7% and 36.5%, respectively.
The increase in our effective tax rate over the corresponding periods in the
prior year was primarily due to an increase in state income taxes and a
reduction in tax-exempt interest. 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 12




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##### Table of Contents



approximately $30.9 million and $30.3 million for the six months ended
June 30, 2004 and 2003, respectively. We expect our cash flows from operations
to be positive in both the short-term and reasonably foreseeable future. Financing and Capital During the first six months of 2004, we received $16.7 million from the
issuance of common stock including approximately $16.0 million from the sale of
497,102 shares sold in our secondary stock offering. The remaining proceeds
were primarily associated with common stock issued to employees in conjunction
with their exercise of common stock options. During the three and six months ended June 30, 2004, we paid common stock
dividends of $0.9 million and $1.7 million, respectively. Comparatively, we
did not pay common stock dividends prior to our initial public offering of
common stock in 2003, but did pay preferred stock dividends of $0.1 million and
$0.3 million for the three and six months ended June 30, 2003. All of the
preferred shares outstanding were converted to common shares in conjunction
with the initial public offering. As of June 30, 2004, 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 $152.0 million. We renewed this
facility for an additional three-year period on July 1, 2004. We believe that
this facility will be sufficient to meet the working capital needs of our
finance operations. Reinsurance The increased capitalization of our insurance subsidiaires enabled us to
reduce our quota share cession percentage. As a result, we ceded 15.7% of our
gross premiums written to reinsurers in the three months ended June 30, 2004 as
compared to 45.4% in the second quarter of 2003. For the first six months of
2004, we ceded 17.6% of our gross premiums written to reinsurers as
compared to
45.8% for the corresponding period in 2003. We plan to cede approximately more
than 15% of our gross premiums written to reinsurers during 2004. 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 June
30, 2004, our investment portfolio of $293.9 million included $4.3 million in
net unrealized losses. The effective duration of our investment portfolio was
4.1 years at June 30, 2004. 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 June 30,
2004: Gross
    
    GrossAmortized
    
    Unrealized
    
    Unrealized
    
    Fair($ in millions)
    
    Cost
    
    Gains
    
    Losses
    
    ValueU.S. Treasury securities and
obligations of U.S. government
corporations and agencies
    
    $
    49.9
    
    
    $
    0.1
    
    
    $
    1.1
    
    
    $
    48.9Obligations of states and
political subdivisions
    
    
    50.3
    
    
    
    0.9
    
    
    
    0.4
    
    
    
    50.8Corporate debt securities
Banks and financial institutions
    
    
    57.6
    
    
    
    0.2
    
    
    
    1.5
    
    
    
    56.3Credit cards and auto loans
    
    
    77.0
    
    
    
    0.1
    
    
    
    1.2
    
    
    
    75.9Industrial
    
    
    34.6
    
    
    
    0.1
    
    
    
    0.9
    
    
    
    33.8Insurance
    
    
    6.8
    
    
    
    
    
    
    
    0.2
    
    
    
    6.6Telecommunications
    
    
    12.5
    
    
    
    0.1
    
    
    
    0.3
    
    
    
    12.3Utilities and Electric Services
    
    
    9.5
    
    
    
    
    
    
    
    0.2
    
    
    
    9.3Corporate debt securities
    
    
    198.0
    
    
    
    0.5
    
    
    
    4.3
    
    
    
    194.2Total
    
    $
    298.2
    
    
    $
    1.5
    
    
    $
    5.8
    
    
    $
    293.9
 13




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##### Table of Contents



The amortized cost and fair value of debt securities available-for-sale as
of June 30, 2004, by contractual maturity, is shown below: ($ in millions)
    
    Amortized Cost
    
    Fair ValueYears to maturity:One or less
    
    $
    7.4
    
    
    $
    7.4After one through five
    
    
    152.4
    
    
    
    150.6After five through ten
    
    
    99.8
    
    
    
    97.9After ten
    
    
    38.6
    
    
    
    38.0Total
    
    $
    298.2
    
    
    $
    293.9
 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 June 30, 2004. 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 June 30, 2004
was as follows: ($ in millions)NAIC Rating
    
    S&P Rating
    
    Amortized Cost
    
    Fair Value
    
    %1
    
    
    AAA
    
    $
    121.7
    
    
    $
    120.4
    
    
    
    41.0
    %1
    
    
    AA
    
    
    36.0
    
    
    
    35.9
    
    
    
    12.2
    %1
    
    
    A
    
    
    73.8
    
    
    
    72.2
    
    
    
    24.5
    %2
    
    
    BBB
    
    
    35.7
    
    
    
    34.9
    
    
    
    11.9
    %1
    
    
    Agency
    
    
    31.0
    
    
    
    30.5
    
    
    
    10.4
    %$
    298.2
    
    
    $
    293.9
    
    
    
    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 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 June 30, 2004: -100 Basis Point
    
    
    
    
    
    +100 Basis Point($ in millions)
    
    Change
    
    Fair Value
    
    ChangeDebt securities, available-for-sale
    
    $
    305.8
    
    
    $
    293.9
    
    
    $
    281.9
 Short-term investments.We have a managed trading account with a
commodities trading company and, as of June 30, 2004, the total fair value of
open trades in this account was $0.3 million, 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 $1.1 million, included in cash and cash
equivalents, are held as collateral for this account. We recognized net
realized losses of $0.2 million on closed contracts and an increase in net
unrealized gains of $0.7 million on open contracts for the second quarter of
2004. 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 (losses) on securities and other
in our consolidated statement of operations. Cash and cash equivalents. Our balance in cash and cash equivalents was
$95.7 million as of June 30, 2004, which was approximately 9.5% higher than the
balance of cash held at December 31, 2003. The increase was primarily
attributable to the growth in business. 14




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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, 2003
filed with the Securities and Exchange Commission on March 9, 2004. 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. 
 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. 15




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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. As we anticipated, one of our subsidiary companies, Direct General
Insurance Company (DGIC), has recently been added as a defendant to the
previously disclosed lawsuit filed against William C. Adair, Jr., our Chairman,
Chief Executive Officer and President in Tennessee state court in November
2003. The original complaint alleged that Mr. Adair induced the plaintiff to
market a Health Plan, that Mr. Adair made certain misrepresentations to the
plaintiff, and that Mr. Adair breached a contract that resulted in a loss of
commissions to the plaintiff. The amended complaint alleges additionally that
such alleged actions of Mr. Adair were in his capacity as an officer of DGIC
and were on behalf of DGIC. Based on these allegations, plaintiff is seeking
compensatory damages and an unspecified amount of punitive damages from each of
the named defendants. This lawsuit is still in the early procedural stages, and
the ultimate outcome of this case is uncertain. We intend to vigorously defend
this lawsuit. 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, 2003 (Form 10-K)
filed with the Securities and Exchange Commission (SEC) on March 9, 2004 and
our periodic reports filed with the SEC under the Securities Exchange Act of
1934 since the filing of our Form 10-K. 
 Item 6. Exhibits and Reports on Form 8-K.  (a)
    
    List of 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).  (b)
    
    Reports on Form 8-K:  (i)
    
    Current Report on Form 8-K filed on May 10, 2004 to
report earnings for the quarter ended March 31, 2004 (Item 12.
Results of Operations and Financial Condition).(ii)
    
    Current Report on Form 8-K filed on June 8, 2004 to
report the adoption of a personal trading plan in accordance
with the Securities and Exchange Commissions Rule 10b5-1 (Item
5. Other Events). 16




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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)August 9, 2004
    
    By:
    /s/ William C. Adair, Jr.Date
    
    (Signature)Name:
    William C. Adair, Jr.Title:
    Chairman, Chief Executive Officer and President August 9, 2004
    
    By:
    /s/ Barry D. ElkinsDate
    
    (Signature)Name:
    Barry D. ElkinsTitle:
    Senior Vice President and Chief Financial Officer 17