Covenant Logistics Group Inc (CVLG) 2005 Q2 法說會逐字稿

Good afternoon. My name is Laurie and I will be your conference facilitator. At this time I would like to welcome everyone to the Covenant Transport second-quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer period. (OPERATOR INSTRUCTIONS) Thank you.

I will now turn the call over to Joey Hogan, Chief Financial Officer. Please go ahead, sir.

Thanks, Laurie. Welcome to our second-quarter 2005 conference call. I'll first read the forward-looking statement disclosure and then we'll start the rest of the call. This conference will contain forward-looking statements within the meaning of Section 27-A of the Securities Act of 1933 as amended and Section 21-E of the SEC Act of 1934 as amended. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements. Please review our disclosures and filings with the SEC.

Our format today will be somewhat different than in the past. First I will make a brief comment on the quarter. The detailed operating information we normally covered is posted on our website. But we will not cover that information during the call. Instead we're going to provide an update on the current status of the Company and expectations for the ongoing transition of our business model. We believe this is the most pressing issue on investors' mind and want to make sure that we address it.

The quarter was pretty simple to explain. We did not have sufficient freight volume to obtain the equipment utilization or level of rate increases needed to produce the results we expect. The economy did not feel as robust as it did during the second quarter of last year but it was a good shipping environment and we are not blaming the economy in general.

As we said after the first quarter, some of our customers were unhappy with the level and tenacity of our rate fuel surcharge and detention time increases last year and they selectively reduced our volumes. We have only lost one or two accounts but many reduced their volumes a few loads and collectively it made a difference. After numerous meetings with customers and participating in several bid and other freight selection processes during the second quarter, we expect the freight to come back over time. But not all at once.

As announced we earned $0.05 a share. Our cost per mile was up 10% and average freight revenue per tractor per week declined slightly as lower utilization outweighed a still nice 8% increase in average freight revenue per total mile. The main expense items were driver pay was up $0.06 per mile; fuel expense net of surcharge revenue was up $0.02 a mile; and operations and maintenance and insurance each up about $0.01 a mile.

Our balance sheet debt increased by $47 million from March 31 primarily because of $26 million in capital expenditures due to front-end loading our equipment purchases to smooth out our expected trade cycle in future periods; a $10 million tax payment and a $10 million for two years of prepaid, insurance. Those of you who follow our bank covenants, we did amend our facility during the quarter to clarify that the non-cash charge we took in the fourth quarter of 2004 is added back to cash flow. With that amendment, we believe we have plenty of room in our covenants.

One last point I will address. It has to do with a question that I receive many times throughout each week which is -- "Joey, looking back would you still have pressed so hard on rates, fuel surcharge and detention last year?" And unfortunately that is a very hard question to answer. Simply if we had not pushed so hard on rates last year, our earnings would not have been, our earnings would have been much lower last year. Remember costs were increasing rapidly and every penny a mile means about $0.18 a share annually. So if we had backed off a bit in the first half and a couple of pennies per mile in the second half, we probably would have earned only about $0.65 or $0.70 for the year excluding the insurance charge.

In addition, our base rate going into this year would have been that much lower. So utilization would have had to have stayed up quite a bit to make up the difference. All in all there are probably some selective instances in which we might have used a different approach. We are not ready to say that last year's strategy was entirely wrong. However, this year we are taking a more incremental approach.

That wraps the discussion of the quarter for statistics. Again, I would like to say that we normally give out -- please see our website and now I will turn it over to David to talk about the current status of the Company's operations and our plans going forward.

Thanks, Joey. You know for the past couple of years we had been spent a lot of time talking about the evolution of our business model. Areas of emphasis have included shortening our length of haul, changing lanes and rate structures, working on tweeners and growing our dedicated division. These have all been part of the evolution of covenant from a predominately transcontinental carrier to a carrier that provides a range of services in four main product groups; expedited team, refrigerated, dedicated and regional.

Very briefly I want to give some historical background on Covenant that may provide greater understanding of the natural progression of the changes we are making as well as the need for focused and patient implementation.

If you'll go back to most of the 1990's, Covenant was primarily a team driver, transcontinental operation. About two-thirds of our trucks were driven by teams and the trucks with solo drivers mainly supported the teams by covering shorter hauls and providing a driver training function. Our business model was based mainly on equipment utilization, that is we put as many miles as we could on a truck and drove down our fixed cost in order to achieve favorable margins.

Here is a snapshot of our operations at that time. We had low revenue per mile but high utilization, about 150,000 miles a truck. We had an 1800 mile length of haul; the drivers were domiciled for transcontinental runs; we had a low deadhead as a percentage of miles but they were about 100 miles a trip. And the transaction intensity was built for long haul trips such as less frequent dispatch, billing, less driver contact -- you know across the board.

Our operations began to change in 1999 when we bought Harold Ives Trucking, a solo operation to meet customer demand that their core carriers provide a greater range of services. At the same time, used truck pricing became much more mileage based than model year based. And manufacturers no longer supported used truck prices that had a lot of miles on them. As a fact that 80% of the trucks, truck frame moves and shorter haul lanes and they were good economic and customer service reasons for building a significant component of lower mile, shorter haul business.

By 2001, our teams were approximately one-third of our fleet instead of two-thirds. Between 2001 and 2004 we took a number of steps to begin the evolution toward improving our profitability and our ability to be able to compete in the shorter haul lanes. By the end of 2004, Covenant looked a lot different than in 1999, to give you some examples. Our average length of haul from '99 to 2004 is down 35%; our average freight revenue per loaded mile is up 17%; our average miles per tractor are down 15%; and our nonrevenue miles, or deadhead is up 22%, and that equals to a revenue of truck per week of a negative, down 3%.

As a whole we are generating revenue in a much different way then we used to. It takes some digging however to understand where the changes lie. Our refrigerated operation has not changed much. Our dedicated division did not exist in 1999 and we are pretty comfortable with its profile because each dedicated contract is so individualized. The most dramatic changes have come in expedited team and regional. And we need to manage those in particular more closely and with different strategies.

This summer we embarked on the next phase of our plan. We are in the process of formally dividing our business into four operating divisions, with a P&L accountability and responsibility for each division resting with that division's general manager. The first division we established was refrigerated. As a side note, this does not included SRT. SRT is running about 470 trucks and generated the best margins in the Company with well over $3000 per truck per week. Our non-SRT refrigerated division has about 250 trucks that used to get mixed in with our drive van fleet and lack the focused attention that SRT has demonstrated.

So effective May 8, we assigned specific sales; we assigned specific customer service; lead (ph) managers, driver and certain other personnel to the refrigerated division all under the authority of the general manager. My general manager will have sales and operations responsibility as well as driver recruiting and retention. And most other functions were direct accountability to make a difference. In addition by the end of the year, we expect to have separate financial statements for each division that will allow us to track operating results, line item performance and return on invested capital.

The general manager's incentives will be tied heavily to the performance of his or her division. Our goal is for each division to receive the focus on customers, drivers and service levels of a smaller company while retaining the purchasing and back office economies of scale of a larger company. We expect to roll out much the same model with our expedited team and dedicated divisions later in 2005. We believe these three divisions which together encompass approximately 1600 tractors, or about half our feet, present the most immediate opportunities for divisional operations and management.

We believe this because we have existing general manager candidates, these three divisions have relatively discrete operations, size and a relatively small magnitude of change that is needed. At the same time we are rolling out the other three divisions, we will be planning the process of dividing our 1600 truck over the road fleet into regional subdivisions. Right now this regional division has an average length of haul of just under 800 miles. The trucks are dispatched centrally and they travel throughout the country in a variety at lanes and length of haul. Over time we expect our regions to operate primarily in short to medium length of haul within their own geographic territory with a target average length of haul trending more toward 500 to 600 miles.

We believe the advantages of the regional model in terms of driver recruiting and retention, freight volumes moving in those lanes, ability to build operational density and assets productivity are well-known. We expect each region to consist of around 200 to 400 trucks once fully operational although some regions may be larger or smaller. Our plan is for each region to operate similarly to our other divisions with a separate general manager, separate accountability and responsibility and separate financial statements. We expect to roll out these regional divisions progressively over the next two years or so.

We plan to search internally and externally for qualified general managers who demonstrate the skills to operate a regional solo driver truck line. We anticipate examining our freight base, our driver domiciles, our current terminal facilities and our favorite lanes to identify locations for regional hubs. We do not intend to assign trucks to a regional operation until we have the management and operating plan in place for that region. Even then we may only assign the number of trucks that we can operate correctly in the region according to the desirable aspects we and the regional general manager identify.

The remaining trucks will remain in the over the road sector until ready for assignment. The continued evolution of our regional operation presents a number of opportunities and challenges. Some of these opportunities and challenges are, for instance like on the opportunities, defined and direct accountability at the general manager level; stronger and deeper management group; greater emphasis and ownership of driver management leading to better retention; better and faster information about our business together with fast acting smaller divisions; more responsiveness to customers; more attractive lanes for our drivers; more emphasis on at lanes with most of the freight that travels by truck. That's some of the challenges.

Developing depth at the general manager level; becoming accustomed to distributing decision-making, coordination of loads, rates, bids, customers and drivers among regions; headcount while regions develop and over the road remains; increase in the percentage of transaction intense freight that requires more frequent communication, customer appointment, equipment turns, driver home time and billing.

One final challenge for us and for the street is to have patience as we design implement these divisions. This is something we have been thinking about and planning and wanting to do for quite a while. And believe me, we want it to happen yesterday. But it is critical that we show the patience that allows us to select the right managers which show the patients that will allow us to have the right freight, and we make sure that we the drivers properly domiciled in the correct areas and that we implement the right procedures before we launch.

This plan is the natural next step in the evolution of our business. We've had four major service offerings for the past few years now and it's time to place more definition, more measurement and more accountability around each area. We have had detailed discussions about this step among our entire management team and the team feels strongly that this is the correct next step. I want to emphasize though, this is an incremental process and not a silver bullet to generate a 90 operating ratio by the end of this year.

What do we expect Covenant's profile to look like in the future? We expect to continue to operate significant refrigerated expedited team and dedicated visions that provide diversified growth, driver retention, customer service and marketing opportunities in the niches and that we believe will remain very attractive over time. We also expect several semi ton (ph) short to medium length of haul region located in economic centers with favorable operating characteristics. We would expect four to eight regions in the next two to three years and more over time. We expect financially and operationally accountable divisions with a targeted 90 operating ratio or better.

We will implement this next step over as much time as we need to do it right. Based on progress to date we are expected that our expedited team and refrigerated divisions to be operationally and financially separate by the end of this year. Dedicated may be on the same schedule or it may be in the first half of 2006. Our regional divisions will roll out gradually over two years or more.

We are pleased to share a glimpse of the next phase of Covenant's evolution with you. Because of the uncertainty in our earnings model during this phase at least for now, we are sticking with our policy of not affording earnings per share guidance. We will be disappointed, however, if our utilization and rates fail to improve sequentially in the second half of 2005.

Those are my statements. And Laurie, we will open it up now for any questions.

(OPERATOR INSTRUCTIONS) Edward Wolfe, Bear Stearns.

Hi Joey and David; it's actually Rob Farley (ph). Ed had to step away. How are you doing?

Fine, how are you doing?

All right. With the new operating structure you're talking about are you going to be breaking that out financially in your statements so that we can see each of those or is that something further down the line?

I think, Rob, what will happen is we, if you examine the accounting requirements as we get to the point of having financial statements for each division, especially around the four divisions, I can foresee us breaking all that information out separately. At the division level, probably not all the way down to the regional level but certainly at the divisional level.

That division level is something that we could see by the end of this year then, right?

Well, as we get all the way through it, I don't know how soon that we will be required to do it for the entire Company but certainly once we get the four divisions broke out -- it just depends on the timing of all those. The answer to your question is, yes, but how quickly -- it just depends on how quickly we can get through splitting all four of them out.

Okay. Can you talk a little bit about demand each month through the quarter? And so far through July?

You know, Rob, April, the first couple of weeks of April really picked up pretty nicely. If you remember March was not a very good end of the quarter month and then the first couple weeks of April picked up and then the last couple weeks of April were pretty slow. April and May -- yes of April. Being May, the first week or so of May started off pretty good and then it died for the remainder of the month. So the last three weeks of May were pretty slaggered.

June, the last two weeks of June started picking up and actively -- actually felt like it was the end of the quarter kind of month for the last two weeks of June. And so far excluding July 4th, the first couple weeks of July have felt pretty good. So we are pretty optimistic about, we definitely think the economy has slowed down a little bit, aside from this Company specific stuff -- I think the economy has slowed down a little bit in the second quarter. But we are seeing an uptake in business and I don't know if it is just the seasonal -- the last half of the year versus the first half or the economy is really picking up. But we are seeing some pick up in demand.

That was kind of my next question. Was the July pick up -- is it seasonal or is it just kind of sequential from staying strong from June?

No, it really feels about like the last two weeks of June which is optimistic. I mean I am very optimistic about that because predominately the way it has gone so far this year is that the first couple of weeks of the month have been pretty down. And we, excluding July 4th, we have not sensed that. Business has been pretty -- we've got some pockets that are a little soft but nothing big and measurable.

Okay. Going back to your first-quarter Q (ph) report, one of the things you blamed was that the economy did feel a little bit slow. What is it now that you think is really at fault? Is it you are saying it is not really a slowdown but is there something you can put your finger on that drove the poor utilization?

Rob, as we said in the first quarter, there is no doubt that we had some company-specific issues and we believe that it came from the standpoint of going to our customers a lot last year and quite frankly upset some customers. We came out of the fourth quarter with a very good fourth quarter. We don't need to forget that we had about right at a 92 operating ratio in the fourth quarter, the best since 1999 only followed by the first quarter of not a good quarter at all.

Mickey Miller and myself have lived on the road for the last couple of months meeting and greeting with all of our customers. The customers are not spit fired mad at us. We've only lost one account period. But we had a lot of accounts that were giving us 10 loads that started giving us six; and we had a lot of accounts giving us eight that gave us four. There is no doubt that they decided -- hey, we can give some of this freight away because of how aggressive right or wrong -- because it was last year on rates and detention, emergency fuel surcharge. You know you take like California last year; the West Coast is about one-third of our business. And with fuel this time last year got up to about $0.50 difference in the price of West Coast fuel as it pertained to the DOE nationally, we could not ignore that.

And so we had to go back to our customers and talk to them about the West Coast. Unfortunately we had some of our customers that they had carriers in their portfolio that did not run the West Coast for them so therefore those carriers were not having to come back to the table like we were having to come to the table. And our customers, quite frankly, really just got tired of that. It felt like we were being too aggressive. This is my assumption after again, meeting with a lot, the vast majority of our customers in the last 60 to 90 days. We have gained some of that freight back and again, excluding one account we are still doing business with these customers and they are still very friendly to Covenant and are giving us the opportunity.

We've not had to go in and change rates. We've not had to go in and change fuel surcharge programs. We've had to change some detention because we were very strict on detention and we had to change some of the detention rules and go along with where the market was at. So at the end of the day, that is really what affected us more than anything, Rob.

So kind of --

More than the economy.

The near term then in terms of improving utilization, is it just hit the road and get more freight in your trucks or are you still having any problems with --?

No, what you just said is exactly correct. In the last, besides our customers started to come back and your original question I'm starting to feel better where the process of bringing on a lot of freight. And we're bringing on that freight not with low cost, not with low rates, maybe not with the rate increases that I felt like that we could get this year but with rate increases. And we are bringing on that business. Just in the last couple of weeks we bought on a lot of freight and I think that we will continue. And once we get enough freight in the bucket then we're going to see the utilization and rate per mile doing what we want it to do -- or the revenue per truck per week anyway.

And just one quick kind of technical one. CapEx expectations, you said this year is front-end loaded. Any change to the full year and do you have an expectation for '06 yet?

Not for '06. The plan for the year hasn't changed at all.

OK. Thanks guys for the time.

John Barnes, BB&T Capital Markets.

Good afternoon, guys. David, you made the comment that you were aggressive on raising rates. And I applaud you for laying out this level of detail in terms of what you are going to do to your business going forward. But between now and when that transition is complete, you still are going to be faced with how do I capture customers? How do I fill up my trucks? How do I get better asset utilization? What is to prevent Covenant from overcooking it on the other side?

I just view price as a slippery slope. First you give away some detention, then you give away a little bit of something else. Are you concerned that you overcook it on the downside and then all of a sudden we're having a conversation six months from now where pricing -- you are seeing downward pressure on your pricing on your pricing again?

John, I don't think that that will happen personally. I mean to be honest with you as you know there is not a whole lot of room there that you can go down on pricing. So we know the traffic lanes that we've got and we know the profitability of those traffic lanes. And if rates were to go down, the only reason why rates would go down is because if it was in a particular traffic lane that allowed us to overcome our cost in that traffic lane, much greater than what that truck is doing today. But discipline for us will be in instead of 10% kind of numbers, the numbers may be 5 or 6% kind of numbers.

Even though what you just said there is a very good question and a possibility, I don't see that happening.

So you are prepared to maintain the discipline you've got today and you are willing that if customers stay a little upset with you that you are willing to forgo some of that freight in order to maintain your pricing power as you see it today?

That's correct. I mean we've got to continue to make money. You can't go the opposite way. You've got to continue to make money and quite frankly, as we speak, July 21 and as Mickey Miller and myself literally for the last three months have probably seen 85% of our revenue, I'm not experiencing that -- I'm not feeling that from one customer in our network that says "I'm taking advantage of this -- you had better lower your --" That is not part of the equation because the fundamentals of the industry have not changed. There is still not a lot of capacity that is coming into this market. The big guys still aren't growing. And the customers realize even though we or the industry may be going through a tad of an economic slowdown, they know that the fundamentals are still very strong and they know how it felt last year when they couldn't get trucks.

Okay.

Literally, John, not coming in demanding me to do that. It was more on the detention side that was a demand and quite frankly they were much more right than what I was. I still think the detention is a correct issue and I still think that the math works out correctly in what we did. But I can't be the only one in the marketplace doing it.

No doubt, no doubt. In terms of asset utilization, if for some reason your discipline on price was to continue to negatively impact you on utilization and pressure your profitability, are you prepared in the meantime while you go through this transition to shrink your Company? I mean are you prepared to say okay, you know, maybe I don't have all that many unmanned tracks trucks but maybe I'm not getting the load factor I want and therefore, I'm willing to pull 100 trucks out of my fleet or something like that? Would you consider that in order to protect your profitability?

Yes, without a doubt. We are prepared to do whatever we've got to do.

Okay. All right. Thanks for your time, guys.

Chaz Jones, Morgan Keegan.

Hi, guys.

Hey, Chaz.

First thing I wanted to ask was you know you outlined some pretty major changes operationally. Just maybe curious if you could comment, David -- I mean how confident you are that you currently have the right kind of people and systems in place? And if you would maybe kind of at the lower-level to handle these kind of major shifts in your model that you talked about? Or is this going to take some time to go out and maybe find some new people to bring on as well?

Chaz, it is really both those statements that you just made. We are being very, very up front with all of our employees a couple of months ago meeting with all the nondrivers which is -- what about 850 of them or so. And then just in the last two days meeting with every operations and marketing person in our Company. And we've been very, very open as well as very optimistic from a standpoint that we do -- management does believes that what you heard today is the correct thing to do. We do believe that the answers are there.

I believe it as the largest shareholder out there, strong enough that our management team that this is the correct thing to do. So we've all sold off -- we're all sold off on that. And everybody within the Company does seem to be on the game plan that it's the right thing to do. They also realize that if we do not have the talent internally, then we have no problem whatsoever going externally in order to get the correct people on this bus. And that's what it's going to boil down to.

As a matter of fact, that's a phrase that I've been using to all our employees is that we're not just going to have folks on the bus; we're going to have the right people on the bus. And hopefully some of those will be internally and quite frankly if they're not, then we are going to out and get the people that can do the job.

Okay. And maybe switching gears to the regional side. Just looking at those slides real quickly that you posted, it would appear that the -- excuse me -- on the refrigerated side that you've seen a nice uptick in business. Now I believe it's up 21%. That seems like it's up quite a bit from where it has been, maybe 12 to 24 months ago. Is there anything in particular that's driving that growth in the refrigerated side?

Yes, that's reaper (ph) side, Chaz, has been just a very good -- a very good piece of business for us. SRT has been growing in the last couple of years, pretty decently. And then internally here just what we've done in the last couple three months is really starting to at least show us that we're heading in the right direction with it. So we are happy with where the refrigerated segment is and we think there's some great opportunity, more opportunities there.

Is that your most profitable division at this point, David?

Yes, without a doubt.

And last thing here, just looking at the rate increase. Anyway you could maybe quantify the breakout in terms of how much of the 9% was kind of pure price versus some of the mix shift changes that you guys have certainly been going through?

There is probably a couple of ways of looking at that. I think that the rate increase that you saw there is a pretty solid number really across the board. And the reason why I say that no doubt the length of haul decreased. And that helps to increase your rate, as you know, as the length of haul decreased and whoever knows that formula -- no one knows. I mean for every 100 miles, does it go down -- up $0.02? You know really who knows exactly what that number is because of the shift of business and where that 9,850 mile length of haul is coming from. Is it the East Coast, Southeast, those kinds of regions?

But the reason why I say that the rates are pretty solid across the board is because the dedicated side has also been growing very nicely and as you know, the dedicated side you are swapping rates for consistency. And so the rate per miles on dedicated are always going to be somewhat lower than what they are in the ad hoc. So if you assume that the length of haul gave you a plus, you've got to also assume -- which it did -- that the increase in dedicated was a negative to the overall rates. So the rate increases really were pretty solid across all of our business mix.

I appreciate the openness today on the plans moving forward, guys. And best of luck to you. Thanks for the time.

Thanks, Chaz.

Will Nasgovitz, Heartland Funds.

Good afternoon.

Hey Will.

I just echo everyone's sentiment and thanks for the insight on the transformation, very helpful. I see on your website you do break out your revenue by segment. And just going back, I appreciate the insight about where Covenant was in the '90s and starting out in 2000. Can you give us an idea of what your revenue by segment was say in the second half of 2000 or just in 2000 in general relative to today's? Is it more concentrated today or was it more concentrated then? For instance (ph), transportation, retail, paper packaging, where was it in 2000 relative to today?

Will, I don't have that readily available but I can tell you off the top of my head --

Yes, that would be great.

Transportation was 35% kind of numbers; retail was around 10% kind of numbers; floor covering was higher -- well might be about a mix now because we've really grown that area -- it was a 10 or 12% back in the '90s, Joey is telling me here. Transportation, retail, electronics was higher -- it was about 7%. Paper and packaging was lower.

Okay. That is helpful.

So a lot of the shift -- definitely retail has gained a lot is really what that says as well as the refrigerated freight.

It's a little more diversified?

More diversified.

Okay. And is your share buyback -- is it terminated or is it done now or you guys fulfilled your authorization or where do we stand there?

No, we've got about -- in May the Board approved 1.3 million shares till May of '06, and since then we've bought about 300,000 shares. So we've got about a million shares left in that program.

Okay, well thanks very much guys. Good luck going forward.

Okay, Will.

Tom Albrecht, Stephens.

I guess, I do appreciate the details as well. But I'm really wondering if this doesn't sound more like a three to five-year project? I'm not trying to be too pessimistic here but I just see a situation where your costs are going to go up in the near term, near term could be more than a year as you get in place the people and systems and the accountability and all that. And then you start to realize some momentum on the revenue and lane side. But I just see that it could be three years or so before you are really humming.

I'm just wondering if that is too pessimistic of a view? What sort of time table have you discussed in your own management meetings as you've begun to get ready to launch this?

Well, you know, I don't disagree with your numbers especially the number three, Tom. In my mind, five has not been there but three has been a number in my mind. I think that as we launch these -- the refrigerated is already done, expedited and dedicated will get done. And those are pretty quickly. So those will definitely in my opinion in the next twelve months will be done and finished. And then as we move into the regional side, those are the ones that could be a couple of years.

So, again, whether it is -- five years is probably pessimistic but I had the number three year has been in my mind.

And I just look at each division and you are right there are some that are performing better and probably closer to the ultimate game plan. But like on the refrigerated side, why are there 250 refrigerated trucks not being managed by SRT right now?

And we ask that, that's a good point, we asked the same question. And we'll continue to ask that same question.

Are those dedicated trucks that --?

A few are. A few are but the answer is predominately no.

So that could be a change just potentially, but --?

It has been on the table.

Okay. Dedicated, I think you've got some momentum there. Team. But I guess for me the real gray area is this regional movement, 1600 trucks. Your average length of haul is about 800 miles; trying to get down to 550. I'm getting goose bumps on me thinking about that transition there. Is that an area where you may actually need to acquire expertise? I don't mean one or two managers but actually go out and acquire a Company that is performing well in that sweet spot?

And then conversely would you think about divesting one of the other businesses in order to make sure that your balance sheet stays healthy if you have to go out and acquire?

Tom, excluding the second comment that you made to be honest with you, everything you are bringing up, you sound like you've been in our meetings with us. Every one of those have exactly been the same discussions that we've had now for six or eight months of very intense thoughts and talkings that we've had. And we're prepared to do every one that you just said. We believe, management team believes and I believe that the processes that we're doing right now are the correct processes that will get us to where we want to go. And I think that they are. If they are not, then we will move down the path that we need to move down.

I think, Tom, too to add to that is that the process in which we'd laid these out, as you know in total we haven't grown the fleet in three or four years. We still don't plan on growing the fleet. The question has come up which is a question that we ask a lot, should we begin shrinking the fleet? But in the meantime if you look inside the four divisions, the division that we feel have done well have been getting those assets. So to the extent that you set up -- we set up refrigerated and expedited and dedicated and two of those are doing well today. And I imagine we will continue to get assets to grow assuming expedited team were able to sort out a few things from the drivers' standpoint and began growing that again. That is our backbone.

If that does. I'm sure we will get assets as well. But in total, we are still not growing. So in essence, that regional side could continue to decline as you are seeing it here in the second quarter; it's down 11%. So I think that the overall strategy of not growing still applies until the overall Company is where we want it. But inside the mix there is much more focus on those pieces that are doing well and they'll continue to get the assets and the ones that won't will shrink. So in essence we're kind of doing the question that John or somebody asked earlier about potentially shrinking fleets is bringing a lot more focus on the assets that are performing well and those that aren't.

I don't pretend to know how to run a trucking company. But when I look at that 1600 trucks again that are potentially targeted for the regional market, I guess it is in that classic tweener level right now. But it's not like you're going to go from 800 to 750 to 700 to 6 -- I mean -- you are either going to start putting trucks in the regional market, 500, 550, or you are not. That just raises a host of operational and executional questions, a 500 mile truck next to a 800 or 900 mile truck. It's not like all 1600 are going to shrink by 50 miles this year, 100 next year.

That is exactly correct. If you look at the last, what three years, Tom, our length of haul is what 1500 to 900?

Correct.

So you've got to believe that from 900 to 600 or 550, it's a three-year process. I mean there is no reason not to think that because even though we thought about this three years ago, Lord help us if we had gone from 15 to 500 in one year.

Yes.

Kind of what you were saying there. I mean you could not do that. So even though we were headed down that road internally of doing what we announced today that we are doing, I guess one way to look at it is that we are possibly halfway there.

And I guess the question I have is let's say you got 1600 trucks there, are you going to go out and try to not dedicate in a truck term but -- say all right we want to get 200 trucks in the next quarter truly operating in the regional market. I mean you really can't be halfway in the regional and halfway in the medium haul market. And then the following quarter we want another 100 over there. I mean --?

That is a correct statement.

Do you see what I am saying? Do you have a plan that explicitly and quickly get trucks into that regional market or if we sort of bleed into it, you're going to bleed results while you are doing that.

Yes. What you are going to be doing, Tom, as you set up a regional market you may start off, as we have already done, we will examine our freight that we currently have got that is part of that 800 miles. We will examine the freight that we've already got and let's say that we assume that a Midwest region of the country can handle 100 trucks as me and you are speaking today.

Okay.

We will take those 100 trucks and start operating them in that regional marketplace because the freight allows us to. Now let's assume that the Midwest region can be 200 to 400 trucks -- let's use the number 300. That we think that it can be 300. Well we know it can be 100 because our freight is already there today with a 800 mile length of haul. So we start off with 100 trucks and as we grow that regional freight, the trucks today will continue doing what they are doing right now, right this moment. But as we grow the regional freight, it will replace some of that 800 other mile length of haul freight. So all of a sudden 100 goes to 150 and 150 goes to 200 and it ends up wherever we determine the marketplace will allow us to be at.

Okay.

So of the freight that we've got today in our network, some of those 1600 trucks are operating very nicely today. I mean there may be 400 of them but there is a portion of those trucks that are operating without us "having come out and formally to find that hey they are operating in the Midwest region."

Right.

So it is not like all 1600 trucks are just absolutely doing zero today. They are operating and some of them are operating in the formulas and that is what the base will be for the Southeast region, for the Midwest region for the East Coast region. They won't -- we will just walk in tomorrow and say hey let's throw 100 trucks that there, we will take the freight -- which we've already studied this -- we will take the freight and then determine what amounts of trucks can run in the already existing freight that is in that region.

Okay.

Does that help you any?

Yes. No, I hear what you were saying and I'm just going to have to keep talking and hearing the progress as we go forward.

I agree.

Thank you.

(OPERATOR INSTRUCTIONS) Sean Nicholson (ph), Kennedy Capital.

Hi, most of my questions have actually been answered. I was wondering if we could switch gears? Did you kind of break out what the cost of raise in driver pay going forward? Have you already done that? And is it already included in this quarter?

Right now we are not showing we did a driver pay increase in March. It was around $0.03 a mile. Right now we are not planning on any more increases for this year. But we haven't made that decision firmly yet.

Are you guys experiencing any of the driver shortages that are going on?

It is just exactly the way the industry is. There is nobody immune to it.

Right, that's all I had.

Edward Wolfe, Bear Stearns.

Guys I just had a follow-up again on the yield growth. If that was kind of firm like you said, and not as much affected by the mix shift, how were you able to get it so much higher than the rest of the group?

Rob, some of it is just the follow up from last year. If you go look at where our rates were last year, they grew so rapidly throughout the year sequentially that what we said -- I said it in October, I said it again in January and I said it again in April, that our rate increases will narrow greatly throughout 2005 just because of how rapidly the base grew last year, especially if you look at the second half. So we're coming off a very high base coming out of 2004 that is really making the comparisons to year ago look still very large. But as we go into the second half, those increases will narrow pretty dramatically.

Okay. So if I kind of take what you said at the end of your prepared statements, if you keep your yield kind of flat sequentially, we're looking at 7% and then kind of almost flat in the fourth quarter? Is that kind of what you were looking at when you said that?

What we said was based on business that David talked about that we've worked hard to bring in, combined with the seasonal growth to freight in the second half, we said we would be disappointed if our rates did not improve sequentially throughout this year even though -- even with that, the percentage increases versus the previous year's quarter will still narrow.

Okay, okay, that is what I have in the statement. All right, guys, thanks again.

John Barnes, BB&T Capital Markets.

Just one quick follow-up. You talked about hitting a 92 OR in the fourth quarter which was potentially the best freight environment the trucking industry has even seen and one of the strongest pricing environments we've ever seen. What else, what other levers are there, David? What else can -- if that is the strongest pricing and the strongest freight and you kind of topped out at 92, what is there about shifting to this new infrastructure that is going to give you the next lever to ratchet it down to 90? Is there another layer of cost that is coming out?

And the reason I asked the question is with all the general managers you are talking about it sounds like we're adding a level of management in this organization. And I just worry that there is not enough cost save elsewhere to offset that.

Yes, there is no doubt one of the challenges that we've talked about is besides having the right people, does the regional side and what we're doing, does it make you add headcount? That is a possibility. We don't think it does but it is a possibility. The same assumption you got is the same assumption we got -- that it is a possibility.

At the end of the day what this thing boils down to is that feel go pretty confident excluding the driver pay -- we feel very confident that we know where our costs are. Our costs are not rising dramatically. As a matter of fact, we think we've got some areas that you're going to see some decreases in costs in the coming months. So we feel very good and comfortable about the expense side of the equation. This truly just comes down to how much revenue are we going to put on these trucks in a given week? Whether it's on the regional or expedited or dedicated. And as that number grows pretty dramatically to what we think it can be most of that, John, is what is going to drop to the bottom.

Okay. Can you elaborate a little bit as to what kind of costs we're going to see come out? I'm not asking magnitude, David. What kind of line items are we talking about? If that cost is available for you to pull out now, what has prevented you from doing it up to this point?

You know, what I said that we see some opportunities there besides knowing what, as you know, the truck situation the last couple of years everybody has gone up. Higher because of the cost of trucks. We're already there. People are going to be catching us from a truck standpoint so a lot at our trucks excluding the '07 situation coming up in the next couple of years, excluding that, we know really where our cost is on our trucks. You've got a lot of carriers that are not there. They are at 50% with a new engine so therefore, they're going to have a higher operating cost on the trucks than what we've got today.

Excluding the driver's, if you look at everything else in the network, we think there is great opportunities that we've got on the safety side and on the insurance side that we continue to going down the same path we've been on now for about a solid year. There are some great opportunities in cost savings on the insurance. So insurance is probably the greatest area, John that we see as opportunities out there for cost savings because of big-ticket items -- because the best you can really hope for when it comes to trucks and trailers and things like that is not a deduction. You're hoping to keep things even.

Okay. That is good, thanks for your time, guys.

At this time there are no further questions. Are there any closing remarks?

We just thank everybody for joining us. And we will be glad to keep you abreast as we go forward. Thank you.

Thank you. This concludes today's Covenant Transport second-quarter earnings release conference call. You may now disconnect.