Covenant Logistics Group Inc (CVLG) 2006 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Covenant Transport second quarter earnings release conference call. [OPERATOR INSTRUCTIONS]

I would now like to turn the call over to Mr. David Parker, President of Covenant Transport. Sir, you may begin your conference.

Thanks. This is Joey Hogan, the Chief Financial Officer at the Company. I'd like to welcome everybody to our second quarter conference call. David Parker, our CEO and Chairman is in attendance with me for this call.

This conference call will contain 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. 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. We ask you please review our disclosures in the filings with the SEC.

Due to the degree of disclosure in our release and that additional detailed financial and operating statistics are posted on our website our prepared comments this quarter will be brief, then we'll open up the call for questions. I'd like to begin by commenting briefly on our expectations for the remainder of the year.

In terms of trucking fundamentals, we're expecting a sound shipping economy, which should support our quarterly goal of growing average freight revenue per truck over the year-ago period by at least 5%. Until the network realignment process stabilizes, we expect that utilization will grow at a faster pace than rates because of changes in mix. All things being equal, we anticipate reducing the fleet by about 150 trucks by the end of the year with the majority of the decrease coming out of our regional division.

From a cost standpoint, outside of general inflation, we don't expect any major increases in our cost per mile throughout the second half of 2006. Excluding the tax adjustment in the second quarter, our after tax cost per mile has been between $1.35 and $1.36 for the last four quarters. Two areas we'll have to watch are fuel prices, if the cost of oil rises consistently over $80 a barrel, and driver wages.

Although we expect the driver market to remain tight, we believe that a combination of improving turnover percentage and a further reduction in our fleet by the end of the year will allow us to avoid a major driver pay increase in order to keep sufficient trucks seated.

We're in the process of trading 2110 trailers and 1960 tractors, 885 of the tractors in the first half of the year, with another 1075 tractors in the second half. The cost of trade prep were heavier in the first half and ran through depreciation as a reduction of sales proceeds. Our cost of maintenance and tires should be reduced in the second half as the fleet gets even younger and we avoid a tire replacement cycle on a portion of the fleet.

As the deadline for new trucks to use new engines draws near we expect the strong used truck market to continue throughout the second half and support meaningful gains as we replace our fleet. Because of our ongoing business realignment, the number of moving parts makes it difficult to predict the pace and magnitude of financial improvements. However, based on the expectation and assumptions I have outlined, and excluding the $0.05 per share tax adjustment in the second quarter, we continue to believe that our goal of earnings for the full year of 2006 to be greater than earnings for the full year of 2005 is attainable.

There are a number of scenarios under which the improvements could be quite meaningful, but we're not prepared to put out any numbers or time lines today. Personally, I can tell you that management's bonuses are tied to numbers significantly higher than last year's earnings, and our team has not given up on striving for those bonuses.

In the end, however, we are building for the long term and are less concerned about a particular quarter's earnings than establishing a foundation for long-term success. Those are our prepared comments, and now, we'll open up for any questions that the group may have.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Justin Yagerman, Wachovia Securities.

Good afternoon, gentlemen.

Hey, Just.

I wanted to get a sense of revenue promoted mile outlook. When looking at what it did in the quarter, it's been decelerating since Q3 and went negative this quarter. I know that there's mix stuff in play there, but how have things changed in the second half now that maybe mix helps you out a little bit more or you're seeing a strengthening? Obviously some seasonality may help you there, but what else is going on that should take that up going forward?

Justin, these rates, the way I'd look at that because there are so many moving parts in this thing, that you brought up some in your question there, exactly what you brought up is exactly what it is. First of all, the rates are at bottom. The rates are there, and I don't see us adding more broker freight. I see us adding less broker freight. I see a lot of this is the mix side. We've grown the expedited side about 10%. Average length of haul being about 1600 miles in that division on the team side, and that thing has been growing. Well, as you know, the longer the length of haul is the lower the rate per mile is.

We will continue to grow that segment of the business that's doing very well. We will continue to grow as much as we can possibly grow that side of the business, and to sit here today to say, well, what are those rates going to be I'm not sure, because I'm not sure from a driver's standpoint, how many teens are we going to able to get, are we going to be able to get up 10%? Will we be able to go up another 10%? I'm not sure. But that's one of the areas that brings the rates down.

And then, as we're doing this rationalization of freight and we are less dependent on freight today going to the East Coast, Virginia to New Jersey, it may pay you $2.40 or $2.50 a mile. We've replaced a lot of that freight that was going up into that part of the country with freight, say coming from Virginia back down into Georgia that's paying you $1.35 or $1.40 a mile. That's one of the reasons why you've increased utilization 4%, because of all these factors being involved in the process.

So the best way for me to say right now is that rates will -- and then the third -- the last last part of that Justin, is that we are increasing rates. Our normal customer base, the people that we've got business relationships and contracts with, those rates are going up about 5%.

Now, again, we're going to those same accounts that were going up 5% and some of that 5% stays with you because it's the lanes that you wanted, but some of that 5%, it leaves you because you change the destination of where that freight is going to, which changes the rate per mile up or down. It could be up, or it could be down.

So it's very hard to sit here and say what is the rate going to do. I just feel very, very confident that the rates are headed north because it's not like we're out here going to existing pieces of business and cutting rates, and those kind of things. It's just because of the rationalization. Now, did you understand what I just said?

Yes, absolutely, David. That was very clear. In looking at one of the things you brought up was the percent of broker freight that's going into that mix, and obviously negatively affecting it. As you guys are using it to balance lanes and what have you. How is that trending and how do you see that going in the second half? I know you said down, but how much can you cut out, do you think, judging by the business stream that you have in the pipeline?

Brokers are about 9%. As we speak right now, to give you an idea, we feel like that that is probably $0.02 a mile on the broker side of the equation, and the brokers alone -- I would be in the second half of this year starting right now to the second half of this year, I would expect that our broker freight will be close to going back to the way it was at about 4, 4.5%.

Okay. So hopefully some positive momentum there.

The brokers, today it's -- in the second quarter, the broker side was as worse or ugly as it could get. There's no doubt in my mind.

When you look at the way that you've organized your fleet, and you guys have done a good job of getting trucks out, it's a regional fleet which obviously is where you've been having more of your difficulty -- how willing are you, when is the point where you say I'm going to either get rid of some of these trucks or how many more of these trucks can your other divisions absorb? Obviously, you've said 150 you're going to take off the table in the back half of this year -- what isn't in that number? How many are going to go to the other divisions within the Company over that time?

Well, at the end of the day, all of it becomes a driver issue. The 150 that you kind of take out of the network there, quite frankly kind of gets rid of basically the open truck side of the occasion. So let's say that you assume that once you get rid of 150 that you virtually have 0 open trucks, and then what you will end up doing after that, because we're now in our fourth month of the P&L statement. The P&L statements will be what the dictation is of how divisions can grow, and there's no doubt that if you've got dedicated operating at a low to mid-90s kind of number, if all of a sudden they go out and get a 20-truck fleet on dedicated side, I'd rather throw it in there at a 93 than I would at 103.

So we'll take them out of the worst performing market that we got, depending upon the driver. There is more to that equation than just saying, okay, yak them out of there, because at the end of the day your goal is not to open up another 100 trucks because the drivers were absolutely committed to running the southeast region or the midwest region or the OTR side of the equation. So there's a balance there, but, yes, to answer your question, the first thing you will do -- and we're committed. We're going to do whatever we've got to do to get Covenant back to the way we want it. It is called a turnaround for a reason, it is a turnaround, but we're committed to doing whatever we've got to do to make that turnaround successful.

One of the places where you've really shown improvement has been on utilization. How much better can that get? We've seen it just going back the last five years or so, you guys have been in the mid to high 30,000 miles per truck in a quarter. Where does that go? If in the near term and then the longer term what is your goal there internally?

There is no doubt that utilization will continue to increase, but the thing that we really are looking at that's driving the Company today, Justin, is revenue per truck, per week. Because -- you say the Midwest region 2,000 miles a week is a very strong number. It's a very good number for them. And if we can get them to producing right now $3200 a week, but our ultimate goal is $3500 a week, then we're very excited and we'll be making extremely good money in that region.

So even though utilization definitely on the long haul is very important, and it will continue to climb, you're going to see the long haul side of it continue to go. I think next year there's probably, another -- when I say next year, over what we think it's going to do this year. I think there's another 3% kind of number that the expedited side can do, but when you put all this into the mix, the short haul may be kind of even where it's doing and the only thing we're doing is continue to work on the revenue.

I mean, Justin, if you take our teams across all of the divisions, because there's teams in three divisions, dedicated had some teams running, refrigerated does, and expedited does obviously. As well as if you take a look at teams and solos across all the division and say, okay, where is, not pie-in-the-sky, but where is good operating performance, 90 OR or better type performance, where would that put our overall consolidated average? And it's somewhere in the 33,000 to 35,000 miles a truck a quarter type number. So there is some pretty nice opportunities still left in utilization, and so I think that there's still some good opportunity. Our solos aren't where we need them, obviously, but there is obviously less opportunity on teams, but there still is -- there still is some more opportunity on teams based on where we've operated them in the past.

Okay. Joey, I guess a couple of questions for you. Looking at tax rate in the quarter, what was driving that to be so high? It seemed like a very similar quarter to last quarter. Second quarter of last year, rather, and the tax rate was considerably higher when adjusting there. How should we be thinking about that tax rate going forward? Is there anything that's changed?

No, I mean, basically besides the tax adjustment, which the $650,000 was in there, we do have an insurance subsidiary that's a captive that is not taxable for federal income tax purposes. To the extent it has a loss and we had some unfavorable development in the quarter, regarding the layers of insurance that it is responsible for, to the extent that subsidiary has a loss you don't get the tax benefit from that loss in that particular quarter.

So this is the father quarter it has ever happened related to that subsidiary since we've had it, and so that did drive our effective rate up somewhat in the quarter versus previous quarters. So there's nothing unusual in there going forward. Part of what drove it up beyond the 650 is that subsidiary did have a loss in the quarter which I didn't get to deduct the benefit for tax purposes.

That makes sense. Then net CapEx this year or next, what are your thoughts on that?

We've tweaked our truck forecast. We made the decision coming out of first quarter, middle of the second quarter to reduce about another trucks. It's going to be somewhere in the 70 to $75 million range. That does not count the sale of the Corporate headquarters facility. So net CapEx for revenue equipment is in that 70 to $75 million range.

Last and then I'll turn it over, I know I asked a lot of questions -- insurance has been a bright spot for you guys, and looks like you've been able to take a lot out of that line. At this point, what's in that in terms of claims experience and where are you with that? How much more can you take out of what your accruals are? I know that you've kind of lowered them as you've had better experience on a per mile basis. So where is that headed? And have we kind of hit terminal velocity on that, or do you still have a little ways to go?

Terminal velocity, that's a good word. Let me think about that for a second. The way that -- to answer the question, the first half we disclosed in the release -- the big number we've been waiting for is when does our overall incident rate begin to materially start dropping. Severity is one question. With $2 million deductibles and the size of deductibles in this industry you can have a really good quarter incident wise, but one bad accident can impact your quarters severity. Our severity was good, we've had really -- we're into our third year of a very, very good severity performance relative to '02 and '03, which were just not good for us. We were like bumpers car out there.

We have seen our incident rate, beginning about the middle of last year and accelerating in the first half of this year really start to turn down very nicely. Our incident rate -- and this is on DOT-reportable accidents. So it's not any funny numbers. Our DOT reportable accidents per million miles were down 12% in the first half. And it's pretty consistent between the first and second quarter.

I think one quarter was 12, the other quarter was 11, the overall was 12 for the first half. And that's exciting. And that's what I've said for about two years now, if we just continue what we started in 2004, there is some money on the table relative to our insurance and claims line, and we didn't have to invest any more fixed cost in doing that. If we just continued doing what we started, there was a pretty meaningful opportunity in the insurance and claims area.

Now, back to your question. What does that number look like long term. We officially have not changed our long-term rate. We've said would be between $0.085 a mile and $0.095 a mile. Well, Joey, you did $0.08 this quarter. We had an exceptional quarter from a standpoint of both accident incidents as well as severity. I still feel like, that -- I won't say we've 100% turned the quarter yet, but I might modify that range to kind of $0.08 to $0.09 based on what we're seeing right now.

We're starting to see what we expected a little earlier than I would have expected. I was thinking late -- second half of '06, but we've just had an outstanding year as well as an outstanding second half of last year. So we're starting to see that right now. So it's starting to come down. Will I say is it's going to be $0.08 for the rest of the year? No. I won't say that yet.

Okay. Thanks, Joe. I appreciate it. Turn it over to someone else.

Your next question comes from the line of Edward Wolfe with Bear Stearns.

Hi, Joey, Dave. It's actually Rob Farley sitting in for Dave, how are you doing? I may have missed it in one of the releases, but did you give cash from operations either for the quarter or the six months?

No, I didn't -- I don't have that handy, Rob, if you'll check with me later. I can get that for you.

Okay. Looking at the pricing before your four different divisions, you laid it out in the press release as regional pricing was down, expedited was flat, refurb was up 2.5 or so, and dedicated looked pretty strong. Can I kind of take from that competitiveness, or can you talk to me about how competitive each of those divisions are right now?

The team -- the expedited side as well as the team cycles, as Joey pointed out a little while ago, three of our divisions have teams in them, and those three segments team is pretty good. I mean, it's -- that's one of the areas that you can take some nice increases in for your teams. And the other side of that, though, Rob is that as we continue to increase our length of haul on those divisions, again, keep in mind that you're reducing the rate per mile because the length of haul was going up just in the competitive marketplace. So the rate per mile goes down, but that business, as you get it, and as contract renewals come up in the future, there are some very good, big, nice opportunities for increases on the team side.

On the refrigerated side, it's done pretty well. I mean, it's, again expanding it's length of haul and it continues to increase. You saw about a 3% rate increase on that side of the business. And that's kind of where -- that's including increasing the lend. So we're very happy with that, because that's is telling you virtually that you're kind of going in with your existing customer base and getting 6 and 7% kind of increases in pricing and at the same time increasing the length of haul at a lower rate. Do you know what I just said?

Yes, I think so.

This rationalization of this freight can be difficult to understand. And then thirdly, the dedicated side, we got in the next six months, we got -- there's quite a few contracts that come up, and there are some very nice opportunities that we see on the dedicated side of increasing pricing.

Okay. And on your dedicated.

Yes.

Is that sort of business -- do you need a back haul for that, or when you're talking dedicated, you've got the back haul all paid for by the customer, both ways?

Thus far, our 650 trucks that we're running in that division has guaranteed kind of miles. We're not having to load the trucks.

Back haul is in it?

Back haul is in it.

Okay. And the growth for that, that sounds like it's coming from customers or are you kind of selling that more than any of the other groups?

Yes. Basically what we're doing is selling the most profitable divisions that we've got and expedited is one of those.

Any unseated trucks? I know you've been trading a lot in.

Say that again, Rob.

Any unseated trucks? I know you've been trading some in, but any unseated for drivers yet?

Yes, we do. We've got about 5% of the fleet open, actually a little bit -- still probably right at that today because the fleet is starting to shrink some. But it's about 5% of the fleet is open and that's exactly where it was last year at this time.

Those are the ones that we're getting rid of, Rob.

Okay.

By reducing the fleet.

All right. Any comments on July at this point?

First week of July was good. Very happy with the first week of July. Stopped last week in the month of July. This week is up. That's kind of where it's at. I was very happy about the first week of July after the holidays. Much greater than what we expected it to be. Last week was less than what we expected it to be, and so far this week, we are up pretty nicely over last week.

Okay.

So if we get back into this week being like the first week of July, then I would say last week was just a little blip. But I was disappointed in last week's revenue.

Then one more question. You mentioned driver pay. You don't have plans right now for it to go up, but we have heard from a lot of other carriers that they have taken it up over the past few months, and a couple have said they plan on taking it up.

We've raised driver pay in the last year and a half.

Since '03.

Since '03. $0.13 a mile, and we're on a scale of 1 to 10, our team pay right now is a solid $0.09, and our single pay is a $0.07 or $0.08. So we're very excited about the pay.

That's fair. Thanks very much, guys.

Your next question comes from the line of Tom Albrecht, Stephens, Inc.

I've got several questions here. Joey or David, one of you mentioned that brokers represent about 9% of your revenues. Isn't that really a misleading number? Isn't OTR regional the vast majority of that and everything else is a small -- has small dependency upon brokers?

The Midwest region, it's got a smaller amount of trucks, but you take the Midwest region, about 35% of it total is broker freight. That equates back in to the overall of 9%. That's not revenue. That's loads I'm talking about on those percentages.

Okay.

So yes and no, the Midwest region as we start bad right now is running 35% on a lower amount of truck. A couple of hundred trucks or so in that division, but 35% of it is broker side which inflates the 9% that used to be 5%.

Okay. That was kind of my point. I felt like that was the one space that was overly dependent upon it. Why is your rate for length of haul longer than a lot of the reefer carriers, at least that I'm aware of, most seem to be 950 to maybe 1100 miles. You were almost 1200 this quarter. The first quarter you were over 1250. You seem to be a having a little bit longer length of haul in the reefer world. Even though that tends to be a longer haul segment

The SRT division, it's always been 1200, 1150, 1200 miles ever since we bought it. It's always operated in the long haul market, and as we've split the Covenant division last May and start off 330 trucks or so in that division with about 100 of them being team drivers, that team side of it is running 1800-mile kind of numbers. So gives you an idea what the 200 singles are running. They're running around 900 miles. Kind of what you're used to looking at. It equates to about a 1200 mile at the hole.

Okay. That's helpful. I guess one of the things I'm still a little puzzled by, I know, Joey, you've described that generally speaking expedited and refrigerated are your best divisions if we just look at an OR. Yet over the years, one of the biggest spots that you've struggled with is freight coming out of the West Coast. It can periodically just go dead. Expedited is growing, it's adding capacity, seems to have good numbers, but aren't you making the Company a little bit more vulnerable to some of those West Coast trends as you transition your business?

Tom, I don't think so. I think that the expedited side of the business has always been our top performer ever since we've had Covenant.

There's no doubt that Chinese New Year's hurts, on the expedited side, but really, the way in which that model, if you remember really works correctly, is that when we were nothing but a team carrier, even during days of operating at 90 OR our first corridor, because of expedited, would always be a little lower because of the inability for those teams to get out here and run like a manufacturing company 24 hours a day in January, February, and Chinese New Years and all that kind of stuff, but as you got to March, almost virtually month by month, maybe excluding April, but starting in March, that model just gets stronger and stronger and stronger, and all of a sudden you're working three shifts about eight months out of year that are producing wonderful, wonderful numbers and that's a reason, again, why, even when we were strictly just this long haul guy, carrier that your first quarter was always less. But when you looked at it for a year you were very happy with a 90 OR. So it is no more, I mean the West Coast is the West Coast, and there's going to be times that freight is good, January, February can be bad, March is good, April gets a little shady, goes up and down.

But then around May 15, produce starts, August 15, Christmas starts, and it runs you all the way until December the 15th, and it's been like that ever since I been in it.

Okay. Let me ask you a question too sort of. April was soft, May was okay, June was very good. As we transition this company -- and I don't want -- I'm not going to take this as guidance, but during the month of June how much would you have made in earnings? Can you give us a sense of that so we can either think about a run rate or think about the possibilities, then we can do our own discounting from there. But it's really hard to know, you enter June with a $0.15 loss and you made $0.18 or whatever. Kind of help us out there a little bit.

Yes, historically, if you think about the second quarter, April is my fourth least favorite month of the year behind February, January, and July, just because it can be a tough month. So coming out of the first quarter, which is usually -- I am going back on almost ten years of my perspective, but usually March is very strong. You take a step backwards in April, then May and June are very good months. One directionally that is not materially different than the other. They're both very important months inside of our model, and I think that's why May is so good, is because of the long haul nature of our refrigerated and our team products, is that once produce kicks in on the West Coast, you have a lot of small mom and pops go back to hauling produce, and you have further capacity drying up out west. So May is typically very good.

This particular year, April was, as David has already said, very soft. It was is a disappointment. And there was a pretty big hole there. We lost money in the month of April. May was basically a break-even type month, and June was -- we made nice money in the month of June. I don't -- is that an ongoing new trend because the change in the model? I don't know yet. That's part of our difficulty right rate now. One year doesn't make a trend to me. The historical perspective that I gave you is a trend, because that's what we saw for many years. So I don't know that I would say that this quarter is indicative of how second quarters are going to be for the future because I've just got one of those.

I think that if you kind of think about our revenue per truck per week, which is the key metric that we're watching, April was flattish, arguably could have been down just a little bit because of the softness in freight. May was okay. And June was up 8, 9%. It was a big, big, big, month. Freight in the month was good. We had a lot of our rate increases that we had planned for the year coming in in June, some of them later in the month than we wanted, some of them drug into July, but nonetheless June from a revenue per truck per week standpoint was also very strong.

So I think that the transit we saw in the quarter, especially from June gives us some pretty good encouragement as we move into third quarter, and David has already characterized July so far which is just always a hard month to get your hands around as well. I think in the quarter, Tom, it's a little early to say that what we saw is a new trend for the future.

Yes, and I wasn't totally trying to get that. I'm just trying to get a sense that when you start to hit on seven or eight cylinders what a potential earnings period could look like. I'm not trying to say that's going to be the third or fourth quarter, but it just seems like it's so volatile any more, at least want a taste of the good side of it.

I do think though, one of the things that we've been talking about for two or three quarters is this whole dynamic regarding the dedicated marketplace. For example, general freight is not up 39%. Our dedicated truck count is up 39% versus year ago. Well, freight in general is not up 39%. So -- and if you look across our competitors, a lot of us have growth in the dedicated market greater than freight is growing. Much greater than the general economy is growing.

So what is going on relative to capacity is some of the freight moving the spot market, if you will, is some of that moving around, is the first half of the year going to be a little bit softer than it has been historically, say throughout the 90s, and the second half is going to be even stronger than it was throughout historical periods, say the period of the 90s through early 2000.

I have to think that because they're going to move those dedicated trucks in January, February, and March, because they're already paying for them. And so I think that that's something that we feel is out there that is moving some of the freight around between the first and the second half of the year. And some of our customers, as we talked about last conference call, have even confirmed that. Some very large shippers have confirmed that that's what they are doing. Because they are already paying for those trucks. They'd rather pay a little bit more to have the capacity for the second half of the year.

That's a good observation. I wanted to ask a question about driver turnover. You guys had a favorable comment on how much it's improved, but you really weren't willing to put a number on that. I think the second quarter turnover, according to the ATA, was, I think, 111%. You said you were significantly better. I know, again, that's not a run rate, but where were you in the second quarter?

Tom, we were better than that number, nicely. We haven't given out that number, one of the few numbers we don't give out. But we were better than that number.

Okay. So even though it was good, you don't want to boast on it here?

Not yet.

Okay.

We still -- things are still being established there, Tom, and I really think that we may have a great opportunity, because we're not ashamed to give out those numbers, so we're not going to try to hide those numbers. We're thrilled to death with what we're seeing.

The system is really starting to work very nicely on the driver turnover, but we're kind of a couple months into some rigid systems that I think in the third quarter we very well could you give some numbers that -- because if I gave you a number right now I'm not sure if it wouldn't go up tomorrow.

That's like safety. You're only as good as a minute ago.

That's exactly correct. So I want to see these couple of months of what these divisions, which all these guys are in the room with us today, but what all these divisions have instituted, and I want a couple more months into it to see how it fairs out, but we are very pleased with what we're seeing thus far.

Okay. Just a couple other questions. At the end of the last quarter, about 200 of your -- I think at that time it was over 1,000 trucks in OTR regional, were committed to these new distinct regional markets. I forget, Columbus, Ohio, and I can't remember the other one, but how many of your 950 now are committed to those more pure regional operations?

You have got over 300 at the present time. So one-third of the, quote, OTR. We call it OTR regional, which then has the sub regions involved in it, and the sub regions are up to 300 trucks of the 900 trucks. The rest of the 600 are in regional. They don't run any further than Dallas, Texas. That's as far as they run. So they are still in a regional marketplace, not going transcontinental with singles. They're also in a regional, but they are not defined yet into those five-state areas, and it will stay at 300 say until the Midwest and the southeast is up and going exactly the way these guys want it to, then they can throw some more OTRs over there.

But I've got to also say that as we started with the Midwest, and you heard 35% and stuff like that getting it started. That's one of the reasons why you're seeing turnover drop, that's a positive side of it, is the turnover, and quite honestly, I think next year that we're going to be seeing some big savings in advertising dollars. And I mean some big savings, I believe, in advertising dollars because of what we're seeing on the turnover side because as they put people in some of these regions and guarantee them going to be home on a weekly basis, the turnover is dropping like a rock on some of those drivers, that maybe you're not -- you got 35% still running brokers in order to support that. So the two profit -- the two areas of good profitability opportunities are going to be redemption of advertising.

Keep in mind, we spend like $3 million a year in advertising. It's going to be a savings in that area, and then as you replace 35% broker freight that's not paying you fuel surcharges that were recovered about 80% of our fuel right now, and all of a sudden you're going to start recovering more fuel and getting higher rates, it's going to do nothing but be positive.

I said all that to say this. Is that also keep in mind, on this OTR, regional, the rest of those 600 trucks, Tom, that half of those trucks that were running we have increased utilization on half of that fleet by about 15%. I mean, those things are now starting to get into at least the numbers that you and I would not be embarrassed about. And if we increase them another 5, 6, 7%, half of that OTR regional 600 trucks, half of those trucks will be running as good as any other public company on miles for singles. So I don't want to -- we got this Midwest and southeast, and that's happening, and it's good, and we're seeing the benefit, but I'm seeing some impressive things also on the OTR regional business.

Okay. Last question. When I look at your customer information, you have 44 new accounts in the top 100. If you're an optimist that means you've got a whale of a sales and marketing department. But if you're a little more realistic about it, that means you probably disappointed a lot of people in the top 100.

If you had to sort of break down the new mix of your top 100, of that 44 that's new, how much of that is because you went out and won some new business versus those that are no longer in the top 100 got disappointed with the service you were providing and chose to move you out of the top 100?

Tom, I can only think of a couple accounts in the last year that we have lost because of service problems out there. Quite frankly, one of them we're back in business with. But there is not a whole lot of customers that we have lost because of service. So most of it is going to be because of going into them in April and stuff, trying to change a -- whatever you want to say, Cincinnati, Ohio, lane, that's going to New Jersey and trying to change it with a customer to go to Chicago, and their answer to us would be, I'm not going to give you the Chicago right now because I got three other carriers running it, and to us say, well, we're not interested in going to New Jersey.

Now, that is the vast majority of that rationalization, and then what ends up happening though is that you are able to convert a lot of your customers, and you bring on some new customers out of Cincinnati going to Chicago, but the customer that you lost going to New Jersey because you told this driver he's going to run in five states and you're committed to the Midwest, when you don't have that, then you go to the broker to make sure that he is getting that Chicago load. And so this marketing guys are doing a great job, bringing on, as you can see evidence, they're bringing on new accounts but it don't get done in a quarter.

The next four quarters it's going to get done, and in my opinion we'll sit there and say, hey, this thing is on-line the way we feel like it would have been well, actually 12 months ago when we announced it last July.

I've asked plenty of questions. Thanks for your good detailed answers.

Let me clarify one thing. Of last year's top ten accounts, if you go on to second quarter of last year, there are two that we lost, and really it wasn't for service issues, it was more of the customer deciding to do something different. Some public information. Conway started their own truckload division.

That business is basically gone and Eagle decided to ramp back up their owner-operator division. Other than that you have got to drop down below about the top 20 before you really see a lot of movement around in last year's top 20. Some of their volume is up, some is down, but as far as lost, i.e. this 44 replaced, it's really a lot of the second-tier-type customers. So I just wanted to clarify that a little bit. We do have some new accounts in our top ten that have grown into that top ten.

Okay. Thanks for that clarification, Joey.

Your next question comes from the line of Chaz Jones, Morgan Keegan.

Yes, hello, David and Joey.

Hey, Chaz.

See if I can come up with a question here. I'm curious, on the nondriver headcount. Certainly a number of changes have been made with new personnel coming in. Was curious if there had necessarily been a significant change over the last 12 months in terms of the nondriver headcount at Covenant.

Chaz, it has grown relative to our truck per nondriver where we were back before the realignment. And we anticipated that that could happen. We said short-term.

Sure.

Short-term was undefined. But probably within the first year. Prior to the restructuring we were running about 3-6, 3-7 trucks per non driver, and right now we're rung 3-3 to 3-4 trucks per nondriver. So it has dropped a little bit. Basically as a result of this realignment.

Now, will there be any nondriver headcount reductions with the 150 trucks that are expected to come out of the fleet?

Yes, there will have to be.

Okay. And then looking at those 600 trucks that have been realigned out of the regional division over the last 12 months, is that placing pressure on those other three divisions, I guess to sort of take up the slack to keep those trucks moving in the system? I mean, I know clearly you're trying to reallocate them to the best performing divisions, but does that essentially drag down overall freight quality of those divisions at all?

Say that question one more time. I'm sorry, Chaz.

I guess what I'm trying to get at is, I understand the strategy in terms of realigning the 600 trucks, or reallocating the 600 trucks from regional OTR to the other three divisions, wherever you see better performance, but has that placed additional pressure on those divisions, perhaps to take on freight that they wouldn't otherwise just in order to keep those trucks running in the system? It almost seemed like in the press release you alluded to that, in the dedicated division.

There's no doubt that getting rid of the 150 trucks is going to lessen pressure, I mean, that will have all the trucks full, but there's also no doubt that as you look at four different financials that are coming out, you've got one at 105 and you've got one at 94, even if it's 40 trucks, I'd rather have the 94 than the 105. So there's no doubt that the 94 could get an opportunity to go to a 91, but you start the process with 150 trucks, and you continue to look at the P&Ls and you make determinations going forward on what you do.

Sure, but that has -- I guess what I'm getting at, and I don't know if you have the breakout from that far back, that that hasn't necessarily put margin pressure on those other three divisions as they've absorbed those 600 trucks over the course of the last year?

No, no, it has not. No. So far, again, the -- you've got four months of P&Ls though, Chaz.

No, understood.

So I don't know how you answer that. I mean, because at the end of the day, you know, there's--.

Maybe I can answer it. The plans that we're executing this year were presented by the various general managers. Were they encouraged to grow where they felt like they could grow? Yes, they were. But did we hog-tie anybody and -- into taking more trucks absent possibly the Covenant reefer division, in taking more trucks than they felt that they could absorb? No, we did not.

So everybody went out, analyzed their market, and set up their divisions, developed their business plans, looked at their driver base what they wanted to accomplish, and made and developed those plans, we interacted with it and tweaked them a little bit, but I can honestly say that nobody was, like I said, unduly pressured to take a significant amount of trucks.

Sure.

More than they were already asking to take. So -- but I understand the question, and it's a fair question. Because we're trying to rationalize that one division very rapidly. But it was not anything that people weren't willing to try to get done.

Okay. And then maybe one last one. General supplies and other expenses seemed to pick up. Is there any particular reason or clarity you could give on that expense line item?

That's where the rent expense on the sale lease-back is now.

Okay.

So of that difference -- let me see. Hold on a second, Chaz. I've got something here. General supplies was up $1.4 million, of which building rent was about an increase of about $700,000. So half of that was that, and the difference is contract labor has risen, because we're trying to keep from hiring people, but we count contract employees as headcount, but instead of hiring them, we've kept them on a contract basis. That's up. We are traveling a tremendous amount as we realign the division. We have different people that are out on the road, so that's up pretty significantly. So the combination of those three items is the majority of the difference.

Okay. No, that's helpful. I appreciate the commentary, guys. Look forward to the execution side of the turnaround here in the second half of the year.

Thanks, Chaz.

Your next question comes from the line of Andrew O'Connor, Wells Capital Management.

Good afternoon, Dave, Joey. Guys, I wanted to know, if you boil it all down, would you expect an improvement in the operating ratio in the second half of '06 versus the second half of '05? And if so, what are the two or three key points in achieving that? Thanks so much.

Yes. I mean, Andy, we do expect operating ratio to improve. The key points for that, I think the first is, the key metric that we've outlined coming into the year and been very consistent on is growing the revenue per truck per week at least 5% over year ago. To the extent that that exceeds that, we're able to grow that faster, improve the utilization on our solos across the divisions, as well as grow our rates. That will be very impactful.

Second, and just as impactful, is if we are able to hold our costs what we've tried to do is be very clear, and that even though our costs are up for the quarter over year ago, our costs are flat, have been flat since the third quarter of 2005. So 2000 -- third quarter of '05, fourth quarter of '05, first quarter of '06, second quarter of '06 has been the same.

So third quarter of '06 we'll begin wrapping around, and we feel like also our costs will be flat for the rest of the year. There's nothing that we see that's going to really move it up significantly. If we're able to hold our costs and grow our revenue per truck sequentially, over the second quarter of '06, then the operating leverage starts to kick in, and you really improve your margins quite nicely very quickly. And so that's pretty much it right now.

We've foreseen that since about the fall of last year when we started putting our plan together. We felt that the second half of '06 would be when we would start seeing margin improvement, which obviously in our case turns into earnings improvement, and that's playing out exactly as we saw.

And so the extent the 5% is a little greater, that helps, as well as our costs are flat. If we're able to decrease our costs, believe it or not, in a few situations, as your utilization improves, you eat your fixed costs faster. So it actually lowers your fixed cost per mile, and so that helps. We're able to continue to not have to do a driver pay increase, and actually lower our open trucks i.e. we've already made the decision to reduce that fleet. That helps. And so I think that everything is pointing to pretty much as we felt that, again, improving our margins in the second half of the year is still there and nothing has changed to change that right now.

Okay. Thanks for that. And then, Joey, what was cash at the end of the second quarter?

Our cash at the end of the second quarter, $2.6 million.

Okay. And then are you guys able to take a stab at what you think cash will be -- cash and total debt will be at year end '06?

Debt's going to grow. We ended the quarter about $72 million of debt, $2.5 million of cash. That number -- we typically forecast very little cash, because we're a borrower. Typically we take excess cash and pay down debt. So to the extent it's more than $1 million or so, that's just timing. That 72 million, by the time we finish up our equipment plan for this year will be 80 to $85 million by the end of the year. It's going to glow some, there's no question, between now and the end of the year.

Okay. That's all we had. Thanks very much.

Your next question comes from the line of Donald Broughton, A.G. Edwards.

Good afternoon, gentlemen.

Hey, Donald.

I'm trying to get a better sense, better feel here David, for why your confidence and your ability to get pricing is so high. As I kind of walk through this, and correct me if I've made a misassumption or misstep here, but like at refrigerated, I've got revenue at the total mile going up 2.4% and with the average length of haul going up a little bit that's good, it's not great. It's not the kind of high single digit rate increases we got accustomed to in '04 and '05 but it's okay. Dedicated is up, miles up 7%, freight for total up 15.7, that looks promising. But quite frankly with a almost 40% increase in that truck fleet I don't know whether that's because you got a couple of really great contracts, dedicated contracts added to that business or that's because all of your dedicated business got vicing. And while that's good, it's no secret that in regional, on a pricing basis, you guys are getting spanked.

Yes.

So the point where I get -- I've got advocates saying, gee, these guys look like they're doing a great job of restructuring the business, and I've got critics saying, looks to me like they're just putting trucks anywhere they can find a load because the overall per total mile, I don't know what to tell you, went up less than 1%.

Right.

So why is it you have such high confidence? Is it just the last couple of contracts you've been able to get pricing? What is it that drives that level of confidence?

Well, again, it goes back, Donald, to that -- probably that first comment I made about the rationalization of this freight. It's is a big, big issue. You take like the team -- excuse me, the dedicated side, those numbers, as you said, they look pretty good, but the reason why those numbers -- we're getting, out of the dedicated, we're getting 4 to 6% increases from our customers as the contracts come up we're getting 4 to 6% kind of increases but these numbers can be a little misleading from a standpoint that we shifted some of our team side, they got team in there but we shifted some of our mix and team on dedicated that came out of the, quote, say Conway, quote Eagle that used to be dedicated, you remember.

Sure.

All that was running over there, producing a ton of miles, and all of a sudden we replaced that with predominantly a lot of single pay that's getting less miles but a higher rate per mile. So you take this, like the dedicated, as you first look at that you'd say, hey, that don't look too bad. Well, at the end of the day we're getting 4 to 5% kind of numbers, but it looks like it does because of the shift in the trucks.

And then as you look at the reefer side of that equation, I don't disagree with your comment that you made, hey, looks okay, it's not what we are used to, it's 2.5%, those kind of numbers, but the average length of haul has increased pretty nicely on the Covenant side on, probably by about 300 miles in the last 12 months on that which if you use the rule of thumb, and I'm not sure that I agree with this rule of thumb, of about $0.30 a mile per hundred miles and length of haul up or down, but it is a number, whatever it is. I don't know how you ever scientifically get to that number but it is a number.

Sure.

And so that's one of the reasons why you say, hey, $2.50 that's not all that great. Well, you increase your length of haul by 300 miles. It's not a bad number. They've done the contracts have came up have been 5, 4 to 6% increases in their rate, and again it's the rationalization of that division that equates to that.

Then you take the OTR, and I don't think that we've been unbashful to say that, hey, here's 35% of this region here, 30% of this region. We ain't taking just any freight we want. Evidenced by the fact that 35% of it is with brokers. Now, that hurts our rate per mile, but it's not -- as a matter of fact, it ought to be the freight that our critics ought to be sitting here be thrilled to death we're taking it because it gives them another load of good paying freight over here. So from that standpoint it drives down the total rate per mile, but we've been very open that, hey, guys, those are our issues. And at the end of the day, it's that rationalization of saying I'm not going to New Jersey at $2.15 a mile, but I'd rather go to Chicago at $1.50. Well, there's a difference in those rates per mile.

One, I'm having turnover drop by 30 and 40% that, again, is going to equate to a savings over here that will make up probably all the pay increase of those particular lanes, I'll probably make it up in the driver turnover if it plays out the way we believe it will start to play out. So it is, I mean, it is a big basket. Your question is very, very fair question. I mean, would I rather the rates be up 5%? Yes, I would rather them be up 5%. But this rationalization of this freight is what is causing the vast majority of this. Good or bad. And I'm not saying the rationalization is bad. It's what we want to do, how we feel like it makes a success in the future. So if that means that the rates were flat, then the rates are flat. And our revenue per truck is up 5%, and if we can get revenue per truck up another 4 or 5%, me and you both will be thrilled.

Sure, sure. Well, obviously your rate per loaded total mile is improving. The question is, I mean, we saw dead-head here fall by -- well, fell sequentially -- fell year-over-year from, what, 10.4 to 9.5.

Right.

The question is, how much of that is driven by more dedicated. Because you're getting paid on all those miles.

That's a portion of it. Out of 3400 trucks, dedicated is 650. So that 1%, I mean, if you want to assume the maximum maximum of that, they probably have added 60 trucks onto their fleet in the last year-over-year, second quarter next year. I mean, last year. We added 200 trucks. I mean, you can do the math. Thank God for it, but whatever the math, if dedicated was half of that, that's great. The other half of it is going to be -- another portion of it is going to be the length of haul went up, what, 30 or 40 miles?

Yes.

Maybe that's a 10th of some number, but it is a number, and then the other part of that -- some of that cheap freight that we're hauling with these brokers is definitely because we're emptied out in Cincinnati, and when we want to go to Chicago and that's the only city we want to go to, so therefore, that's reducing dead-heads.

Well, congratulations on the insurance line. Nice to see you get down to that $0.08 a mile. Remind me your policy, your retention level and when it comes up for renewal, your reinsurance.

We have $2 million deductible and it comes up in March of '07.

All right.

March 1, of '07.

So next big stair-step chance is probably then?

I think we've got some good opportunities if we continue on.

Fair enough. I'll let someone else ask a question. Thanks, guys.

Okay, Donald, thanks.

Your next question comes from the line of Shaun Nicholson, Kennedy Capital.

Hi, guys. Hi, guys, I just had one kind of general question. Looking at the turnaround, I know you stated you're a year into it. There's obviously a year to go, in your opinion. How do we know -- I mean, how do you know when you've actually turned it around? What metrics are you using to say we've completed the turnaround?

Well, at the end of the day it's definitely quarterly EPS. It's definitely operating ratios. I mean, that is the report card that tells you as you're progressing, it it is, Shaun, all those different little steps that you take, and as I've used the baseball analogy in the past, we are between first and second.

That's where we're at in this turnaround, which says that last July we were at the home plate, and today we're somewhere between first and second base, and we still got two more bases to go. So we're not there yet. But it is. It's revenue per truck is the key component we look at, and then it is driver turn-over, then it gets into the expense side of how much -- driver turnover is going down, but how much can we save on advertising on that $3 million that we spend a year on advertising?

And so it's really a lot of little small steps that we look at, and the thing that I told my employees just about a month ago, because I really believe this, is that guys, in the last 12 months, it was kind of like we were taking a step forward and two steps backwards, as we were doing the reorg, and as we were putting in divisions and as we are doing computer software and P&L statements. We would go a step forward, we would be happy, only followed by two steps backward.

And the way I feel today is that we're going a step and a half forward and a step backwards. So it's not like I get up every morning and everything's wonderful and everything's great and we got this sucker turned around.

I walk in every morning with issues on execution and a good day and a bad day. But I will say that we are going a step and a half forward for every step backwards. And that's one of the key things that keeps everybody's chin going up, and it's everybody in this room, you got every division manager, except for Jeff Acuff that's in this room. So everybody feels the same way, and they go to their desk every day and they see wins, they see things that are happening good followed by something that's negative that they have to deal with. So that's really the way in which we grade ourselves.

But at the end of the day it is on profitability, as you turn something around, there's no doubt that you wish, you wish that you didn't have fuel that went up $0.30 a gallon in the second quarter, like it did. You would like to get some wind in your sail helping you in that. I mean, it would make you feel better, but you don't have that. You wish that over -- looking over four years of averages, virtually average for four years, you wish that your health insurance was not up by $2 million. I mean, it's a big -- the first six months of the year. I mean, if we didn't have that we would be reporting some better, better numbers. Hopefully that's going to go down. Maybe it will, maybe it won't. Who knows?

I know that it's up $2 million over average of the last four years. So you wish that you had some of those sails, but I'm going to tell you, we keep doing what we're doing, we keep working hard. We got smart people in here helping us, assisting us, and we keep plugging away. We will get some sail in these winds, and when it does, it's going to produce some nice numbers for us.

Great. You guys have done obviously--. you've come a long way in a year, so look forward to the next year.

Okay, buddy.

Thanks.

At this time, there are no further questions.

Guys, we appreciate everybody joining us, and we look forward to meeting with you in the future. Thanks.

This concludes today's conference call. You may now disconnect.