Dear Fellow Stockholders,
We are now just over one and a half years into our business realignment. At the beginning of this major initiative, we expected a multi‑year effort, and our stated goal was “measurable improvement” within two years. Although earnings improvement has yet to come, we have accomplished many of our major foundational goals and are more convinced than ever that the business realignment was the right decision for Covenant.
Our initial action was to divide Covenant into service offerings with separate operations and management, while building a financial reporting structure to proactively manage equipment used in different regions and/or lengths of haul. Starting in July 2005, we began to separate Covenant both operationally and financially into separate service offerings. More importantly, we hired a general manager to head up each service offering. This was a long and involved process that was largely completed by July, 2006.
Over the second half of 2006, the realignment had its intended effect, as areas of strength and areas of challenge stood out more plainly, facilitating our evaluation of the revenue and cost structure of each offering. Based on this and other key information, we started to make long‑term focused decisions for the betterment of Covenant.
For example, we began 2006 with 1,200 trucks operating in our Covenant OTR Regional service offering. As the performance of this offering was revealed more clearly, we decided on a different path for fulfilling the demands of our customers for regional service. First, we reduced this fleet’s size to 600 trucks during the second half of 2006, with a goal of retaining the better freight and improving our revenue per truck in the remaining units. Second, we began evaluating the market for acquiring a well‑run regional carrier to jump‑start our effort in this service offering. In September 2006, we purchased Star Transportation with the expectation of operating Star as a stand alone subsidiary, similar to SRT. The president of Star, Jim Brower, has been with Star for 20 years and will continue in that role. This acquisition immediately gave us a deeper impact into the regional marketplace.
We next turned to our temperature‑controlled service offering, where we have recognized a problem area and put a plan in place to correct the situation. SRT, our refrigerated subsidiary operated by Tony Smith and his management team, has operated at a 91% operating ratio or better for several years, with a fleet of 600 trucks in 2006. In late 2006, we determined that Covenant’s Temperature-Controlled service offering was starting to duplicate the SRT efforts, but at much lower performance. In January 2007, we dissolved the Covenant Temperature-Control service offering and assimilated its 175 single drivers into SRT. We then took the 115 team trucks of the Temperature-Controlled service offering and put them into Covenant’s Expedited service offering. While it will take SRT a few months to assimilate these trucks and drivers, in the end we expect a stronger temperature control business model for our customers.
Please allow me to give you an even deeper insight into the Covenant family that should assist you in understanding the opportunities that are before us. In total, the soon to be re-named Covenant Transportation Group operates approximately 3,700 tractors comprised of the Covenant Expedited, Covenant OTR Regional, and Covenant Dedicated service offerings, plus SRT and Star Transportation. Of these 3,700 trucks, approximately 2,500 are assigned to Expedited, Star, and SRT, all of which have achieved operating ratios in the high 80's and low 90's most years over the past five years. Another 600 trucks are assigned to our Dedicated service offering, where we expect contract turnover to drive the operating ratio below 95% by the end of 2007, with future improvement to the low 90's or better. That leaves us with the 600 truck OTR group as a major project. While we have the patience to allow a talented and relatively new management team to deal with a difficult job made more difficult by a lackluster freight market, we are committed to financial success for each of our service offerings and will make tough decisions if needed.
Outside of our asset-based business, we also believe Covenant Transport Solutions, our newly-formed brokerage subsidiary, affords great opportunity. In less than a year, this subsidiary has grown to an approximately $8 million annual revenue run-rate, has assisted customers with freight requirements as we migrated lanes, and is solidly profitable.
I hope the discussion of our realignment has been useful to all readers, as it has been the most important process in our company for the past 20 months. After considering what we have accomplished, I hope you feel as I do, that our turnaround is not insurmountable. With the realignment largely complete, we are now well into the execution stage of our plans. We were expecting to see improvement in the last half of 2006. However, the economy began to slow for the trucking industry and the housing and automotive related industries upon which the trucking industry heavily relies. Various freight hauling indicators, including the American Trucking Associations' freight index, indicated a significant drop in truck tonnage. There is no doubt that this economic situation made our turnaround more difficult. Though it would have been helpful to enter 2007 with a robust economy, we will continue to focus on improving our earnings and profitability as the economy will eventually strengthen. Therefore, while it may take longer than we would like, we are confident that we will be able to achieve our goal of getting Covenant back to a low 90’s operating ratio.
Before closing these remarks, I would like to express my appreciation to all of our hard working employees. They have been our strongest attribute, as they are the ones helping to make and implement the vital long-term decisions within Covenant. They are a pleasure to work with and I could not ask for a better team to assist in the transformation of Covenant.
I also want to stress to you, our stockholders, my appreciation for your support and patience during this process. I can assure that you we continue to work without ceasing to achieve the results that you and I both expect. Our new corporate statement says it all as we transform Covenant for the future: “Quality and Integrity is our Covenant” to you, our customers, vendors and employees.
Sincerely,
David R. Parker
President