How Old Values Succeed in a New Era

Speaker Name: Ernie Schaub
Speaker Title: President and CEO
Speaker Company: EnPro Industries
EnPro Industries Website

Ernie SchaubThank you, Bill, for that very kind and flattering introduction. And thank you, Dean Edwards and Chancellor Peacock, for the opportunity to speak to the students and community of Appalachian State University.

Good afternoon ladies and gentlemen. After spending the morning with some of the Walker College of Business students, I can truly say that it is a pleasure to be with you today.

It is also an honor to follow the distinguished group of lecturers who have preceded me. When I look over the list of those who have delivered this talk, I see the names of an impressive list of leaders of other North Carolina companies. It’s a privilege to be included among them.

One of those leaders is Bill Holland, who introduced me just now. Bill delivered a talk in this series a few years ago when he was chairman and CEO of United Dominion Industries. Today, he’s the non-executive chairman of the EnPro board of directors, and therefore my boss.

Speaking in front of the boss is always an interesting experience. Obviously, you want to make sure your facts are straight and your thoughts are clear. But the challenge is even greater when the boss is an eloquent speaker and a good story teller like Bill. However, I’m going to do my best to rise to the occasion and I believe that Bill will be especially interested in what I have to say because he was deeply involved in the topic I’m going to discuss.

The title of my talk is "How Old Values Succeed in a New Era: The Birth and Growth of EnPro Industries." Both Bill and I were involved in the decision-making process that led to the creation of EnPro and to whatever success we’ve had in the marketplace or in the establishment of a culture that values integrity.

Let me start my talk by giving you a little background on EnPro. Our company is made up of a group of businesses that manufacture engineered products - hence our name, En-Pro. These companies are old-line businesses, some of which have been around over 100 years. The names of our businesses don’t mean much to consumers, but if you work in the industries we serve, names like Garlock, Fairbanks Morse, Quincy Compressor, Stemco and GGB have real significance.

Our products are important to basic aspects of every day life. The seals Garlock makes help power plants generate electricity, refineries produce gasoline, paper mills make newsprint and dozens of other industries produce their products. Bearings made by GGB make car doors open easily, help the compressor in your refrigerator operate efficiently, and allow hundreds of mechanisms to move freely. Quincy makes compressors that provide sanitary air to hospital emergency rooms and air to drive pneumatic tools in factories that make goods you use everyday. Fairbanks Morse diesel engines propel U.S. Navy ships and provide a source of electric power generation for those ships and for institutions like schools and hospitals. On the highway, nearly half the heavy-duty trucks you see are likely to have a Stemco seal on their wheels.

Our sales are about $830 million a year. We have about 4200 employees and we operate facilities in North and South America, Europe and Asia.

Now that I’ve given you a little background about EnPro, we can talk about the EnPro story. It starts in 2001.

The businesses that make up our company were then known as the Engineered Industrial Products segment of Goodrich Corporation. Goodrich was completing its evolution from it origins as a tire and rubber company many years ago into the aerospace company it is today. As it explored ways to improve its focus on the aerospace sector, Goodrich concluded that it would be more attractive to investors if it no longer owned its industrial products businesses. Subsequently, the Goodrich board made the decision to spin them out to Goodrich shareholders.

As the then president of the Engineered Industrial Products segment, the businesses that Goodrich had decided to spin out, I was given the opportunity to join the new company as president and chief executive officer. After some deliberation about leaving Goodrich, where I had spent the previous 30 years, I accepted the opportunity. At the same time, Bill accepted the responsibilities as chairman of the board of the new company.

Needless to say, we were both very excited about the opportunity that lay before us. Very few people in the course of a career are given the opportunity to create and mold their own company, especially one made up of as strong a group of companies as Goodrich had decided to give to its shareholders. It was our chance to build a legacy of success and to set the groundwork for what we believed would be a vibrant and growing company.

On September 4, 2001, Bill joined me and several Goodrich executives on a conference call to explain the spin-off and its benefits to shareholders, and to introduce ourselves as the new company’s senior executives. It was an exciting day, and we were looking forward to a quick transition from being a small part of a large corporation to being an independent company, responsible for our own destiny.

September 4 that year was on a Tuesday. The day passed quickly as did the next several days. We began to put together our business strategies, to recruit our corporate staff and to accomplish all the other tasks that would be required for our new adventure.

On the following Tuesday, September 11, 2001, our work came to a dead halt. The world changed abruptly and dramatically that day. In the overall scope of the tragedy, the fact that it caused a delay in our plans was infinitely insignificant. But it did cause a delay and as we delayed, other things began to happen.

The stock market was closed for a full week. The economy, which was growing sluggish even before September 11, weakened more. Once the stock market reopened, stock prices fell and it was clear investors were looking elsewhere for places to put their money.

Then a series of scandals unfolded and shook investor confidence even more.

In Houston, Enron was on its way to becoming the largest bankruptcy in history. Enron shares had been falling steadily since the beginning of 2001. Just a few weeks before September 11, as the shares continued to fall, the chairman of Enron was urging employees to buy shares for their 401K plans. At the same time he was selling shares he owned. Soon, accounting improprieties came to light, and ultimately Enron’s story moved into the courtroom. In less than a year, the value of an Enron share went from 84 dollars to less than one dollar. In the aftermath, investors lost millions in the collapse and Arthur Anderson, an old and respected accounting firm, became so entangled in the events that led to Enron’s fall that it went out of business.

Enron may have been the best known of the corporate scandals of the early years of the current decade, but it was far from the only one. There were allegations of improper behavior at Adelphia, AOL-Time Warner, Dynegy, Global Crossing, Qwest Communications, Tyco, and WorldCom, just to name a few in what Forbes magazine called "an avalanche of corporate accounting scandals."

Insider trading was also in the spotlight as details about Martha Stewart’s trading in ImClone stock came to light. Finally, questions about the objectivity of Wall Street research arose when it was alleged that several highly regarded security analysts had issued false or misleading reports about the companies they covered, and that the investment banks they worked for had played favorites among their institutional clients to the detriment of individual investors.

So, as we were trying to establish the ground work for a new public company, the world’s opinion of public companies, their accountants and the investment community was changing for the worse. The economy - although it recovered slightly in the weeks and months after September 11 - remained weak. In short, it was a tough time to be planning the debut of a new public company.

The list of specific events and the motivations for the abuses I’ve describe would probably be very long. But in my estimation, they all boiled down either to weak corporate governance standards at the businesses involved or to lax oversight by those who were responsible for enforcing the standards.

The public’s reaction was one of mistrust of corporate leaders, and in some instances, that mistrust was fully justified. It is easy to understand how an individual could turn skeptical when his personal investments declined or the money he had set aside for retirement in a 401K lost much of its value because of the dubious management strategies, corporate accounting abuses and other corporate scandals. At the same time, the public perception was that all corporate leaders were fat cats who didn’t mind sacrificing the little guy for their personal gain.

As is often the case, an entire group of people was judged - or in this case, misjudged - by the actions of a few. The reality is that most corporate leaders are honest and upright people who understand that their best interests are served only when they serve the best interests of others.

Bill and I wanted to create a culture at EnPro that understood this philosophy. The philosophy is simple and direct. Its fundamental principle is a commitment to the truth, and all of its other aspects grow from there. We knew the environment developing around us would accept only the highest standards of corporate governance. But our goals were not the result of public sentiment at the time of EnPro’s conception. Rather, they were the result of our conviction that no matter what success we might find, it would be meaningless if it was achieved by taking short cuts, or by enabling unacceptable behavior by our employees, our managers, our senior executives or our board of directors.

So in this environment, we set out to establish the practices that would govern the way we managed EnPro. We wanted our strategies to be clear and straightforward and our governance practices to be high. We wanted there to be no doubt of our intentions to manage our company with the highest level of accountability.

We started by looking for an accomplished and respected board of directors. One of the most significant concerns that arose in the wake of the events I’ve discussed was the issue of the independence of boards of directors. Many boards were criticized for having too many insiders and for cozy relationships between directors and management.

We addressed these concerns by recruiting an able and independent board to oversee the strategies and management of the company. Except for me, none of our other directors, including Bill Holland, our chairman, is an employee of the company. Each of our directors has served in similar positions for other companies and many have served as board chairmen.

We also set high standards for the make-up and functioning of board committees and for management’s accountability to our board and our shareholders. Our board committees bring high levels of expertise and experience to their responsibilities. For example, the compensation committee is made up of directors who are experienced in that area and the audit committee is composed of qualified financial experts.

The non-executive members of our board meet independently of management to encourage frank discussion of our strategies, our direction, our people and our performance. That group also meets independently with our auditors to ensure the integrity of our financial statements.

While we were establishing the guidelines EnPro would live by, the government was doing what the government does when it feels the need to appease public outrage. It passed a law. In August of 2002, we got the Sarbanes-Oxley Act of 2002. Facetiously, we call Sarbanes-Oxley the accounting industry full employment act because it has created new levels of accountability for all public corporations. Higher levels of accountability have led an increase in the number of accountants employed by both corporations and public accounting firms, and so accounting has become a growth industry.

To the credit of the Sarbanes-Oxley Act, the law seeks to protect investors by requiring corporate executives to attest to the accuracy and reliability of their financial statements and their public disclosures every quarter. At EnPro, we’ve taken that requirement a step further and require our division presidents and their controllers to make the same kind of attestation relating to their financial statements.

Some aspects of the law have been considered onerous, especially by small companies who find the cost of complying with Sarbanes-Oxley to be particularly high in relation to their size. But in short, its requirements are simple - don’t hide the facts and always tell the truth. It’s the same advice parents have always given children, but no matter who gives it, it is always good advice. It is tried and true, and it is the advice we followed as we charted a path for EnPro.

At the same time Sarbanes-Oxley was being drafted, debated and passed into law, the Securities Exchange Commission and the New York Stock Exchange were also raising the bar on corporate governance issues.

I’m pleased to say we were ahead of the curve. By the time the laws were passed and the new regulations put into effect, we had already put almost all of their requirements plus some into effect at EnPro. We incorporated these perspectives into our standards well before they were required by law or regulation. Without bragging, I can tell you that our governance strategies have been very effective.

One of the offshoots of the irregularities in corporate governance in the early years of this decade is an industry devoted to scoring companies on corporate governance. Investors, particularly institutional investors, use these scores to help them decide whether or not a corporate board is doing a good job for its shareholders. I’m proud to say that in each of the three years that EnPro has been scored by one of these companies, our governance has been judged to exceed more than 90 percent of all companies surveyed.

With our governance practices established, we also began to outline our strategies for the management of our new company. As we saw Enron and other companies stumble, it was clear that many of their business strategies were complicated beyond comprehension. In some cases, it seemed their gains were made on the illusion of success, rather than true success in an effort to create an ever higher stock price. The gains the world saw from these stocks seemed almost too good to be true.

And when things look too good to be true, they usually are. That turned out to be the case with many companies in the early years of this decade. We set out to make sure it would not be the case at EnPro.

At the beginning of my talk, I told you a little bit about the products our businesses make. They have lots of uses and are used by many, many industries in literally tens of thousands of applications. But one thing that has made them successful, no matter what the product, is a reputation for high quality and for reliability. They are not simple products - manufacturing them takes a lot of know-how, a lot of experience and research and a lot of skill. But they serve very basic purposes and they meet a critical requirement of all our customers - they work and they work exceptionally well.

We wanted our business strategies to do the same - they should serve the basic purpose of making EnPro a better company tomorrow than it is today and they should do that day after day, week after week, month after month and year after year. We weren’t looking for complex business plans or for high flying returns. We believed we had been given a good, sound group of businesses, and we intended to develop sound business strategies that would complement them.

We wanted our strategies to be clear to two important groups of people. One was our employees, who would be asked to execute our strategies. The other was our investors, who would be asked to support our company with their money. We believed that if our strategies were clear to both of these groups of people, good things would happen.

Our strategies are these:

First, we wanted to improve the efficiency with which our businesses operate. That meant addressing a lot of measurements that are not very exciting to discuss, unless you’re talking to an efficiency expert - things like turn-around times and inventories and on-time deliveries. It also meant looking at unused or underutilized facilities and outdated procedures.

To help our employees understand this concept, we implemented lean manufacturing techniques in a program we called Total Customer Value or TCV. If you’re not familiar with lean manufacturing, it’s a concept that was developed in Japan by Toyota. Its primary objective is to eliminate waste - both in terms of physical waste and in terms of wasted effort and wasted energy. The idea is to reduce the amount of time and material required for us to manufacture a product.

Of course, this concept can be frightening to employees - in their eyes, the less time it takes to make a product, the fewer employees you need to make it. To help them accept the program, we promised that no employee would lose his or her job because of the implementation of TCV. As a result, the philosophy has been embraced, we have trained 100 percent of our employees in its techniques and we are seeing its benefits in our performance.

Our second strategy is to expand our product offerings and our customer base. Our businesses have long histories because they’ve developed new products and found new customers in good times and in bad. Nevertheless, we felt it was important to reinvigorate the process. As an independent company, we’ve expanded from our traditional bases in North America and Western Europe into China and Eastern Europe; and we’ve opened up distribution channels into the Middle East, Asia and South America.

At the same time, we’ve focused on research and development to create new products; and we’ve expanded our marketing skills to understand and anticipate our customer’s needs.

Our third strategy is to strengthen the mix of our businesses by making acquisitions and by ensuring our existing businesses and product lines provide appropriate value to our shareholders. Our objective is to increase the returns we receive from our businesses so that we can continue to invest in them and in their growth and improvement.

These three strategies are as basic as our products. There is nothing fancy or complicated about them and they are straightforward in their execution. They have been around as long as people have managed businesses.

I’m happy to say that we’ve been successful in each of them, and the proof is in our financial performance, which has improved by every measure. Sales have grown, profits have improved and returns to our shareholders have increased dramatically. Which I think underscores the importance of simplicity and of time honored and proven values.

However, we’ve embraced a fourth strategy as well - one that is a by-product of our modern system. For over 25 years, our subsidiary, Garlock Sealing Technologies, has been a defendant in lawsuits alleging that plaintiffs were exposed to asbestos in Garlock’s products. It is a fact that Garlock manufactured sealing products that contained asbestos. The asbestos was encapsulated in the product; and in its application, the product was usually enclosed in a pipe flange or pump or some other piece of equipment.

It is our belief, and one that has been supported many times by a jury’s verdict, that no one could have contracted an asbestos-related disease from a Garlock product. Nevertheless, the economic reality is that settling a case is cheaper than trying a case, even if you win, especially when there are thousands of possible claims. As a result, Garlock has settled over five hundred thousand claims by people alleging they were exposed to asbestos in a Garlock product, and between Garlock and its insurers, over one billion - let me repeat - one billion - dollars has been paid to the claimants, most of whom were not sick at all, much less sick because they were exposed to a Garlock product.

I’m not going to get on a soap box to talk about the legal system or tort reform. I believe we’ve been unfairly saddled with this problem, but fair or not, it’s ours and it’s ours to manage. At the time of our spin off, we were obligated to pay significant amounts for claims settlements, and as a result, we saw cash we’d prefer to have invested in our businesses go instead to asbestos claims of uncertain validity.

To reverse this pattern, we’ve struck a hard line with the plaintiff’s attorneys. We prefer to settle claims because settlement is cheaper and less risky than going to court. But when settlement demands are unreasonable, we’ll take it to trial because we believe in a fair trial, we can win. As a result of our strategy and the effectiveness of legal reforms in some states, the amounts we pay to settle asbestos claims steadily decreased from 2001 to 2004.

So we’ve been successful at that strategy as well. In fact, three years ago, many people - maybe even most people - thought asbestos claims would consume us. But today, we’ve proven we can manage this significant issue just as effectively as we can manage our businesses.

There you have the EnPro story, at least through the current chapter. We came into this world following a period of turmoil, both in the world’s politics and in its economic environment. Our first steps were delayed by events that were both tragic and unforeseen. When we finally took them, our direction was influenced by the fall of corporations who thought they could outsmart the public but ended up only outsmarting themselves.

As we established our company, we set out to do the opposite - to keep things as straightforward and basic as our products and the industries we serve. We wanted to make sure our objectives were clear and understandable by employee and investor alike, and to make sure our practices could stand the light of day and the scrutiny of a then skeptical public. We plan to always be honest and forthright, no matter whom we address.

I believe we’ve achieved those things; and in the process, we’ve created stability and employment for the over 4,000 people who work for us around the world. I believe Bill Holland would join me when I tell you we’ve put EnPro on the right track by doing the right thing.

It’s been a pleasure to share our story with you, and I thank you for your attention.