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Schaeffler Group

Introduction by the chief executive officer

Klaus Rosenfeld | Chief Executive Officer Schaeffler AG Klaus Rosenfeld | Chief Executive Officer

It is my pleasure to summarize for you the Schaeffler Group’s progress in 2017 in this annual report.

After setting the course for the further development of the Schaeffler Group in 2016 with our strategic concept “Mobility for tomorrow” and its 8 strategic pillars, our Excellence program “Agenda 4 plus One” with its 16 strategic initiatives, as well as the Financial Ambitions 2020 derived from it, in 2017 we were able to record initial successes by implementing our strategy and the various strategic initiatives. In this, we were mainly led by the first of our 8 strategic pillars: “We want to be the preferred technology partner for our customers.” This ambition is both an obligation and an incentive for us. It is based on the conviction that the Schaeffler Group with its capabilities and expertise can contribute to making the world a “cleaner, safer, and smarter” place – as is stated in our vision that we formulated in 2016 as the starting point for our strategy development.

Strong growth – Net income increased

For the first time ever, the Schaeffler Group generated revenue of more than EUR 14 billion in 2017. This represents constant currency growth of 5.9 % and means we have exceeded the target we set for ourselves with our guidance for 2017 of 4 to 5 %. Both divisions and all four regions contributed to this strong growth, which is good news and proves that the Schaeffler Group is on track for sustainable growth. Particularly noteworthy is the encouraging development of our Industrial division, which grew by 5.7 % at constant currency in 2017, almost as much as our Automotive division with growth of 5.9 %. I would also like to highlight the above-average performance of our Greater China region over many years. Revenue there rose by around 24 % at constant currency in 2017, making the Greater China region once again our strongest driver for growth.

In accomplishing all this, we did not rest on our successes achieved to date but continued to invest, particularly in the future-oriented areas of E-Mobility and Industry 4.0, without neglecting our traditional core business, however. We continued to gain ground especially in the area of electric mobility. This is reflected not only in the accelerated acquisition of the remaining shares in Compact Dynamics GmbH, but also in the increasing number of customer projects. In addition, the launch of series production in two major projects with Chinese manufacturers at the beginning of this year marks another significant milestone. This clearly confirms that we are on the right track. We will consistently continue along this path. Establishing our globally-oriented separate E-Mobility business division and three competence centers in Buehl, Wooster, and Anting, as well as further expanding our global E-Mobility team, will support us in this. We can also report initial success in realizing our second key opportunity for the future, Industry 4.0. Interest among customers is strong. Effective January 1, 2018, we have set up an independent organizational unit responsible for expanding this important future-oriented business worldwide in which we combine our expertise. Looking for common ground and our decision to become even more flexible and more customer- and market-oriented through our new three-division model and the stand-alone Automotive Aftermarket division are helpful here too.

However, the Schaeffler Group’s business is not only made up of E-Mobility and Industry 4.0. We are proud of our core business, which did well in nearly all sectors in 2017. This trend will continue in 2018. One indicator of this is the order intake in our Automotive OEM business, reported externally for the first time in 2017, which increased to around EUR 11.5 billion, or around 1.3 times the revenue generated in 2017. The Industrial division’s order book also developed well, especially towards the end of 2017. Thus, all signs are pointing to continued growth.

That brings us to the results for 2017: Even though we were able to grow the Schaeffler Group’s consolidated net income to EUR 980 million, which is an increase of around 14 % over the prior year, we can only be partially satisfied with the development of operating results over the course of 2017. With earnings before financial result and income taxes (EBIT) before special items of EUR 1,584 million, our EBIT margin before special items was 11.3 %. This compares to 12.7 % in the prior year. On one hand, the decline in the EBIT margin before special items resulted from temporary operating problems that led to a profit warning and a reduction in our guidance for our EBIT margin before special items from 12 to 13 % to 11 to 12 % in the second quarter. On the other hand, the margin decline is attributable to the additional expenses and investments associated with the implementation of our program “Agenda 4 plus One”. These measures are necessary in order to prepare the Schaeffler Group for the future. They will remain with us in 2018 and can be expected to affect our operating profitability. It should not be overlooked, however, that the “Agenda 4 plus One” initiatives and the associated costs and investments over the next few years are designed to generate additional earnings potential that will help to secure the Schaeffler Group’s operating profitability in the long term – whether through cost optimization, synergy effects, or revenue increases. This is also the basis for bringing our EBIT margin before special items back to the long-term average of 12 to 13 % and for meeting our Financial Ambitions for 2020, and similarly applies to free cash flow, which amounted to EUR 515 million before cash in- and outflows for M&A activities in 2017.

In this context, I would like to highlight the fact that we have further increased our capital expenditures. In total, the Schaeffler Group invested around EUR 1.3 billion in 2017. This corresponds to 9.1 % of our revenue, a figure well above the medium-term average of 6 to 8 %. We are also proud of the fact that we created around 3,500 new jobs in 2017, approximately 500 of them in Germany. This positive trend has been possible because, being a family business, we think long-term and constantly resort to our proven success factors: Quality, technology, and innovation.

Our net debt continued to decrease over the course of 2017. It currently amounts to approximately EUR 2.4 billion. This corresponds to a net debt to EBITDA ratio for the Schaeffler Group of 1.0x. At the same time, the equity ratio increased from 17.3 % at the end of 2016 to 22.1 %. These indicators demonstrate that the quality of our balance sheet has further improved. Once again, we have regained sufficient financial flexibility to consider selective acquisitions as part of our M&A strategy. This is key to implementing our strategy “Mobility for tomorrow”.

Strategy “Mobility for tomorrow” – “Agenda 4 plus One”

Our strategy “Mobility for tomorrow” is finalized. It is conclusive, and it is understood, accepted, and appreciated by our customers and business partners, as well as by our executives and employees. That is an important prerequisite. However, its implementation is even more crucial. To this end, we launched our Excellence program “Agenda 4 plus One” with 16 strategic initiatives over the course of 2016. Since then we have expanded it to a total of 20 strategic initiatives.

The program “Agenda 4 plus One” owes its name to the fact that it is designed to run for 4+1 years. It is a broad-based approach and we will successfully complete it by the end of 2020. For this purpose, we have set up a program organization that systematically monitors and supports the implementation of the program and each of its initiatives. This also includes regularly determining the implementation status, known as the “completion ratio”. Today, this figure – including the four new initiatives added to the program at the beginning of this year – is around 35 %. This means there is still a lot of work ahead of us.

Equally important as monitoring the progress of implementation are the business cases we have developed for each of the initiatives showing how much extra effort, additional investments, and, of course, additional benefits result from the individual initiatives. This is necessary to demonstrate whether the program pays off financially, which is all the more important because the program encompasses initiatives of very different character: From concrete business initiatives such as “E Mobility” and “Industry 4.0” to initiatives aimed at increasing our operational excellence, designed, for example, to improve and harmonize our groupwide processes (see initiative “Process Excellence”). Enhancing and modernizing our IT infrastructure (see initiative “IT 2020”) is essential to successfully carrying out this undertaking. Of course, “Agenda 4 plus One” also includes our "Digital Agenda", with which we intend to make the Schaeffler Group fit for the digital age and which, together with the “E-Mobility” and “Industry 4.0” initiatives, represents one of our key opportunities for the future. Due to its significance, the “Digital Agenda” practically represents a program within the program.

Addressing all 20 initiatives would be beyond the scope of this foreword. Therefore, I would like to use just one of them as an example that has been of particular interest to us in 2017 and which is of fundamental importance to the Schaeffler Group’s future success: The initiative “Leadership & Corporate Values”.

Leadership & Corporate Values – In die Zukunft führen

As part of our strategy concept “Mobility for tomorrow”, we agreed in the course of 2016 on four key corporate values based on the “Transparency, Trust, and Teamwork” Leadership Principles adopted in 2014. In 2017, the Executive Board of the Schaeffler Group worked extensively on how to further operationalize this framework and develop it into a conclusive leadership model.

These efforts resulted in our six Leadership Essentials. These are designed and formulated in a way that they can serve as guidelines for all our executives worldwide in their day-to-day management activities. Whether on the shop floor in our plants or at board level, in Germany, or at locations worldwide. Completely in line with our “One Schaeffler” approach. As these Leadership Essentials are particularly important to us, we have decided to choose “Leading into the Future” as the motto for our annual report 2017. See for yourself and read the following interview with Corinna Schittenhelm and myself on the topic of “Leadership”, as well as the details of the six Leadership Essentials on pages i18 to i33 of this annual report.

As members of the Executive Board, we are convinced that we will be able to successfully handle the Schaeffler Group’s upcoming transformation process if we lead the way by setting good examples, with a great deal of respect, and the necessary decisiveness. This is especially true in situations in which we cannot always meet all the interests of everyone involved. And this is also true even if we have to accelerate the transformation process further. We want to shape the future, take our employees along on this path, and inspire their enthusiasm for our concept. We will only succeed in this through good leadership. Our new leadership model will therefore become one, if not the decisive factor in ensuring the continued success of the Schaeffler Group in the future. And that is best done together. As One Schaeffler Group. As One team that speaks with One voice.

One Schaeffler – One Team – One Voice

Even though the environment will remain challenging in 2018, we have ambitious plans for the year. On a constant-currency basis, we aim to grow by 5 to 6 % and achieve an EBIT margin before special items of 10.5 to 11.5 %, including the charges resulting from the accelerated implementation of our program “Agenda 4 plus One”. On this basis, free cash flow is expected to amount to around EUR 450 million before cash in- and outflows for M&A activities in 2018. In addition, as in the past two years, we intend to pay a dividend of 30 to 40 % of net income before special items. These are ambitious targets – we will do everything in our power to ensure they can be achieved. However, we are not only concerned with short-term financial targets. There’s even more to it: We want to prepare the Schaeffler Group for the challenges ahead of us. We want to further improve our image internally and externally, continue to invest, and, above all, create secure and sustainable jobs. We will only be able to do all this if we play an active role in shaping the major changes in the markets and regions in which we operate. If we join forces, continue to grow together, speak with one voice, both within and outside, and act as one Schaeffler Group, as a strong automotive and industrial supplier. That means: “One Schaeffler – One Team – One Voice”. That’s our goal, and that is what we stand for. In the best interest of our customers, our business partners, and our employees worldwide. And in your interest, of course!

Ladies and gentlemen, dear shareholders, 2017 was a challenging year. We grew faster than expected, especially in the second half of the year. Our net income increased by approximately 14 % compared to the prior year. And despite its reduced level, our EBIT margin of 11.3 % is still favorable compared to our competitors. We have made investments, achieved a great deal, and are working to secure our future. Naturally, this is not always easy. And of course, 2017 has also made us aware of the fact that we have to take an even more forward-looking approach. This also holds true for expectations placed on us from outside. However, that does not change the fact that we are on the right track. Why? Because we combine long-term thinking with innovative strength and orientation toward the future. Because we know what we are capable of. And because we trust in our four core values that characterize the Schaeffler Group as a family business: “Sustainable”, “Innovative”, “Excellent”, and “Passionate”.

On this note, and on behalf of all members of the Executive Board of the Schaeffler Group, I would like to extend my sincere thanks to our family shareholders, to the members of the Supervisory Board, and to you for your constructive and trustful cooperation in 2017. Special thanks go to our now more than 90,000 employees around the world whose excellent and hard work generated the successes of 2017. I look forward to continuing our collaboration in the future.

Yours sincerely,

Klaus Rosenfeld | Chief Executive Officer

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