Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Fastenal Company:

We have audited the accompanying consolidated balance sheets of Fastenal Company and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of earnings, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2012. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed in the table of contents at Item 15. We also have audited the Company’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Fastenal Company’s management is responsible for these consolidated financial statements and the financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fastenal Company and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Furthermore, in our opinion, Fastenal Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ KPMG LLP

Minneapolis, Minnesota

February 7, 2013

FASTENAL COMPANY AND SUBSIDIARIES

Consolidated Balance Sheets

(Amounts in thousands except share information)

	December 31
	2012				2011
ASSETS
Current assets:
Cash and cash equivalents	$	79,611			117,676
Marketable securities	354				27,165
Trade accounts receivable, net of allowance for doubtful accounts of $6,728 and $5,647, respectively	372,159				338,594
Inventories	715,383				646,152
Deferred income tax assets	14,420				16,718
Other current assets	97,361				89,833
Prepaid income taxes	7,368				—
Total current assets	1,286,656				1,236,138
Property and equipment, less accumulated depreciation	516,427				435,601
Other assets, net	12,749				13,209
Total assets	$	1,815,832			1,684,948
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	78,019			73,779
Accrued expenses	126,155				111,962
Income taxes payable	—				2,077
Total current liabilities	204,174				187,818
Deferred income tax liabilities	51,298				38,154
Commitments and contingencies (notes 5, 9, and 10)
Stockholders’ equity:
Preferred stock, 5,000,000 shares authorized	—				—
Common stock, 400,000,000 shares authorized, 296,564,382 and 295,258,674 shares issued and outstanding, respectively	2,966				2,953
Additional paid-in capital	61,436				16,856
Retained earnings	1,477,601				1,424,371
Accumulated other comprehensive income	18,357				14,796
Total stockholders’ equity	1,560,360				1,458,976
Total liabilities and stockholders’ equity	$	1,815,832			1,684,948

See accompanying notes to consolidated financial statements

FASTENAL COMPANY AND SUBSIDIARIES

Consolidated Statements of Earnings

(Amounts in thousands except earnings per share)

For the year ended December 31,

	2012				2011			2010
Net sales	$	3,133,577			2,766,859			2,269,471
Cost of sales	1,519,053				1,332,687			1,094,635
Gross profit	1,614,524				1,434,172			1,174,836
Operating and administrative expenses	941,236				859,369			745,112
(Gain) Loss on sale of property and equipment	(403		)		194			35
Operating income	673,691				574,609			429,689
Interest income	464				472			951
Earnings before income taxes	674,155				575,081			430,640
Income tax expense	253,619				217,152			165,284
Net earnings	$	420,536			357,929			265,356
Basic net earnings per share	$	1.42			1.21			0.90
Diluted net earnings per share	$	1.42			1.21			0.90
Basic weighted average shares outstanding	296,089				295,054			294,861
Diluted weighted average shares outstanding	297,151				295,869			294,861

See accompanying notes to consolidated financial statements

FASTENAL COMPANY AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(Amounts in thousands)

For the year ended December 31,

	2012				2011			2010
Net earnings	$	420,536			357,929			265,356
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments (net of tax of $0 in 2012, 2011, and 2010)	3,522				(3,791	)		5,062
Change in marketable securities (net of tax of $0 in 2012, 2011, and 2010)	39				95			35
Comprehensive income	$	424,097			354,233			270,453

See accompanying notes to consolidated financial statements

FASTENAL COMPANY AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(Amounts in thousands)

	Common Stock
	Shares			Amount				Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Stockholders’ Equity
Balance as of December 31, 2009	294,861			$	2,948			(1,141	)		1,175,641			13,395			1,190,843
Dividends paid in cash	—			—				—			(182,814	)		—			(182,814	)
Stock based compensation	—			—				4,030			—			—			4,030
Net earnings	—			—				—			265,356			—			265,356
Other comprehensive income (loss)	—			—				—			—			5,097			5,097
Balance as of December 31, 2010	294,861			$	2,948			2,889			1,258,183			18,492			1,282,512
Dividends paid in cash	—			—				—			(191,741	)		—			(191,741	)
Stock options exercised	397			5				8,934			—			—			8,939
Stock based compensation	—			—				4,050			—			—			4,050
Excess tax benefits from stock based compensation	—			—				983			—			—			983
Net earnings	—			—				—			357,929			—			357,929
Other comprehensive income (loss)	—			—				—			—			(3,696	)		(3,696	)
Balance as of December 31, 2011	295,258			$	2,953			16,856			1,424,371			14,796			1,458,976
Dividends paid in cash	—			—				—			(367,306	)		—			(367,306	)
Stock options exercised	1,306			13				29,631			—			—			29,644
Stock based compensation	—			—				4,800			—			—			4,800
Excess tax benefits from stock based compensation	—			—				10,149			—			—			10,149
Net earnings	—			—				—			420,536			—			420,536
Other comprehensive income (loss)	—			—				—			—			3,561			3,561
Balance as of December 31, 2012	296,564			$	2,966			61,436			1,477,601			18,357			1,560,360

See accompanying notes to consolidated financial statements

FASTENAL COMPANY AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Amounts in thousands)

For the year ended December 31,

	2012				2011			2010
Cash flows from operating activities:
Net earnings	$	420,536			357,929			265,356
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation of property and equipment	53,459				44,113			40,688
(Gain) Loss on sale of property and equipment	(403		)		194			35
Bad debt expense	9,726				9,217			8,658
Deferred income taxes	15,442				15,747			1,602
Stock based compensation	4,800				4,050			4,030
Excess tax benefits from stock based compensation	(10,149		)		—			—
Amortization of non-compete agreements	593				593			67
Changes in operating assets and liabilities:
Trade accounts receivable	(43,291		)		(77,678	)		(64,622	)
Inventories	(69,231		)		(88,783	)		(48,964	)
Other current assets	(7,528		)		(19,294	)		(24,577	)
Accounts payable	4,240				13,305			6,984
Accrued expenses	14,193				15,550			30,393
Income taxes	704				(3,222	)		16,956
Other	3,201				(3,232	)		3,882
Net cash provided by operating activities	396,292				268,489			240,488
Cash flows from investing activities:
Purchase of property and equipment	(138,406		)		(120,043	)		(73,597	)
Proceeds from sale of property and equipment	4,524				3,554			4,459
Net decrease (increase) in marketable securities	26,811				4,054			(581	)
Increase (decrease) in other assets	(133		)		212			(10,329	)
Net cash used in investing activities	(107,204		)		(112,223	)		(80,048	)
Cash flows from financing activities:
Proceeds from exercise of stock options	29,644				8,939			—
Excess tax benefits from stock based compensation	10,149				983			—
Payment of dividends	(367,306		)		(191,741	)		(182,814	)
Net cash used in financing activities	(327,513		)		(181,819	)		(182,814	)
Effect of exchange rate changes on cash	360				(464	)		1,215
Net decrease in cash and cash equivalents	(38,065		)		(26,017	)		(21,159	)
Cash and cash equivalents at beginning of year	117,676				143,693			164,852
Cash and cash equivalents at end of year	$	79,611			117,676			143,693
Supplemental disclosure of cash flow information:
Cash paid during each year for income taxes	$	268,357			205,614			146,726

See accompanying notes to consolidated financial statements

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements

Note 1. Business Overview and Summary of Significant Accounting Policies

Business Overview

Fastenal is a leader in the wholesale distribution of industrial and construction supplies operating stores primarily located in North America. On December 31, 2012, we operated approximately 2,700 company-owned or leased store locations.

Principles of Consolidation

The consolidated financial statements include the accounts of Fastenal Company and its wholly-owned subsidiaries (collectively referred to as ‘Fastenal’ or by such terms as ‘we’, ‘our’, or ‘us’). All material intercompany balances and transactions have been eliminated in consolidation.

Revenue Recognition and Accounts Receivable

Net sales include products, services, and freight and handling costs billed, net of any related sales incentives paid to customers and net of an estimate for product returns. We recognize revenue when persuasive evidence of an arrangement exists, title and risk of ownership have passed, the sales price is fixed or determinable, and collectibility is probable. These criteria are met at the time the product is shipped to, or picked up by, the customer. We recognize billings for freight and handling charges at the time the products are shipped to, or picked up by, the customer. We recognize services at the time the service is provided to the customer. We estimate product returns based on historical return rates. Accounts receivable are stated at their estimated net realizable value. The allowance for doubtful accounts is based on an analysis of customer accounts and our historical experience with accounts receivable write-offs. Sales taxes collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales in the accompanying consolidated statements of earnings.

Foreign Currency Translation and Transactions

The functional currency of our foreign operations is the applicable local currency. The functional currency is translated into United States dollars for balance sheet accounts (with the exception of retained earnings) using current exchange rates as of the balance sheet date, for retained earnings at historical exchange rates, and for revenue and expense accounts using a weighted average exchange rate during the period. The translation adjustments are deferred as a separate component of stockholders’ equity captioned accumulated other comprehensive income. Gains or losses resulting from transactions denominated in foreign currencies are included in operating and administrative expenses in the consolidated statements of earnings.

Cash and Cash Equivalents

Cash and cash equivalents are held primarily at two financial institutions. For purposes of the consolidated statements of cash flows, we consider all highly-liquid money market instruments purchased with original maturities of three months or less to be cash equivalents.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Financial Instruments and Marketable Securities

All financial instruments are carried at amounts that approximate estimated fair value. The fair value is the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties. Assets measured at fair value are categorized based upon the lowest level of significant input to the valuations. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration. Level 3 inputs are unobservable inputs based upon our own assumptions used to measure assets and liabilities at fair value. In determining fair value we use observable market data when available.

Marketable securities as of December 31, 2012 and 2011 consist of common stock and debt securities. We classify our marketable securities as available-for-sale. Available-for-sale securities are recorded at fair value based on current market value. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings but are included in comprehensive income and are reported as a separate component of stockholders’ equity until realized, unless a decline in the market value of any available-for-sale security is below cost then the amount is deemed other than temporary and is charged to earnings, resulting in the establishment of a new cost basis for the security.

Inventories

Inventories, consisting of finished goods merchandise held for resale, are stated at the lower of cost (first in, first out method) or market.

Property and Equipment

Property and equipment are stated at cost. Depreciation on buildings and equipment is provided for using the straight-line method over the anticipated economic useful lives of the related property. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, we first compare undiscounted cash flows expected to be generated by the asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values, and third-party independent appraisals, as considered necessary. There were no impairments recorded during any of the three years reported in these consolidated financial statements.

Leases

We lease space under operating leases for several distribution centers, several manufacturing locations, and certain store locations with initial terms of one to 60 months. Most store locations have initial lease terms of 36 to 48 months. These leases do not have significant rent escalation holidays, concessions, leasehold improvement incentives, or other build-out clauses. Any such terms are recognized as rent expense over the term of the lease. Further, the leases do not contain contingent rent provisions. Leasehold improvements on operating leases are amortized over a 36-month period. We lease certain semi-tractors and pick-ups under operating leases. The semi-tractor leases typically have a 36-month term. The pick-up leases typically have a non-cancellable lease term of one year, with renewal options for up to 72-months.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Other Long-Lived Assets

Other assets consist of prepaid security deposits, goodwill, non-compete agreements, and other related intangible assets. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. Goodwill is reviewed for impairment annually. The non-compete and related intangible assets are amortized on a straight-line basis over their estimated life.

Goodwill and other identifiable intangible long-lived assets are reviewed whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, or on an annual basis if no event or change occurs, to determine that the unamortized balances are recoverable. Recoverability is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset, and, in the case of goodwill, by also looking at an adverse change in legal factors or the business climate, a transition to a new product or services strategy, a significant change in the customer base, and/or a realization of failed marketing efforts. If the asset is deemed to be impaired, the amount of impairment is charged to earnings as a part of operating and administrative expenses in the current period. Assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to sell.

Accounting Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.

Insurance Reserves

We are self-insured for certain losses relating to medical, dental, workers’ compensation, and other casualty losses. Specific stop loss coverage is provided for catastrophic claims in order to limit exposure to significant claims. Losses and claims are charged to operations when it is probable a loss has been incurred and the amount can be reasonably estimated. Accrued insurance liabilities are based on claims filed and estimates of claims incurred but not reported.

Product Warranties

We offer a basic limited warranty for certain of our products. The specific terms and conditions of those warranties vary depending upon the product sold. We typically recoup these costs through product warranties we hold with the original equipment manufacturers. Our warranty expense has historically been minimal.

Stockholders’ Equity and Stock-Based Compensation

We have a stock option employee compensation plan ('stock option plan'). The options granted under our stock option plan vest and become exercisable over a period of up to eight years. Each option will terminate, to the extent not previously exercised, 13 months after the end of the relevant vesting period. Compensation expense equal to the grant date fair value is recognized for these awards over the vesting period.

Income Taxes

We account for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We record interest and penalties related to unrecognized tax benefits in income tax expense.

Earnings Per Share

Basic net earnings per share is calculated using net earnings available to common stockholders divided by the weighted average number of shares of common stock outstanding during the year. Diluted net earnings per share is similar to basic net earnings per share except that the weighted average number of shares of common stock outstanding includes the incremental shares assumed to be issued upon the exercise of stock options considered to be ‘in-the-money’ (i.e. when the market price of our stock is greater than the exercise price of our outstanding stock options).

Segment Reporting

We have determined that we meet the aggregation criteria outlined in the accounting standards as our various operations have similar (1) economic characteristics, (2) products and services, (3) customers, (4) distribution channels, and (5) regulatory environments. Therefore, we report as a single business segment.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 2. Financial Instruments and Marketable Securities

We follow a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest priority to measurements involving significant unobservable inputs (Level 3). The three levels of the fair value hierarchy are as follows:

•	Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.

•	Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, included in Level 1 that are observable either directly or indirectly.

•	Level 3 inputs are unobservable for the asset or liability, but are based upon our own assumptions used to measure assets and liabilities at fair value.

The level in the fair value hierarchy within which a fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.

The following table presents the placement in the fair value hierarchy of assets that are measured at fair value on a recurring basis:

December 31, 2012:	Total				Level 1			Level 2			Level 3
Common stock	$	354			354			—			—
Total available-for-sale securities	$	354			354			—			—

December 31, 2011:	Total				Level 1			Level 2			Level 3
Common stock	$	320			320			—			—
Government and agency securities	26,845				26,845			—			—
Total available-for-sale securities	$	27,165			27,165			—			—

There were no transfers between levels during 2012 and 2011.

As of December 31, 2012, our financial assets that are measured at fair value on a recurring basis include only common stock.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Marketable securities, all treated as available-for-sale securities, consist of the following:

December 31, 2012:	Amortized cost				Gross unrealized gains			Gross unrealized losses			Fair value
Common stock	$	197			157			—			354
Total available-for-sale securities	$	197			157			—			354

December 31, 2011:	Amortized cost				Gross unrealized gains			Gross unrealized losses			Fair value
Common stock	$	197			123			—			320
Government and agency securities	26,851				—			(6	)		26,845
Total available-for-sale securities	$	27,048			123			(6	)		27,165

The unrealized gains and losses recorded in accumulated other comprehensive income and the realized gains and losses recorded in earnings were immaterial during the three years reported in these consolidated financial statements.

Future maturities of our available-for-sale securities consist of the following:

	Less than 12 months							Greater than 12 months
December 31, 2012:	Amortized cost				Fair value			Amortized cost			Fair value
Common stock	$	197			354			—			—
Total available-for-sale securities	$	197			354			—			—

Note 3. Long-Lived Assets

Property and equipment

Property and equipment at year end consists of the following:

	Depreciable life in years			2012				2011
Land	—			$	31,831			31,350
Buildings and improvements	15 to 40			200,439				172,372
Automated storage and retrieval equipment	5 to 30			69,404				61,371
Equipment and shelving	3 to 10			398,240				339,471
Transportation equipment	3 to 5			52,093				49,074
Construction in progress	—			88,071				71,466
				840,078				725,104
Less accumulated depreciation				(323,651		)		(289,503	)
Net property and equipment				$	516,427			435,601

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 4. Accrued Expenses

Accrued expenses at year end consist of the following:

	2012				2011
Payroll and related taxes	$	19,614			16,808
Bonuses and commissions	14,159				16,233
Profit sharing contribution	11,110				7,717
Insurance	25,188				30,548
Promotions	13,581				10,866
Sales, real estate, and personal property taxes	38,562				26,676
Vehicle loss reserve and deferred rebates	200				743
Legal reserves	531				100
Other	3,210				2,271
	$	126,155			111,962

Note 5. Stockholders’ Equity

Our authorized, issued, and, outstanding shares (stated in whole numbers) at year end consist of the following:

	Par Value		2012			2011
Preferred Stock	.01/share
Authorized			5,000,000			5,000,000
Shares issued and outstanding			—			—
Common Stock	.01/share
Authorized			400,000,000			400,000,000
Shares issued and outstanding			296,564,382			295,258,674

Dividends

On January 16, 2013, our board of directors declared a quarterly dividend of $0.10 per share of common stock to be paid in cash on March 1, 2013 to shareholders of record at the close of business on February 1, 2013. We paid aggregate annual dividends per share of $1.24, $0.65, and $0.62 in 2012, 2011, and 2010, respectively.

Stock Options

The following tables summarize the details of grants made under our stock option plan that are still outstanding, and the assumptions used to value these grants. All options granted were effective at the close of business on the date of grant.

	Options granted			Option exercise (strike) price				Closing stock price on date of grant				December 31, 2012
Date of grant	Options outstanding			Options vested
April 17, 2012	1,235,000			$	54.00			$	49.01			1,177,500			—
April 19, 2011	410,000			$	35.00			$	31.78			380,000			—
April 20, 2010	530,000			$	30.00			$	27.13			380,000			—
April 21, 2009	790,000			$	27.00			$	17.61			540,000			—
April 15, 2008	550,000			$	27.00			$	24.35			286,167			116,167
April 17, 2007	4,380,000			$	22.50			$	20.15			2,072,125			1,052,625
Total	7,895,000											4,835,792			1,168,792

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Date of grant	Risk-free interest rate			Expected life of option in years			Expected dividend yield			Expected stock volatility			Estimated fair value of stock option
April 17, 2012	0.9	%		5.00			1.4	%		39.25	%		$	13.69
April 19, 2011	2.1	%		5.00			1.6	%		39.33	%		$	11.20
April 20, 2010	2.6	%		5.00			1.5	%		39.10	%		$	8.14
April 21, 2009	1.9	%		5.00			1.0	%		38.80	%		$	3.64
April 15, 2008	2.7	%		5.00			1.0	%		30.93	%		$	7.75
April 17, 2007	4.6	%		4.85			1.0	%		31.59	%		$	5.63

All of the options in the tables above vest and become exercisable over a period of up to eight years. Each option will terminate, to the extent not previously exercised, 13 months after the end of the relevant vesting period.

The fair value of each share-based option was estimated on the date of grant using a Black-Scholes valuation method that uses the assumptions listed above. The expected life is the average length of time over which we expect the employee groups will exercise their options, which is based on historical experience with similar grants. Expected volatilities are based on the movement of our stock over the most recent historical period equivalent to the expected life of the option. The risk-free interest rate is based on the U.S. Treasury rate over the expected life at the time of grant. The dividend yield is estimated over the expected life based on our current dividend payout, historical dividends paid, and expected future cash dividends.

A summary of the activity under our stock option plan is as follows:

	Options outstanding			Exercise Price1				Remaining Life2
Outstanding as of January 1, 2012	5,132,750			$	24.92			4.72
Granted	1,235,000			$	54.00			8.41
Exercised/earned	(1,305,708	)		$	22.70
Cancelled/forfeited	(226,250	)		$	34.12
Outstanding as of December 31, 2012	4,835,792			$	32.51			5.40
Exercisable as of December 31, 2012	1,168,792			$	22.95			3.45

	Options outstanding			Exercise Price1				Remaining Life2
Outstanding as of January 1, 2011	5,320,000			$	24.03			5.50
Granted	410,000			$	35.00			7.93
Exercised/earned	(397,250	)		22.50
Cancelled/forfeited	(200,000	)		$	26.78
Outstanding as of December 31, 2011	5,132,750			$	24.92			4.72
Exercisable as of December 31, 2011	1,852,750			$	22.50			3.16

1	Weighted-average exercise price

2	Weighted-average remaining contractual life in years

The total intrinsic value of stock options exercised during the years ended December 31, 2012, 2011, and 2010 was $34,424, $4,977, and $0, respectively. The intrinsic value represents the difference between the exercise price and fair value of the underlying shares at a specified date.

At December 31, 2012, there was $20,131 of total unrecognized compensation cost related to unvested stock options granted under the plan. The cost is expected to be recognized over a weighted average period of 4.69 years. The total fair value of shares vested under our stock option plan during 2012, 2011, and 2010 was $3,866, $9,168, and $1,125, respectively.

Total stock-based compensation expense related to our stock option plan was $4,800, $4,050, and $4,030 for 2012, 2011, and 2010, respectively.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Earnings Per Share

The following tables present a reconciliation of the denominators used in the computation of basic and diluted earnings per share and a summary of the options to purchase shares of common stock which were excluded from the diluted earnings calculation because they were anti-dilutive:

Reconciliation	2012			2011			2010
Basic-weighted average shares outstanding	296,089,348			295,053,790			294,861,424
Weighted shares assumed upon exercise of stock options	1,061,602			814,936			—
Diluted-weighted average shares outstanding	297,150,950			295,868,726			294,861,424

Summary of anti-dilutive options excluded	2012				2011			2010
Options to purchase shares of common stock	847,254				704,384			5,328,246
Weighted-average exercise prices of options	$	54.00			32.05			23.94

Any dilutive impact summarized above would relate to periods when the average market price of our stock exceeded the exercise price of the potentially dilutive option securities then outstanding.

Note 6. Retirement Savings Plan

The Fastenal Company and Subsidiaries 401(k) and Employee Stock Ownership Plan covers all of our employees in the United States. Our employees in Canada may participate in a Registered Retirement Savings Plan. The general purpose of both of these plans is to provide additional financial security during retirement by providing employees with an incentive to make regular savings. In addition to the contributions of our employees, we make a profit sharing contribution on an annual basis based on an established formula. Our contribution under this profit sharing formula was approximately $11,110, $7,717 and $5,005 for 2012, 2011, and 2010, respectively.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 7. Income Taxes

Earnings before income taxes were derived from the following sources:

	2012				2011			2010
Domestic	$	649,098			545,527			409,068
Foreign	25,057				29,554			21,572
	$	674,155			575,081			430,640

Components of income tax expense (benefit) are as follows:

2012 :	Current				Deferred			Total
Federal	$	202,095			14,742			216,837
State	27,586				981			28,567
Foreign	8,476				(261	)		8,215
	$	238,157			15,462			253,619

2011 :	Current				Deferred			Total
Federal	$	164,125			17,343			181,468
State	28,669				(244	)		28,425
Foreign	8,683				(1,424	)		7,259
	$	201,477			15,675			217,152

2010 :	Current				Deferred			Total
Federal	$	136,247			(936	)		135,311
State	22,914				(492	)		22,422
Foreign	4,448				3,103			7,551
	$	163,609			1,675			165,284

Income tax expense in the accompanying consolidated financial statements differs from the expected expense as follows:

	2012				2011			2010
Federal income tax expense at the ‘expected’ rate of 35%	$	235,954			201,278			150,724
Increase (decrease) attributed to:
State income taxes, net of federal benefit	19,565				18,210			14,259
State tax matters	884				737			1,238
Other, net	(2,784		)		(3,073	)		(937	)
Total income tax expense	$	253,619			217,152			165,284

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

The tax effects of temporary differences that give rise to deferred income tax assets and liabilities at year end are as follows:

	2012				2011
Deferred income tax asset (liability):
Inventory costing and valuation methods	$	4,045			4,643
Allowance for doubtful accounts receivable	2,618				2,202
Insurance claims payable	7,825				10,807
Promotions payable	945				797
Accrued legal reserves	207				39
Stock based compensation	4,715				5,853
Federal and state benefit of uncertain tax positions	1,871				1,632
Other, net	267				920
Total deferred income tax assets	22,493				26,893
Property and equipment	(59,371		)		(48,329	)
Total deferred income tax liabilities	(59,371		)		(48,329	)
Net deferred income tax asset (liability)	$	(36,878	)		(21,436	)

No significant valuation allowance for deferred tax assets was necessary as of December 31, 2012 and 2011. The character of the deferred tax assets is such that they can typically be realized through carryback to prior tax periods or offset against future taxable income.

A reconciliation of the beginning and ending amount of total gross unrecognized tax benefits is as follows:

	2012				2011
Balance at start of year:	$	4,653			3,617
Increase related to prior year tax positions	172				578
Decrease related to prior year tax positions	(1,025		)		(65	)
Increase related to current year tax positions	2,170				523
Decrease related to statute of limitation lapses	—				—
Settlements	(639		)		—
Balance at end of year:	$	5,331			4,653

Included in the liability for unrecognized tax benefits is an immaterial amount for interest and penalties, both of which we classify as a component of income tax expense. The amount of unrecognized tax benefits that would favorably impact the effective tax rate, if recognized, is not material.

Fastenal Company or one of its subsidiaries files income tax returns in the United States federal jurisdiction, all states, and various foreign jurisdictions. With limited exceptions, we are no longer subject to income tax examinations by taxing authorities for taxable years before 2009 in the case of United States federal and non-United States examinations and 2008 in the case of state and local examinations.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 8. Geographic Information

Our revenues and long-lived assets relate to the following geographic areas:

Revenues	2012				2011			2010
United States	$	2,798,124			2,474,805			2,067,860
Canada	218,570				198,592			145,078
Other foreign countries	116,883				93,462			56,533
	$	3,133,577			2,766,859			2,269,471

Long-Lived Assets	2012				2011			2010
United States	$	495,609			426,329			361,083
Canada	15,954				11,105			9,536
Other foreign countries	17,613				11,376			6,814
	$	529,176			448,810			377,433

The accounting policies of the operations in the various geographic areas are the same as those described in the summary of significant accounting policies. Long-lived assets consist of property and equipment, location security deposits, goodwill, and other intangibles. Revenues are attributed to countries based on the location of the store from which the sale occurred. No single customer represents 10% or more of our consolidated net sales.

Note 9. Operating Leases

We lease space under non-cancelable operating leases for several distribution centers, several manufacturing locations, and certain store locations with initial terms of one to 60 months. Most store locations have initial lease terms of 36 to 48 months. These leases do not have significant rent escalation holidays, concessions, leasehold improvement incentives, or other build-out clauses. Any such terms are recognized as rent expense over the term of the lease. Further, the leases do not contain contingent rent provisions. Leasehold improvements, with a net book value of $2,180 at December 31, 2012, on operating leases are amortized over a 36-month period. We lease certain semi-tractors and pick-ups under operating leases. The semi-tractor leases typically have a 36-month term. The pick-up leases typically have a non-cancellable lease term of approximately one year, with renewal options for up to 72-months. Our average lease term for pick-ups is typically for 28 to 36 months. Future minimum annual rentals for the leased facilities and the leased vehicles are as follows:

	Leased facilities				Leased vehicles			Total
2013	$	87,942			18,962			106,904
2014	64,092				10,017			74,109
2015	42,993				4,473			47,466
2016	23,343				—			23,343
2017	7,603				—			7,603
2018 and thereafter	—				—			—
	$	225,973			33,452			259,425

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Rent expense under all operating leases was as follows:

	Leased facilities				Leased vehicles			Total
2012	$	96,540			29,039			125,579
2011	$	95,808			23,866			119,674
2010	$	92,854			21,540			114,394

Certain operating leases for vehicles contain residual value guarantee provisions which would generally become due at the expiration of the operating lease agreement if the fair value of the leased vehicles is less than the guaranteed residual value. The aggregate residual value guarantee related to these leases is approximately $43,654. We believe the likelihood of funding the guarantee obligation under any provision of the operating lease agreements is remote, except for a $200 loss on disposal reserve provided at December 31, 2012. Our fleet also contains vehicles we estimate will settle at a gain. Gains on these vehicles will be recognized when we sell or dispose of the vehicle or at the end of the lease term.

Note 10. Commitments and Contingencies

Credit Facilities and Commitments

In December 2012, we entered into a new $125 million unsecured revolving credit facility. The facility includes a $40 million letter of credit subfacility. The facility will expire, and any outstanding loans under the facility will mature on December 13, 2015. At year end there was one letter of credit outstanding under the facility, with an undrawn balance of $29,250. No loans were outstanding under the facility at year end.

Loans under the facility, other than swing line loans, bear interest at a rate per annum equal to, at our election, either (i) LIBOR for an interest period of one month, reset daily, plus 0.875%, or (ii) LIBOR for an interest period of one, two, three, six or twelve months as selected by us, reset at the end of the selected interest period, plus 0.875%. Swing line loans bear interest at a rate per annum equal to LIBOR for an interest period of one month, reset daily, plus 0.875%. We pay a commitment fee for the unused portion of the facility of 0.10% per annum, if the average quarterly utilization of the facility is 20% or more, or 0.125% per annum, if the average quarterly utilization of the facility is less than 20%. For each letter of credit issued under the facility, we pay a commission fee on the amount available to be drawn under such letter of credit equal to 0.875% per annum and, subject to certain exceptions, an issuance fee equal to 0.075% of the face amount of such letter of credit.

During 2001, we completed the construction of a new building for our Kansas City warehouse, and completed an expansion of this warehouse in 2004. We were required to obtain financing for the construction and expansion of this facility under an Industrial Revenue Bond ('IRB'). We subsequently purchased 100% of the outstanding bonds under the IRB at par. In addition to purchasing the outstanding obligations, we have a right of offset included in the IRB debt agreement. Accordingly, we have netted the impact of the IRB in the accompanying consolidated financial statements. The outstanding balance of the IRB was approximately $3,200 and $9,733 at December 31, 2012 and 2011, respectively.

Legal Contingencies

We are involved in certain legal actions. The outcomes of these legal actions are not within our complete control and may not be known for prolonged periods of time. In some actions, the claimants seek damages, as well as other relief, that could require significant expenditures or result in lost revenues. We record a liability for these legal actions when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is reasonably possible but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed. In most cases, significant judgment is required to estimate the amount and timing of a loss to be recorded. As of December 31, 2012, there were no material litigation matters that we consider to be probable or reasonably estimable.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 11. Sales by Product Line

The percentages of our net sales by product line are as follows:

Type	Introduced		2012		2011		2010
Fasteners1	1967		44.0%		46.9%		49.1%
Tools	1993		9.3%		9.4%		9.3%
Cutting tools	1996		5.1%		4.6%		4.4%
Hydraulics & pneumatics	1996		7.6%		7.8%		7.2%
Material handling	1996		6.0%		6.1%		6.1%
Janitorial supplies	1996		6.6%		6.2%		6.1%
Electrical supplies	1997		4.7%		4.7%		4.6%
Welding supplies	1997		4.3%		3.9%		3.6%
Safety supplies	1999		9.3%		7.9%		7.0%
Metals	2001		0.5%		0.5%		0.5%
Direct ship2	2004		1.6%		1.6%		1.6%
Office supplies	2010		0.1%		0.1%		0.1%
Other			0.9%		0.3%		0.4%
			100.0%		100.0%		100.0%

1	Fastener product line represents fasteners and miscellaneous supplies.

2	Direct ship represents a cross section of products from the eleven product lines. The items included here represent certain items with historically low margins which are shipped directly from our distribution channel to our customers, bypassing our store network.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 12. Subsequent Events

We evaluated all subsequent event activity and concluded that no subsequent events have occurred that would require recognition in the financial statements or disclosure in the notes to the financial statements, with the exception of the dividend disclosed in note 5.

Note 13. New and Proposed Accounting Pronouncements

In June 2011, the Financial Accounting Standards Board ('FASB') issued Accounting Standards Update ('ASU') No. 2011-06, Comprehensive Income (Topic 820). This accounting standard update eliminates the option to present components of other comprehensive income as part of the statement of equity and requires that the total of comprehensive income, the components of net income, and the components of other comprehensive income be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. It also requires presentation on the face of the financial statements of reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. This accounting standard update was effective beginning in our first quarter of fiscal 2012. The adoption of this accounting standard did not have an impact on our financial statements other than the presentation of the required information.

In August 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350) Testing Goodwill for Impairment (and in February 2012 provided additional information with the issuance of ASU No. 2012-02). These updates approved a revised accounting standard update intended to simplify how an entity tests goodwill for impairment. The amendment allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity is no longer required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount. We adopted these accounting standard updates in the quarters they were issued. The adoption of these accounting standard updates did not have a material impact on our financial statements.

Proposed Accounting Pronouncements

In recent exposure drafts, the International Accounting Standards Board and the FASB proposed a new approach to the accounting for leases. From a lessee’s perspective, the exposure drafts propose to abolish the distinction between operating and finance/capital leases. In its place, a right-of-use model would be used. This proposal, as currently written, would require the lessee to recognize an asset for its right to use the underlying leased asset and a liability for its obligation to make lease payments. This would lead to an increase in assets and liabilities for leases currently classified as operating leases and could also lead to a change in timing as to when the expense is recognized. This exposure draft is not yet finalized; however, we believe knowledge of this information is useful to the reader of our financial statements as many of our store locations and many of our vehicles are currently leased, and those leases are accounted for as operating leases.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 14. Selected Quarterly Financial Data (Unaudited)

(Amounts in thousands except per share information)

2012 :	Net sales				Gross profit			Pre-tax earnings			Net earnings			Basic net earnings per share1
First quarter	$	768,875			394,177			161,129			100,194			0.34
Second quarter	804,890				415,151			179,039			112,306			0.38
Third quarter	802,577				414,375			175,836			109,320			0.37
Fourth quarter	757,235				390,821			158,151			98,716			0.33
Total	$	3,133,577			1,614,524			674,155			420,536			1.42

2011 :	Net sales				Gross profit			Pre-tax earnings			Net earnings			Basic net earnings per share1
First quarter	$	640,583			333,380			128,811			79,547			0.27
Second quarter	701,730				366,233			150,182			94,112			0.32
Third quarter	726,742				377,381			155,319			96,798			0.33
Fourth quarter	697,804				357,178			140,769			87,472			0.30
Total	$	2,766,859			1,434,172			575,081			357,929			1.21

1 Note – Amounts may not foot due to rounding difference.

End of Notes to Consolidated Financial Statements