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, 2013 and 2012, 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, 2013. 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, 2013, based on criteria established in Internal Control – Integrated Framework (1992) 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, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, 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, 2013, based on criteria established in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

/s/ KPMG LLP

Minneapolis, Minnesota

February 6, 2014

FASTENAL COMPANY AND SUBSIDIARIES

Consolidated Balance Sheets

(Amounts in thousands except share information)

	December 31
	2013				2012
ASSETS
Current assets:
Cash and cash equivalents	$	58,506			79,611
Marketable securities	451				354
Trade accounts receivable, net of allowance for doubtful accounts of $9,248 and $6,728, respectively	414,331				372,159
Inventories	784,068				715,383
Deferred income tax assets	18,248				14,420
Prepaid income taxes	24,869				7,368
Other current assets	107,988				97,361
Total current assets	1,408,461				1,286,656
Property and equipment, less accumulated depreciation	654,850				516,427
Other assets, net	12,473				12,749
Total assets	$	2,075,784			1,815,832
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	91,253			78,019
Accrued expenses	148,579				126,155
Total current liabilities	239,832				204,174
Deferred income tax liabilities	63,255				51,298
Commitments and contingencies (notes 5, 9, and 10)
Stockholders’ equity:
Preferred stock, 5,000,000 shares authorized	—				—
Common stock, 400,000,000 shares authorized, 296,753,544 and 296,564,382 shares issued and outstanding, respectively	2,968				2,966
Additional paid-in capital	69,847				61,436
Retained earnings	1,688,781				1,477,601
Accumulated other comprehensive income	11,101				18,357
Total stockholders’ equity	1,772,697				1,560,360
Total liabilities and stockholders’ equity	$	2,075,784			1,815,832

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,

	2013				2012			2011
Net sales	$	3,326,106			3,133,577			2,766,859
Cost of sales	1,606,661				1,519,053			1,332,687
Gross profit	1,719,445				1,614,524			1,434,172
Operating and administrative expenses	1,007,431				941,236			859,369
(Gain) loss on sale of property and equipment	(643		)		(403	)		194
Operating income	712,657				673,691			574,609
Interest income	924				464			472
Interest expense	(113		)		—			—
Earnings before income taxes	713,468				674,155			575,081
Income tax expense	264,832				253,619			217,152
Net earnings	$	448,636			420,536			357,929
Basic net earnings per share	$	1.51			1.42			1.21
Diluted net earnings per share	$	1.51			1.42			1.21
Basic weighted average shares outstanding	296,754				296,089			295,054
Diluted weighted average shares outstanding	297,684				297,151			295,869

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,

	2013				2012			2011
Net earnings	$	448,636			420,536			357,929
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments (net of tax of $0 in 2013, 2012, and 2011)	(7,354		)		3,522			(3,791	)
Change in marketable securities (net of tax of $0 in 2013, 2012, and 2011)	98				39			95
Comprehensive income	$	441,380			424,097			354,233

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, 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
Dividends paid in cash	—			—				—			(237,456	)		—			(237,456	)
Purchases of common stock	(200	)		(2		)		(9,078	)		—			—			(9,080	)
Stock options exercised	389			4				9,302			—			—			9,306
Stock-based compensation	—			—				5,400			—			—			5,400
Excess tax benefits from stock-based compensation	—			—				2,787			—			—			2,787
Net earnings	—			—				—			448,636			—			448,636
Other comprehensive income (loss)	—			—				—			—			(7,256	)		(7,256	)
Balance as of December 31, 2013	296,753			$	2,968			69,847			1,688,781			11,101			1,772,697

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,

	2013				2012			2011
Cash flows from operating activities:
Net earnings	$	448,636			420,536			357,929
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation of property and equipment	63,770				53,459			44,113
(Gain) loss on sale of property and equipment	(643		)		(403	)		194
Bad debt expense	9,421				9,726			9,217
Deferred income taxes	8,129				15,442			15,747
Stock-based compensation	5,400				4,800			4,050
Excess tax benefits from stock-based compensation	(2,787		)		(10,149	)		—
Amortization of non-compete agreements	421				593			593
Changes in operating assets and liabilities:
Trade accounts receivable	(51,593		)		(43,291	)		(77,678	)
Inventories	(68,685		)		(69,231	)		(88,783	)
Other current assets	(10,627		)		(7,528	)		(19,294	)
Accounts payable	13,234				4,240			13,305
Accrued expenses	22,424				14,193			15,550
Income taxes	(14,714		)		704			(3,222	)
Other	(6,266		)		3,201			(3,232	)
Net cash provided by operating activities	416,120				396,292			268,489
Cash flows from investing activities:
Purchases of property and equipment	(206,540		)		(138,406	)		(120,043	)
Proceeds from sale of property and equipment	4,990				4,524			3,554
Net (increase) decrease in marketable securities	(97		)		26,811			4,054
(Increase) decrease in other assets	(145		)		(133	)		212
Net cash used in investing activities	(201,792		)		(107,204	)		(112,223	)
Cash flows from financing activities:
Borrowings under line of credit	260,000				—			—
Payments against line of credit	(260,000		)		—			—
Proceeds from exercise of stock options	9,306				29,644			8,939
Excess tax benefits from stock-based compensation	2,787				10,149			983
Purchases of common stock	(9,080		)		—			—
Payment of dividends	(237,456		)		(367,306	)		(191,741	)
Net cash used in financing activities	(234,443		)		(327,513	)		(181,819	)
Effect of exchange rate changes on cash	(990		)		360			(464	)
Net decrease in cash and cash equivalents	(21,105		)		(38,065	)		(26,017	)
Cash and cash equivalents at beginning of year	79,611				117,676			143,693
Cash and cash equivalents at end of year	$	58,506			79,611			117,676
Supplemental disclosure of cash flow information:
Cash paid during each year for interest	$	113			—			—
Cash paid during each year for income taxes	$	270,615			268,357			205,614

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 a store-based business with approximately 2,700 locations. These locations are primarily in North America.

Principles of Consolidation

The consolidated financial statements include the accounts of Fastenal Company and its 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 (and value added taxes in foreign jurisdictions) 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

We consider all investments purchased with original maturities of three months or less to be cash equivalents.

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, 2013 and 2012 consist of common stock. 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.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

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 certain distribution centers, stores, and manufacturing locations. 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 their estimated service lives on a straight-line basis. We lease certain semi-tractors and pick-ups under operating leases.

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.

Accounting Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) 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.

Stock-Based Compensation

We estimate the value of stock option grants using a Black-Scholes valuation model. Stock-based compensation expense is recognized on a straight-line basis over the vesting period. Our stock-based compensation expense is recorded in operating and administrative expenses in the Consolidated Statements of Earnings.

We report the benefits of tax deductions in excess of recognized stock-based compensation as cash flows from financing activities, thereby reducing net operating cash flows and increasing net financing cash flows.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

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.

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 and how they are determined are defined earlier in Note 1.

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, 2013:	Total				Level 1			Level 2			Level 3
Common stock	$	451			451			—			—
Total available-for-sale securities	$	451			451			—			—

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

There were no transfers between levels during 2013 and 2012.

As of December 31, 2013, our financial assets that are measured at fair value on a recurring basis include only common stock.

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

December 31, 2013:	Amortized Cost				Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
Common stock	$	197			254			—			451
Total available-for-sale securities	$	197			254			—			451

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

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, 2013:	Amortized Cost				Fair Value			Amortized Cost			Fair Value
Common stock	$	197			451			—			—
Total available-for-sale securities	$	197			451			—			—

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 3. Long-Lived Assets

Property and equipment

Property and equipment at year end consists of the following:

	Depreciable Life in Years			2013				2012
Land	—			$	36,644			31,831
Buildings and improvements	15 to 40			216,852				200,439
Automated storage and retrieval equipment	5 to 30			98,474				69,404
Equipment and shelving	3 to 10			462,224				398,240
Transportation equipment	3 to 5			57,536				52,093
Construction in progress	—			148,172				88,071
				1,019,902				840,078
Less accumulated depreciation				(365,052		)		(323,651	)
Net property and equipment				$	654,850			516,427

Note 4. Accrued Expenses

Accrued expenses at year end consist of the following:

	2013				2012
Payroll and related taxes	$	21,960			19,614
Bonuses and commissions	12,502				14,159
Profit sharing contribution	12,211				11,110
Insurance	30,880				25,188
Promotions	18,047				13,581
Sales, real estate, and personal property taxes	47,784				38,562
Vehicle loss reserve and deferred rebates	36				200
Legal reserves	795				531
Other	4,364				3,210
	$	148,579			126,155

Note 5. Stockholders’ Equity

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

	Par Value		2013			2012
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			296,753,544			296,564,382

Dividends

On January 14, 2014, our board of directors declared a quarterly dividend of $0.25 per share of common stock to be paid in cash on February 28, 2014 to shareholders of record at the close of business on January 31, 2014. We paid aggregate annual dividends per share of $0.80, $1.24, and $0.65 in 2013, 2012, and 2011, respectively.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

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, 2013
Date of Grant	Options Outstanding			Options Exercisable
April 16, 2013	205,000			$	54.00			$	49.25			172,500			—
April 17, 2012	1,235,000			$	54.00			$	49.01			1,127,500			—
April 19, 2011	410,000			$	35.00			$	31.78			350,000			25,000
April 20, 2010	530,000			$	30.00			$	27.13			300,000			—
April 21, 2009	790,000			$	27.00			$	17.61			413,300			173,300
April 15, 2008	550,000			$	27.00			$	24.35			206,750			113,000
April 17, 2007	4,380,000			$	22.50			$	20.15			1,786,580			1,131,080
Total	8,100,000											4,356,630			1,442,380

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 16, 2013	0.7	%		5.00		1.6	%		37.42	%		$	12.66
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, 2013	4,835,792			$	32.51			5.40
Granted	205,000			$	54.00			8.41
Exercised	(389,162	)		$	23.91
Cancelled/forfeited	(295,000	)		$	35.89
Outstanding as of December 31, 2013	4,356,630			$	34.06			4.66
Exercisable as of December 31, 2013	1,442,380			$	23.61			2.74

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

	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	(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

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, 2013, 2012, and 2011 was $9,925, $34,424, and $4,977, 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, 2013, there was $15,976 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 4.21 years. The total grant date fair value of options vested under our stock option plan during 2013, 2012, and 2011 was $3,508, $3,866, and $9,168, respectively.

Total stock-based compensation expense related to our stock option plan was $5,400, $4,800, and $4,050 for 2013, 2012, and 2011, respectively.

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	2013			2012			2011
Basic-weighted average shares outstanding	296,754,160			296,089,348			295,053,790
Weighted shares assumed upon exercise of stock options	929,428			1,061,602			814,936
Diluted-weighted average shares outstanding	297,683,588			297,150,950			295,868,726

Summary of Anti-dilutive Options Excluded	2013				2012			2011
Options to purchase shares of common stock	1,273,527				847,254			704,384
Weighted-average exercise prices of options	$	54.00			54.00			32.05

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 $12,211, $11,110 and $7,717 for 2013, 2012, and 2011, 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:

	2013				2012			2011
Domestic	$	697,062			649,098			545,527
Foreign	16,406				25,057			29,554
	$	713,468			674,155			575,081

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

2013 :	Current				Deferred			Total
Federal	$	220,588			8,547			229,135
State	29,073				527			29,600
Foreign	7,487				(1,390	)		6,097
	$	257,148			7,684			264,832

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

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

	2013				2012			2011
Federal income tax expense at the ‘expected’ rate of 35%	$	249,714			235,954			201,278
Increase (decrease) attributed to:
State income taxes, net of federal benefit	17,150				19,565			18,210
State tax matters	(467		)		884			737
Other, net	(1,565		)		(2,784	)		(3,073	)
Total income tax expense	$	264,832			253,619			217,152

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:

	2013				2012
Deferred income tax assets (liabilities):
Inventory costing and valuation methods	$	3,834			4,045
Allowance for doubtful accounts receivable	3,586				2,618
Insurance claims payable	10,594				7,825
Promotions payable	1,240				945
Accrued legal reserves	309				207
Stock-based compensation	5,974				4,715
Federal and state benefit of uncertain tax positions	1,158				1,871
Foreign net operating loss and credit carryforwards	5,089				3,309
Foreign valuation allowances	(2,819		)		(2,090	)
Other, net	(1,482		)		(952	)
Total deferred income tax assets	27,483				22,493
Property and equipment	(72,490		)		(59,371	)
Total deferred income tax liabilities	(72,490		)		(59,371	)
Net deferred income tax assets (liabilities)	$	(45,007	)		(36,878	)

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

	2013				2012
Balance at start of year:	$	5,331			4,653
Increase related to prior year tax positions	37				172
Decrease related to prior year tax positions	(1,695		)		(1,025	)
Increase related to current year tax positions	1,058				2,170
Decrease related to statute of limitation lapses	—				—
Settlements	(1,449		)		(639	)
Balance at end of year:	$	3,282			5,331

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 2010 in the case of United States federal and non-United States examinations and 2009 in the case of state and local examinations.

In general, it is our practice and intention to reinvest the earnings of our foreign subsidiaries into our foreign operations. As of December 31, 2013, we have not made a provision for United States income taxes or for additional foreign withholding taxes on approximately $85,000 of the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries that are essentially permanent in duration. Generally, such amounts become subject to United States taxation upon the remittance of dividends and under certain other circumstances. It is not practicable to estimate the amount of deferred income tax liabilities related to investments in these foreign subsidiaries.

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	2013				2012			2011
United States	$	2,951,673			2,798,124			2,474,805
Canada	227,756				218,570			198,592
Other foreign countries	146,677				116,883			93,462
	$	3,326,106			3,133,577			2,766,859

Long-Lived Assets	2013				2012			2011
United States	$	632,783			495,609			426,329
Canada	22,572				15,954			11,105
Other foreign countries	11,968				17,613			11,376
	$	667,323			529,176			448,810

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 $1,827 at December 31, 2013, 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-cancelable 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
2014	$	89,289			20,263			109,552
2015	65,242				10,796			76,038
2016	41,115				4,733			45,848
2017	20,575				—			20,575
2018	8,894				—			8,894
2019 and thereafter	—				—			—
	$	225,115			35,792			260,907

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Rent expense under all operating leases was as follows:

	Leased Facilities				Leased Vehicles			Total
2013	$	99,483			32,907			132,390
2012	$	96,540			29,039			125,579
2011	$	95,808			23,866			119,674

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 $44,720. We believe the likelihood of funding the guarantee obligation under any provision of the operating lease agreements is remote, except for a $36 loss on disposal reserve provided at December 31, 2013. 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 $125,000 unsecured revolving credit facility. The facility includes a $40,000 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 were undrawn letters of credit outstanding under the facility, with a face amount of $34,415. 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 at December 31, 2013 and 2012.

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, 2013, there were no litigation matters that we consider to be probable or reasonably possible to have a material adverse outcome.

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		2013		2012		2011
Fasteners1	1967		42.1%		44.0%		46.9%
Tools	1993		9.2%		9.3%		9.4%
Cutting tools	1996		5.4%		5.1%		4.6%
Hydraulics & pneumatics	1996		7.3%		7.6%		7.8%
Material handling	1996		5.7%		6.0%		6.1%
Janitorial supplies	1996		7.0%		6.6%		6.2%
Electrical supplies	1997		4.6%		4.7%		4.7%
Welding supplies	1997		4.5%		4.3%		3.9%
Safety supplies	1999		11.2%		9.3%		7.9%
Metals	2001		0.5%		0.5%		0.5%
Direct ship2	2004		1.5%		1.6%		1.6%
Office supplies	2010		0.1%		0.1%		0.1%
Other			0.9%		0.9%		0.3%
			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.

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 February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220) Reporting of Amounts Reclassified Out Of Accumulated Other Comprehensive Income. This accounting standard requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. This accounting standard update was effective beginning in our first quarter of 2013. The adoption of this accounting standard did not have a material impact on our financial statements.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Proposed Accounting Pronouncements

In May 2013, the FASB reissued an exposure draft on lease accounting that would require entities to recognize assets and liabilities arising from lease contracts on the balance sheet. The proposed exposure draft states that lessees and lessors should apply a “right-of-use model” in accounting for all leases. Under the proposed model, lessees would recognize an asset for the right to use the leased asset, and a liability for the obligation to make rental payments over the lease term. When measuring the asset and liability, variable lease payments are excluded whereas renewal options that provide a significant economic incentive upon renewal would be included. The lease expense from real estate based leases would continue to be recorded under a straight line approach, but other leases not related to real estate would be expensed using an effective interest method that would accelerate lease expense. Comments were due by September 13, 2013 and redeliberations are anticipated in 2014. Upon issuance of a final standard, we will evaluate the impact the adoption of the guidance would have on our financial position, results of operations, and cash flows. 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.

Note 14. Selected Quarterly Financial Data (Unaudited)

(Amounts in thousands except per share information)

2013 :	Net Sales				Gross Profit			Pre-tax Earnings			Net Earnings			Basic Net Earnings per Share
First quarter	$	806,326			421,880			175,172			109,048			0.37
Second quarter	847,596				442,721			192,379			121,009			0.41
Third quarter	858,424				443,395			188,643			119,350			0.40
Fourth quarter	813,760				411,449			157,274			99,229			0.33
Total	$	3,326,106			1,719,445			713,468			448,636			1.51

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

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

End of Notes to Consolidated Financial Statements