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, 2016 and 2015, 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, 2016. 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, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 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, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, 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. Also in our opinion, Fastenal Company and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by COSO.

/s/ KPMG LLP

Minneapolis, Minnesota

February 6, 2017

FASTENAL COMPANY AND SUBSIDIARIES

Consolidated Balance Sheets

(Amounts in thousands except share information)

	December 31
	2016				2015
Assets
Current assets:
Cash and cash equivalents	$	112,735			129,019
Trade accounts receivable, net of allowance for doubtful accounts of $11,249 and $11,729, respectively	499,716				468,375
Inventories	992,989				913,263
Prepaid income taxes	12,907				22,558
Other current assets	102,423				131,561
Total current assets	1,720,770				1,664,776
Property and equipment, net	899,697				818,889
Other assets, net	48,417				48,797
Total assets	$	2,668,884			2,532,462
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of debt	$	10,482			62,050
Accounts payable	108,740				125,973
Accrued expenses	156,422				185,143
Total current liabilities	275,644				373,166
Long-term debt	379,518				302,950
Deferred income tax liabilities	80,628				55,057
Commitments and contingencies (Notes 4, 8, and 9)
Stockholders’ equity:
Preferred stock, $0.01 par value, 5,000,000 shares authorized; no shares issued or outstanding	—				—
Common stock, $0.01 par value, 400,000,000 shares authorized; 289,161,924 and 289,581,682 shares issued and outstanding, respectively	2,892				2,896
Additional paid-in capital	37,363				2,024
Retained earnings	1,940,143				1,842,772
Accumulated other comprehensive income (loss)	(47,304		)		(46,403	)
Total stockholders’ equity	1,933,094				1,801,289
Total liabilities and stockholders’ equity	$	2,668,884			2,532,462

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

	2016				2015			2014
Net sales	$	3,962,036			3,869,187			3,733,507
Cost of sales	1,997,259				1,920,253			1,836,105
Gross profit	1,964,777				1,948,934			1,897,402
Operating and administrative expenses	1,169,470				1,121,590			1,110,776
Gain on sale of property and equipment	(532		)		(1,411	)		(964	)
Operating income	795,839				828,755			787,590
Interest income	394				373			759
Interest expense	(6,504		)		(3,108	)		(915	)
Earnings before income taxes	789,729				826,020			787,434
Income tax expense	290,251				309,659			293,284
Net earnings	$	499,478			516,361			494,150
Basic net earnings per share	$	1.73			1.77			1.67
Diluted net earnings per share	$	1.73			1.77			1.66
Basic weighted average shares outstanding	288,950				291,453			296,490
Diluted weighted average shares outstanding	289,158				292,045			297,313

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

	2016				2015			2014
Net earnings	$	499,478			516,361			494,150
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments (net of tax of $0 in 2016, 2015, and 2014)	(901		)		(38,567	)		(18,683	)
Change in marketable securities (net of tax of $0 in 2016, 2015, and 2014)	—				—			(254	)
Comprehensive income	$	498,577			477,794			475,213

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, 2013	296,753			$	2,968			69,847			1,688,781			11,101			1,772,697
Dividends paid in cash	—			—				—			(296,581	)		—			(296,581	)
Purchases of common stock	(1,200	)		(12		)		(52,930	)		—			—			(52,942	)
Stock options exercised	315			3				7,694			—			—			7,697
Stock-based compensation	—			—				7,039			—			—			7,039
Excess tax benefits from stock-based compensation	—			—				2,094			—			—			2,094
Net earnings	—			—				—			494,150			—			494,150
Other comprehensive income (loss)	—			—				—			—			(18,937	)		(18,937	)
Balance as of December 31, 2014	295,868			$	2,959			33,744			1,886,350			(7,836	)		1,915,217
Dividends paid in cash	—			—				—			(327,101	)		—			(327,101	)
Purchases of common stock	(7,100	)		(71		)		(60,042	)		(232,838	)		—			(292,951	)
Stock options exercised	814			8				19,091			—			—			19,099
Stock-based compensation	—			—				5,841			—			—			5,841
Excess tax benefits from stock-based compensation	—			—				3,390			—			—			3,390
Net earnings	—			—				—			516,361			—			516,361
Other comprehensive income (loss)	—			—				—			—			(38,567	)		(38,567	)
Balance as of December 31, 2015	289,582			$	2,896			2,024			1,842,772			(46,403	)		1,801,289
Dividends paid in cash	—			—				—			(346,588	)		—			(346,588	)
Purchases of common stock	(1,600	)		(16		)		(3,905	)		(55,519	)		—			(59,440	)
Stock options exercised	1,180			12				29,260			—			—			29,272
Stock-based compensation	—			—				4,100			—			—			4,100
Excess tax benefits from stock-based compensation	—			—				5,884			—			—			5,884
Net earnings	—			—				—			499,478			—			499,478
Other comprehensive income (loss)	—			—				—			—			(901	)		(901	)
Balance as of December 31, 2016	289,162			$	2,892			37,363			1,940,143			(47,304	)		1,933,094

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

	2016				2015			2014
Cash flows from operating activities:
Net earnings	$	499,478			516,361			494,150
Adjustments to reconcile net earnings to net cash provided by operating activities, net of acquisitions:
Depreciation of property and equipment	103,525				86,071			72,145
Gain on sale of property and equipment	(532		)		(1,411	)		(964	)
Bad debt expense	8,550				8,769			11,480
Deferred income taxes	25,571				8,290			1,760
Stock-based compensation	4,100				5,841			7,039
Excess tax benefits from stock-based compensation	(5,884		)		(3,390	)		(2,094	)
Amortization of non-compete agreements	527				527			527
Changes in operating assets and liabilities, net of acquisitions:
Trade accounts receivable	(40,490		)		(20,608	)		(63,418	)
Inventories	(80,853		)		(47,830	)		(87,622	)
Other current assets	29,138				(15,778	)		(7,510	)
Accounts payable	(17,233		)		20,617			12,501
Accrued expenses	(28,721		)		11,141			25,263
Income taxes	15,535				(26,610	)		34,405
Other	1,288				4,950			1,730
Net cash provided by operating activities	513,999				546,940			499,392
Cash flows from investing activities:
Purchases of property and equipment	(189,451		)		(155,168	)		(189,474	)
Cash paid for acquisitions	—				(23,493	)		(5,575	)
Proceeds from sale of property and equipment	6,505				9,941			5,819
Net decrease in marketable securities	—				—			451
Other	(5,147		)		(11,907	)		(2	)
Net cash used in investing activities	(188,093		)		(180,627	)		(188,781	)
Cash flows from financing activities:
Borrowings under debt obligations	950,000				1,215,000			705,000
Payments against debt obligations	(920,000		)		(955,000	)		(615,000	)
Proceeds from exercise of stock options	29,272				19,099			7,697
Excess tax benefits from stock-based compensation	5,884				3,390			2,094
Purchases of common stock	(59,440		)		(292,951	)		(52,942	)
Payments of dividends	(346,588		)		(327,101	)		(296,581	)
Net cash used in financing activities	(340,872		)		(337,563	)		(249,732	)
Effect of exchange rate changes on cash and cash equivalents	(1,318		)		(14,227	)		(4,889	)
Net (decrease) increase in cash and cash equivalents	(16,284		)		14,523			55,990
Cash and cash equivalents at beginning of year	129,019				114,496			58,506
Cash and cash equivalents at end of year	$	112,735			129,019			114,496
Supplemental disclosure of cash flow information:
Cash paid for interest	$	6,183			3,103			915
Net cash paid for income taxes	$	248,329			327,034			257,514

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 2,500 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 terms such 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, shipping and handling charges, and lease fees billed, net of any related sales incentives, 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 reasonably assured. These criteria are met at the time the product is shipped to or picked up by the customer. We recognize services at the time the service is completed and product is provided to the customer. We recognize revenue for shipping and handling charges at the time the products are shipped to or picked up by the customer. We recognize revenue for lease fees on a straight-line basis over the corresponding lease term. 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.

Foreign Currency Translation and Transactions

The functional currency of our foreign operations is typically the applicable local currency. The functional currency is translated into United States dollars for balance sheet accounts, except 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 (loss). Gains or losses resulting from transactions denominated in foreign currencies are included in cost of sales or operating and administrative expenses.

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 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.

Due to the varying short-term cash needs of our business, we periodically have available-for-sale marketable securities. We did not have any marketable securities as of December 31, 2016 or December 31, 2015. 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 accumulated other comprehensive income (loss) as a separate component of stockholders' equity until realized. If a decline in the market value of any available-for-sale security is below cost and is deemed other than temporary, it is charged to net 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 property 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 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, or the remaining lease term, whichever is shorter. We lease certain semi-tractors, pick-ups, and equipment under operating leases.

Other Long-Lived Assets

Other assets consist of prepaid 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 the consolidated 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, revenues and expenses, and the disclosure of contingent liabilities. 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 but unpaid 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.

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

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 to be 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 for our North American operations 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. Considering the insignificance of our operations outside of North America, we report as a single business segment.

Note 2. Long-Lived Assets

Property and equipment

Property and equipment at year end consisted of the following:

	Depreciable Life in Years			2016				2015
Land	—			$	37,339			37,671
Buildings and improvements	15 to 40			297,093				271,302
Automated distribution and warehouse equipment	5 to 30			216,276				204,708
Shelving, industrial vending, and equipment	3 to 10			723,854				548,921
Transportation equipment	3 to 5			71,750				61,429
Construction in progress	—			152,523				200,892
				1,498,835				1,324,923
Less accumulated depreciation				(599,138		)		(506,034	)
Property and equipment, net				$	899,697			818,889

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Note 3. Accrued Expenses

Accrued expenses at year end consisted of the following:

	2016				2015
Payroll and related taxes	$	23,180			24,407
Bonuses and commissions	14,156				15,441
Profit sharing contribution	8,665				13,669
Insurance reserves	34,640				31,821
Promotions	24,853				25,261
Indirect taxes	43,443				66,563
Deferred revenue	2,767				2,875
Legal reserves	1,393				1,930
Other	3,325				3,176
Accrued expenses	$	156,422			185,143

Note 4. Stockholders' Equity

Dividends

On January 17, 2017, our board of directors declared a quarterly dividend of $0.32 per share of common stock to be paid in cash on February 28, 2017 to shareholders of record at the close of business on February 1, 2017. We paid aggregate annual dividends per share of $1.20, $1.12, and $1.00 in 2016, 2015, and 2014, respectively.

Stock Options

Effective January 3, 2017, the compensation committee of our board of directors granted to our employees options to purchase a total of 764,789 shares of our common stock at an exercise strike price of $47.00 per share. The closing stock price on the effective date of the grant was $46.95 per share.

The following tables summarize the details of options granted under our stock option plan that were still outstanding as of December 31, 2016, and the assumptions used to value those grants. All such grants 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, 2016
Date of Grant	Options Outstanding			Options Exercisable
April 19, 2016	845,440			$	46.00			$	45.74			789,363			—
April 21, 2015	893,220			$	42.00			$	41.26			738,834			—
April 22, 2014	955,000			$	56.00			$	50.53			608,750			122,500
April 16, 2013	205,000			$	54.00			$	49.25			115,000			3,500
April 17, 2012	1,235,000			$	54.00			$	49.01			981,500			682,250
April 19, 2011	410,000			$	35.00			$	31.78			83,900			46,400
April 20, 2010	530,000			$	30.00			$	27.13			147,300			94,800
April 21, 2009	790,000			$	27.00			$	17.61			228,650			186,150
April 15, 2008	550,000			$	27.00			$	24.35			64,650			64,650
Total	6,413,660											3,757,947			1,200,250

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 19, 2016	1.3	%		5.00		2.6	%		26.34	%		$	8.18
April 21, 2015	1.3	%		5.00		2.7	%		26.84	%		$	7.35
April 22, 2014	1.8	%		5.00		2.0	%		28.55	%		$	9.57
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

All of the options in the tables above vest and become exercisable over a period of up to eight years. Generally, each option will terminate approximately nine years after the grant date.

The fair value of each share-based option is estimated on the date of grant using a Black-Scholes valuation method that uses the assumptions listed above. The risk-free interest rate is based on the U.S. Treasury rate over the expected life of the option at the time of grant. 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. The dividend yield is estimated over the expected life of the option based on our current dividend payout, historical dividends paid, and expected future cash dividends. Expected stock volatilities are based on the movement of our stock price over the most recent historical period equivalent to the expected life of the option.

A summary of activities under our stock option plan consisted of the following:

	Options Outstanding			Exercise Price(1)				Remaining Life(2)
Outstanding as of January 1, 2016	4,530,982			$	41.49			4.89
Granted	845,440			$	46.00			8.41
Exercised	(1,180,242	)		$	24.80
Cancelled/forfeited	(438,233	)		$	49.49
Outstanding as of December 31, 2016	3,757,947			$	46.81			5.85
Exercisable as of December 31, 2016	1,200,250			$	45.93			3.74

	Options Outstanding			Exercise Price(1)				Remaining Life(2)
Outstanding as of January 1, 2015	4,712,330			$	38.52			4.59
Granted	893,220			$	42.00			8.41
Exercised	(813,838	)		$	23.47
Cancelled/forfeited	(260,730	)		$	45.84
Outstanding as of December 31, 2015	4,530,982			$	41.49			4.89
Exercisable as of December 31, 2015	1,792,242			$	31.00			2.15

(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, 2016, 2015, and 2014 was $23,236, $14,174, and $7,466, respectively. The intrinsic value represents the difference between the exercise price and fair value of the underlying shares at the date of exercise.

At December 31, 2016, there was $14,455 of total unrecognized stock-based compensation expense related to outstanding unvested stock options granted under the plan. This expense is expected to be recognized over a weighted average period of 4.56 years. Any future change in estimated forfeitures will impact this amount. The total grant date fair value of stock options vested under our stock option plan during 2016, 2015, and 2014 was $7,083, $5,143, and $7,287, respectively.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Total stock-based compensation expense related to our stock option plan was $4,100, $5,841, and $7,039 for 2016, 2015, and 2014, 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	2016			2015			2014
Basic weighted average shares outstanding	288,949,525			291,453,107			296,490,378
Weighted shares assumed upon exercise of stock options	207,998			592,335			822,866
Diluted weighted average shares outstanding	289,157,523			292,045,442			297,313,244

Summary of Anti-dilutive Options Excluded	2016				2015			2014
Options to purchase shares of common stock	3,095,343				2,611,367			1,903,767
Weighted average exercise prices of options	$	50.09			51.89			54.67

Any dilutive impact summarized above related to periods when the average market price of our stock exceeded the exercise price of the potentially dilutive stock options then outstanding.

Note 5. 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 contributions. In addition to the participation of our employees, we make annual profit sharing contributions based on an established formula. The expense recorded under this profit sharing formula was approximately $8,665, $13,669, and $11,460 for 2016, 2015, and 2014, respectively.

Note 6. Income Taxes

Earnings before income taxes were derived from the following sources:

	2016				2015			2014
Domestic	$	739,383			785,916			757,896
Foreign	50,346				40,104			29,538
Earnings before income taxes	$	789,729			826,020			787,434

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

2016:	Current				Deferred			Total
Federal	$	223,837			23,149			246,986
State	28,231				1,236			29,467
Foreign	12,634				1,164			13,798
Income tax expense	$	264,702			25,549			290,251

2015:	Current				Deferred			Total
Federal	$	256,748			7,362			264,110
State	31,297				227			31,524
Foreign	13,677				348			14,025
Income tax expense	$	301,722			7,937			309,659

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

2014:	Current				Deferred			Total
Federal	$	250,527			1,919			252,446
State	30,768				256			31,024
Foreign	10,518				(704	)		9,814
Income tax expense	$	291,813			1,471			293,284

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

	2016				2015			2014
Federal income tax expense at the 'expected' rate of 35%	$	276,405			289,107			275,602
Increase (decrease) attributed to:
State income taxes, net of federal benefit	20,038				21,613			20,549
Other, net	(6,192		)		(1,061	)		(2,867	)
Total income tax expense	$	290,251			309,659			293,284
Effective income tax rate	36.8		%		37.5	%		37.2	%

The tax effects of temporary differences that give rise to deferred income tax assets and liabilities at year end consisted of the following:

	2016				2015
Deferred income tax assets (liabilities):
Inventory costing and valuation methods	$	4,788			4,556
Allowance for doubtful accounts	4,339				4,529
Insurance reserves	11,489				10,930
Promotions payable	1,651				1,738
Stock-based compensation	6,789				8,270
Federal and state benefit of uncertain tax positions	1,908				1,911
Foreign net operating loss and credit carryforwards	5,121				5,155
Foreign valuation allowances	(3,998		)		(3,406	)
Other, net	2,123				1,541
Total deferred income tax assets	34,210				35,224
Property and equipment	(114,838		)		(90,281	)
Total deferred income tax liabilities	(114,838		)		(90,281	)
Net deferred income tax liabilities	$	(80,628	)		(55,057	)

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

	2016				2015
Balance at beginning of year:	$	5,417			3,772
Increase related to prior year tax positions	194				704
Decrease related to prior year tax positions	—				(43	)
Increase related to current year tax positions	846				984
Decrease related to statute of limitation lapses	(1,050		)		—
Balance at end of year:	$	5,407			5,417

Included in the liability for gross 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 gross unrecognized tax benefits that would favorably impact the effective tax rate, if recognized, is not material. We do not anticipate significant changes in total unrecognized tax benefits during the next twelve months.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Fastenal files income tax returns in the United States federal jurisdiction, all states, and various local and foreign jurisdictions. With limited exceptions, we are no longer subject to income tax examinations by taxing authorities for taxable years before 2014 in the case of United States federal examinations, and 2012 in the case of foreign, state, and local examinations.

In general, it is our practice and intention to permanently reinvest the earnings of our foreign subsidiaries and repatriate earnings only when the tax impact is zero or very minimal. As of December 31, 2016, we have not made a provision for United States income taxes or for additional foreign withholding taxes on $147,000 of unremitted earnings. Such earnings are considered to be indefinitely reinvested and, accordingly, no U.S. federal or state deferred income taxes have been provided on this amount or any additional excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries. Earnings is the most significant component of the basis difference which is indefinitely reinvested. 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.

Note 7. Geographic Information

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

Revenues	2016				2015			2014
United States	$	3,493,459			3,441,141			3,308,226
Canada	228,685				223,270			238,590
Other foreign countries	239,892				204,776			186,691
Total revenues	$	3,962,036			3,869,187			3,733,507

Long-Lived Assets	2016				2015			2014
United States	$	899,133			821,063			725,189
Canada	33,164				32,290			37,580
Other foreign countries	15,817				14,333			13,068
Total long-lived assets	$	948,114			867,686			775,837

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 net property and equipment, deposits, goodwill, and other net intangibles. Revenues are attributed to countries based on the location of the store from which the sale occurred. In each of the years presented in the table above, no single customer represented 5% or more of our consolidated net sales.

Note 8. Operating Leases

We lease space under non-cancelable operating leases for several distribution centers, several manufacturing locations, and certain store 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. The net book value of leasehold improvements at December 31, 2016 was $3,122. We lease certain semi-tractors and pick-ups under operating leases. Future minimum lease payments for all operating leases are as follows:

	Leased Facilities and Equipment				Leased Vehicles			Total
2017	$	97,456			31,989			129,445
2018	72,345				20,453			92,798
2019	47,070				8,917			55,987
2020	28,571				1,575			30,146
2021	11,620				—			11,620
2022 and thereafter	1,386				—			1,386
Total minimum lease payments	$	258,448			62,934			321,382

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Rent expense under all operating leases was as follows:

	Leased Facilities and Equipment				Leased Vehicles			Total
2016	$	110,123			42,663			152,786
2015	$	105,961			38,178			144,139
2014	$	103,294			35,731			139,025

Certain operating leases for pick-up trucks 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 was approximately $76,808. We believe the likelihood of funding the guarantee obligation under any provision of the operating lease agreements is remote other than where we have established an accrual for estimated losses, which was immaterial at December 31, 2016. To the extent our fleet contains vehicles we estimate will settle at a gain, such gains on these vehicles will be recognized when we sell the vehicle.

Note 9. Debt Commitments and Contingencies

Credit Facility, Notes Payable, and Commitments

Debt obligations and letters of credit outstanding at year end consisted of the following:

	2016				2015
Outstanding loans under unsecured revolving Credit Facility	$	305,000			350,000
2.00% Senior unsecured promissory note payable	40,000				—
2.45% Senior unsecured promissory note payable	35,000				—
Note payable under asset purchase agreement	10,000				15,000
Total debt	390,000				365,000
Less: Current portion of debt	(10,482		)		(62,050	)
Long-term debt	$	379,518			302,950
Outstanding letters of credit under unsecured revolving Credit Facility - contingent obligation	$	36,267			36,266

Unsecured Revolving Credit Facility

We have a $700,000 committed unsecured revolving credit facility ('Credit Facility'). The Credit Facility includes a committed letter of credit subfacility of $55,000. The commitments under the Credit Facility will expire (and any borrowings outstanding under the Credit Facility will become due and payable) on March 1, 2018. In the next twelve months, we have the ability and intent to repay a portion of the outstanding loans using cash; therefore, we have classified this portion as a current liability. The Credit Facility contains certain financial and other covenants, and our right to borrow under the Credit Facility is conditioned upon, among other things, our compliance with these covenants. We are currently in compliance with these covenants.

Borrowings under the Credit Facility generally bear interest at a rate per annum equal to the London Interbank Offered Rate ('LIBOR') for interest periods of various lengths selected by us, plus 0.95%. Based on the interest periods we have chosen, our weighted per annum interest rate at December 31, 2016 was approximately 1.7%. We pay a commitment fee for the unused portion of the Credit Facility. This fee is either 0.10% or 0.125% per annum based on our usage of the Credit Facility.

Senior Unsecured Promissory Notes Payable

On July 20, 2016 (the 'Effective Date'), we entered into a master note agreement (the 'Master Note Agreement') with certain institutional lenders, pursuant to which, during the period commencing on the Effective Date and ending three years thereafter, we may issue at our discretion in private placements, and the institutional lenders may purchase at their discretion, senior unsecured promissory notes of the Company (the 'Notes') in the aggregate principal amount outstanding from time to time of up to $200,000. The Notes will bear interest at either a fixed rate, or a floating rate based on LIBOR for an interest period of one, three, or six months. The Notes will mature no later than 12 years after the date of issuance thereof, in the case of fixed rate Notes, or 10 years after the date of issuance thereof, in the case of floating rate Notes. All of the Notes will be prepayable at our option in whole or in part. The Master Note Agreement contains certain financial and other covenants. We are currently in compliance with these covenants.

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

Two series of unsecured senior Notes are currently outstanding under the Master Note Agreement, each of which was issued on the Effective Date. The first series of Notes ('Series A') is in an aggregate principal amount of $40,000, is due and payable in full on July 20, 2021, and bears interest at a fixed rate of 2.00% per annum. The second series of Notes ('Series B') is in an aggregate principal amount of $35,000, is due and payable in full on July 20, 2022, and bears interest at a fixed rate of 2.45% per annum. There is no amortization of the Series A and Series B Notes prior to their maturity dates. Interest on such Notes is payable quarterly in arrears on January 20, April 20, July 20, and October 20 of each year, beginning on October 20, 2016. The carrying value of our Series A and Series B Notes approximates fair value. The fair value was based on available external pricing data and current market rates for similar debt instruments, among other factors, which are classified as level 2 inputs within the fair value hierarchy.

Note Payable Under Asset Purchase Agreement

On December 7, 2015, we signed an agreement to purchase, effective January 2, 2017 ('Asset Purchase Effective Date'), certain assets related to the collection and management of certain portions of our business and financial data from Apex Industrial Technologies, LLC ('Apex'), a provider of automated point-of-use dispensing and supply chain technologies. The agreement includes a transition arrangement which requires us to assume responsibility for certain software that is licensed by Apex. The total consideration for the assets is $27,000, of which $12,000 was paid in cash in December 2015 in advance of the Asset Purchase Effective Date. The remaining $15,000 is payable in installments pursuant to an unsecured note. The first $5,000 installment was paid in December 2016, while the two remaining installments of $5,000 each will be paid in June 2017 and December 2017. The note bears interest at an annual rate of 0.56%. Interest on the unpaid principal balance of the note is due and payable on the last day of each calendar quarter. In 2015, the $15,000 note represented a non-cash investing and financing activity in our Consolidated Statements of Cash Flows, while the payments made in 2016 and 2015 are included in our Consolidated Statements of Cash Flows as net cash used in investing activities in 'Other'.

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, 2016, 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 10. Sales by Product Line

The percentages of our sales by product line were as follows:

Type	Introduced		2016		2015		2014
Fasteners(1)	1967		36.6%		38.3%		40.2%
Tools	1993		9.9%		9.5%		9.3%
Cutting tools	1996		5.7%		5.6%		5.5%
Hydraulics & pneumatics	1996		6.9%		7.2%		7.2%
Material handling	1996		6.4%		6.5%		6.1%
Janitorial supplies	1996		7.6%		7.5%		7.3%
Electrical supplies	1997		4.8%		4.7%		4.7%
Welding supplies	1997		4.6%		4.7%		4.7%
Safety supplies(2)	1999		14.9%		13.9%		12.8%
Metals	2001		0.5%		0.5%		0.4%
Direct ship(3)	2004		0.5%		0.4%		1.0%
Office supplies	2010		0.1%		0.1%		0.1%
Other			1.5%		1.1%		0.7%
			100.0%		100.0%		100.0%

(1) Fastener product line represents fasteners and miscellaneous supplies.

(2) The safety supplies product line has expanded, as a percentage of sales, in the last several years due to our industrial vending program.

(3) Direct ship represents a cross section of products from the remaining 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 11. Subsequent Events

We evaluated all subsequent event activity and concluded that no subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the Notes to Consolidated Financial Statements, with the exception of the dividend declaration and stock option grant disclosed in Note 4.

Note 12. New Accounting Pronouncements

In August 2015, the Financial Accounting Standards Board ('FASB') issued Accounting Standards Update ('ASU') 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which defers the effective date of ASU 2014-09 for all entities by one year. This update is effective for public business entities for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. ASU 2014-09 was to become effective for us beginning January 2017. ASU 2015-14 defers our effective date until January 2018 which is when we plan to adopt this standard. The ASU permits two methods of adoption: retrospectively to each prior reporting period presented (full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). The ASU also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. While we are still in the process of evaluating the effect of adoption on our consolidated financial statements and are currently assessing our contracts with customers, we do not currently expect a material impact on our results of operations, cash flows or financial position. We anticipate we will expand our consolidated financial statement disclosures in order to comply with the new ASU. We have not yet concluded on our transition method upon adoption, but plan to select a transition method by the middle of 2017.

In February 2016, FASB issued ASU 2016-02, Leases, which introduces the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous guidance. The guidance will be effective for annual reporting periods beginning after December 15, 2018 and interim periods within those fiscal years with early adoption permitted. The guidance will be applied on a modified retrospective basis with the earliest period presented. Based on the

Fastenal Company and Subsidiaries

Notes to Consolidated Financial Statements—Continued

effective date, this guidance would apply beginning January 2019 which is when we plan to adopt this ASU. While we are still in the process of evaluating the effect of adoption on our consolidated financial statements and are currently assessing our leases, we expect the adoption will lead to a material increase in the assets and liabilities recorded on our consolidated balance sheet. As part of our assessment, we will need to determine the impact of lease extension provisions provided in our facility and vehicle leases which will impact the amount of the right of use asset and lease liability recorded under the new ASU.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The standard simplifies several aspects of the accounting for employee share-based payment transactions, including accounting for income taxes, forfeitures, and statutory tax withholdings requirements, as well as classification in the consolidated statement of cash flows. The guidance will be effective for annual reporting periods beginning after December 15, 2016 and interim periods within those fiscal years. We are currently evaluating the impact of the updated guidance and believe the adoption of the guidance will impact our accounting for excess tax benefits and deficiencies. We are in the process of determining the financial statement impact and are currently unable to estimate the impact on our consolidated financial statements and related disclosures.

Note 13. Selected Quarterly Financial Data (Unaudited)

(Amounts in thousands except per share information)

2016:	Net Sales				Gross Profit			Pre-tax Earnings			Net Earnings			Basic Net Earnings per Share (1)			Diluted Net Earnings per Share
First quarter	$	986,680			491,460			199,851			126,227			0.44			0.44
Second quarter	1,014,287				501,592			207,817			131,521			0.46			0.45
Third quarter	1,013,122				499,834			201,239			126,925			0.44			0.44
Fourth quarter	947,947				471,891			180,822			114,805			0.40			0.40
Total	$	3,962,036			1,964,777			789,729			499,478			1.73			1.73

2015:	Net Sales				Gross Profit			Pre-tax Earnings			Net Earnings			Basic Net Earnings per Share			Diluted Net Earnings per Share
First quarter	$	953,317			484,050			203,512			127,606			0.43			0.43
Second quarter	997,827				502,087			225,099			140,357			0.48			0.48
Third quarter	995,250				502,225			219,204			136,494			0.47			0.47
Fourth quarter	922,793				460,572			178,205			111,904			0.39			0.39
Total	$	3,869,187			1,948,934			826,020			516,361			1.77			1.77

(1) Amounts may not foot due to rounding difference.

End of Notes to Consolidated Financial Statements