Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is management's discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements.

Business and Operational Overview

Fastenal is a North American leader in the wholesale distribution of industrial and construction supplies. We distribute these supplies through a network of approximately 3,000 in-market locations. Most of our customers are in the manufacturing and non-residential construction markets. The manufacturing market includes both original equipment manufacturers (OEM) and maintenance, repair, and operations (MRO). The non-residential construction market includes general, electrical, plumbing, sheet metal, and road contractors. Other users of our product include farmers, truckers, railroads, oil exploration, production and refinement companies, mining companies, federal, state, and local governmental entities, schools, and certain retail trades. Geographically, our branches and customers are primarily located in North America.

It is helpful to appreciate several aspects of our marketplace: (1) It's big, the North American marketplace for industrial supplies is estimated to be in excess of $140 billion per year (and we have expanded beyond North America) and no company has a significant portion of this market. (2) Many of the products we sell are individually inexpensive, but the cost and time to manage, procure, and transport these products can be quite meaningful. (3) Purchasing professionals often expend disproportionate effort managing the high SKU count of low-volume, low value MRO supplies which is better allocated to their higher volume, higher value OEM supplies. (4) Many customers prefer to reduce their number of suppliers to simplify their business, while also utilizing various technologies and models (including our local branches when they need something quickly or unexpectedly) to improve availability and reduce waste. (5) We believe the markets are efficient. To us, this means we can grow our market share if we provide the greatest value to our customer.

Our approach to addressing these aspects of our marketplace is captured in our motto Growth through Customer Service. The concept of growth is simple: find more customers every day and increase our activity with them. However, execution is hard work. First, we recruit service-minded individuals to support our customers and their business. Second, we operate in a decentralized fashion to help identify the greatest value for our customers. Third, we have a great team behind our customer-facing resources to operate efficiently and to help identify new business solutions. Fourth, we strive to generate strong profits, which produce the cash flow necessary to fund our growth and to support the needs of our customers. Lastly, we identify drivers that allow us to get closer to our customers and gain market share.

We believe our ability to grow is amplified if we can serve our customers at the closest economic point of contact. At one point, the closest economic point of contact was the local branch. Today, in some cases, we have moved the branch inside the customer's facility. We also are frequently positioned right at the point of consumption within customers' facilities through our industrial vending or FMI capabilities. Therefore, our focus centers on understanding our customers' day, their opportunities, and their obstacles. By doing these things every day, Fastenal remains a growth-centric organization.

Executive Overview

Net sales increased $428.5, or 10.8%, in 2017 relative to 2016. Our gross profit as a percentage of net sales declined to 49.3% in 2017 from 49.6% in 2016. Our operating income as a percentage of net sales in 2017 was comparable to 2016 at 20.1% in both years.

We recorded a provisional income tax expense of $294.5 in 2017, or 33.7% of earnings before income taxes. This amount reflects an estimated reduction in our deferred income tax liabilities of $30.8 as a result of the income tax rate decrease included in the Tax Act, offset by an estimated increase in income tax payable in the amount of $6.5 as a result of the transition tax on cash and cash equivalent balances related to accumulated earnings associated with our international operations, also included in the Tax Act. Absent the impact of the Tax Act, our income tax expense for 2017 would have been approximately $318.8, or 36.5% of earnings before income taxes. Income tax expense was $290.3 in 2016, or 36.8% of earnings before income taxes.

Our net earnings in 2017 were $578.6, an increase of 15.8% when compared to 2016. Our diluted net earnings per share were $2.01 in 2017 compared to $1.73 in 2016. If we excluded the discrete items that benefited our income tax rate in the fourth quarter of 2017 (primarily related to the impact of the Tax Act), our net earnings in the period would have been approximately $554.2, an increase of 11.0% when compared to 2016, and our diluted net earnings per share would have been $1.92.

We continued to focus on our growth drivers in 2017. We signed 168 new national account contracts (defined as new customer accounts with a multi-site contract). Additionally, we signed 270 new Onsite customer locations (defined as dedicated sales and service provided from within, or in close proximity to, the customer's facility) and 19,355 new industrial vending devices.

The table below summarizes our in-market location employee count and our total employee count at the end of the periods presented, and changes in that count from the end of the prior periods to the end of the most recent period. The final four items below summarize our cumulative investments in branch locations, Onsite locations, total in-market locations, and industrial vending devices.

	Q4 2017			Q4 2016			Twelve-month % Change
End of period total in-market locations (1) - employee count	13,424			12,966			3.5	%
End of period total employee count	20,565			19,624			4.8	%
Number of public branch locations	2,383			2,503			-4.8	%
Number of active Onsite locations	605			401			50.9	%
Number of in-market locations (1)	2,988			2,904			2.9	%
Industrial vending devices (installed count) (2)	71,421			62,822			13.7	%
Ratio of industrial vending devices to in-market locations	24:1			22:1

(1) 'In-market locations' is defined as the sum of the total number of public branch locations and the total number of active Onsite locations.

(2) This number represents devices which principally dispense product and produce product revenues, and excludes approximately 15,000 devices which are principally used for the check-in/check-out of equipment.

During the last twelve months, we increased our headcount by 458 people in our in-market locations and 941 people in total. Our total headcount at the end of 2017 includes 127 people related to our Mansco acquisition. The remaining increase is mostly a function of additions we have made to support customer growth in the field as well as investments in our growth drivers.

We opened 18 branches and closed 130 branches in 2017. Additionally, eight branches were converted from public branches to non-public locations. Our branch network forms the foundation of our business strategy, and we will continue to open or close branches as is deemed necessary to sustain and improve our network and support our growth drivers.

Results of Operations

The following sets forth consolidated statements of earnings information (as a percentage of net sales) for the periods ended December 31:

		2017			2016			2015
Net sales		100.0	%		100.0	%		100.0	%
Gross profit		49.3	%		49.6	%		50.4	%
Operating and administrative expenses		29.2	%		29.5	%		29.0	%
Gain on sale of property and equipment		0.0	%		0.0	%		0.0	%
Operating income		20.1	%		20.1	%		21.4	%
Net interest expense		-0.2	%		-0.2	%		-0.1	%
Earnings before income taxes		19.9	%		19.9	%		21.3	%
Note – Amounts may not foot due to rounding difference.

Net Sales

Note – Daily sales are defined as the total net sales for the period divided by the number of business days (in the United States) in the period.

The table below sets forth net sales and daily sales for the periods ended December 31, and changes in such sales from the prior period to the more recent period:

	2017			2016			2015
Net sales	4,390.5			3,962.0			3,869.2
Percentage change	10.8	%		2.4	%		3.6	%
Business days	254			255			254
Daily sales	17.3			15.5			15.2
Percentage change	11.3	%		2.0	%		3.2	%
Daily sales impact of acquisitions	1.0	%		0.6	%		0.2	%
Impact of currency fluctuations	0.1	%		-0.4	%		-1.2	%

The increases in net sales in the periods noted above for 2017, 2016, and 2015 were driven primarily by higher unit sales. Price was not a material factor in the periods presented.

The higher unit sales in 2017 resulted primarily from two sources. The first is improvement in underlying market demand. We believe the improvement in general business activity is reflected in a number of metrics. For instance, the Purchasing Managers Index, published by the Institute for Supply Chain Management, averaged 57.0, 55.8, 58.6, and 58.9 in the first, second, third, and fourth quarters of 2017, respectively, well above 49.8, 51.8, 51.2, and 53.3 in the first, second, third, and fourth quarters of 2016, respectively. Readings above 50 are indicative of growing demand, and we believe this favorably influenced our unit sales. Daily sales of fasteners, our most cyclical product line, grew 8.4% in 2017. We also experienced growth in sales to 79 of our top 100 customers in 2017, which compares to growth in sales to 50 of our top 100 customers in 2016. As business conditions strengthen, they tend to lift our net sales growth rates as well.

The second source is success within our growth initiatives. We signed 19,355 industrial vending devices during 2017, an increase of 7.2% over 2016. In addition to an increase in our installed base, we were also more efficient with the existing base, resulting in a modest increase in average sales per device, and we decreased our device removals by 3.8%. Combined sales through our vending devices accelerated throughout 2017, finishing with growth in the high teens. We signed 270 new Onsite locations in 2017 and had 605 active sites on December 31, 2017, an increase of 50.9% over December 31, 2016. We signed 168 new national account contracts in 2017. The contribution of these new contracts and strong penetration of existing national account customers resulted in daily sales from our national account customers growing 14.5% in 2017 compared to 2016.

In 2016, we saw relative weakness from non-residential construction and heavy manufacturing customers and in demand for our fastener products, speaking to the sustained softness in heavy and general industrial markets. Business with our largest customers was also relatively weak, with sales to our top 100 customers rising modestly in the first half of 2016 and falling modestly in the second half of 2016. While these trends were representative of conditions in the United States and Canada, total sales outside of these geographic areas were relatively strong and improved over the course of 2016.

During 2015, our business weakened compared to 2014. This initially involved customers tied to the oil and gas sector, but expanded during the course of the year to include customers across additional industries and in geographic areas not typically associated with the oil and gas sector. November and especially December experienced a greater frequency and duration of customer plant shutdowns than is typical of these holiday-affected periods.

Net sales in 2016 and 2015 were also impacted by slight inflationary price changes in our non-fastener products and some price deflation in our fastener products, with the net impact being a slight drag on growth.

Sales by Product Line

The approximate mix of sales from the fastener product line and from the other product lines was as follows:

	2017		2016		2015
Fastener product line	35.6%		36.6%		38.3%
Other product lines	64.4%		63.4%		61.7%

The decrease in our fastener sales as a percentage of total sales arises from two factors. First, we believe non-fastener products represent a larger market opportunity than fasteners, and that we are relatively under-represented in this market. Over time, this

has led to faster growth in the non-fastener product lines, a trend amplified by the growth of our industrial vending program through which we sell primarily non-fastener products. We believe this factor impacted each year shown and will continue to promote a lower mix of fasteners in our total sales over time. Second, a weak industrial production environment, has a disproportionately negative effect on fastener sales relative to non-fastener sales (which relates more to plant operations than production). This weakness is more of a cyclical factor than a structural one, and as such was relevant in 2015 and 2016, but not in 2017 when a better economic environment at least partially mitigated the first factor discussed.

Annual Sales Changes, Sequential Trends, and End Market Performance

This section focuses on three distinct views of our business – annual sales changes by month, sequential trends, and end market performance. The first discussion regarding sales changes by month provides a good mechanical view of our business. The second discussion provides a framework for understanding the sequential trends (that is, comparing a month to the immediately preceding month, and also looking at the cumulative change from an earlier benchmark month) in our business. Finally, we believe the third discussion regarding end market performance provides insight into activities with our various types of customers.

Annual Sales Changes, by Month

During the months noted below, all of our selling locations, when combined, had daily sales growth rates of (compared to the same month in the preceding year):

	Jan.			Feb.			Mar.			Apr.			May			June			July			Aug.			Sept.			Oct.			Nov.			Dec.
2017	3.8	%		6.1	%		8.4	%		8.9	%		9.7	%		13.0	%		12.9	%		12.8	%		15.3	%		13.8	%		15.4	%		14.7	%
2016	3.3	%		2.6	%		0.0	%		3.8	%		1.1	%		0.0	%		2.1	%		0.3	%		2.8	%		3.9	%		1.2	%		3.2	%
2015	12.0	%		8.6	%		5.6	%		6.1	%		5.3	%		3.7	%		3.2	%		1.6	%		-0.3	%		-0.8	%		-1.1	%		-3.8	%

Sequential Trends

We find it helpful to think about the monthly sequential changes in our business using the analogy of climbing a stairway – This stairway has several predictable landings where there is a pause in the sequential gain (i.e. April, July, and October to December), but generally speaking, climbs from January to October. The October landing then establishes the benchmark for the start of the next year.

History has identified these landings in our business cycle. They generally relate to months where certain holidays impair business days and/or seasons impact certain end markets, particularly non-residential construction. The first landing centers on Easter and the Good Friday holiday that precedes it, which alternates between March and April (Good Friday occurred in April 2017, in March 2016, in April 2015, and in 2018, will fall in March), the second landing centers on July 4th, and the third landing centers on the approach of winter with its seasonal impact on primarily our non-residential construction business and with the Christmas/New Year holidays. The holidays we noted impact the trends because they either move from month-to-month or because they move around during the week (the July 4th and Christmas/New Year holiday impacts are examples of the latter).

The table below shows the pattern to the sequential change in our daily sales. The line labeled 'Benchmark' is an historical average of our sequential daily sales change for the trailing five year average (2012-2016). We believe this time frame serves to show the historical pattern and could serve as a benchmark for current performance. The '2017', '2016', and '2015' lines represent our actual sequential daily sales changes. The '17Delta', '16Delta', and '15Delta' lines indicate the difference between the 'Benchmark' and the actual results in the respective year.

It is important to note that these benchmarks are historical averages. In a year where demand is strong, our daily sales growth rates will tend to have more months that exceed the benchmark than fall below it. In a year where demand is weak, we will tend to have more months that fall short of the benchmark than exceed it. In both cases, there is a random element that makes it difficult to know how any single month will perform.

	Jan.(1)			Feb.			Mar.			Apr.			May			June			July			Aug.			Sept.			Oct.			Cumulative Change from Jan. to Oct.
Benchmark	-1.1	%		0.9	%		4.5	%		-1.0	%		1.9	%		1.8	%		-3.7	%		3.8	%		1.8	%		-2.4	%		7.6	%
2017	0.2	%		1.5	%		3.6	%		2.2	%		1.4	%		2.8	%		-2.4	%		2.2	%		3.8	%		-2.1	%		13.5	%
17Delta	1.3	%		0.6	%		-0.9	%		3.1	%		-0.5	%		1.0	%		1.3	%		-1.6	%		2.0	%		0.3	%		5.9	%
2016	0.4	%		-0.8	%		1.5	%		1.7	%		0.6	%		-0.2	%		-2.3	%		2.4	%		1.5	%		-0.9	%		3.6	%
16Delta	1.5	%		-1.7	%		-3.0	%		2.7	%		-1.3	%		-1.9	%		1.4	%		-1.4	%		-0.2	%		1.5	%		-4.0	%
2015	-3.6	%		-0.1	%		4.2	%		-2.1	%		3.4	%		0.9	%		-4.3	%		4.1	%		-0.9	%		-2.0	%		2.9	%
15Delta	-2.5	%		-1.0	%		-0.4	%		-1.1	%		1.4	%		-0.9	%		-0.6	%		0.3	%		-2.7	%		0.4	%		-4.7	%

(1) The January figures represent the percentage change from the previous October, whereas the remaining figures represent the percentage change from the previous month.

Note – Amounts may not foot due to rounding difference.

A graph of the sequential daily sales change patterns discussed above, starting with a base of '100' in the previous October and ending with the next October, would be as follows:

End Market Performance

The sequential trends noted above were directly linked to fluctuations in our end markets. To place this in perspective – we estimate approximately 65% of our business has historically been with customers engaged in some type of manufacturing, a significant subset of which finds its way into the heavy equipment market. The daily sales growth rates to these manufacturing customers, when compared to the same period in the prior year, were as follows(1):

	Q1			Q2			Q3			Q4			Annual
2017	6.2	%		11.5	%		15.3	%		16.6	%		12.3	%
2016	1.3	%		1.4	%		1.1	%		2.8	%		1.6	%
2015	8.2	%		4.6	%		1.6	%		-2.5	%		2.9	%

(1) In July 2017, we reclassified certain end market designations. The daily sales growth rates in the above table for all periods through the second quarter of 2017 differ from prior disclosures.

Our manufacturing business consists of two subsets: the industrial production business (this is business where we supply products that become part of the finished goods produced by our customers and is sometimes referred to as OEM - original equipment manufacturing) and the maintenance portion (this is business where we supply products that maintain the facility or the equipment of our customers engaged in manufacturing and is sometimes referred to as MRO - maintenance, repair, and operations). The industrial business is more fastener centered, while the maintenance portion is represented by all product categories.

The best way to understand the change in our industrial production business is to examine the results in our fastener product line (35% to 40% of our business) which is heavily influenced by changes in our business with heavy equipment manufacturers. From a company perspective, daily sales growth rates of fasteners, when compared to the same period in the prior year, were as follows (note: this information includes all end markets):

	Q1			Q2			Q3			Q4			Annual
2017	0.8	%		7.9	%		12.1	%		13.4	%		8.4	%
2016	-1.7	%		-2.4	%		-2.9	%		-2.4	%		-2.3	%
2015	5.5	%		0.0	%		-4.4	%		-6.2	%		-1.4	%

The daily sales growth rates of fasteners noted in the table above for the second, third, and fourth quarters of 2017, include 3.6, 3.8, and 3.9 percentage points, respectively, attributable to Mansco (acquired on March 31, 2017).

By contrast, the best way to understand the change in the maintenance portion of the manufacturing business is to examine the results in our non-fastener product lines. From a company perspective, daily sales growth rates of non-fasteners, when compared to the same period in the prior year, were as follows (note: this information includes all end markets):

	Q1			Q2			Q3			Q4			Annual
2017	9.4	%		12.2	%		14.6	%		16.1	%		13.1	%
2016	4.7	%		4.7	%		4.9	%		5.9	%		5.0	%
2015	11.7	%		9.0	%		5.9	%		1.2	%		6.8	%

The non-fastener business demonstrated greater relative resilience over the last several years, when compared to our fastener business and to the distribution industry in general, due to our industrial vending program. However, this business was not immune to the impact of a weak industrial environment.

Our non-residential construction and reseller customers have historically represented 20% to 25% of our business. The daily sales growth rates to these customers, when compared to the same period in the prior year, were as follows(1):

	Q1			Q2			Q3			Q4			Annual
2017	6.9	%		8.8	%		9.4	%		11.6	%		9.1	%
2016	1.6	%		0.5	%		2.8	%		2.6	%		1.8	%
2015	10.1	%		5.6	%		0.1	%		-2.6	%		3.1	%

(1) In July 2017, we reclassified certain end market designations. The daily sales growth rates in the above table for all periods through the second quarter of 2017 differ from prior disclosures.

Our non-residential construction and reseller business is heavily influenced by the industrial economy, particularly the energy sector. The volatility and weakness of energy prices weakened this business, particularly beginning in the second quarter of

2015 and throughout 2016. In 2017, improvements in energy sector metrics, including oil prices, as well as an improving outlook for industrial capital spending contributed to an improvement in growth for these end markets.

Gross Profit

The gross profit percentage during each period was as follows:

	Q1			Q2			Q3			Q4			Annual
2017	49.4	%		49.8	%		49.1	%		48.8	%		49.3	%
2016	49.8	%		49.5	%		49.3	%		49.8	%		49.6	%
2015	50.8	%		50.3	%		50.5	%		49.9	%		50.4	%

Our gross profit, as a percentage of net sales, was 49.3% in 2017 and 49.6% in 2016. The gross profit percentage for 2017 declined by 30 basis points due to two elements of mix. The first was a change in product and customer mix. Fasteners are our largest product line and our highest gross profit margin product line due to the high transaction cost surrounding the sourcing and supply of the product for customers. As a result, the decline in our fastener product line to 35.6% of sales in 2017 from 36.6% of sales in 2016 contributed to the decline in our gross profit margin. This effect was exacerbated by relative growth in the period from sales of our OEM fasteners, which tend to have a lower gross profit margin than our MRO fasteners. Larger customers (for which national accounts are a good proxy), whose more focused buying patterns allow us to offer them better pricing, also influence the gross profit margin. Sales to our national account customers increased to 48.7% in 2017 from 47.4% of sales in 2016, which contributed to the decline in our gross profit margin. The combination of relatively slower growth in our fastener product line and relatively faster growth in sales to our largest customers explains the decline in our overall gross profit margin in 2017. The second element of mix was driven by the acquisition of Mansco. Mansco's customer mix is more heavily oriented toward larger customers and its product mix tends to carry a lower gross profit product mix than the company's other products.

During 2016 and 2015, our gross profit, as a percentage of net sales, decreased when compared to the prior year. In each year, the decrease was primarily caused by changes in product and customer mix.

Operating and Administrative Expenses

Our operating and administrative expenses (including a gain on the sale of property and equipment), as a percentage of net sales, improved to 29.2% in 2017 from 29.5% in 2016. The primary contributor to this improvement was relatively modest growth in occupancy-related expenses. Though our employee-related and selling transportation expenses grew more quickly than our occupancy expenses, they also contributed to this leverage in 2017.

The growth in employee-related, occupancy-related, and selling transportation expenses (the three largest components of our operating and administrative expenses) compared to the same periods in the preceding year, is outlined in the table below.

	Approximate Percentage of Total Operating and Administrative Expenses	Twelve-month Period
	2017			2016			2015
Employee-related expenses	65% to 70%	10.2	%		2.7	%		0.7	%
Occupancy-related expenses	15% to 20%	1.3	%		10.1	%		7.4	%
Selling transportation expenses	5%	8.1	%		2.9	%		-13.1	%

Employee-related expenses include: (1) payroll (which includes cash compensation, stock option expense, and profit sharing), (2) health care, (3) personnel development, and (4) social taxes. Our employee-related expenses increased in 2017. This was related to: (1) an increase in full-time equivalent ('FTE') headcount related to efforts to support growth in our business, (2) higher performance bonuses and commissions due to growth in net sales and net earnings, as well as regulatory driven incremental compensation, (3) an increase in our profit sharing contribution and option awards, (4) increased health care costs, and (5) the inclusion of Mansco personnel. The increase in 2016, when compared to 2015, was caused by increases in average annual FTE headcount and an increase in health care costs, which were partially offset by a contraction in our performance bonuses and commissions and in our profit sharing contribution, primarily due to lower sales growth, gross profit, and operating income (both on a dollar basis and on a relative basis). The slight increase in 2015, when compared to 2014, was caused by increases in full-time equivalent headcount and growth in our profit sharing contribution, primarily due to our expanding growth in operating income. Offsetting factors included lower performance bonuses and commissions due to the decrease in our gross profit percentage, and a focused reduction in overtime hours paid.

The table below summarizes the percentage change in our FTE headcount at the end of the periods presented compared to the end of the prior period:

	Twelve-month Period
	2017			2016			2015
In-market locations	7.0	%		-5.6	%		15.7	%
Total selling (includes in-market locations)	7.3	%		-4.9	%		15.8	%
Distribution	8.4	%		-0.7	%		5.5	%
Manufacturing	8.4	%		-9.1	%		3.3	%
Administrative	10.7	%		0.3	%		8.3	%
Total	7.7	%		-4.1	%		13.3	%

Occupancy-related expenses include: (1) building rent and depreciation, (2) building utility costs, (3) equipment related to our branches and distribution locations, and (4) industrial vending equipment (we consider the vending equipment, excluding leased locker equipment, to be a logical extension of our branch operation and classify the depreciation and repair costs as occupancy expense). The slight increase in occupancy-related expenses in 2017, when compared to 2016, was mainly driven by increases in costs related to industrial vending equipment, FMI bins, and automation equipment at our distribution centers. The most significant components of our occupancy-related expenses, facility costs and utility expenses, were mostly flat in 2017, when compared to 2016 due to a reduction in our number of public branches. The increase in 2016, when compared to 2015, was mainly driven by an increase in the amount of industrial vending equipment and an increase in occupancy expense related to rent. The largest impact came from the industrial vending equipment. The increase in 2015, when compared to 2014, was driven by an increase in the amount of industrial vending equipment and an increased investment in our distribution infrastructure over the previous several years, primarily related to automation.

Our selling transportation expenses consist primarily of expenses for our branch fleet of vehicles, including branch fuel expense, as most of the distribution fleet costs are included in cost of sales. Selling transportation expenses increased in 2017 when compared to 2016. We increased the size of our field-based vehicle fleet for sales personnel which resulted in higher expenses. However, the larger impact was an increase in fuel expense due to higher fuel prices and consumption during the period. This was partially offset by gains on sales of leased vehicles. Selling transportation expenses increased in 2016, when compared to 2015. This was driven by an increase in the number of vehicles for sales personnel, and was partially offset by a decrease in fuel expense. The contraction in selling transportation expenses in 2015, when compared to 2014, was driven by the decline in fuel costs.

The last several years have seen some variation in the cost of diesel fuel and gasoline. During the first, second, third, and fourth quarters of 2017, our total vehicle fuel costs were approximately $8.9, $9.0, $8.5, and $9.7, respectively. During the first, second, third, and fourth quarters of 2016, our total vehicle fuel costs were approximately $6.4, $8.2, $8.3, and $8.0, respectively. The fluctuations were a result of: (1) variations in fuel costs, (2) the service levels provided to our in-market locations from our distribution centers, (3) the number of vehicles at our branch locations, (4) the number of other sales centered vehicles as a result of the expansion of our sales force, and (5) changes in driving conditions. These fuel costs include the fuel utilized in our distribution vehicles (semi-tractors, straight trucks, and sprinter trucks) which is recorded in cost of sales and the fuel utilized in our branch delivery and other sales centered vehicles which is included in operating and administrative expenses (the split in the last several years has been approximately 50/50 between distribution and branch and other sales centered use).

In 2017, aside from these larger impacts, our operating and administrative expenses were also affected by increases in spending on information technology, incremental operating expenses, including amortization, related to our acquisition of Mansco, and the absence of supplier marketing incentives that existed in the first nine months of 2016 as part of our CSP 16 initiative.

Net Interest Expense

Our net interest expense was $8.7 in 2017 compared to $6.1 in 2016, and $2.7 in 2015. The increase in 2017, when compared to 2016, was mainly caused by higher average interest rates and a slightly higher average debt balance during the period. The increase in 2016, when compared to 2015, was driven by higher average interest rates and increased borrowings.

Income Taxes

We recorded a provisional income tax expense of $294.5 in 2017, or 33.7% of earnings before income taxes. This amount reflects an estimated reduction in our deferred income tax liabilities of $30.8 as a result of the income tax rate decrease included in the Tax Act, partially offset by an estimated increase in income tax payable in the amount of $6.5 as a result of the transition tax on cash and cash equivalent balances related to accumulated earnings associated with our international

operations, also included in the Tax Act. Absent the impact of the Tax Act, our income tax expense for 2017 would have been approximately $318.8, or 36.5% of earnings before income taxes. The decrease in our income tax rate from 2016 to 2017 was also related to changes in our reserve for uncertain tax positions and the adoption of the Financial Accounting Standards Board ('FASB') Accounting Standard Update ('ASU') 2016-09, Improvements to Employee Share-Based Payment Accounting, in the first quarter of 2017. This standard addresses accounting for excess tax benefits from stock-based compensation that were previously recorded in additional paid-in capital on the balance sheet and are now recognized in income tax expense on the consolidated statement of earnings for the year ended December 31, 2017. A more detailed description of the adoption of ASU 2016-09 is included in Note 1 of the Notes to Consolidated Financial Statements.

Income taxes, as a percentage of earnings before income taxes, were approximately 36.8% and 37.5% for 2016 and 2015, respectively. The decrease in our income tax rate from 2015 to 2016 was caused by a slight change in jurisdictional income and changes in the reserve for uncertain tax positions. As our international business and profits grew the past several years, the lower income tax rates in those jurisdictions, relative to the United States, lowered our effective tax rate.

We are evaluating the impacts of the Tax Act on our 2018 provisional income tax expense booking rate. We currently estimate this rate will be in the range of 24% to 26% of earnings before income taxes.

Net Earnings

Net earnings, net earnings per share (EPS), percentage change in net earnings, and the percentage change in EPS, were as follows:

Dollar Amounts	2017 (1)				2016			2015
Net earnings	$	578.6			499.4			516.4
Basic EPS	2.01				1.73			1.77
Diluted EPS	2.01				1.73			1.77
Percentage Change	2017 (1)				2016			2015
Net earnings	15.8		%		-3.3	%		4.5	%
Basic EPS	16.1		%		-2.3	%		6.0	%
Diluted EPS	16.2		%		-2.3	%		6.6	%

(1) Absent the impact of the Tax Act, our net earnings for 2017 would have been $554.2, an increase of 11.0% when compared to 2016, and our basic and diluted earnings per share would have each been $1.92, an increase of 11.2% and 11.3%, respectively.

During 2017, net earnings increased, primarily due to stronger sales and operating profits combined with a reduction in income tax expense. The slightly higher increase in basic and diluted earnings per share was primarily due to the purchase of our shares of common stock in 2017. During 2016, net earnings decreased, despite our nominal sales growth, primarily due to the reduction in the gross profit percent realized and an increase in operating and administrative expenses. The contraction of basic and diluted earnings per share was smaller due primarily to the purchase of our shares of common stock in 2015 and early 2016. During 2015, the net earnings increase was greater than that of sales primarily due to the effective management of operating expenses.

Liquidity and Capital Resources

Net Cash Provided by Operating Activities

Net cash provided by operating activities in dollars and as a percentage of net earnings were as follows:

	2017				2016			2015
Net cash provided	$	585.2			519.9			550.3
% of net earnings	101.1		%		104.1	%		106.6	%

In 2017, the increase in net cash provided by operating activities was primarily due to our net earnings growth. The decline in our operating cash flow as a percentage of net earnings largely reflects working capital trends, and specifically accounts receivable as further described below. In 2016, the slight contraction in the net cash provided by operating activities was driven by our current initiative to add additional products into branch inventory under our CSP 16 format, and an increase in net accounts receivable growth. This decrease was partially offset by a reduction in net cash paid for income taxes. In 2015, the increase in net cash provided by operating activities was driven by growth in net earnings, and a decrease in the cash required

to fund our net working capital, which includes accounts receivable and inventory changes. This was partially offset by an increase in cash paid for income taxes.

Operational Working Capital

Operational working capital, which we define as accounts receivable, net and inventories, is highlighted below. The annual dollar change and the annual percentage change were as follows:

Dollar change	2017				2016
Accounts receivable, net	$	108.1			31.3
Inventories	99.9				79.7
Operational working capital	$	208.1			111.1
Annual percentage change	2017				2016
Accounts receivable, net	21.6		%		6.7	%
Inventories	10.1		%		8.7	%
Operational working capital	13.9		%		8.0	%

Note – Amounts may not foot due to rounding difference.

In 2017, the annual growth in net accounts receivable reflects accelerating growth in sales throughout the course of the year combined with relatively stronger growth of our national accounts and international business. Growth in accounts receivable continued in the fourth quarter of 2017, with the timing of the Christmas and New Year holidays affecting the timing of these customers' payments. Currency fluctuations also impacted accounts receivable in 2017. In 2016, the annual growth in net accounts receivables outpaced the growth in sales. This was not the case through the third quarter, and was mostly a function of conditions in the fourth quarter of 2016. In the fourth quarter of 2015, we collected receivables from our seasonally stronger third quarter, but because demand fell off surprisingly sharply in November and December, our fourth quarter receivables were unseasonably low. In the fourth quarter of 2016, by contrast, we collected receivables from our seasonally stronger third quarter, but because demand was more closely in line with seasonal norms, our receivables in the period were similarly more normal. Over a longer period of time, if we continue to see relatively strong growth in our international business and of our large customer accounts it could continue to create difficulty in managing the growth of accounts receivables relative to the growth in net sales.

Our growth in inventory balances over time does not have as direct a relationship to our monthly sales patterns as does our growth in accounts receivable. This is impacted by other aspects of our business. For example, the dramatic economic slowdown in late 2008 and early 2009 caused our inventory to spike. This occurred because the lead time for inventory procurement is typically longer than the visibility we have into future monthly sales patterns. Over the last decade, we increased our relative inventory levels due to the following: (1) new branch openings, (2) expanded stocking breadth at distribution centers (for example, our master stocking hub in Indianapolis expanded its product breadth over six fold from 2005 to 2011), (3) expanded direct sourcing, (4) expanded Fastenal brands, (5) expanded industrial vending solutions, (6) national accounts and Onsite growth, (7) international growth, and (8) expanded stocking breadth at individual branches related to our CSP initiatives. All of these items impacted both 2017 and 2016, though new branch openings have taken on a significantly diminished role. However, in 2017, the most significant contributor to the increase in inventories was improving business activity and the growth of our Onsite business. In 2016, the most significant contributors to the increase in inventories were the impact of infusing incremental inventory into our network beginning at the end of 2015 as part of our CSP 16 initiative, the relative growth of international sales, the growth of our Onsite business, and opportunist product purchases at year-end. Absent the opportunistic product purchases at year-end, growth in inventories would have moderated substantially from earlier in the year, reflecting the stabilizing of CSP 16 inventories.

The approximate percentage mix of inventory stocked at our selling locations versus our distribution center and manufacturing locations was as follows at year end:

	2017			2016			2015
Selling locations	65	%		64	%		61	%
Distribution center and manufacturing locations	35	%		36	%		39	%
Total	100	%		100	%		100	%

Net Cash Used in Investing Activities

Net cash used in investing activities in dollars and as a percentage of net earnings were as follows:

	2017				2016			2015
Net cash used	$	179.3			188.1			180.6
% of net earnings	31.0		%		37.7	%		35.0	%

The changes in net cash used in investing activities were primarily related to changes in our net capital expenditures as discussed below and cash paid for acquisitions in 2017 and 2015.

Net capital expenditures (purchases of property and equipment, less proceeds from the sale of property and equipment) in dollars and as a percentage of net earnings were as follows:

	2017				2016			2015
Net capital expenditures	$	112.5			183.0			145.3
% of net earnings	19.4		%		36.6	%		28.1	%

Note – A reconciliation of net capital expenditures is outlined in the table below.

Our net capital expenditures decreased in 2017, when compared to 2016, primarily due to lower spending in 2017 related to: (1) the absence of spending on vending equipment that occurred in 2016 related to the leased locker rollout, (2) the absence of spending on shelving and signage that occurred in 2016 for the CSP 16 initiative, and (3) timing associated with the addition of pickup trucks. Our net capital expenditures increased in 2016, when compared to 2015, which was primarily due to the purchase of industrial vending devices related to the leased locker program we signed in February 2016 and spending on automation in certain distribution centers. Our net capital expenditures decreased in 2015, when compared to 2014, which was largely related to the completion of distribution center automation projects in process during 2014.

Property and equipment expenditures in 2017, 2016, and 2015 consisted of: (1) the purchase of software and hardware for our information processing systems, (2) the addition of fleet vehicles, (3) the purchase of signage, shelving, and other fixed assets related to branch openings and our CSP 16 initiative, (4) the addition of manufacturing and warehouse equipment, (5) the expansion or improvement of certain owned or leased branch properties, (6) purchases related to industrial vending, and (7) costs related to enhancements to distribution centers including automation systems equipment. Disposals of property and equipment consisted of the planned disposition of certain pick-up trucks, distribution vehicles and trailers in the normal course of business, and the disposition of real estate relating to several branch locations and a distribution center (2015).

Set forth below is an estimate of our 2018 net capital expenditures and a recap of our 2017, 2016, and 2015 net capital expenditures.

	2018				2017			2016			2015
	(Estimate)				(Actual)			(Actual)			(Actual)
Manufacturing, warehouse and packaging equipment, industrial vending equipment, and facilities	$	87.0			66.2			131.8			112.5
Shelving and related supplies for branch openings and for product expansion at existing branches	16.0				8.3			14.1			8.9
Data processing software and equipment	28.0				23.2			18.0			19.7
Real estate and improvements to branch locations	14.0				6.2			5.5			4.2
Vehicles	12.0				16.0			20.1			9.9
Purchases of property and equipment	157.0				119.9			189.5			155.2
Proceeds from sale of property and equipment	(8.0		)		(7.4	)		(6.5	)		(9.9	)
Net Capital Expenditures	$	149.0			112.5			183.0			145.3

We anticipate funding our capital expenditure needs with cash generated from operations, from available cash and cash equivalents, and from our borrowing capacity.

Net Cash Used in Financing Activities

Net cash used in financing activities in dollars and as a percentage of net earnings were as follows:

	2017				2016			2015
Net cash used	$	407.2			346.8			340.9
% of net earnings	70.4		%		69.4	%		66.0	%

The fluctuations in net cash used in financing activities are due to changes in the level of our dividend payments and in the level of common stock purchases. These amounts were partially offset by the exercise of stock options and net proceeds from debt obligations. These items in dollars and as a percentage of earnings were as follows:

	2017				2016			2015
Dividends paid	$	369.1			346.6			327.1
% of net earnings	63.8		%		69.4	%		63.3	%
Common stock purchases	82.6				59.5			292.9
% of net earnings	14.3		%		11.9	%		56.7	%
Total returned to shareholders	$	451.7			406.1			620.0
% of net earnings	78.1		%		81.3	%		120.1	%
Proceeds from the exercise of stock options	$	(9.5	)		(29.3	)		(19.1	)
% of net earnings	-1.6		%		-5.9	%		-3.7	%
Cash borrowings, net	$	(35.0	)		(30.0	)		(260.0	)
% of net earnings	-6.0		%		-6.0	%		-50.4	%
Net cash used	$	407.2			346.8			340.9
% of net earnings	70.4		%		69.4	%		66.0	%

Stock Purchases

In 2017, we purchased 1,900,000 shares of our common stock at an average price of approximately $43.43 per share, in 2016, we purchased 1,600,000 shares at an average price of approximately $37.15 per share, and in 2015, we purchased 7,100,000 shares at an average price of approximately $41.26 per share.

Dividends

We declared a quarterly dividend of $0.37 per share on January 16, 2018. We paid aggregate annual dividends per share of $1.28, $1.20, and $1.12 in 2017, 2016, and 2015, respectively.

Debt

In order to fund the considerable cash needed to purchase industrial vending devices under our leased locker program, to expand our industrial vending business, to increase the use of automation in our distribution centers, to purchase our common stock and pay dividends, and to fund the acquisition of Mansco on March 31, 2017, we have borrowed under our Credit Facility and our Master Note Agreement in recent periods.

Our borrowings under the Credit Facility peaked during each quarter of 2017 and 2016 as follows:

Peak borrowings	2017				2016
First quarter	$	325.0			440.0
Second quarter	365.0				485.0
Third quarter	365.0				460.0
Fourth quarter	325.0				405.0

As of December 31, 2017, we had loans outstanding under the Credit Facility of $280.0 and contingent obligations from letters of credit outstanding under the Credit Facility in an aggregate face amount of $36.3. As of December 31, 2017, we also had

loans outstanding under the Master Note Agreement of $135.0. Descriptions of our Credit Facility and Master Note Agreement are contained in Note 10 of the Notes to Consolidated Financial Statements.

Unremitted Foreign Earnings

Approximately $92.0 of cash and cash equivalents are held by non-U.S. subsidiaries. These funds may create foreign currency translation gains or losses depending on the functional currency of the entity holding the cash. We have considered the financial requirements of each foreign subsidiary and our parent company and will continue to reinvest these funds to support our expansion activities outside the U.S. even after taking into consideration the deemed repatriation and transition tax under the Tax Act. The income tax impact of repatriating cash associated with investments in foreign subsidiaries is discussed in Note 7 of the Notes to Consolidated Financial Statements.

Effects of Inflation

Throughout 2017, we experienced increasing product cost inflation, particularly in our fastener products. We were able to take actions during the period, including pricing adjustments, to mostly offset this inflation. In the aggregate, the overall impact of inflation and pricing on sales and profits was not material in 2017. During the first half of 2016, we experienced some deflation in our fastener products, which was largely offset by some inflation in the latter half of the year, and minimal price movements in our non-fastener products. In 2015, we experienced some deflation in our fastener products and minimal price movements in our non-fastener products, with the net impact being a slight drag on growth.

Critical Accounting Policies and Estimates

In preparing our consolidated financial statements in conformity with U.S. GAAP, we must make decisions that impact the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. Such decisions include the selection of the appropriate accounting principles to be applied and the assumptions on which to base accounting estimates. In reaching such decisions, we apply judgments based on our understanding and analysis of relevant circumstances, historical experience, and actuarial valuations. Actual amounts could differ from those estimated at the time the consolidated financial statements are prepared.

Our significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements. Some of those significant accounting policies require us to make difficult, subjective, or complex judgments, or estimates. An accounting estimate is considered to be critical if it meets both of the following criteria: (i) the estimate requires assumptions about matters that are highly uncertain at the time the accounting estimate is made, and (ii) different estimates reasonably could have been used, or changes in the estimate that are reasonably likely to occur from period to period may have a material impact on the presentation of our financial condition, changes in financial condition, or results of operations. Our critical accounting estimates include the following:

Allowance for doubtful accounts – This reserve is for accounts receivable balances that are potentially uncollectible. The reserve is based on an analysis of customer accounts and our historical experience with accounts receivable write-offs. Our methodology for estimating this reserve includes ongoing reviews of the aging of accounts receivable, the financial condition of a customer or industry, and general economic conditions. If business or economic conditions change, our estimates and assumptions may be adjusted as deemed appropriate. Historically, actual required reserves have not varied materially from estimated amounts.

Inventory obsolescence reserves – These reserves are based on an analysis of inventory trends including reviews of inventory levels, sales information, and the on-hand quantities relative to the sales history for the product. Our methodology for estimating these reserves is continually evaluated for factors that could require changes to the reserves including significant changes in product demand, market conditions, condition of the inventory, or liquidation value. If business or economic conditions change, our estimates and assumptions may be adjusted as deemed appropriate. Historically, actual required reserves have not varied materially from estimated amounts.

General insurance reserves – These reserves are for general claims related to workers' compensation, property and casualty losses, and other general liability self-insured losses. The reserves are based on an analysis of reported claims and claims incurred but not yet reported related to our historical claim trends. We perform ongoing reviews of our insured and uninsured risks and use this information to establish appropriate reserve levels. We analyze historical trends, claims experience, and loss development patterns to ensure the appropriate loss development factors are applied to the incurred costs associated with the claims made. Historically, actual required reserves have not varied materially from estimated amounts.

New Accounting Pronouncements

A description of new accounting pronouncements is contained in Note 1 of the Notes to Consolidated Financial Statements.

Geographic Information

Information regarding our revenues and long-lived assets by geographic area is contained in Note 8 of the Notes to Consolidated Financial Statements. Risks related to our foreign operations are described earlier in this Form 10-K under the heading 'Forward-Looking Statements' and 'Item 1A. Risk Factors'.

Certain Contractual Obligations

As of December 31, 2017, we had outstanding long-term debt and facilities, equipment, and vehicles leased under operating leases. Our future obligations to pay principal of and interest on such long-term debt and to make minimum lease payments under such operating leases are as follows:

	Total				2018			2019 and 2020			2021 and 2022			After 2022
Principal of long-term debt	$	415.0			3.0			277.0			75.0			60.0
Interest on long-term debt(1)	35.5				11.3			16.4			5.6			2.2
Operating leases	324.7				133.8			152.5			36.4			2.0
Total	$	775.2			148.1			445.9			117.0			64.2

(1) Interest on the long-term debt outstanding under our Credit Facility was calculated using the interest rates and balances at December 31, 2017.

Purchase orders and contracts for the purchase of inventory and other goods and services are not included in the table above. Our purchase orders are based on current distribution needs and are fulfilled by our suppliers within short time horizons. We do not have significant agreements for the purchase of inventory or other goods or services specifying minimum order quantities.

Liabilities for uncertain tax positions have been excluded from the table above due to the uncertainty surrounding the ultimate settlement and timing of these liabilities. A discussion of income taxes is contained in Note 7 of the Notes to Consolidated Financial Statements.

Non-GAAP Financial Measures

On December 22, 2017, the Tax Act was signed into law. The financial information included in this Form 10-K reflects the estimated impact of the enactment of the Tax Act. Our income tax expense, net earnings, our basic and diluted net earnings per share, and our income tax as a percentage of earnings before income tax, excluding the impact of the Tax Act, are non-GAAP financial measures. Management believes reporting these measures will help investors understand the effect of tax reform on comparable reported results.