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 over 3,200 in-market locations. Most of our customers are in the manufacturing and non-residential construction markets. The manufacturing market includes both OEM and MRO customers. The non-residential construction market includes general, electrical, plumbing, sheet metal, and road contractors. Other users of our products include farmers, truckers, railroads, oil exploration companies, oil production and refinement companies, mining companies, federal, state, and local governmental entities, schools, and certain retail trades. Geographically, our branches, Onsite locations, and customers are primarily located in North America.

It is helpful to appreciate several aspects of our marketplace: (1) It's big. We estimate the North American marketplace for industrial supplies is 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 $368.6, or 7.4%, in 2019 relative to 2018. Our gross profit as a percentage of net sales declined to 47.2% in 2019 from 48.3% in 2018. Our operating income as a percentage of net sales declined to 19.8% in 2019 from 20.1% in 2018.

Our net earnings in 2019 were $790.9, an increase of 5.2% when compared to 2018. Our diluted net earnings per share were $1.38 in 2019 compared to $1.31 in 2018, an increase of 5.2%. Discrete tax items benefited net earnings by $7.1 in 2018.

We continued to focus on our growth drivers in 2019. Daily sales to our national account customers (defined as customer accounts with a multi-site contract) grew 11.9% in the period. Additionally, we signed 362 new Onsite customer locations (defined as dedicated sales and service provided from within, or in close proximity to, the customer's facility) and 21,857 new industrial vending devices. We experienced sales growth in the mid-teens through both our vending devices and our Onsite locations (excluding sales transferred from a branch).

The table below summarizes our total employee headcount, our investments in in-market locations (defined as the sum of the total number of public branch locations and the total number of active Onsite locations), and industrial vending devices at the end of the periods presented and the percentage change compared to the end of the prior period.

	Q4 2019			Q4 2018			Twelve-month % Change
In-market locations - absolute employee headcount	13,977			14,015			-0.3	%
Total absolute employee headcount	21,948			21,644			1.4	%
Number of public branch locations	2,114			2,227			-5.1	%
Number of active Onsite locations	1,114			894			24.6	%
Number of in-market locations	3,228			3,121			3.4	%
Industrial vending devices (installed count) (1)	89,937			81,137			10.8	%
Ratio of industrial vending devices to in-market locations	28:1			26:1

(1) This number primarily represents devices which principally dispense product and produce product revenues, and excludes approximately 15,000 devices that are part of a locker lease program where the devices are principally used for the check-in/check-out of equipment.

During the last twelve months, we reduced our absolute employee headcount by 38 people in our in-market locations and increased by 304 people in total. The reduction in our absolute employee headcount in our in-market locations reflects actions taken by leadership in our public branches over the past couple of quarters to control expenses in response to weaker demand, which was only partly offset by increases to support growth in our number of Onsite locations. The increase in our total absolute employee headcount is mostly from additions we have made to support customer acquisition, implementation, and growth in the field, particularly as it relates to our growth drivers and to support general corporate and hub functions.

We opened twelve branches and closed 125 branches, net of conversions, in 2019. We activated 312 Onsite locations and closed 92, net of conversions, in 2019. The number of closings reflects both normal churn in our business, whether due to exiting customer relationships, the shutting or relocation of a customer facility, or a customer decision, as well as a review of certain underperforming locations. Our in-market network forms the foundation of our business strategy, and we will continue to open or close locations as is deemed necessary to sustain and improve our network, support our growth drivers, and manage our operating expenses.

Results of Operations

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

		2019			2018			2017
Net sales		100.0	%		100.0	%		100.0	%
Gross profit		47.2	%		48.3	%		49.3	%
Operating and administrative expenses		27.4	%		28.2	%		29.2	%
Gain on sale of property and equipment		0.0	%		0.0	%		0.0	%
Operating income		19.8	%		20.1	%		20.1	%
Net interest expense		-0.3	%		-0.3	%		-0.2	%
Earnings before income taxes		19.6	%		19.9	%		19.9	%
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:

	2019				2018			2017
Net sales	$	5,333.7			4,965.1			4,390.5
Percentage change	7.4		%		13.1	%		10.8	%
Business days	254				254			254
Daily sales	$	21.0			19.5			17.3
Percentage change	7.4		%		13.1	%		11.3	%
Daily sales impact of currency fluctuations	-0.3		%		0.1	%		0.1	%
Daily sales impact of acquisitions	0.1		%		0.4	%		1.0	%

The increases in net sales noted above for both 2019 and 2018 were a result of higher unit sales and, to a lesser degree, higher prices. Higher product prices were realized throughout 2019 and 2018 as a result of actions (beginning initially in late 2017) taken to offset increases in product costs, and we believe these increases contributed 0.9% to 1.0% and 0.7% to 0.8% to sales growth during 2019 and 2018, respectively. The increase in net sales for 2017 was driven primarily by higher unit sales. Price increases were not a material factor in 2017.

The higher unit sales in 2019 and 2018 resulted primarily from two sources. The first is higher underlying market demand, which we believe is reflected in a number of metrics. For instance, the U.S. Purchasing Managers Index, published by the Institute for Supply Chain Management, averaged 51.2 in 2019 and 58.8 in 2018. Readings above 50 are indicative of growing demand, and we believe these levels are consistent with the sales growth rates we experienced in the respective periods. In addition, U.S. Industrial Production, which is published by the Federal Reserve, increased 0.8% in 2019 and increased 3.9% in 2018. We believe U.S. Industrial Production is a good proxy for the state of our marketplace and that the growth in this metric is consistent with the sales growth rates we experienced in the respective periods. This was reflected as well in daily sales of fasteners, our most cyclical product line, which grew 5.5% and 11.2% in 2019 and 2018, respectively. We also experienced growth in sales to 75 of our top 100 customers in 2019, which compares to growth in sales to 84 of our top 100 customers in 2018.

Another explanation for our results is that while underlying demand throughout 2018 was stable at high levels, underlying demand in 2019 began strong but weakened throughout the year. For instance, the U.S. Purchasing Managers Index averaged 55.4 in the first quarter of 2019 but averaged 47.9 in the fourth quarter of 2019. In addition, U.S. Industrial Production increased 2.9% in the first quarter of 2019 but decreased 0.9% in the fourth quarter of 2019. The slowing in these metrics from the start to the end of 2019 mirrors the slowing growth we experienced in our unit sales over the same period.

A relatively greater contributor to our growth in 2019 was the success of our growth initiatives. We signed 21,857 industrial vending devices during 2019. While this represented a slight decrease in signings of 1.0% from 2018, it also contributed to growth in our installed base to 89,937 vending devices at the end of 2019, an increase of 10.8% over 2018. Growth in our installed base was primarily responsible for sales growth through our vending devices in the mid-teens during 2019. We signed 362 new Onsite locations in 2019, an increase of 7.7% over 2018, and had 1,114 active sites on December 31, 2019, an increase of 24.6% over December 31, 2018. Growth in our number of active sites was primarily responsible for sales growth through our Onsites in the mid-teens during 2019. The contribution of new national account contracts and strong penetration of existing national account customers resulted in daily sales from our national account customers growing 11.9% in 2019 compared to 2018.

We signed 22,073 industrial vending devices during 2018, an increase of 14.0% over 2017. In addition to an increase in our installed base, we achieved a low-single digit increase in average sales per device. These variables combined to generate sales growth through our vending devices in excess of 20% in 2018. We signed 336 new Onsite locations in 2018, an increase of 24.4% over 2017, and had 894 active sites on December 31, 2018, an increase of 47.8% over December 31, 2017. We signed 152 new national account contracts in 2018. The contribution of these new contracts and strong penetration of existing national account customers resulted in daily sales from our national account customers growing 18.1% in 2018 compared to 2017.

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

a decrease in our device removals of 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, an increase of 53.4% over 2016, 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.

Sales by Product Line

The approximate mix of sales from fasteners, safety supplies, and all other product lines was as follows:

	2019		2018		2017
Fasteners	34.2%		34.9%		35.6%
Safety supplies	17.9%		17.2%		16.3%
Other product lines	47.9%		47.9%		48.1%

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, particularly OEM fasteners 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 2019, but not in 2018 or 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.
2019	13.3	%		10.5	%		12.7	%		7.4	%		9.5	%		7.0	%		6.1	%		6.3	%		5.8	%		4.3	%		5.7	%		1.0	%
2018	12.0	%		14.8	%		13.1	%		13.4	%		12.5	%		13.5	%		12.0	%		13.7	%		13.5	%		12.4	%		12.3	%		14.5	%
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	%

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 2019, March 2018, and April 2017, and will fall in April in 2020), 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 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 (2014-2018). We believe this time frame serves to show the historical pattern and could serve as a benchmark for current performance. The '2019', '2018', and '2017' lines represent our actual sequential daily sales changes. The '19Delta', '18Delta', and '17Delta' 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	-1.2	%		1.5	%		3.7	%		0.1	%		2.0	%		2.0	%		-3.3	%		3.7	%		1.8	%		-1.9	%		9.8	%
2019	-0.5	%		1.4	%		4.2	%		-2.4	%		2.5	%		1.4	%		-4.4	%		3.9	%		3.1	%		-4.4	%		4.9	%
19Delta	0.6	%		-0.1	%		0.5	%		-2.5	%		0.5	%		-0.6	%		-1.1	%		0.3	%		1.3	%		-2.5	%		-4.9	%
2018	-1.3	%		4.0	%		2.1	%		2.4	%		0.6	%		3.7	%		-3.6	%		3.8	%		3.6	%		-3.0	%		13.9	%
18Delta	-0.2	%		2.5	%		-1.6	%		2.4	%		-1.5	%		1.8	%		-0.3	%		0.1	%		1.7	%		-1.1	%		4.2	%
2017	0.2	%		1.5	%		3.6	%		2.2	%		1.4	%		2.8	%		-2.4	%		2.2	%		3.8	%		-2.1	%		13.5	%
17Delta	1.4	%		0.0	%		-0.1	%		2.1	%		-0.6	%		0.9	%		0.9	%		-1.4	%		2.0	%		-0.2	%		3.8	%

(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
2019	13.4	%		9.1	%		7.7	%		5.1	%		8.8	%
2018	14.3	%		13.3	%		13.0	%		13.3	%		13.5	%
2017	6.2	%		11.5	%		15.3	%		16.6	%		12.3	%

(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 (approximately 35% 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
2019	11.8	%		5.5	%		3.0	%		1.8	%		5.5	%
2018	11.8	%		11.1	%		10.8	%		11.3	%		11.2	%
2017	0.8	%		7.9	%		12.1	%		13.4	%		8.4	%

The daily sales growth rates of fasteners noted in the table above for first quarter of 2018, and the second, third, and fourth quarters of 2017, include 3.7, 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
2019	12.7	%		9.5	%		8.0	%		5.1	%		8.8	%
2018	14.5	%		14.8	%		14.9	%		14.6	%		14.7	%
2017	9.4	%		12.2	%		14.6	%		16.1	%		13.1	%

While not immune to the impact of a weak industrial environment as was experienced in the latter half of 2019, our non-fastener business did demonstrate greater relative resilience when compared to our fastener business and to the distribution industry in general. Non-fastener growth slowed, but remained above the growth of the fastener business. The strong relative performance of the non-fastener business when compared to the fastener business and to the distribution industry in general was also evident during the strong 2018 and 2017 periods. We believe this is due to both the growth of our vending business and our lower penetration of the non-fastener marketplace relative to our penetration of the fastener marketplace.

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
2019	12.1	%		6.0	%		0.6	%		0.7	%		4.7	%
2018	11.7	%		17.6	%		19.2	%		16.4	%		16.3	%
2017	6.9	%		8.8	%		9.4	%		11.6	%		9.1	%

(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 manufacturing economy as well as infrastructure spending. In 2019, the slowing production environment, as described above, and the accompanying worsening trends for commodities, caused the growth in our non-residential construction and reseller customers to slow. In 2018 and 2017, improving trends for commodities such as metals and energy, industrial capital spending, and the state of the broader economy 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
2019	47.7	%		46.9	%		47.2	%		46.9	%		47.2	%
2018	48.7	%		48.7	%		48.1	%		47.7	%		48.3	%
2017	49.4	%		49.8	%		49.1	%		48.8	%		49.3	%

Our gross profit, as a percentage of net sales, was 47.2% in 2019 and 48.3% in 2018. The gross profit percentage for 2019 declined by 110 basis points based on three items. (1) A change in product and customer mix. Fasteners are our largest and highest gross profit margin product line due to the high transaction cost surrounding the sourcing and supply of the product for customers. Our fastener product line declined to 34.2% of sales in 2019 from 34.9% of sales in 2018. 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 53.6% in 2019 from 50.7% of sales in 2018. The combination of relatively slower growth in our fastener product line and relatively faster growth in sales to our largest customers contributed to the decline in our overall gross profit margin in 2019. (2) We operate our own fleet of trucks for moving product between suppliers, our distribution centers, and our in-market locations. We believe this provides us a competitive advantage in terms of our ability to move product efficiently and quickly. There is a cost to supporting and maintaining these assets, which we traditionally attempt to minimize by charging freight. During periods of weaker business conditions it can be more difficult to charge freight, and as a result our freight revenues were down in 2019. At the same time, the overall cost of our fleet assets is relatively stable, resulting in reduced absorption of our fixed costs. (3) We experienced an increase in the cost of our products due to generalized inflation and tariffs resulting from disputes between the United States and its trade partners. We implemented several actions to mitigate the impact of these cost increases in 2019, including price increases. For the full year, the net impact of these actions was minor. However, the impact through the year differed, with a larger negative impact on the gross profit percentage in the first half of 2019 and a relatively modest impact in the second half of 2019.

During 2018 and 2017, 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 the changes in product and customer mix noted above and rising freight expense as a result of costs related to transporting products, particularly shipping fees, driver wages, and fuel. In 2018, our gross profit percentage was also affected by rising product costs as a result of generalized inflation and tariffs. In 2017, our gross profit percentage was also affected by the acquisition of Mansco, the customer mix of which 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.

Operating and Administrative Expenses

Our operating and administrative expenses (including the gain on sales of property and equipment), as a percentage of net sales, improved to 27.3% in 2019 from 28.2% in 2018. This improvement was a function of the growth in employee-related, occupancy-related, and all other operating and administrative expenses being more modest than the growth in sales. Employee-related expenses reduced the ratio of operating and administrative expenses as a percentage of sales by approximately 40 to 45 basis points in 2019 from 2018. Occupancy-related and all other operating and administrative expenses each reduced the ratio of operating and administrative expenses as a percentage of sales by approximately 20 to 25 basis points each in 2019 from 2018.

The growth in employee-related, occupancy-related, and all other operating and administrative expenses (including the gain on sales of property and equipment) 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
	2019			2018			2017
Employee-related expenses	65% to 70%	5.1	%		11.1	%		10.2	%
Occupancy-related expenses	15% to 20%	2.8	%		5.0	%		1.3	%
All other operating and administrative expenses	15% to 20%	1.5	%		5.2	%		21.4	%

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 2019. 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, (3) an increase in our profit sharing contribution and options awards, (4) increases in hourly base wages, and (5) increased health care costs. The increase in 2018, when compared to 2017, was related to: (1) an increase in 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, (3) an increase in our profit sharing contribution, (4) increases in hourly base wages, and (5) increased health care costs. The increase in 2017, when compared to 2016, was related to: (1) an increase in 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 options awards, (4) increased health care costs, and (5) the inclusion of Mansco personnel.

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
	2019			2018			2017
In-market locations	0.2	%		5.7	%		7.0	%
Total selling (includes in-market locations)	0.8	%		5.4	%		7.3	%
Distribution	2.2	%		12.2	%		8.4	%
Manufacturing	-2.7	%		12.0	%		8.4	%
Administrative	8.5	%		7.3	%		10.7	%
Total	1.4	%		6.8	%		7.7	%

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 in-market operations and classify the depreciation and repair costs as occupancy expense). The increase in occupancy-related expenses in 2019, when compared to 2018, was mainly driven by increases related to industrial vending equipment. The increase in occupancy-related expenses in 2018, when compared to 2017 was mainly driven by increases related to industrial vending equipment and non-branch occupancy and utility costs, only partly offset by a slight decline in branch occupancy costs from a lower public branch count. The slight increase 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.

All other operating and administrative expenses include: (1) selling-related transportation, (2) information technology (IT) expenses, (3) general corporate expenses, which consists of legal expenses, general insurance expenses, travel and marketing expenses, etc., and (4) the gain on sales of property and equipment. Combined, all other operating and administrative expenses increased in 2019 when compared to 2018. This was primarily due to higher IT spending. The increase in 2018 when compared to 2017, was due to an increase in selling-related transportation expenses, consisting of both higher vehicle movement and fuel costs, as well as higher IT spending. General corporate expenses were slightly down. The increase in 2017 when compared to 2016, was driven by increases in selling-related transportation, including higher vehicle movement and fuel costs, IT spending, and general corporate expenses.

Net Interest Expense

Our net interest expense was $13.6 in 2019 compared to $12.3 in 2018, and $8.7 in 2017. The increase in 2019, when compared to 2018, was mainly caused by higher average interest rates and a higher average debt balance during the period. The increase in 2018, when compared to 2017, was mainly caused by higher average interest rates and a higher average debt balance during the period.

Income Taxes

We recorded income tax expense of $252.8 in 2019, or 24.2% of earnings before income taxes. Our income tax expense was reduced by $2.6 as a result of applying guideline clarifications issued by the IRS on certain aspects of tax reform as well as tax benefits associated with the exercise of stock options. This reduced our tax rate in the period by 30 basis points.

We recorded income tax expense of $235.1 in 2018, or 23.8% of earnings before income taxes. The effective income tax rate was significantly impacted by the following two items: (1) The lower corporate tax rate provided by the Tax Act resulted in a

lower tax rate beginning in the first quarter of 2018. The effective income tax rate includes the immaterial impact of the U.S. tax on certain offshore earnings referred to as Global Intangible Low-Taxed Income (GILTI), a new deduction for Foreign Derived Intangible Income (FDII), and the new alternative U.S. tax on certain Base Erosion Anti-Avoidance (BEAT) payments from a U.S. company to any foreign related party. (2) Discrete income tax items to adjust our transition tax liability, reflect the impacts of accelerating depreciation for certain physical assets, and remeasure the impact of the U.S. tax rate on certain inter-company transactions. These discrete items resulted in approximately $7.1 of income tax benefit during 2018. The accounting for the income tax effects of the Tax Act is complete as of December 31, 2018.

We recorded a provisional income tax expense of $294.5 in 2017, or 33.7% of earnings before income taxes. This amount reflects a provisional estimate for the 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. 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.

Net Earnings

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

Dollar Amounts	2019				2018 (1)			2017
Net earnings	$	790.9			751.9			578.6
Basic EPS	1.38				1.31			1.00
Diluted EPS	1.38				1.31			1.00
Percentage Change	2019				2018 (1)			2017
Net earnings	5.2		%		29.9	%		15.8	%
Basic EPS	5.3		%		30.5	%		16.1	%
Diluted EPS	5.2		%		30.5	%		16.2	%
	2019				2018			2017
Tax Rate	24.2		%		23.8	%		33.7	%

(1) As a result of the Tax Act, discrete tax items benefited our net earnings by $7.1 during 2018.

During 2019, net earnings increased, primarily due to stronger sales and operating profits, and were only partly offset by an increase in income tax expense. During 2018, net earnings increased, primarily due to stronger sales and operating profits combined with a reduction in income tax expense. The increase in basic and diluted earnings per share also reflected the purchase of our shares of common stock in 2018. 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.

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:

	2019				2018			2017
Net cash provided	$	842.7			674.2			585.2
% of net earnings	106.5		%		89.7	%		101.1	%

In 2019, the increase in our operating cash flow as a percentage of net earnings reflects a reduced drag from working capital investment than was experienced in 2018 and, to a lesser degree, higher net income. In 2018, the increase in net cash provided by operating activities was primarily due to our net earnings growth, which resulted from pre-tax earnings growth and a lower tax rate as a result of the Tax Act. The decline in our operating cash flow as a percentage of net earnings largely reflects working capital trends, as further described below. In 2017, the increase in net cash provided by operating activities was primarily due to our net earnings growth.

Operational Working Capital Assets

Operational working capital assets, 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	2019				2018
Accounts receivable, net	$	27.5			106.4
Inventories	87.7				185.8
Operational working capital assets	$	115.2			292.2
Annual percentage change	2019				2018
Accounts receivable, net	3.9		%		17.5	%
Inventories	6.9		%		17.0	%
Operational working capital assets	5.8		%		17.2	%

Note – Amounts may not foot due to rounding difference.

In 2019, the annual growth in net accounts receivable reflects not only our growth in sales, but also the fact that our growth is being driven disproportionately by our national accounts program where our customers tend to have longer payment terms than our customer base as a whole. Growth was also relatively stronger with customers outside the U.S., which similarly tend to have longer payment terms than our customer base as a whole. The rate of growth in receivables did slow throughout 2019, largely reflecting the impact on receivables of softer business activity. In 2018, 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. In addition, two trends emerged among our customer base that increased our net accounts receivable. The first was a push from our customers to contractually increase the period between when they are invoiced and when payment is due. The second was customers delaying payments beyond the end of the applicable quarter. We saw these behaviors intensify throughout 2018.

Our inventory balances over time will respond to business activity, though various factors produce a looser relationship to our monthly sales patterns than we tend to experience in accounts receivable. One reason for this is cyclical. We source significant quantities of product from overseas, and the lead time involved in procuring these products is typically longer than the visibility we have into future monthly sales patterns. As a result, trends in our inventory will often lag trends in economic conditions. Another reason inventories may fluctuate independently of monthly sales patterns is based on strategic decisions. For instance, at various times we have increased our relative inventory levels to enhance product breadth and availability in our branches and distribution centers, expand direct sourcing, and broaden Fastenal brands. Our growth drivers, including industrial vending solutions, national accounts, and Onsite and international locations, have also required significant investments in inventory. In 2019, our inventories increased to support higher sales, largely reflecting large increases in the number of installed vending devices and active Onsite locations, and from inflation and tariffs. We intend to continue to invest in the inventory necessary to support our vending and Onsite initiatives. However, over the course of the year we did reduce other spending, both reflecting proactive efforts to reduce inventory and in reaction to the effect of softer business activity, which allowed us to meaningfully decelerate inventory growth in the fourth quarter of 2019. In 2018, our inventories increased as a result of growth in general demand and successful execution of our growth drivers. Inflation had an increasing impact in the second half of 2018, and our decision to accelerate shipments of product to the U.S. from overseas ahead of potential tariffs resulted in extra inventory of approximately $12.0 in the fourth quarter of 2018.

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

	2019			2018			2017
Selling locations	60	%		61	%		65	%
Distribution center and manufacturing locations	40	%		39	%		35	%
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:

	2019				2018			2017
Net cash used	$	239.7			173.9			179.3
% of net earnings	30.3		%		23.1	%		31.0	%

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

Property and equipment expenditures typically consist primarily of: (1) purchases related to industrial vending, (2) purchases of property and equipment related to expansion of and enhancements to distribution centers, (3) spending on software and hardware for our information processing systems, (4) the addition of fleet vehicles, (5) expansion, improvement or investment in certain owned or leased branch properties, and (6) the addition of manufacturing and warehouse 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.

Set forth below is a recap of our 2019, 2018, and 2017 net capital expenditures in dollars and as a percentage of net sales and net earnings:

	2019			2018			2017
Manufacturing, warehouse and packaging equipment, industrial vending equipment, and facilities	172.7			110.7			66.2
Shelving and related supplies for in-market location openings and for product expansion at existing in-market locations	12.3			9.6			8.3
Data processing software and equipment	31.1			30.9			23.2
Real estate and improvements to branch locations	8.9			12.9			6.2
Vehicles	21.4			12.2			16.0
Purchases of property and equipment	246.4			176.3			119.9
Proceeds from sale of property and equipment	(6.6	)		(9.5	)		(7.4	)
Net capital expenditures	239.8			166.8			112.5
% of net sales	4.5	%		3.4	%		2.6	%
% of net earnings	30.3	%		22.2	%		19.4	%

Our net capital expenditures increased in 2019, when compared to 2018, primarily due to increased spending on hub property and equipment, both to expand current capacity and for potential future expansion, higher spending on vending devices to support the growth of our industrial vending program, and investment in our trucking assets. While the sources of the increase in our net capital spending in 2019 were expected, our total spend exceeded our targeted range of $195.0 to $225.0. We had significant spending in 2019 on facilities, with a couple of locations having higher costs than originally anticipated. Our net capital expenditures increased in 2018, when compared to 2017, primarily due to increased spending on hub property and equipment, both to expand current capacity and for potential future expansion, as well as vending devices to support the growth of our industrial vending program. Our net capital expenditures decreased in 2017, when compared to 2016, primarily due to lower spending in 2017 related to the absence of spending on vending equipment that occurred in 2016 related to the leased locker rollout, the absence of spending on shelving and signage that occurred in 2016 for the CSP 16 initiative, and timing associated with the addition of pick-up trucks.

We expect our net capital expenditures in 2020 to be within a range of $180.0 to $205.0. This decrease from 2019 is primarily attributable to reduced projects to develop and expand certain distribution center assets and, to a lesser degree, reduced fleet vehicle investment. 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:

	2019				2018			2017
Net cash used	$	595.1			446.5			407.2
% of net earnings	75.2		%		59.4	%		70.4	%

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 payments (proceeds) from debt obligations. These items in dollars and as a percentage of earnings were as follows:

	2019				2018			2017
Dividends paid	$	498.6			441.9			369.1
% of net earnings	63.0		%		58.8	%		63.8	%
Common stock purchases	—				103.0			82.6
% of net earnings	—				13.7	%		14.3	%
Total returned to shareholders	$	498.6			544.9			451.7
% of net earnings	63.0		%		72.5	%		78.1	%
Proceeds from the exercise of stock options	$	(58.5	)		(13.4	)		(9.5	)
% of net earnings	-7.4		%		-1.8	%		-1.6	%
Cash payments (borrowings), net	$	155.0			(85.0	)		(35.0	)
% of net earnings	19.6		%		-11.3	%		-6.0	%
Net cash used	$	595.1			446.5			407.2
% of net earnings	75.2		%		59.4	%		70.4	%

Stock Purchases

In 2019, we did not purchase any shares of our common stock. In 2018, we purchased 4,000,000 shares of our common stock at an average price of approximately $25.75 per share, and in 2017, we purchased 3,800,000 shares at an average price of approximately $21.72 per share.

Dividends

We declared a quarterly dividend of $0.25 per share on January 16, 2020. We paid aggregate annual dividends per share of $0.87, $0.77, and $0.64 in 2019, 2018, and 2017, respectively.

Debt

In order to fund the considerable cash needed to expand our industrial vending business, to expand capacity and increase the use of automation in our distribution centers, pay dividends, and to purchase our common stock in 2018, 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 2019 and 2018 as follows:

Peak borrowings	2019				2018
First quarter	$	450.0			335.0
Second quarter	400.0				360.0
Third quarter	395.0				330.0
Fourth quarter	310.0				435.0

As of December 31, 2019, we had loans outstanding under the Credit Facility of $210.0 and contingent obligations from letters of credit outstanding under the Credit Facility in an aggregate face amount of $36.3. As of December 31, 2019, 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 9 of the Notes to Consolidated Financial Statements.

Unremitted Foreign Earnings

Approximately $122.7 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

We experienced higher product costs through 2019 relative to 2018 as a result of generalized inflation and tariffs, though the impact of these items did moderate later in the year as economic activity slowed and conditions around trade stabilized. We took actions during the year to mitigate the effects of higher product costs, including increasing product prices. These actions were not able to offset the pressure we experienced on our gross profit percentage in the first half of 2019, but were more effective at doing so in the second half of 2019. Throughout 2018, we experienced increasing product cost inflation for non-fastener and, especially, fastener products. We took actions in the latter part of 2017 and throughout 2018, including pricing adjustments, to offset this inflation. While we succeeded in raising prices through the year, we were not able to do so at the same rate that our costs rose which negatively affected our profit margins and earnings in 2018. Apart from generalized inflation, tariffs were instituted on certain products that we source from China, but this occurred later in the year and did not have a meaningful impact on sales or profits in 2018. 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.

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 most significant accounting policies, including Revenue Recognition and Inventories, 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 most 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 2 and Note 3 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, 2019, 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				2020			2021 and 2022			2023 and 2024			After 2024
Principal of long-term debt	$	345.0			3.0			75.0			267.0			—
Interest on long-term debt(1)	37.2				10.1			18.8			8.3			—
Operating leases(2)	261.5				105.1			117.2			35.5			3.7
Total	$	643.7			118.2			211.0			310.8			3.7

(1) Interest on the long-term debt outstanding under our Credit Facility was calculated using the interest rates and balances at December 31, 2019.

(2) Amounts include lease liabilities for pick-up truck leases, which typically have a non-cancelable lease term of less than one year and are not included on the consolidated balance sheets as an operating lease right-of-use asset.

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, which we believe will be immaterial. A discussion of income taxes is contained in Note 7 of the Notes to Consolidated Financial Statements.