2004  $_{ }$ Management’s Discussion & Analysis of Financial Condition & Results of Operations (Dollar Amounts in Millions except Per Share Information and as Otherwise Noted)  Management included the net earnings growth  rate information excluding the gain on disposal  of the DIY Business and excluding the extraordinary gain on acquisition because we  believe it provides a consistent presentation of  the growth experienced in Fastenal’s ordinary  course operations.  adjustments, and the on-hand quantities relative  to the sales history for the product. Historically,  results have reflected the reserves previously  recorded. Management believes the results could  be materially different if historical trends do not  reflect actual results.  During 2004 and 2003, the net earnings growth  rate was greater than that of net sales primarily  because of the earlier mentioned impact of  payroll and related costs, and, in the case of 2004  only, the improvements in gross profit margins.  During 2002, the net earnings growth rate was  lower than that of net sales primarily because of  the earlier mentioned impact of operating and  administrative costs.  Health insurance reserves – This reserve is for  incurred but not reported and reported and  unpaid health claims. The reserve is based on an  analysis of external data related to the Company’s historical claim reporting trends.  Historically, results have reflected the reserves  previously recorded. Management believes the  results could be materially different if historical  trends do not reflect actual results.  Effects of Inflation—  Price inflation related to  certain products positively impacted net sales in  2004. Price deflation related to certain products  negatively impacted net sales in 2003 and 2002. General insurance reserves – This reserve is for  general claims related to worker’s compensation,  property and casualty losses, and other self- insured losses. The reserve is based on an  analysis of external data related to the Company’s historical general claim trends. Management believes the results could be materially different if historical trends do not  reflect actual results.  Critical Accounting Policies—  The Company’s  estimates related to certain assets and liabilities  are an integral part of the consolidated financial  statements. These estimates are considered critical to the consolidated financial statements  because they require subjective and complex  judgments.  Net cash provided by operating activities was: Allowance for doubtful accounts – This reserve  is for accounts receivable balances that are  potentially uncollectible. The reserve is based on  (1) an analysis of customer accounts and (2) the  Company’s historical experience with accounts  receivable write-offs. The analysis includes the  aging of accounts receivable, the financial condition of a customer or industry, and general  economic conditions. Historically, results have  reflected the reserves previously recorded. Management believes the results could be materially different if historical trends do not  reflect actual results or if economic conditions  worsened for the Company’s customers.  Inventory reserves – This reserve is for shrinkage. The reserve is based on an analysis of  inventory trends. The analysis includes inventory  levels, physical inventory counts, cycle count  The 2004 decrease in net cash provided by  operating activities was primarily due to the  increase in inventories. The 2003 increase in net  cash provided by operating activities was primarily due to the increase in net earnings and  the impact of lower growth in inventories when  compared to 2002, and, to a lesser degree, the  impact of effective accounts payable management and of the strengthening Canadian  dollar when compared to the United States  dollar. The 2003 increase was partially offset by  expected increases in trade accounts receivable. 2004 ANNUAL REPORT – PAGE 13  Liquidity and Capital Resources  2004  $ 57.4  2003  $ 90.6  2002  $ 17.6 