W.W. Grainger (GWW)

The following comments at the segment level include external and intersegment net sales and operating earnings. Comments at the business unit level include external and inter- and intrasegment net sales and operating earnings. See Note 18 to the Consolidated Financial Statements.

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The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 10 to the Condensed Consolidated Financial Statements.

The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 8 to the Condensed Consolidated Financial Statements.

The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 6 to the Condensed Consolidated Financial Statements.

The following comments at the segment level include external and intersegment net sales and operating earnings. Comments at the business unit level include external and inter- and intrasegment net sales and operating earnings. See Note 17 to the Consolidated Financial Statements.

The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 9 to the Condensed Consolidated Financial Statements.

The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 8 to the Condensed Consolidated Financial Statements.

The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 8 to the Condensed Consolidated Financial Statements.

The following comments at the segment level include external and intersegment net sales and operating earnings. Comments at the business unit level include external and inter- and intrasegment net sales and operating earnings. See Note 19 to the Consolidated Financial Statements.

The following comments at the segment level refer to external and intersegment net sales. Comments at the business unit level include external and inter- and intrasegment net sales. See Note 7 to the Condensed Consolidated Financial Statements.

Branch-based Distribution

Net sales of $3,850.1 million increased $321.2 million, or 9.1%, in the first nine months of 2005 compared to net sales of $3,528.9 million in the first nine months of 2004. Sales in the United States were up 8.3% with growth in all customer end markets, led by the government, manufacturing and natural resource sectors. National accounts sales within all customer segments were up 12% for the nine-month period. The sales growth was negatively affected by 2 percentage points by the wind-down of Integrated Supply and related automotive contracts. The Company is expecting an additional 2 percentage point reduction in sales growth related to these types of contacts in 2006.

In 2004, the Company launched a multiyear initiative to strengthen its presence in top metropolitan markets and better position itself to serve the local customer. Phases 1 through 3 include 10 markets. As of the third quarter of 2005, the Company had begun Phase 4 of the project. Additional phases are scheduled for 2006 and beyond.

Net sales in Canada during the first nine months of 2005 were 15.8% higher than the comparable 2004 period, benefiting from the stronger Canadian economy fueled by its natural resources industry and a favorable exchange rate. In local currency, sales increased 6.7%. Sales in Mexico increased 19.2% in the year-to-date period ended September 30, 2005, driven by an improving economy, increased telesales and incremental sales for one new branch added in September of 2004.

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Table of Contents

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The gross profit margin increased 1.4 percentage points in the first nine months of 2005 over the comparable period of 2004. Contributing to the improvement in gross profit margin were favorable changes in selling price category mix and the positive effect of product mix. A major driver of the improvement in selling price category mix was reduced sales to Integrated Supply and automotive customers, which carry lower margins than the overall average.

Operating expenses for the Branch-based Distribution businesses were up 13.0% in the first nine months of the year. Increased costs related to market expansion and the SAP system implementation were the primary drivers of the operating expense growth. Higher expenses for payroll, benefits and profit sharing also contributed to the increase. Partially offsetting these increases were lower bad debt expenses.

In the first nine months of 2005, operating earnings of $379.0 million increased 14.7% compared with $330.4 million for the comparable period of 2004. The earnings improvement resulted from higher sales and improved gross profit margin, partially offset by operating expenses that increased at a faster rate than sales.

Lab Safety

Net sales for Lab Safety were $288.9 million for the first nine months of 2005, an increase of $30.6 million, or 11.8%, when compared with $258.3 million for the same period in 2004. The sales growth was primarily attributable to incremental sales from AW Direct, acquired on January 14, 2005. Excluding AW Direct, sales were up 3.6%.

The gross profit margin of 42.8% for the first nine months of 2005 increased 1.1 percentage points when compared with the first nine months of 2004. The margin improvement was primarily attributable to the elimination of a 2004 fulfillment program that had lower than average gross profit margins. The 2005 gross profit margin also benefited from inflation recovery. These margin increases were partially offset by incremental sales of AW Direct products, which generally have lower gross profit margins than other Lab Safety products.

Operating expenses at Lab Safety of $82.9 million were $11.6 million, or 16.3%, higher in the first nine months of 2005 due to incremental costs associated with the acquisition of AW Direct, as well as increased investment in media. Excluding AW Direct, operating expenses were up $4.7 million or 6.6%.

Operating earnings of $40.8 million, up 12.1% in the first nine months of 2005 over 2004, resulted primarily from increased sales and improved gross profit margin, partially offset by higher operating expenses.

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Table of Contents

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS