W.W. Grainger, Inc. is a broad-line distributor of maintenance, repair and operating (MRO) supplies, and other related products and services used by businesses and institutions.  W.W. Grainger, Inc.’s operations are primarily in the United States (U.S.) and Canada, with a presence in Europe, Asia and Latin America.  In this report, the words “Company” or “Grainger” mean W.W. Grainger, Inc. and its subsidiaries.

The Condensed Consolidated Financial Statements of the Company and the related notes are unaudited and should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 20152016 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC).

The Condensed Consolidated Balance Sheet as of December 31, 20152016 has been derived from the audited consolidated financial statements at that date, but does not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements.

The unaudited financial information reflects all adjustments (primarily consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of the statements contained herein.

transactions, including accounting for income taxes, forfeitures and statutory tax withholdings requirements, as well as classification in the statement of cash flows. The effective date for the standard is for fiscal years and interim periods withwithin those years beginning after December 15, 2016. As of January 1, 2017, the Company adopted the ASU and it resulted in the following:

The effective datedates of ASU 2016-08, ASU 2016-10 and ASU 2016-20 are consistent with ASU 2014-09. The Company has elected not to early adopt these ASUs. The standard permits the use of either the full retrospective or the modified retrospective adoption method. The Company is planning to elect the modified retrospective method and recognize the cumulative effect of initially applying the new standard as an adjustment to the opening balance of equity as of January 1, 2018. These ASUs require expanded qualitative and quantitative disclosures of revenue and cash flows emerging from contracts with customers.

The Company has evaluated the provisions of the amendment tonew standard and is in the process of assessing its impact on financial statements, information systems, business processes and financial statement disclosures. Based on initial reviews, the standard is for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The company is evaluatingnot expected to have a material impact on the impact of this ASU.Company's Consolidated Financial Statements.

The estimated fair value of the Company’s 3.75% Senior Notes due 2046 (3.75% Notes) and 4.60% Senior Notes due 2045 (4.60% Notes) was based on available external pricing data and current market rates for similar debt instruments, among other factors, which are classified as level 2 inputs within the fair value hierarchy. The fair value of the 3.75% Notes was approximately $380 million and $371 million as of March 31, 2017 and December 31, 2016, respectively. The fair value of the 4.60% Notes was approximately $1.1 billion as of March 31, 2017 and December 31, 2016, respectively. The carrying value of other long-term debt approximates fair value due to thetheir variable interest rates.

The Company has a postretirement healthcare benefits plan that provides coverage for a majority of its United StatesU.S. employees hired prior to January 1, 2013, and their dependents should they elect to maintain such coverage upon retirement. Covered employees become eligible for participation when they qualify for retirement while working for the Company. Participation in the plan is voluntary and requires participants to make contributions toward the cost of the plan, as determined by the Company.

The net periodic benefit costs charged to operating expenses, which are valued at the measurement date of January 1 and recognized evenly throughout the year, consisted of the following components (in thousands of dollars):

The Company has established a Group Benefit Trust to fund the plan and process benefit payments. The funding of the trust is an estimated amount which is intended to allow the maximum deductible contribution under the Internal Revenue Code of 1986 (IRC), as amended.  There are nozero minimum funding requirements and the Company intends to follow its practice of funding the maximum deductible contribution under the IRC. The Company did not make a contribution to the trust during the three and six months ended June 30, 2016.March 31, 2017.

The Company has two reportable segments: the United StatesU.S. and Canada. The United StatesU.S. operating segment reflects the results of the Company's U.S. business. The Canada operating segment primarily reflects the results for Acklands – Grainger Inc. (Acklands-Grainger), the Company’s Canadian business. Other businesses include MonotaRO in Japan, Zoro the single channel business in the United States,U.S. and business unitsoperations in Europe, Asia and Latin America. OtherThese businesses individually do not meet the definition of a reportable segment. Operating segments generate revenue almost exclusively through the distribution of maintenance, repair and operatingMRO supplies, as service revenues account for less thanapproximately 1% of total revenues for each operating segment. Following is a summary of segment results (in thousands of dollars):

Following are reconciliations of segment information with the consolidated totals per the financial statements (in thousands of dollars):

Assets for operatingreportable segments include net accounts receivable and first-in, first-out inventory which are reported to the Company's Chief Operating Decision Maker. Other current and non-current assets include all other asset balances for the operatingreportable segments.

Unallocated expenses and unallocated assets primarily relate to the Company headquarter's support services, which are not part of any business segment, as well as intercompany eliminations. Unallocated expenses include payroll and benefits, depreciation and other costs associated with headquarters-related support services. Unallocated assets

include non-operating cash and cash equivalents, certain prepaid expenses and property, buildings and equipment-net. Unallocated expenses of $45 million increased 22% in the three months ended June 30, 2016 versus $37 million in the prior year quarter. The increase was driven primarily by a $9 million write-down of a corporate aircraft that the Company plans to sell in connection with the outsourcing of the aviation department.

Intersegment net sales for the U.S. segment increased by $17 million and $36$12 million for the three and six months ended June 30, 2016, respectively,of 2017 compared to the prior year, driven by increased sales from the U.S. business to Zoro. The U.S. business' supply chain network is Zoro's primary source of inventory.

The following table sets forth the computation of basic and diluted earnings per share under the two-class method (in thousands of dollars, except for share and per share amounts):

From time to time the Company is involved in various legal and administrative proceedings that are incidental to its business, including claims related to product liability, general negligence, contract disputes, environmental issues, wage and hour laws, intellectual property, employment practices, regulatory compliance or other matters and actions brought by employees, consumers, competitors, suppliers or governmental entities. As a government contractor selling to federal, state and local governmental entities, the Company is also subject to governmental or regulatory inquiries or audits or other proceedings, including those related to pricing compliance. It is not expected that the ultimate resolution of any of these matters will have, either individually or in the aggregate, a material adverse effect on the Company's consolidated financial position or results of operations.

Grainger is a broad-line distributor of maintenance, repair and operating (MRO) supplies, and other related products and services used by businesses and institutions. Grainger’s operations are primarily in the United States (U.S.) and Canada, with a presence in Europe, Asia and Latin America. Grainger uses a combination of multichannel and single channel business models to provide customers with a range of options for finding and purchasing products utilizing sales representatives, catalogs, direct marketing materials and eCommerce. Grainger serves approximately 3 million customers worldwide through a network of highly integrated branches, distribution centers and websites.

Given Grainger's large number of customers and the diverse industries it serves, several economic factors and industry trends tend to shape Grainger’s business environment. The overall economy and leading economic indicators provide general insight into projecting Grainger's growth. Grainger’s sales in the United StatesU.S. and Canada tend to positively correlate with Business Investment, Business Inventory, Exports and Industrial Production. In the United States,U.S., sales tend to positively correlate with Gross Domestic Product (GDP). In Canada, sales tend to positively correlate with oil prices. The table below provides these estimated indicators for 2016:2017:

Per the Global Insight April 2017 forecast, to remain below 2.0% for the year.

There were 64 sales days in the U.S.first quarter of 2017 and Canada, partially offset by improved gross profit and operating expense leverage in the second half of the year. In addition, the Company is now expecting a higher effective tax rate for the year due to an increased concentration of earnings in higher tax rate jurisdictions and lower benefit from the clean energy investments.2016.

The increase in net sales was primarily driven by the acquisition of Cromwell in September 2015 and single channel online businesses in the U.S. and Japan. Refer to the Segment Analysis below for further details.

Gross profit of $1,040$1,019 million for the secondfirst quarter of 20162017 decreased 3%2%. The gross profit margin of 40.6%40.1% during the secondfirst quarter of 20162017 decreased 2.01.6 percentage points when compared to the same period in 2015, due primarily to2016, driven by the strategic price deflation exceeding cost deflation, negative customer selling mix, as well as an inventory reserves adjustment in Canada.initiatives.

The table below reconciles reported diluted earnings per share determined in accordance with United StatesU.S. generally accepted accounting principles (GAAP) to adjusted diluted earnings per share, a non-GAAP measure. Management believes adjusted diluted earnings per share is an important indicator of operations because it excludes items that may not be indicative of core operating results. Because non-GAAP financial measures are not standardized, it may not be possible to compare this financial measure with other companies' non-GAAP financial measures having the same or similar names.

Grainger’s two reportable segments are the United StatesU.S. and Canada. The United StatesU.S. operating segment reflects the results of Grainger’sthe Company's U.S. business. The Canada operating segment primarily reflects the results for Acklands – Grainger Inc., Grainger’s Canadian business. Other businesses include MonotaRO in Japan, Zoro in the U.S. and business unitsoperations in Europe, Asia and Latin America.

The following comments at the segment and business unitother businesses level include external and intersegment net sales and operating earnings. See Note 108 to the Condensed Consolidated Financial Statements.

Net sales were $1,979$1,953 million for the secondfirst quarter of 2016,2017, a decrease of 3%$13 million, or 1%, when compared with net sales of $2,031$1,966 million for the same period in 2015. On a daily basis, sales2016. Sales decreased 3%. The 3% daily decrease1% for the quarter and consisted of the following:

In the three months ended June 30, 2016,March 31, 2017, eCommerce sales for the United StatesU.S. business were $916$976 million, an increase of 11% over the prior yearyear. Total eCommerce sales represented 50% and represented 46%45% of total sales.sales for the three months ended March 31, 2017 and 2016, respectively. The increase was primarily driven by an increase in sales via EDI and electronic purchasing platforms.

Operating expenses of $487$494 million in the secondfirst quarter of 20162017 were down $21$19 million, or 4% versus the secondfirst quarter of 2015.2016. Operating expenses in 20162017 included $6a $9 million inbenefit from the gain on sale of branches and $3 million of restructuring costs. Excluding restructuring costs for the previously announced branch closures and the offshoring of some IT support functions. These charges were more than offset by $15 million in gainsgain on the sale of branch real estateassets for a net restructuring benefit of $9 million. Excluding the restructuring impact,both quarters, operating expenses decreased 2%.were flat.

Operating earnings of $349$312 million for the secondfirst quarter of 20162017 decreased 6% from $370$332 million for the secondfirst quarter of 2015 driven by lower sales and lower gross profit margins, partially offset by lower operating expenses.2016. Excluding the restructuring gainscharges and gain on the sale of assets mentioned above, operating earnings decreased 8%.12%, driven by the strategic price initiatives.

Net sales were $194$186 million for the secondfirst quarter of 2016, a decrease2017, an increase of $45$7 million, or 19%4%, when compared with $239$179 million for the same period in 2015.2016. In local currency, sales decreased 16%increased 1%. On a daily sales basis, sales decreased 19%Sales increased 4% for the quarter and consisted of the following:

Sales performanceThe business in Canada continues to be affected by a weak economic environment, resulting in lower sales to most customer end markets. The Alberta region, which represents about one-thirdstabilize based on the improved economy and recovery from the implementation of the salescommon ERP platform in North America system in 2016. The business also increased prices to offset foreign exchange-related costs of goods sold inflation in the Canadian business, decreased 28% versus prior year, on a daily basis, as it was negatively impacted by wildfiresfirst quarter, but most customers are under contract and oil prices. Sales growth forwill not experience price increases until later in the remaining regions in aggregate was down 11% in local currency.year.

In the three months ended June 30, 2016,March 31, 2017, eCommerce sales in Canada were $25$31 million, a decreasean increase of 7%38% over the prior yearyear. Total eCommerce represented 17% and represented 13% of total sales.sales for the three months ended March 31, 2017 and 2016, respectively. If the Company included KeepStock®, the electronic inventory management offering, total eCommerce and KeepStock® sales would represent 30% and 25% of total sales for the three months ended March 2017 and 2016, respectively.

The gross profit margin decreased 11.92.7 percentage points in the secondfirst quarter of 2017 versus the first quarter of 2016 versus the second quarter of 2015 due largely to an inventory adjustment, along with cost of goods inflation exceeding price inflation due to unfavorable foreign exchange.price deflation versus cost inflation and higher freight costs from an increase in shipping directly to customers.

Operating expenses decreasedincreased 3% in the secondfirst quarter of 2017 versus the first quarter of 2016, versusdriven by the second quarterre-establishment of 2015, benefitingthe annual national sales meeting and the unfavorable comparison to the 2016 gain from lower SAP project costs and lower advertising costs,the sale of the former Toronto distribution center, partially offset by restructuring costs of $7 million.lower IT expenses.

Operating earnings of $30$32 million for the secondfirst quarter of 20162017 were up $15$10 million compared to the secondfirst quarter of 2015.2016. The earnings performance for the quarter versus prior year was primarily driven by strong resultsperformance from the online businesses Zoro in the U.S. and the businessMonotaRO in Japan as well as the acquisition of Cromwell, which reported modest profit as expected.Japan.

Other income and expense was $23$25 million of expense in the secondfirst quarter of 20162017 compared to $8$20 million of expense in the secondfirst quarter of 2015.2016. The increase in expense was primarily due todriven by higher interest expense from the $1 billion of debt the Company issued in June 2015 andadditional $400 million of debt issued in May 2016, as well as expected losses from the Company's investments in clean energy.

Grainger’s effective tax rates were 36.1%32.4% and 36.9%35.6% for the sixthree months ended June 30,March 31, 2017 and 2016, and 2015, respectively. The decrease was primarily due to the adoption of ASU 2016-09, which recognizes the excess tax benefits of stock options as a reduction to income tax expense instead of the previous methodology which recorded the benefit directly to equity. The adoption of this standard generated a $0.13 benefit to earnings per share in the tax rate was due to a discrete benefit arising from the effective settlement of certain federal income tax issues under audit for the years 2009 through 2012, offset by a larger proportion of earnings from higher tax rate jurisdictions. Grainger is expecting an effective tax rate, excluding the settlement benefit, of approximately 36.8% to 37.8% for the full year 2016.quarter.

Net cash used in investing activities was $74$38 million and $170$45 million for the sixthree months ended June 30,March 31, 2017 and 2016, and 2015, respectively. The lower use of cash was driven by lowerthe higher proceeds from the sales of assets net of higher additions to property, buildings and equipment compared to the prior year and higher proceeds from the sales of branch real estate assets.year.

Working capital consists of current assets (less non-operating cash) and current liabilities (less short-term debt and current maturities of long-term debt).

The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses in the financial statements. Management bases its estimates on historical experience and other assumptions, which it believes are reasonable. If actual amounts are ultimately different from these estimates, the revisions are included in Grainger’s results of operations for the period in which the actual amounts become known.

Accounting policies are considered critical when they require management to make assumptions about matters that are highly uncertain at the time the estimates are made and when there are different estimates that management reasonably could have made, which would have a material impact on the presentation of Grainger’s financial condition, changes in financial condition or results of operations. For a description of Grainger’s critical accounting policies see Grainger's Annual Report on Form 10-K for the year ended December 31, 2015.2016.

From time to time, in this Quarterly Report on Form 10-Q, as well as in other written reports, communications and verbal statements, Grainger makes forward-looking statements that are not historical in nature but concern forecasts of future results, business plans, analyses, prospects, strategies, objectives and other matters that may be deemed to be “forward-looking statements” under the federal securities laws. Such forward-looking statements are identified by words such as “anticipate,” “estimate,” “believe,” “expect,” “could,” “forecast,” “may,” “intend,” “plan,” “predict,” “project” and similar terms and expressions.

Grainger cannot guarantee that any forward-looking statement will be realized, although Grainger does believe that its assumptions underlying its forward-looking statements are reasonable. Achievement of future results is subject to risks and uncertainties, many of which are beyond the Company's control, which could cause Grainger's results to differ materially from those whichthat are presented.

Important factors that could cause actual results to differ materially from those presented or implied in a forward-looking statement include, without limitation: higher product costs or other expenses; a major loss of customers; loss or disruption of source of supply; increased competitive pricing pressures; failure to develop or implement new technologies or business strategies; the implementation, timing and results of the Company's strategic pricing actions and other responses to market pressures; the outcome of pending and future litigation or governmental or regulatory proceedings, including with respect to wage and hour, anti-bribery and corruption, environmental, advertising, privacy and cybersecurity matters; investigations, inquiries, audits and changes in laws and regulations; disruption of information technology or data security systems; general industry or market conditions; general global economic conditions; currency exchange rate fluctuations; market volatility; commodity price volatility; labor shortages; facilities disruptions or shutdowns; higher fuel costs or disruptions in transportation services; natural and other catastrophes; unanticipated weather conditions; loss of key members of management; the Company's ability to operate, integrate and leverage acquired businessesbusinesses; changes in credit ratings; changes in effective tax rates; and theother factors identified under Item 1A: Risk Factors in the Company's Annual Report on Form 10-K for the year-endedyear ended December 31, 2015 and other filings with2016, as updated in the SEC.Company's Quarterly Reports on Form 10-Q.

Caution should be taken not to place undue reliance on Grainger's forward-looking statements and Grainger undertakes no obligation to publicly update theany of its forward-looking statements, whether as a result of new information, future events or otherwise.

For quantitative and qualitative disclosures about market risk, see “Item 7A: Quantitative and Qualitative Disclosures About Market Risk” in Grainger's Annual Report on Form 10-K for the fiscal year ended December 31, 2015.2016.

Grainger carried out an evaluation, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of Grainger's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that Grainger’s disclosure controls and procedures were effective as of the end of the period covered by this report in (i) ensuring that information required to be disclosed by Grainger in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and (ii) ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

There werehave been no changes in Grainger's internal control over financial reporting that occurred duringfor the second quarter ended March 31, 2017, that have materially affected, or are reasonably likely to materially affect, Grainger'sGrainger’s internal control over financial reporting.