GRAINGER W W INC (Form: 10-Q, Received: 08/02/2006 11:30:29)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from

Commission file number 1-5684

W.W. Grainger, Inc.
(Exact name of registrant as specified in its charter)

Illinois			36-1150280
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)

100 Grainger Parkway, Lake Forest, Illinois			60045-5201
(Address of principal executive offices)			(Zip Code)
(847) 535-1000
(Registrant’s telephone number including area code)

Not Applicable
(Former name, former address and former fiscal year; if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a

non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of

the Exchange Act). (Check One):

Large accelerated filer

Accelerated filer

Non-accelerated filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the

Exchange Act).

Yes

There were 88,576,212 shares of the Company’s Common Stock outstanding as of June 30, 2006.

TABLE OF CONTENTS		Page No.

PART I	FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Condensed Consolidated Statements of Earnings for the Three Months and Six Months Ended June 30, 2006 and June 30, 2005	3

	Condensed Consolidated Statements of Comprehensive Earnings for the Three Months and Six Months Ended June 30, 2006 and June 30, 2005	4

	Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005	5 - 6

	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and June 30, 2005	7 - 8

	Notes to Condensed Consolidated Financial Statements	9 - 21

Item 2.	Management’s Discussion and Analysis of Financial
	Condition and Results of Operations	22 – 32

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33

Item 4.	Controls and Procedures	33

PART II	OTHER INFORMATION

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34

Item 6.	Exhibits	35

Signatures		36

EXHIBITS

Exhibit 11	Computations of Earnings Per Share

Exhibits 31 & 32	Certifications

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands of dollars, except for per share amounts)

(Unaudited)

	Three Months Ended June 30,		Six Months Ended June 30,
	2006	2005	2006	2005

Net sales	$ 1,482,880	$ 1,372,808	$ 2,901,997	$ 2,707,688
Cost of merchandise sold	899,575	845,679	1,748,365	1,681,683
Gross profit	583,305	527,129	1,153,632	1,026,005
Warehousing, marketing and administrative expenses	438,761	400,936	874,671	786,855
Operating earnings	144,544	126,193	278,961	239,150
Other income and (expense):
Interest income	5,381	2,402	10,740	4,849
Interest expense	(502)	(438)	(995)	(928)
Equity in income of unconsolidated entities	862	890	2,069	1,310
Gain on sale of unconsolidated entity	2,291	–	2,291	–
Unclassified – net	293	(64)	170	(102)
Total other income and (expense)	8,325	2,790	14,275	5,129
Earnings before income taxes	152,869	128,983	293,236	244,279
Income taxes	59,130	47,394	113,264	89,898

Net earnings	$ 93,739	$ 81,589	$ 179,972	$ 154,381
Earnings per share:
Basic	$ 1.05	$ 0.91	$ 2.01	$ 1.72

Diluted	$ 1.02	$ 0.89	$ 1.95	$ 1.68

Weighted average number of shares outstanding:
Basic	89,342,642	89,489,470	89,490,188	89,942,454

Diluted	92,104,424	91,080,031	92,294,563	91,770,062

Cash dividends paid per share	$ 0.29	$ 0.24	$ 0.53	$ 0.44

The accompanying notes are an integral part of these financial statements.

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(In thousands of dollars)

(Unaudited)

	Three Months Ended June 30,		Six Months Ended June 30,
	2006	2005	2006	2005

Net earnings	$ 93,739	$ 81,589	$ 179,972	$ 154,381

Other comprehensive earnings (losses):
Foreign currency translation adjustments, net of tax (expense) benefit of $(2,474), $636, $(2,230), and $1,083, respectively	12,611	(2,676)	10,754	(5,137)

Comprehensive earnings	$ 106,350	$ 78,913	$ 190,726	$ 149,244

The accompanying notes are an integral part of these financial statements.

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except for per share amounts)

(Unaudited)

ASSETS	June 30, 2006	Dec. 31, 2005
CURRENT ASSETS
Cash and cash equivalents	$ 453,541	$ 544,894
Accounts receivable (less allowances for doubtful
accounts of $17,920 and $18,401, respectively)	608,353	518,625
Inventories	781,991	791,212
Prepaid expenses and other assets	57,792	54,334
Deferred income taxes	92,179	88,803
Total current assets	1,993,856	1,997,868

PROPERTY, BUILDINGS AND EQUIPMENT	1,776,061	1,719,651
Less accumulated depreciation and amortization	991,472	949,026
Property, buildings and equipment – net	784,589	770,625

DEFERRED INCOME TAXES	12,984	4,373

INVESTMENTS IN UNCONSOLIDATED ENTITIES	7,483	25,155

GOODWILL	196,893	182,726

OTHER ASSETS AND INTANGIBLES – NET	127,022	127,174

TOTAL ASSETS	$ 3,122,827	$ 3,107,921

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)

(In thousands of dollars, except for per share amounts)

(Unaudited)

LIABILITIES AND SHAREHOLDERS' EQUITY	June 30, 2006	Dec. 31, 2005

CURRENT LIABILITIES
Current maturities of long-term debt	$ 4,590	$ 4,590
Trade accounts payable	319,445	319,254
Accrued contributions to employees’ retirement plans	70,299	106,825
Accrued expenses	230,588	271,741
Income taxes	41,728	24,554
Total current liabilities	666,650	726,964

LONG-TERM DEBT (less current maturities)	4,895	4,895

DEFERRED INCOME TAXES	6,378	7,019

ACCRUED EMPLOYMENT-RELATED BENEFITS COSTS	89,038	80,067

SHAREHOLDERS' EQUITY
Cumulative Preferred Stock – $5 par value – 12,000,000 shares authorized; none issued nor outstanding	–	–
Common Stock – $0.50 par value – 300,000,000 shares authorized; issued 109,657,938 shares	54,829	54,834
Additional contributed capital	501,100	451,578
Retained earnings	2,854,360	2,722,103
Unearned restricted stock compensation	(38,135)	(17,280)
Accumulated other comprehensive earnings	37,836	27,082
Treasury stock, at cost – 21,081,726 and 19,952,297 shares, respectively	(1,054,124)	(949,341)

Total shareholders' equity	2,355,866	2,288,976

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$ 3,122,827	$ 3,107,921

The accompanying notes are an integral part of these financial statements.

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

(Unaudited)

	Six Months Ended June 30,
	2006	2005
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings	$ 179,972	$ 154,381
Provision for losses on accounts receivable	1,508	1,855
Deferred income taxes	(14,858)	17,304
Depreciation and amortization:
Property, buildings and equipment	46,611	46,664
Capitalized software and other intangibles	8,213	6,132
Stock-based compensation	20,628	5,611
Tax benefit of stock incentive plans	4,599	2,902
Net gains on sales of property, buildings and equipment	(6,268)	(3,508)
Gain on sale of unconsolidated entity	(2,291)	–
Equity in income of unconsolidated entities	(2,069)	(1,310)
Change in operating assets and liabilities – net of business acquisitions:
(Increase) in accounts receivable	(88,571)	(52,925)
(Increase) decrease in inventories	14,286	(27,370)
(Increase) in prepaid expenses	(3,239)	(7,635)
Increase (decrease) in trade accounts payable	(3,138)	13,867
(Decrease) in other current liabilities	(78,750)	(48,459)
Increase in current income taxes payable	17,156	48
Increase in accrued employment-related benefit costs	8,971	6,851
Other – net	(2,237)	166

Net cash provided by operating activities	100,523	114,574

CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, buildings and equipment – net of dispositions	(52,494)	(45,631)
Additions to capitalized software	(3,368)	(23,515)
Net cash paid for business acquisitions	(13,859)	(24,838)
Proceeds from sale of unconsolidated entity	27,413	–
Other – net	(1,718)	4,140

Net cash used in investing activities	(44,026)	(89,844)

W.W. Grainger, Inc. and Subsidiaries

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

(In thousands of dollars)

(Unaudited)

	Six Months Ended June 30,
	2006	2005
CASH FLOWS FROM FINANCING ACTIVITIES:
Stock options exercised	$ 43,662	$ 14,627
Excess tax benefits from stock-based compensation	5,533	–
Purchase of treasury stock – net	(150,116)	(102,756)
Cash dividends paid	(47,715)	(39,723)

Net cash used in financing activities	(148,636)	(127,852)

Exchange rate effect on cash and cash equivalents	786	(91)

NET (DECREASE) IN CASH AND CASH EQUIVALENTS	(91,353)	(103,213)

Cash and cash equivalents at beginning of year	544,894	429,246

Cash and cash equivalents at end of period	$ 453,541	$ 326,033

The accompanying notes are an integral part of these financial statements.

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. BACKGROUND AND BASIS OF STATEMENT PRESENTATION

W.W. Grainger, Inc. distributes facilities maintenance products and provides services and related information used by businesses and institutions in North 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, 2005, 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, 2005 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 (consisting of normal recurring adjustments) which, in the opinion of management, are necessary for a fair presentation of the statements contained herein. Certain prior period amounts have been reclassified to conform to the current year’s presentation.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

STOCK INCENTIVE PLANS

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R). SFAS No. 123R revised SFAS No. 123 to require companies to measure all stock-based compensation awards using a fair value method and recognize the related compensation cost in their financial statements. Effective January 1, 2006, the Company adopted SFAS No. 123R using the modified prospective method. Under this transition method, compensation cost recognized in 2006 includes: (a) compensation costs for all share-based payments granted prior to, but not fully vested as of January 1, 2006, based on the grant date fair value as calculated under the proforma disclosure-only expense provisions of SFAS No. 123, and (b) compensation costs for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with provisions of SFAS No. 123R. The adoption of SFAS No. 123R primarily resulted in compensation expense being recorded for stock options. The results for prior periods have not been restated.

Prior to January 1, 2006, the Company applied Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25), and related interpretations in accounting for its stock-based compensation plans. Under APB No. 25, no compensation expense was recognized for non-qualified stock option awards as the exercise price of the awards on the date of grant was equal to the current market price of the Company’s stock. The Company also provided the disclosure-only pro forma expense provision of SFAS No. 123 in its footnotes.

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The Company recorded pretax compensation expense of $8.0 million ($4.9 million net of tax, or $0.05 per diluted share) for the three months ended June 30, 2006 and $12.2 million ($7.4 million net of tax, or $0.08 per diluted share) for the six months ended June 30, 2006, related to the expensing of the Company’s non-qualified stock options. If the tax deductions realized in the Company’s income tax return exceed the amount of cumulative compensation costs recognized in the financial statements, the excess tax benefit is recorded as an increase to additional paid in capital. For the six months ended June 30, 2006, $5.5 million of excess tax benefits were realized and reflected as a source of cash from financing activities in the condensed consolidated statements of cash flows. If SFAS No. 123R had not been adopted, this $5.5 million would have been reflected as a source of cash from operating activities.

The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation for 2005. For the purposes of the pro forma disclosure, the value of options was estimated using a Black-Scholes option-pricing model.

	Three Months Ended	Six Months Ended
	June 30, 2005	June 30, 2005
	(In thousands of dollars,
	except for per share amounts)
Net earnings, as reported	$ 81,589	$ 154,381
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax	(6,876)	(9,888)
Add: Stock-based employee compensation cost, net of related tax, included in net earnings, as reported	3,307	3,834
Net earnings, pro forma	$ 78,020	$ 148,327

Earnings per share:
Basic – as reported	$ 0.91	$ 1.72
Basic – pro forma	$ 0.87	$ 1.65
Diluted – as reported	$ 0.89	$ 1.68
Diluted – pro forma	$ 0.85	$ 1.61

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The Company maintains stock incentive plans under which the Company may grant a variety of incentive awards to employees and Directors. Shares of common stock were authorized for issuance under the plans in connection with awards of nonqualified stock options, stock appreciation rights, restricted stock, stock units and other stock-based awards. As of June 30, 2006, restricted stock, restricted stock units, performance shares and non-qualified stock options have been granted.

In 2005, the shareholders of the Company approved the 2005 Incentive Plan (“Plan”) which replaced all prior active plans (“Prior Plans”). Awards previously granted under Prior Plans will remain outstanding in accordance with their terms but no new awards are allowed. The Plan authorizes the granting of options to purchase shares at a price of not less than 100% of the closing market price on the last trading day preceding the date of grant. All options expire no later than ten years after the date of grant. A total of 9.5 million shares of common stock have been reserved for issuance under the Plan. As of June 30, 2006, there were 5,907,389 shares available for grant under the Plan.

Options

Option awards are granted with an exercise price equal to the closing market price of the Company’s stock on the last trading day preceding the date of grant. The options generally vest over three years and generally expire ten years from the grant date.

Stock option transactions for the six months ended June 30, 2006 are summarized as follows:

	Shares Subject to Option	Weighted Average Price Per Share	Options Exercisable

Outstanding at December 31, 2005	8,691,840	$ 48.37	4,572,250
Granted	1,416,800	$ 75.88
Exercised	(950,311)	$ 45.94
Canceled or expired	(120,565)	$ 55.34
Outstanding at June 30, 2006	9,037,764	$ 52.83	5,051,249

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Information about stock options outstanding and exercisable as of June 30, 2006, is as follows:

	Options Outstanding			Options Exercisable
		Weighted Average			Weighted Average Exercise Price
Range of Exercise Prices	Number Outstanding	Remaining Contractual Life	Exercise Price	Number	Weighted Average Exercise Price

$30.88 – $44.91	1,998,602	4.3 years	$40.30	1,727,372	$40.74
$44.92 – $51.69	2,238,001	5.3 years	$47.36	2,072,741	$47.29
$51.70 – $54.45	2,008,861	8.3 years	$53.15	110,411	$53.62
$54.46 – $76.61	2,792,300	8.1 years	$65.95	1,140,725	$54.65

	9,037,764	6.6 years	$52.83	5,051,249	$46.85

The weighted average fair value of the stock options granted during 2005 was $13.36. The fair value of each option granted in the first six months of 2005, based on the Black-Scholes valuation model, used the following assumptions:

		Year Ended December 31, 2005
Risk-free interest rate		4.1%
Expected life		7 years
Expected volatility		20.1%
Expected dividend yield		1.8%

Effective January 1, 2006, the Company adopted a binomial lattice model for the valuation of stock options. The weighted average fair value of options granted in the first six months of 2006 was $18.91. The fair value of each option granted in the first six months of 2006, based on the binomial lattice model, used the following assumptions:

		Six Months Ended June 30, 2006
Risk-free interest rate		4.9%
Expected life		6 years
Expected volatility		23.9%
Expected dividend yield		1.5%

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Cash received from options exercised in the six months ended June 30, 2006 and 2005 was $43.7 million and $14.6 million, respectively. The actual tax benefits realized for the tax deductions from options exercised totaled $10.1 million and $2.9 million for the six months ended June 30, 2006 and 2005, respectively. The total intrinsic value of options exercised was $15.3 million and $4.6 million for the six months ended June 30, 2006 and 2005, respectively.

Performance Shares

On February 22, 2006, the Company awarded performance-based shares to certain executives. Receipt of Company stock is contingent upon the Company meeting sales growth and return on invested capital (ROIC) performance goals. Each participant was granted a base number of shares. At the end of the first year performance period (fiscal 2006), the number of shares granted will increase, decrease or remain the same based upon actual Company sales growth versus target sales growth. The shares, as determined at the end of 2006, will be issued at the end of the third year (fiscal 2008) if the Company’s ROIC target is achieved for the three year performance period. The base number of shares granted for 2006 was 56,400. The amount expensed for the three months and six months ended June 30, 2006 was $0.2 million and $0.5 million, respectively, based upon the number of shares projected to be earned at the end of the performance year. Amounts expensed will be periodically adjusted to reflect the most current projection of the achievement of performance goals.

Performance share value is based upon closing market prices on the last trading day preceding the date of award and is charged to earnings on a straight-line basis over the three year period. Holders of performance shares are entitled to receive cash payments equivalent to cash dividends after the end the first year performance period. If the performance shares vest, they will be settled by the issuance of Company common stock certificates in exchange for the performance shares on a one-for-one basis.

Restricted Stock and Restricted Stock Units (RSUs)

Unvested restricted stock is held by the Company pursuant to the terms and conditions related to the applicable grants. Except for the right of disposal, holders of restricted stock have full shareholders’ rights during the period of restriction, including voting rights and the right to receive dividends.

Restricted Stock Units (RSUs) granted to management vest over periods from three to seven years from issuance, although accelerated vesting is provided in certain instances. Holders of RSUs are entitled to receive cash payments equivalent to cash dividends and other distributions paid with respect to common stock. At various times after vesting, RSUs will be settled by the issuance of stock certificates evidencing the conversion of the RSUs into shares of the Company common stock on a one-for-one basis. Compensation expense related to RSUs is based upon the closing market price on the last trading day preceding the date of the award and is charged to earnings on a straight-line basis over the vesting period.

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following table summarizes restricted stock and RSU activity for the six months ended June 30, 2006:

	Restricted Stock	Restricted Stock Units

Beginning units outstanding	270,000	717,450
Issuance	–	346,650
Shares Converted to RSUs	–	–
Cancellations	(10,000)	(8,300)
Vesting	–	(3,100)
Vesting/Settlements	(15,000)	–
Ending units outstanding	245,000	1,052,700

Weighted average value of issuances	N/A	$76.56
Compensation expense	$ 0.5 million	$ 7.4 million

Director Stock Awards

The Company provides members of the Board of Directors with deferred stock unit grants. The number of shares covered by each grant is equal to $60,000 divided by the fair market value of a share of common stock at the time of the grant, rounded up to the next ten-share increment. The Company also awards stock units in connection with elective deferrals of director fees and dividend equivalents on existing stock units. A stock unit is the economic equivalent of a share of common stock. Deferred fees and dividend equivalents on existing stock units are converted into stock units on the basis of the market value of the stock at the relevant times. Payment of the value of stock units is scheduled to be made after termination of service as a director. As of June 30, 2006, there were eleven nonemployee directors who held stock units. The Company recognizes income (expense) for the change in value of equivalent stock units.

The following table summarizes activity for Director stock units for the six months ended June 30, 2006 (dollars in thousands):

	Units	Dollars

Beginning Balance	51,977	$ 3,696
Dividends	394	29
Deferred Fees / Grants	14,781	1,124
Retirement Distributions	(6,481)	(461)
Unit Appreciation	–	176
Ending Balance	60,671	$ 4,564

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

For all nonvested share-based compensation arrangements granted under the Plan, there was $69.0 million of total unrecognized compensation as of June 30, 2006. That cost is expected to be recognized over the weighted-average period of 2.1 years.

NEW ACCOUNTING STANDARDS

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140.” SFAS No. 155 allows companies to elect to measure at fair value entire financial instruments containing embedded derivatives that would otherwise have to be accounted for separately. It also requires companies to identify interests in securitized financial assets that are freestanding derivatives or contain embedded derivatives that would have to be accounted for separately, clarifies which interest- and principal-only strips are subject to SFAS No. 133, and amends SFAS No. 140 to revise the conditions of a qualifying special purpose entity due to the new requirement to identify whether interests in securitized financial assets are freestanding derivatives or contain embedded derivatives. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a remeasurement event after the beginning of a company’s first fiscal year that begins after September 15, 2006. The Company does not expect adoption of SFAS No. 155 to have a material effect on its results of operations or financial position.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140.” SFAS No. 156 requires the recognition of a servicing asset or liability each time a company undertakes an obligation to service a financial asset in certain situations. It requires all separately recognized servicing assets and liabilities to be initially measured at fair value, if practical. SFAS No. 156 is effective as of the beginning of a company’s first fiscal year that begins after September 15, 2006. The Company does not expect adoption of SFAS No. 156 to have a material effect on its results of operations or financial position.

In June 2006, the Emerging Issues Task Force (EITF) reached a consensus with respect to EITF Issue 06-2, “Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences.” Under Issue 06-2, an employee’s right to a compensated absence under a sabbatical or similar benefit arrangement in which the employee is not required to perform any duties during the absence “accumulates” and therefore should be accounted for as a liability if the other conditions for recognition in SFAS No. 43 are met. The other conditions in SFAS No. 43 are that the obligation relates to services already rendered, payment is probable, and the amount can be reasonably estimated. Issue 06-2 is effective for fiscal years beginning after December 15, 2006 with early application permitted. The Company does not expect adoption of Issue 06-2 to have a material effect on its results of operations or financial position.

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

In June 2006, the EITF reached a consensus with respect to EITF Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).” Issue 06-3 permits the presentation of sales and other taxes on either a gross (included in revenues and costs) or net (excluded from revenues) basis and is an accounting policy decision that should be disclosed pursuant to APB Opinion No. 22, “Disclosures of Accounting Policies.” If reported on a gross basis, the amount of any such taxes should be disclosed in interim and annual financial statements. The effective date is for disclosures presented for interim and annual financial periods beginning after December 15, 2006. The Company does not expect to change its presentation of sales and other taxes, which is currently on a net basis.

In July 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measure of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact that adoption of FIN 48 may have on its results of operations or financial position.

3. ACQUISITION

On January 31, 2006, Lab Safety Supply, Inc. (Lab Safety), a wholly owned subsidiary of the Company, acquired substantially all of the assets of Rand Materials Handling Equipment Co. (Rand). Rand is a national catalog distributor of warehouse, storage and packaging supplies. The purchase price was $13.9 million in cash and $2.3 million in assumed liabilities. The estimated goodwill recognized in the transaction amounted to $9.1 million and is expected to be fully deductible for tax purposes. Rand had more than $16 million in sales in 2005. The results of Rand are included in the Company’s consolidated results from the date of acquisition.

4. INVESTMENTS IN UNCONSOLIDATED ENTITIES

On February 23, 2006, Acklands - Grainger Inc. (Acklands - Grainger), the Company’s Canadian subsidiary, received a Notice of Purchase advising Acklands - Grainger that Uni-Select Inc. was exercising its contractual option to purchase all of Acklands - Grainger’s shares in the USI-AGI Prairies Inc. joint venture. The transaction closed on May 31, 2006 for Canadian $30.3 million (US$27.4 million) resulting in a US$2.3 million pre-tax gain for the Company. The joint venture investment was previously reported in “Investments in Unconsolidated Entities” on the Company’s balance sheet, and for 2006 the Company recognized US$1.1 million in equity income from the joint venture.

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

5. DIVIDEND

On July 26, 2006, the Board of Directors declared a quarterly dividend of 29 cents per share, payable September 1, 2006 to shareholders of record on August 14, 2006.

6. GUARANTEES

The Company has an outstanding guarantee related to an industrial development revenue bond assumed by the buyer of one of the Company’s formerly owned facilities. The maximum exposure under this guarantee is $8.5 million. The bond matures on December 15, 2008. The Company has not recorded any liability relating to this guarantee and believes it is unlikely that material payments will be required.

WARRANTY RESERVES

The Company generally warrants the products it sells against defects for one year. For a significant portion of warranty claims, the manufacturer of the product is responsible for the expenses associated with this warranty program. For warranty expenses not covered by the manufacturer, the Company provides a reserve for future costs based on historical experience. The warranty reserve activity was as follows:

	Six Months Ended June 30,
	2006	2005
	(In thousands of dollars)

Beginning balance	$ 3,763	$ 3,428
Returns	(3,326)	(5,276)
Provision	3,605	5,441
Ending balance	$ 4,042	$ 3,593

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. EMPLOYEE BENEFITS

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

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:

	Three Months Ended June 30,		Six Months Ended June 30,
	2006	2005	2006	2005
	(In thousands of dollars)

Service cost	$ 2,434	$ 1,894	$ 4,868	$ 3,788
Interest cost	1,900	1,572	3,800	3,144
Expected return on assets	(697)	(625)	(1,395)	(1,250)
Amortization of transition asset	(36)	(36)	(72)	(72)
Amortization of unrecognized losses	726	481	1,452	962
Amortization of prior service cost	(214)	(215)	(429)	(430)
Net periodic benefit costs	$ 4,113	$ 3,071	$ 8,224	$ 6,142

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 no minimum funding requirements and the Company intends to follow its practice of funding the maximum deductible contribution under the IRC. During the three and six months ended June 30, 2006, the Company contributed $0.7 million, and $1.3 million respectively, to the trust.

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

8. SEGMENT INFORMATION

Beginning January 1, 2006, the Company revised its segment disclosure from two reportable segments to three reportable segments. The three reportable segments are Grainger Branch-based, Acklands - Grainger Branch-based and Lab Safety. Grainger Branch-based is an aggregation of the following: Industrial Supply, Grainger, S.A. de C.V. (Mexico), Grainger Caribe Inc. (Puerto Rico) and China. Acklands - Grainger is the Company’s Canadian branch-based distribution business. Lab Safety is a direct marketer of safety and other industrial products.

Segment information has been modified for all periods in order to conform to the new presentation.

	Three Months Ended June 30, 2006
	Grainger Branch-based	Acklands - Grainger Branch-based	Lab Safety	Total
	(In thousands of dollars)
Total net sales	$ 1,233,574	$ 146,920	$ 103,273	$ 1,483,767
Intersegment net sales	(345)	–	(542)	(887)
Net sales to external customers	$ 1,233,229	$ 146,920	$ 102,731	$ 1,482,880

Segment operating earnings	$ 151,811	$ 3,070	$ 13,472	$ 168,353

	Three Months Ended June 30, 2005
	Grainger Branch-based	Acklands - Grainger Branch-based	Lab Safety	Total
	(In thousands of dollars)
Total net sales	$ 1,146,819	$ 129,609	$ 97,668	$ 1,374,096
Intersegment net sales	(785)	–	(503)	(1,288)
Net sales to external customers	$ 1,146,034	$ 129,609	$ 97,165	$ 1,372,808

Segment operating earnings	$ 125,505	$ 4,491	$ 13,547	$ 143,543

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

	Six Months Ended June 30, 2006
	Grainger Branch-based	Acklands - Grainger Branch-based	Lab Safety	Total
	(In thousands of dollars)
Total net sales	$ 2,410,715	$ 285,942	$ 207,152	$ 2,903,809
Intersegment net sales	(660)	–	(1,152)	(1,812)
Net sales to external customers	$ 2,410,055	$ 285,942	$ 206,000	$ 2,901,997

Segment operating earnings	$ 284,663	$ 6,948	$ 28,699	$ 320,310

	Six Months Ended June 30, 2005
	Grainger Branch-based	Acklands - Grainger Branch-based	Lab Safety	Total
	(In thousands of dollars)
Total net sales	$ 2,272,056	$ 246,772	$ 191,151	$ 2,709,979
Intersegment net sales	(1,144)	–	(1,147)	(2,291)
Net sales to external customers	$ 2,270,912	$ 246,772	$ 190,004	$ 2,707,688

Segment operating earnings	$ 235,377	$ 7,767	$ 27,175	$ 270,319

	Grainger Branch-based	Acklands - Grainger Branch-based	Lab Safety	Total
Segment assets :	(In thousands of dollars)
June 30, 2006	$ 1,917,052	$ 417,190	$ 186,959	$ 2,521,201

December 31, 2005	$ 1,821,884	$ 389,855	$ 175,201	$ 2,386,940

W.W. Grainger, Inc. and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

Following are reconciliations of segment information with the consolidated totals per the financial statements:

	Three Months Ended June 30,		Six Months Ended June 30,
	2006	2005	2006	2005
Operating earnings :	(In thousands of dollars)
Total operating earnings for reportable segments	$ 168,353	$ 143,543	$ 320,310	$ 270,319
Unallocated expenses and eliminations	(23,809)	(17,350)	(41,349)	(31,169)
Total consolidated operating earnings	$ 144,544	$ 126,193	$ 278,961	$ 239,150

	June 30, 2006	December 31, 2005
Assets :	(In thousands of dollars)
Total assets for reportable segments	$ 2,521,201	$ 2,386,940
Unallocated assets	601,626	720,981
Total consolidated assets	$ 3,122,827	$ 3,107,921

Unallocated expenses and unallocated assets primarily relate to the Company headquarters’ support services, which are not part of any business segment. 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. The unallocated expense increase was primarily driven by the expensing of stock options due to the adoption of SFAS No. 123R and higher profit sharing accruals.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Item 2.

Overview

General

Grainger is a leading broad-line supplier of facilities maintenance products and provides services and related information. Grainger distributes a wide range of products used by businesses and institutions to maintain and repair their facilities and equipment. Grainger uses a multichannel business model to provide customers with a range of options for finding and purchasing products through a network of branches, field sales representatives, call centers, direct marketing media and the Internet. Grainger serves customers through a network of 596 branches, 18 distribution centers and multiple Web sites.

Grainger has revised its segment disclosure included in Note 8 to the Condensed Consolidated Financial Statements from two reportable segments to three reportable segments. The three reportable segments are Grainger Branch-based,

Acklands – Grainger Branch-based and Lab Safety. Grainger Branch-based is an aggregation of the following business units: Industrial Supply, Grainger, S.A. de C.V. (Mexico), Grainger Caribe Inc. (Puerto Rico) and China. Acklands – Grainger is the Company’s Canadian branch-based distribution business. Lab Safety is a direct marketer of safety and other industrial products. Segment information has been modified for all periods in order to conform to the new presentation.

Business Environment

Several economic factors and industry trends shape Grainger’s business environment. Grainger’s sales tend to correlate positively with production growth, particularly manufacturing output, as well as growth in non-farm payrolls. According to the Federal Reserve, overall industrial production in June of 2006 was 4.5% above June of 2005. Manufacturing output was 5.7% above June of 2005, although manufacturing employment levels were essentially flat. Non-farm employment levels grew 1.4% since June of 2005. Grainger’s sales to the heavy manufacturing customer sector continue to show improvement over the prior year, reflecting the strength in industrial production. Current economic growth projections by Consensus Forecast–USA for 2006 industrial production and GDP are 4.2% and 3.4%, respectively.

For the first six months of 2006, the Company had approximately $33.1 million of capital expenditures related to its U.S. branch network and information technology systems. The upgraded SAP system was installed in the U.S. branch-based businesses effective January 30, 2006. Installation in other business units is scheduled for 2008 and beyond .

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Matters Affecting Comparability

Effective January 1, 2006, Grainger adopted SFAS No. 123R, “Share-Based Payment”, for the accounting of employee stock-based compensation. The effect of the adoption was approximately a $0.05 and $0.08 earnings per share reduction for the three months and six months ended June 30, 2006, respectively.

As a result of recent system enhancements in 2006, second quarter earnings benefited $0.05 per share due to changes in the timing of certain inventory-related transactions and estimates that would have been recorded in the fourth quarter of 2006 if the prior system had been used. The six month benefit was $0.10 per share.

Grainger’s operating results for the six months of 2006 include the operating results of Rand Materials Handling Equipment Co. (Rand) from the acquisition date of January 31, 2006. Rand’s results are included in the Lab Safety segment.

Results of Operations – Three Months Ended June 30, 2006

The following table is included as an aid to understanding the changes in Grainger’s Condensed Consolidated Statements of Earnings:

	Three Months Ended June 30,
	Items in Condensed Consolidated Statements of Earnings

	As a Percent of Net Sales		Percent Increase
	2006	2005	Percent Increase
Net sales	100.0%	100.0%	8.0%
Cost of merchandise sold	60.7	61.6	6.4
Gross profit	39.3	38.4	10.7
Operating expenses	29.6	29.2	9.4
Operating earnings	9.7	9.2	14.5
Other income	0.6	0.2	198.4
Income taxes	4.0	3.5	24.8
Net earnings	6.3	5.9	14.9

Grainger’s net sales of $1,482.9 million in the second quarter of 2006 increased 8.0% compared with sales of $1,372.8 million for the comparable 2005 quarter. Second quarter 2006 sales benefited from the economy, ongoing strategic initiatives and a favorable Canadian exchange rate. Partially offsetting these improvements was the negative effect of the wind-down of low margin integrated supply and automotive contracts and the negative effect from the timing of the Easter holiday, which fell into the second quarter of 2006 versus the first quarter of 2005. Net sales increased in all three segments of the business.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The gross profit margin improved 0.9 percentage point to 39.3% for the second quarter of 2006 from 38.4% in the comparable period of 2005. Contributing to the gross profit margin improvement were positive inflation recovery, the positive effect of selling price category mix and a change in the timing of certain inventory-related transactions and estimates. Partially offsetting these improvements were higher operating expenses in each segment and at headquarters. Operating expenses of $438.8 million in 2006 increased 9.4% over the prior year, driven by payroll and benefits, primarily the result of increased headcount, higher stock-based compensation due to the adoption of SFAS No. 123R and higher profit sharing accruals, and to increased advertising expenses. Partially offsetting these increases were lower market expansion costs, primarily the result of 2006 gains on sales of branch facilities of $6.3 million. Operating earnings for the second quarter of 2006 totaled $144.5 million, an increase of 14.5% over the second quarter of 2005.

Net earnings for the second quarter of 2006 increased by 14.9% to $93.7 million from $81.6 million in 2005. Diluted earnings per share of $1.02 in the second quarter of 2006 were 14.6% higher than the $0.89 for the second quarter of 2005. The growth in net earnings for the quarter resulted from the improvement in operating earnings and higher other income, partially offset by a higher tax rate for the Company.

Segment Analysis

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.

Grainger Branch-based

In the second quarter of 2006, net sales of $1,233.6 million increased by 7.6% compared to net sales of $1,146.8 million in the second quarter of 2005. Sales in the United States were up 7.6%, with growth in all customer end markets, led by the heavy manufacturing and government sectors. Sales were positively affected by 1 percentage point due to higher sales of seasonal products. Product line expansion contributed approximately 1 percentage point to the growth in the segment. The wind-down of the Company’s low margin integrated supply and automotive contracts reduced sales growth by approximately 2 percentage points. Also negatively impacting sales was the timing of the Easter holiday, which fell into the second quarter of 2006 versus the first quarter of 2005.

Market expansion contributed approximately 2 percentage points to the sales growth for the segment. Results for the market expansion program were as follows:

	2006 Second Quarter
	Sales Increase	Percent Complete
Phase 1 (Atlanta, Denver, Seattle)	14%	100%
Phase 2 (Four markets in Southern California)	14%	95%
Phase 3 (Houston, St. Louis, Tampa)	15%	85%
Phase 4 (Baltimore, Cincinnati, Kansas City, Miami, Philadelphia, Washington D.C.)	9%	75%

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Sales in Mexico increased 16.5% in the second quarter of 2006 versus 2005, driven by an expanded telesales operation, a new branch in Santa Catarina and an expanded presence in Tijuana, supported by a strong economy. In local currency, sales were up 18.9%.

The gross profit margin for the segment increased 1.1 percentage points in the 2006 quarter over the comparable quarter of 2005, driven by positive inflation recovery, a positive change in selling price category mix and changes in the timing of certain inventory-related transactions and estimates. A major driver in the improvement in selling price category mix was the reduction of sales related to low margin integrated supply and automotive contracts. As a result of recent system enhancements in 2006, gross profit margins benefited from an improved methodology to capture data related to certain inventory transactions and estimates. Under the old system these quarterly inventory adjustments would have been recorded in the fourth quarter of 2006.

Operating expenses were up 6.5% in the quarter. The operating expense growth was primarily driven by higher payroll and benefits costs due to increased headcount, higher stock-based compensation due to the adoption of SFAS No. 123R and higher accruals for profit sharing and to increased advertising expenses. Partially offsetting these increases were lower market expansion costs, primarily the result of gains on sales of branch facilities.

Operating earnings of $151.8 million for the second quarter of 2006 increased 21.0% over the $125.5 million for the second quarter of 2005. The earnings improvement resulted from higher sales, improved gross profit margins, and operating expenses which grew at a slower rate than sales.

Acklands – Grainger Branch-based (Canada)

Net sales in Canada in the second quarter of 2006 were 13.4% higher than the comparable quarter of 2005 including the effect of a favorable exchange rate. In local currency, sales increased 2.2%.

The gross profit margin increased 0.7 percentage point in the 2006 quarter over the second quarter of 2005. Contributing to the improvement was positive inflation recovery, partially offset by higher freight costs.

Operating expenses for Canada were up 21.3% in the quarter primarily driven by payroll and benefits due to increased headcount, higher severance costs as a result of a leadership change and higher information technology costs.

Operating earnings of $3.1 million in the second quarter of 2006 were down $1.4 million or 31.7% due to higher operating expenses, partially offset by increased sales and a higher gross profit margin.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Lab Safety

Net sales at Lab Safety were $103.3 million for the second quarter of 2006, an increase of $5.6 million, or 5.7%, when compared with $97.7 million for the same period in 2005. The sales growth included the benefit of incremental sales from Rand, acquired on January 31, 2006. Excluding Rand, sales increased 1.6%.

The gross profit margin decreased 0.2 percentage point for the second quarter of 2006 from the second quarter of 2005.

Operating expenses of $30.1 million were $2.2 million, or 8.0%, higher in the quarter due to higher healthcare costs and incremental costs associated with the acquisition of Rand.

Operating earnings of $13.5 million in the second quarter of 2006 were flat versus 2005. Increased sales were offset by a lower gross profit margin and higher operating expenses.

Other Income and Expense

Other income and expense was income of $8.3 million in the second quarter of 2006 compared with $2.8 million in the second quarter of 2005. The following table summarizes the components of other income and expense:

	Three Months Ended June 30,
	2006	2005
	(In thousands of dollars)
Other income and (expense):
Interest income (expense) – net	$ 4,879	$ 1,964
Equity in income of unconsolidated entities	862	890
Gain on sale of unconsolidated entity	2,291	–
Unclassified – net	293	(64)
Total other income and (expense)	$ 8,325	$ 2,790

The improvement in other income and expense was primarily attributable to higher interest income and the gain on the sale of Acklands – Grainger’s interest in the USI-AGI Prairies joint venture. The increase in interest income in 2006 was the result of higher average cash balances and higher interest rates.

Income Taxes

Grainger’s effective tax rate was 38.7% and 36.7% for the second quarter of 2006 and 2005, respectively. Excluding the effect of equity in income of unconsolidated entities, which is recorded net of tax, the effective income tax rate was 38.9% for the second quarter of 2006 and 37.0% for the second quarter of 2005. The full year 2005 rate was 35.0% and benefited from a favorable revision to the estimate of income taxes for various state and local tax jurisdictions and the resolution of certain federal and state tax contingencies.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Results of Operations – Six Months Ended June 30, 2006

The following table is included as an aid to understanding the changes in Grainger’s Condensed Consolidated Statements of Earnings:

	Six Months Ended June 30,
	Items in Condensed Consolidated Statements of Earnings

	As a Percent of Net Sales		Percent Increase
	2006	2005	Percent Increase
Net sales	100.0%	100.0%	7.2%
Cost of merchandise sold	60.2	62.1	4.0
Gross profit	39.8	37.9	12.4
Operating expenses	30.2	29.1	11.2
Operating earnings	9.6	8.8	16.6
Other income	0.5	0.2	178.3
Income taxes	3.9	3.3	26.0
Net earnings	6.2	5.7	16.6

Grainger’s net sales of $2,902.0 million in the first six months of 2006 increased 7.2% compared with sales of $2,707.7 million for the comparable 2005 period. First half 2006 sales benefited from the economy, ongoing strategic initiatives and a favorable Canadian exchange rate. Partially offsetting these improvements was the negative effect of the wind-down of low margin integrated supply and automotive contracts. Net sales increased in all three segments of the business.

The gross profit margin for the six months ended June 30, 2006 improved 1.9 percentage points to 39.8% from 37.9% in the comparable period of 2005. Contributing to the gross profit margin improvement were positive inflation recovery, the positive effect of selling price category mix and a change in the timing of certain inventory-related transactions and estimates. Partially offsetting these improvements were higher operating expenses in each segment and at headquarters. Operating expenses of $874.7 million in 2006 increased 11.2% over the prior year, driven by payroll and benefits, primarily the result of increased headcount, higher stock-based compensation due to the adoption of SFAS No. 123R and higher profit sharing accruals. Also contributing were increased advertising expenses and higher market expansion costs, partially offset by 2006 gains on sales of branch facilities of $6.3 million. Operating earnings for the six months ended June 30, 2006 totaled $279.0 million, an increase of 16.6% over the first six months of 2005.

Net earnings for the six months ended June 30, 2006 increased by 16.6% to $180.0 million from $154.4 million in 2005. Diluted earnings per share of $1.95 in the first half of 2006 were 16.1% higher than the $1.68 for the first half of 2005. The growth in net earnings for the quarter resulted from the improvement in operating earnings and higher other income, partially offset by a higher tax rate for the Company.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Segment Analysis

Grainger Branch-based

Net sales of $2,410.7 million increased by 6.1% in the first six months of 2006 compared to net sales of $2,272.1 million in the first six months of 2005. Sales in the United States were up 6.1%, with growth in all customer end markets, led by the government, reseller and heavy manufacturing sectors. The wind-down of the Company’s low margin integrated supply and automotive contracts reduced sales growth by approximately 2 percentage points.

Market expansion contributed approximately 2 percentage points to the sales growth for the segment. Results for the market expansion program were as follows:

	2006 Year-to-Date
	Sales Increase	Percent Complete
Phase 1 (Atlanta, Denver, Seattle)	12%	100%
Phase 2 (Four markets in Southern California)	13%	95%
Phase 3 (Houston, St. Louis, Tampa)	14%	85%
Phase 4 (Baltimore, Cincinnati, Kansas City, Miami, Philadelphia, Washington D.C.)	8%	75%

Sales in Mexico increased 19.5% in the first half of 2006 versus 2005. In local currency, sales were up 17.9% driven by an improving economy, an expanded telesales operation and increased direct marketing efforts.

The gross profit margin increased 2.2 percentage points in the first half of 2006 over the comparable 2005 period, driven by positive inflation recovery, a positive change in selling price category mix and changes in the timing of certain inventory-related transactions and estimates. A major driver in the improvement in selling price category mix was the reduction of sales related to lower margin integrated supply and automotive contracts. As a result of recent system enhancements in 2006, gross profit margins benefited from more timely data related to certain inventory transactions and estimates that would have been recorded in the fourth quarter of 2006 had the prior system been used.

Operating expenses were up 9.0% for the six months ended June 30, 2006. The operating expense growth was primarily driven by higher payroll and benefits costs due to increased headcount, higher stock-based compensation due to the adoption of SFAS No. 123R, higher accruals for profit sharing, and increased advertising expenses and market expansion costs.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Operating earnings of $284.7 million for the first half of 2006 increased 20.9% over the $235.4 million for the first half of 2005. The earnings improvement resulted from higher sales and improved gross profit margins, partially offset by operating expenses, which grew at a faster rate than sales.

Acklands – Grainger Branch-based (Canada)

Net sales of $285.9 million increased by 15.9% in the first six months of 2006 compared to 2005 net sales of $246.8 million, including the effect of a favorable exchange rate. In local currency, sales increased 6.7% due to a stronger economy, improved branch presence, and higher sales to the oil and gas sectors.

The gross profit margin increased 0.6 percentage point in the first half of 2006 over the first half of 2005. Contributing to the improvement was positive inflation recovery, partially offset by higher freight costs.

Operating expenses for Canada were up 20.9% in the first six months of 2006, primarily driven by payroll and benefits due to increased headcount, higher severance costs as a result of a leadership change and higher information technology costs.

Operating earnings of $6.9 million in the first six months of 2006 were down 10.5% from the $7.8 million in 2005 due to higher operating expenses, partially offset by increased sales and a higher gross profit margin.

Lab Safety

Net sales at Lab Safety were $207.2 million for the first six months of 2006, an increase of $16.0 million, or 8.4%, when compared with $191.2 million for the same period in 2005. The sales growth included the benefit of incremental sales from Rand, acquired on January 31, 2006, as well as strong sales to the manufacturing sector. Excluding Rand, sales increased 4.8%.

The gross profit margin was flat for the first half of 2006 compared to the 2005 period.

Operating expenses of $60.1 million were $5.4 million, or 9.8%, higher in the first six months of 2006 due to higher healthcare costs and incremental costs associated with the acquisition of Rand.

Operating earnings of $28.7 million for the first six months of 2006 were up 5.6% over 2005, resulting from increased sales, partially offset by higher operating expenses.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Other Income and Expense

Other income and expense was income of $14.3 million in the first half of 2006 compared with $5.1 million in the first half of 2005. The following table summarizes the components of other income and expense:

	Six Months Ended June 30,
	2006	2005
	(In thousands of dollars)
Other income and (expense):
Interest income (expense) – net	$ 9,745	$ 3,921
Equity in income of unconsolidated entities	2,069	1,310
Gain on sale of unconsolidated entity	2,291	–
Unclassified – net	170	(102)
Total other income and (expense)	$ 14,275	$ 5,129

The improvement in other income and expense was primarily attributable to the combination of higher interest income and the gain on the sale of Acklands – Grainger’s interest in the USI-AGI Prairies joint venture. The increase in interest income in 2006 was the result of higher average cash balances and higher interest rates.

Income Taxes

Grainger’s effective tax rate was 38.6% and 36.8% for the first six months of 2006 and 2005, respectively. Excluding the effect of equity in income of unconsolidated entities, which is recorded net of tax, the effective income tax rate was 38.9% for the first half of 2006 and 37.0% for 2005. The full year 2005 rate was 35.0% and benefited from a favorable revision to the estimate of income taxes for various state and local tax jurisdictions and the resolution of certain federal and state tax contingencies.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Financial Condition

For the six months ended June 30, 2006, working capital of $1,327.2 million increased by $56.3 million when compared to $1,270.9 million at December 31, 2005. The ratio of current assets to current liabilities was 3.0 at June 30, 2006, versus 2.7 at December 31, 2005.

Net cash provided by operating activities was $100.5 million and $114.6 million for the six months ended June 30, 2006 and 2005, respectively. Net cash flows from operating activities serve as the Company’s primary source to fund its growth initiatives. Contributing to cash flows from operations were net earnings in the first six months ended June 30, 2006 of $180.0 million and the change in non-cash items such as stock-based compensation accruals and depreciation and amortization. Partially offsetting these amounts were Changes in operating assets and liabilities – net of business acquisitions, which resulted in a net use of cash of $133.3 million for the first six months of 2006. The principal operating uses of cash were increases in accounts receivable and a reduction of other current liabilities. The increase in receivables was due to a higher sales volume and an increase in days sales outstanding. Other current liabilities declined primarily due to the timing of annual cash payments for profit sharing and bonuses.

Net cash used in investing activities was $44.0 million and $89.8 million for the six months ended June 30, 2006 and 2005, respectively. In the first half of 2006, Grainger continued funding the Company’s growth initiatives with the purchase of Rand and its ongoing investment in the market expansion program. The cash portion of the Rand purchase price was $13.9 million. Rand is included as part of the Lab Safety segment. Cash expended for additions to property, buildings, equipment and capitalized software was $64.0 million in the first six months of 2006 versus $77.2 million in the first six months of 2005. In the second quarter of 2006, Acklands – Grainger’s interest in the USI-AGI Prairies joint venture was sold for $27.4 million in cash.

Net cash used in financing activities was $148.6 million and $127.9 million for the six months ended June 30, 2006 and 2005, respectively. Purchases of treasury stock were $47.4 million higher in the first six months of 2006 as Grainger repurchased 2,044,900 shares compared with 1,840,400 shares in the first six months of 2005. As of June 30, 2006, approximately 2.6 million shares of common stock remained available under Grainger’s repurchase authorization. Dividends paid to shareholders were $47.7 million and $39.7 million for the first half of 2006 and 2005, respectively. Partially offsetting these financing cash outlays were proceeds and excess tax benefits realized from stock options exercised of $49.2 million in 2006 versus proceeds of $14.6 million in 2005.

Grainger maintains a debt ratio and liquidity position that provide flexibility in funding working capital needs and long-term cash requirements. In addition to internally generated funds, Grainger has various sources of financing available, including commercial paper sales and bank borrowings under lines of credit. Total debt as a percent of total capitalization was 0.4% at both June 30, 2006 and December 31, 2005.

W.W. Grainger, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Critical Accounting Policies and Estimates

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 uncertain at the time the estimate is made and when different estimates than those management reasonably could have made 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Forward-Looking Statements

This document may contain forward-looking statements under the federal securities laws. The forward-looking statements relate to Grainger’s expected future financial results and business plans, strategies and objectives and are not historical facts. They are often identified by qualifiers such as “will,” “believes,” “intends,” “expect,” “expected,” “anticipate,” “estimated,” “assumption,” “may,” “contingent,” “projection,” “percent complete,” “scheduled,” “goals,” “target,” “trends” or similar expressions. There are risks and uncertainties the outcome of which could cause Grainger’s results to differ materially from what is projected.

Factors that may affect forward-looking statements include the following: higher product costs or other expenses; a major loss of customers; increased competitive pricing pressure on Grainger’s businesses; failure to develop or implement new technologies or other business strategies; the outcome of pending and future litigation and governmental proceedings; changes in laws and regulations; facilities disruptions or shutdowns; disruptions in transportation services; natural and other catastrophes; unanticipated weather conditions; and other difficulties in achieving or improving margins or financial performance.

Trends and projections could also be affected by general industry and market conditions, gross domestic product growth rates, general economic conditions, including industrial production, interest rate and currency rate fluctuations, global and other conflicts, job creation and employment levels in manufacturing, non-farm and other sectors, and other factors.

W.W. Grainger, Inc. and Subsidiaries

PART I – FINANCIAL INFORMATION

Item 3. Quantitative and Qualitative Disclosures about Market Risk

For quantitative and qualitative disclosures about market risk, see “Item 7A: Quantitative and Qualitative Disclosures About Market Risk” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

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 the design and operation of Grainger’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. 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.

Changes in Internal Control Over Financial Reporting

There were no changes in Grainger’s internal control over financial reporting that occurred during the second quarter, that have materially affected, or are reasonably likely to materially affect, Grainger’s internal control over financial reporting.

W.W. Grainger, Inc. and Subsidiaries

PART II – OTHER INFORMATION

Items 1, 1A, 3, 4 and 5 not applicable.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities – Second Quarter

Period	Total Number of Shares Purchased	Average Price Paid per Share (A)	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (B)	Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs

April 1 – April 30	–	$ –	–	4,214,900	shares

May 1 – May 31	757,200	$ 73.65	757,200	3,457,700	shares

June 1 – June 30	826,300	$ 70.72	826,300	2,631,400	shares

Total	1,583,500	$ 72.12	1,583,500

(A)

Average price paid per share includes any commissions paid. Activity is reported on a trade date basis.

(B)

Purchases were made pursuant to a share repurchase program approved by Grainger’s Board of Directors. As reported in Grainger’s Form 10-Q for the quarter ended September 30, 2002, which was filed on November 11, 2002, authority under the program was restored to 10 million shares on October 30, 2002. The program has no specified expiration date. No share repurchase plan or program expired or was terminated during the period covered by this report.

W.W. Grainger, Inc. and Subsidiaries

Item 6. Exhibits
	(a)	Exhibits (numbered in accordance with Item 601 of Regulation S-K)
		(10)	Material Contracts
			(a) 1990 Long Term Stock Incentive Plan, as amended
			(b) 2001 Long Term Stock Incentive Plan, as amended
			(c) Director Stock Plan, as amended
			(d) 2005 Incentive Plan, as amended
		(11)	Computations of Earnings per Share
		(31)	Rule 13a – 14(a)/15d – 14(a) Certifications
			(a) Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
			(b) Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
		(32)	Section 1350 Certifications
			(a) Chief Executive Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
			(b) Chief Financial Officer certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		W.W. Grainger, Inc.
		(Registrant)
Date: August 1, 2006	By:	/s/ P. O. Loux
		P. O. Loux, Senior Vice President, Finance and Chief Financial Officer
Date: August 1, 2006	By:	/s/ J. E. Andringa
		J. E. Andringa, Vice President and Controller

GRAINGER

_________________

1990 LONG TERM STOCK INCENTIVE PLAN

As Amended July 26, 2006

_________________

W.W. Grainger, Inc.

100 Grainger Parkway

Lake Forest, Illinois 60045-5201

(847) 535-1000

W.W. GRAINGER, INC.

1990 LONG TERM STOCK INCENTIVE PLAN

As Amended July 26, 2006

Section 1. Objective.

The objective of the W.W. Grainger, Inc. 1990 Long Term Stock Incentive Plan (the “Plan”) is to attract and retain the best available executive personnel and other key employees to be responsible for the management, growth and success of the business, and to provide an incentive for such employees to exert their best efforts on behalf of the Company and its shareholders.

Section 2. Definitions.

2.1. General Definitions . The following words and phrases, when used herein, shall have the following meanings:

(a) “Act” - The Securities Exchange Act of 1934, as amended.

(b) “Agreement” - The document which evidences the grant of any Award under the Plan and which sets forth the terms, conditions, and limitations relating to such Award.

(c) “Award” - The grant of any stock option, stock appreciation right, share of restricted stock, share of phantom stock, other stock-based award, or any combination thereof.

(d) “Board” - The Board of Directors of W.W. Grainger, Inc.

(e) “Change in Control” means any one or more of the following events:

(i) approval by the shareholders of the Company of:

(A) any merger, reorganization or consolidation of the Company or any Subsidiary with or into any corporation or other Person if Persons who were the beneficial owners (as such term is used in Rule 13d-3 under the Act) of Common Stock and securities of the Company entitled to vote generally in the election of directors (“Voting Securities”) immediately before such merger, reorganization or consolidation are not, immediately thereafter, the beneficial owners, directly or indirectly, of at least 60% of the then-outstanding common shares and the combined voting power of the then-outstanding Voting Securities (“Voting Power”) of the corporation or other Person surviving or resulting from such merger, reorganization or consolidation (or the parent corporation thereof) in substantially the same respective proportions as their

beneficial ownership, immediately before the consummation of such merger, reorganization or consolidation, of the then-outstanding Common Stock and Voting Power of the Company;

(B) the sale or other disposition of all or substantially all of the consolidated assets of the Company, other than a sale or other disposition by the Company of all or substantially all of its consolidated assets to an entity of which at least 60% of the common shares and the Voting Power outstanding immediately after such sale or other disposition are then beneficially owned (as such term is used in Rule 13d-3 under the Act) by shareholders of the Company in substantially the same respective proportions as their beneficial ownership of Common Stock and Voting Power of the Company immediately before the consummation of such sale or other disposition; or

provided, however, that if the consummation of an event described in this paragraph (i) (a “Transaction”) is subject to an Other Party Approval Requirement (as defined below), the approval of such Transaction by the shareholders of the Company shall not be deemed a Change in Control until the first date on which such Other Party Approval Requirement has been satisfied. For this purpose, “Other Party Approval Requirement” means a requirement expressly set forth in a Transaction Agreement (as defined below) between the Company and another Person to the effect that such Person shall obtain the approval of one or more elements of the Transaction by the stockholders, members, partners, or other holders of equity interests of such Person (or of a parent of such Person) prior to the consummation of such Transaction in order to comply with the mandatory provisions of (x) the law of the jurisdiction of the incorporation or organization of such Person (or its parent) or (y) the articles of incorporation or other charter or organizational documents of such Person (or its parent) that are applicable to such Transaction. For this purpose, “Transaction Agreement” means a written agreement that sets forth the terms and conditions of the Transaction;

(ii) the following individuals cease for any reason to constitute a majority of the directors of the Company then serving: individuals who, on the Effective Date, constitute the Board and any subsequently appointed or elected director of the Company (other than a director whose initial assumption of office is in connection with an actual or threatened election contest, including a consent solicitation, relating to the election or removal of one or more directors of the Company) whose appointment or election by the Board or nomination for election by the Company’s shareholders was approved or recommended by a vote of at least two-thirds of the Company’s directors then in office whose appointment, election or

nomination for election was previously so approved or recommended or who were directors on the Effective Date; or

(iii) the acquisition or holding by any person, entity or “group” (within the meaning of Section 13(d)(3) or 14(d)(2) of the Act, other than by any Exempt Person (as such term is defined below), the Company, any Subsidiary, any employee benefit plan of the Company or a Subsidiary) of beneficial ownership (within the meaning of Rule 13d-3 under the Act) of 20% or more of either the Company’s then-outstanding Common Stock or Voting Power; provided that:

(A) no such person, entity or group shall be deemed to own beneficially any securities held by the Company or a Subsidiary or any employee benefit plan (or any related trust) of the Company or a Subsidiary;

(B) no Change in Control shall be deemed to have occurred solely by reason of any such acquisition if both (x) after giving effect to such acquisition, such person, entity or group has beneficial ownership of less than 30% of the then-outstanding Common Stock and Voting Power of the Company and (y) prior to such acquisition, at least two-thirds of the directors described in (and not excluded from) paragraph (ii) of this definition vote to adopt a resolution of the Board to the specific effect that such acquisition shall not be deemed a Change in Control; and

(C) no Change in Control shall be deemed to have occurred solely by reason of any such acquisition or holding in connection with any merger, reorganization or consolidation of the Company or any Subsidiary which is not a Change in Control within the meaning of paragraph (i)(A) above.

Notwithstanding the occurrence of any of the events specified in paragraphs (i), (ii) or (iii) of this definition, no Change in Control shall occur with respect to any Participant if (x) the event which otherwise would be a Change in Control (or the transaction which resulted in such event) was initiated by such Participant, or was discussed by him with any third party, without the approval of the Board with respect to such Participant’s initiation or discussion, as applicable, or (y) such Participant is, by written agreement, a participant on his own behalf in a transaction in which the persons (or their affiliates) with whom such Participant has the written agreement cause the Change in Control to occur and, pursuant to the written agreement, such Participant has an equity interest (or a right to acquire such equity interest) in the resulting entity.

(f) “Code” - The Internal Revenue Code of 1986, as amended, including the regulations promulgated pursuant thereto.

(g) “Committee” - The Compensation Committee of the Board, which shall consist of two or more members. The members of the Committee shall be “non-employee directors” within the meaning of Rule 16b-3, as the same may be amended or supplemented from time to time, as promulgated under the Act.

(h) “Common Stock” - The present shares of common stock of the Company, and any shares into which such shares are converted, changed or reclassified.

(i) “Company” - W.W. Grainger, Inc., an Illinois corporation.

(j) “Effective Date” - December 9, 1998.

(k) “Employee” - Any person designated as an employee of the Company or a Subsidiary on the payroll records thereof.

(l) “Exempt Person” means any one or more of the following:

(i) any descendant of W.W. Grainger (deceased) or any spouse, widow or widower of any such descendant (any such descendants, spouses, widows and widowers collectively defined as the “Grainger Family Members”);

(ii) any descendant of E.O. Slavik (deceased) or any spouse, widow or widower of any such descendant (any such descendants, spouses, widows and widowers collectively defined as the “Slavik Family Members” and with the Grainger Family Members collectively defined as the “Family Members”);

(iii) any trust which is in existence on the Effective Date and which has been established by one or more Grainger Family Members, any estate of a Grainger Family Member who died on or before the Effective Date, and The Grainger Foundation (such trusts, estates and named entity collectively defined as the “Grainger Family Entities”);

(iv) any trust which is in existence on the Effective Date and which has been established by one or more Slavik Family Members, any estate of a Slavik Family Member who died on or before the Effective Date, Mark IV Capital, Inc., and Mountain Capital Corporation (such trusts, estates and named entities collectively defined as the “Slavik Family Entities” and with the Grainger Family Entities collectively defined as the “Existing Family Entities”);

(“Charitable Organizations”), collectively, are the beneficiaries of at least 50% of the actuarially determined beneficial interests in such estate or trust;

(vi) any Charitable Organization which is established by one or more Family Members or Existing Family Entities (a “Family Charitable Organization”);

(vii) any corporation of which a majority of the voting power and a majority of the equity interest is held, directly or indirectly, by or for the benefit of one or more Family Members, Existing Family Entities, estates or trusts described in clause (v) above, or Family Charitable Organizations; or

(viii) any partnership or other entity or arrangement of which a majority of the voting interest and a majority of the economic interest is held, directly or indirectly, by or for the benefit of one or more Family Members, Existing Family Entities, estates or trusts described in clause (v) above, or Family Charitable Organizations.

(m) “Fair Market Value” - The fair market value of Common Stock on a particular day shall be the closing price of the Common Stock on the New York Stock Exchange, or any other national stock exchange on which the Common Stock is traded, on the last preceding trading day on which such Common Stock was traded.

(n) “Option” - The right to purchase Common Stock at a stated price for a specified period of time. For purposes of the Plan, the option is a non-qualified stock option.

(o) “Other Stock Based Award” - An award under Section 9 that is valued in whole or in part by reference to, or is otherwise based on, the Common Stock.

(p) “Participant” - Any Employee designated by the Committee to participate in the Plan.

(q) “Person” - Any individual, corporation, partnership, limited liability company, sole proprietorship, trust or other entity.

(r) “Period of Restriction” - The period during which Shares of Restricted Stock or Phantom Stock rights are subject to forfeiture or restrictions on transfer pursuant to Section 8 of the Plan.

(s) “Phantom Stock” - A right to receive payment from the Company in cash, stock, or in combination thereof, in an amount determined by the Fair Market Value.

(t) “Restricted Stock” - Shares granted to a Participant which are subject to restrictions on transferability pursuant to Section 8 of the Plan.

(u) “Shares” - Shares of Common Stock.

(v) “Stock Appreciation Right” or “SAR” - The right to receive a payment from the Company in cash, Common Stock, or in combination thereof, equal to the excess of the Fair Market Value of a share of Common Stock on the date of exercise over a specified price fixed by the Committee, but subject to such maximum amounts as the Committee may impose.

(w) “Subsidiary” - Any corporation, partnership, joint venture, limited liability company, or other entity in which the Company directly or indirectly owns securities representing a majority of the aggregate voting power.

2.2. Other Definitions . In addition to the above definitions, certain words and phrases used in the Plan and any Agreement may be defined elsewhere in the Plan or in such Agreement.

Section 3. Common Stock.

3.1. Number of Shares . Subject to the provisions of Section 3.3, the number of Shares which may be issued or sold or for which Options or Stock Appreciation Rights may be granted under the Plan may not exceed 8,056,828 Shares. ¹ Notwithstanding the foregoing, the total number of Shares with respect to which Options or Stock Appreciation Rights may be granted to any Participant shall not exceed 800,000 Shares ² (proportionately adjusted pursuant to Section 3.3) in any calendar year.

3.2. Re-usage . If an Option or SAR expires or is terminated, surrendered, or canceled without having been fully exercised, if Restricted Stock is forfeited or cancelled, if Shares otherwise deliverable upon (i) exercise of Options, (ii) exercise of SARs, or (iii) vesting of Restricted Stock, regardless of when the Options, SARs or Restricted Stock shall have been granted, are not delivered by reason of payments of the Option exercise price pursuant to Section 6.5(b) hereunder or withholdings of Shares in satisfaction of tax obligations pursuant to under Section 14.4 hereunder, or if any other grant results in any Shares not being delivered, the Shares covered by such Option, SAR, grant of Restricted Stock, or other grants, or not so delivered, as the case may be, shall again be available for Awards under the Plan. Notwithstanding the foregoing, in cases of events, transactions or occurrences that would cause the Plan, in the event of such re-availability, to be deemed a “formula plan” within the meaning of Section 303A.08 of the New York Stock Exchange Listed Company Manual, as the same may be amended or interpreted by the New York Stock Exchange from time to time, the Shares shall again

__________________

¹ As adjusted to reflect (i) the number of shares remaining available for grants under the Company’s Restated 1975 Non-Qualified Stock Option Plan, (ii) the Company’s 1991 two-for-one stock split and (iii) the Company’s 1998 two-for-one stock split.

² As adjusted to reflect the Company’s 1998 two-for-one stock split.

be available for Awards under the Plan only by reason of such events, transactions or occurrences within a period of ten years following the date of the original approval of the Plan by the shareholders of the Company or, if later, the date of the most recent approval of the Plan, including without limitation any amendment to the Plan to increase the number of Shares available for Awards thereunder, by the shareholders of the Company.

3.3. Adjustments. In the event of any change in the outstanding Common Stock by reason of a stock split, stock dividend, combination, reclassification or exchange of Shares, recapitalization, merger, consolidation or other similar event, the number of SARs and the number of Shares available for Options, grants of Restricted Stock, grants of Phantom Stock, and Other Stock-Based Awards and the number of Shares subject to outstanding Options, SARs, grants of Restricted Stock, grants of Phantom Stock, and Other Stock-Based Awards, and the price thereof, and the Fair Market Value, as applicable, shall be appropriately and equitably adjusted by the Committee and any such adjustment shall be binding and conclusive on all parties. Any fractional Shares resulting from any such adjustment shall be disregarded.

Section 4. Eligibility and Participation.

Participants in the Plan shall be those key employees selected by the Committee to participate in the Plan who hold positions of responsibility and whose participation in the Plan the Committee or management of the Company determines to be in the best interests of the Company.

Section 5. Administration.

5.1. Committee . The Plan shall be administered by the Committee. The members of the Committee shall be appointed by and shall serve at the pleasure of the Board, which may from time to time change the Committee’s membership.

5.2. Authority . The Committee shall have the sole and complete authority to:

(a) determine the individuals to whom Awards are granted, the type and amounts of awards to be granted and the time of all such grants;

(b) determine the terms, conditions and provisions of, and restrictions relating to, each Award granted;

(d) prescribe, amend and rescind rules and regulations relating to the Plan;

(e) determine the content and form of all Agreements;

(f) determine all questions relating to Awards under the Plan;

(g) maintain accounts, records and ledgers relating to Awards;

(h) maintain records concerning its decisions and proceedings;

(i) employ agents, attorneys, accountants or other persons for such purposes as the Committee considers necessary or desirable;

(j) do and perform all acts which it may deem necessary or appropriate for the administration of the Plan and to carry out the objectives of the Plan.

5.3. Determinations . All determinations, interpretations, or other actions made or taken by the Committee pursuant to the provisions of the Plan shall be final, binding, and conclusive for all purposes and upon all persons.

5.4. Delegation . Except as required by Rule 16b-3 promulgated under the Act (and any successor to such Rule) with respect to the grant of Awards to Participants who are subject to Section 16 of the Act, the Committee may delegate to appropriate senior officers of the Company its duties under the Plan pursuant to such conditions and limitations as the Committee may establish.

Section 6. Stock Options.

6.1. Type of Option . It is intended that only non-qualified stock options may be granted by the Committee under this section of the Plan.

6.2. Grant of Option . An Option may be granted to Participants at such time or times as shall be determined by the Committee. Each Option shall be evidenced by an Option Agreement that shall specify the exercise price, the duration of the Option, the number of Shares to which the Option applies, and such other terms and conditions not inconsistent with the Plan as the Committee shall determine.

6.3. Option Price . The per share option price shall be at least 100% of the Fair Market Value at the time the Option is granted.

6.4. Exercise of Options . Options awarded under the Plan shall be exercisable at such times and shall be subject to such restrictions and conditions, including the performance of a minimum period of service after the grant, as the Committee may impose, which need not be uniform for all participants; provided, however, that no Option shall be exercisable for more than 10 years after the date on which it is granted.

6.5 . Payment . Options shall be exercised by the delivery of a written notice to the Company, setting forth the number of Shares with respect to which the Option is to be exercised, and accompanied by full payment for the Shares. Upon the exercise of any Option, the exercise price shall be payable by any one or combination of the following means:

(a) cash or its equivalent,

(b) with the prior approval of the Committee, delivery of Shares already owned by the participant and valued at the Fair Market Value thereof at the time of exercise,

(c) with the prior approval of the Committee, a cashless exercise through a broker-dealer approved for this purpose by the Company.

6.6. Rights as a Shareholder . Until the exercise of an Option and the issuance of the Shares in respect thereof, a Participant shall have no rights as a Shareholder with respect to the Shares covered by such Option.

Section 7. Stock Appreciation Rights.

7.1. Grant of Stock Appreciation Rights . Stock Appreciation Rights may be granted to Participants at such time or times as shall be determined by the Committee and shall be subject to such terms and conditions as the Committee may decide. A grant of an SAR shall be made pursuant to a written Agreement containing such provisions not inconsistent with the Plan as the Committee shall approve.

7.2. Exercise of SARs . SARs may be exercised at such times and subject to such conditions, including the performance of a minimum period of service, as the Committee shall impose. SARs which are granted in tandem with an Option may only be exercised upon the surrender of the right to exercise an equivalent number of Shares under the related Option and may be exercised only with respect to the Shares for which the related Option is then exercisable. Notwithstanding any other provision of the Plan, the Committee may impose conditions on the exercise of an SAR, including, without limitation, the right of the Committee to limit the time of exercise to specified periods.

7.3. Payment of SAR Amount . Upon exercise of an SAR, the Participant shall be entitled to receive payment of an amount determined by multiplying:

(a) any increase in the Fair Market Value of a Share at the date of exercise over the Fair Market Value of a Share at the date of grant, by

(b) the number of Shares with respect to which the SAR is exercised;

provided, however, that at the time of grant, the Committee may establish, in its sole discretion, a maximum amount per Share which will be payable upon exercise of an SAR.

7.4. Method of Payment . Subject to the discretion of the Committee, which may be exercised at the time of grant, the time of payment, or any other time, payment of an SAR may be made in cash, Shares or any combination thereof.

Section 8. Restricted Stock or Phantom Stock.

8.1. Grant of Restricted Stock or Phantom Stock . The Committee may grant Shares of Restricted Stock or Phantom Stock rights to such Participants at such times and in such amounts, and subject to such other terms and conditions not inconsistent with the Plan as it shall determine. Each grant of Restricted Stock or Phantom Stock rights shall be evidenced by a written Agreement setting forth the terms of such Award.

8.2. Restrictions on Transferability . Restricted Stock or Phantom Stock rights may not be sold, transferred, pledged, assigned, or otherwise alienated until such time, or until the satisfaction of such conditions as shall be determined by the Committee (including without limitation, the satisfaction of performance goals, the occurrence of such events as shall be determined by the Committee, or pursuant to a determination under Section 14.1). At the end of the period of restriction applicable to any Restricted Stock, such Shares will be transferred to the Participant free of all restrictions. At the end of the restriction period applicable to Phantom Stock, payment shall be made in the manner set forth in the applicable award agreement.

8.3. Rights as a Shareholder . Unless otherwise determined by the Committee at the time of grant, Participants holding Restricted Stock granted hereunder may exercise full voting rights and other rights as a Shareholder with respect to those Shares during the period of restriction. Holders of Phantom Stock rights shall not be deemed Shareholders and, except to the extent provided in accordance with the Plan, shall have no rights related to any Shares.

8.4. Dividends and Other Distributions . Unless otherwise determined by the Committee at the time of grant, Participants holding Restricted Stock shall be entitled to receive all dividends and other distributions paid with respect to those Shares, provided that if any such dividends or distributions are paid in shares of stock, such shares shall be subject to the same forfeiture restrictions and restrictions on transferability as apply to the Restricted Stock with respect to which they were paid. Unless otherwise determined by the Committee at the time of grant, Participants holding shares of Phantom Stock shall be entitled to receive cash payments equal to any cash dividends and other distributions paid with respect to a corresponding number of Shares; provided, however, that if any such dividends or distributions are paid in Shares, the Fair Market Value of such Shares shall be converted into shares of Phantom Stock which shall be subject to the same forfeiture restrictions and restrictions on transferability as apply to the shares of Phantom Stock with respect to which they are paid.

8.5. Payment of Phantom Stock Rights . The Committee may, at the time of grant, provide for other methods of payment in respect of Phantom Stock rights in cash, Shares, partially in cash and partially in Shares, or in any other manner not inconsistent with this Plan.

Section 9. Other Stock Based Awards and Other Benefits.

9.1. Other Stock Based Awards . The Committee shall have the right to grant Other Stock Based Awards which may include, without limitation, the grant of Shares based on certain conditions, the payment of cash based on the performance of the Common

Stock, and the payment of Shares in lieu of cash under other Company incentive bonus programs. Payment under or settlement of any such Awards shall be made in such manner and at such times as the Committee may determine.

9.2. Other Benefits . The Committee shall have the right to provide types of Awards under the Plan in addition to those specifically listed utilizing shares of stock or cash, or a combination thereof, if the Committee believes that such Awards would further the purposes for which the Plan was established. Payment under or settlement of any such Awards shall be made in such manner and at such times as the Committee may determine.

Section 10. Amendment, Modification, and Termination of Plan.

The Board at any time may terminate or suspend the Plan, and from time to time may amend or modify the Plan. No amendment, modification, or termination of the Plan shall in any manner adversely affect any Award theretofore granted under the Plan to a Participant without the consent of such Participant.

Section 11. Termination of Employment.

11.1. Termination of Employment Due to Retirement . Unless otherwise determined by the Committee at the time of grant, in the event a Participant’s employment terminates by reason of retirement, any Option or SAR granted to such Participant which is then outstanding may be exercised at any time prior to the expiration of the term of the Option or SAR or within six (6) years following the Participant’s termination of employment, whichever period is shorter, and any Restricted Stock, Phantom Stock rights, or other Award then outstanding for which any restriction has not lapsed prior to the effective date of retirement shall be forfeited.

11.2. Termination of Employment Due to Death or Disability . Unless otherwise determined by the Committee at the time of grant, in the event a Participant’s employment is terminated by reason of death or disability, any Option or SAR granted to such Participant which is then outstanding may be exercised by the Participant, the Participant’s designated beneficiary, the Participant’s legal representative or other person entitled thereto, at any time prior to the expiration date of the term of the Option or SAR or within six (6) years following the Participant’s termination of employment, whichever period is shorter, and any Restricted Stock, Phantom Stock rights, or other Award then outstanding shall become nonforfeitable and shall become transferable or payable, as the case may be, as though any restriction had expired.

11.3. Termination of Employment for Any Other Reason . Unless otherwise determined by the Committee at the time of grant, in the event the employment of the Participant shall terminate for any reason other than misconduct or one described in Section 11.1 or 11.2, any Option or SAR granted to such Participant which is then outstanding may be exercised by the Participant at any time prior to the expiration date of the term of the Option or SAR or within three (3) months following the Participant’s termination of employment, whichever period is shorter; any Restricted Stock, Phantom Stock rights,

or other Award then outstanding for which any restriction has not lapsed prior to the date of termination of employment shall be forfeited upon termination of employment. If the employment of a Participant is terminated by the Company or a Subsidiary by reason of the Participant’s misconduct, any outstanding Option or SAR shall cease to be exercisable on the date of the Participant’s termination of employment; any Restricted Stock, Phantom Stock rights, or other Award then outstanding for which any restriction has not lapsed prior to the date of termination of employment shall be forfeited upon termination of employment. As used herein, “misconduct” means that the Participant has engaged, or intends to engage, in competition with the Company or a Subsidiary, has induced any customer of the Company or a Subsidiary to breach any contract with the Company or a Subsidiary, has made any unauthorized disclosure of any of the secrets or confidential information of the Company or a Subsidiary, has committed an act of embezzlement, fraud, or theft with respect to the property of the Company or a Subsidiary, or has deliberately disregarded the rules of the Company or a Subsidiary in such a manner as to cause any loss, damage, or injury to, or otherwise endanger the property, reputation, or employees of the Company or a Subsidiary. The Committee shall determine whether a Participant’s employment is terminated by reason of misconduct.

11.4. Accrual of Right at Date of Termination . The Participant shall have the right to exercise an Option or SAR as indicated in Sections 11.1, 11.2, and 11.3 only to the extent the Participant’s right to exercise such Option or SAR had accrued at the date of termination of employment pursuant to the terms of the Option or SAR Agreement and had not previously been exercised.

Section 12. Change in Control.

Except as otherwise provided in an Agreement, if a Change in Control occurs, then:

(i) the Participant’s Restricted Stock, Phantom Stock, or Other Stock-Based Awards that were forfeitable shall, unless otherwise determined by the Committee, become nonforfeitable and, to the extent applicable, shall be converted into Shares; and

(ii) any unexercised Option or SAR, whether or not exercisable on the date of such Change in Control, shall thereupon be fully exercisable and may be exercised, in whole or in part.

Section 13. Effect of Disposition of Facility or Operating Unit.

otherwise exercisable or remove any restrictions applicable to any Awards and (ii) extend the period during which Awards will be exercisable to a date subsequent to the date when such Awards would otherwise have expired by reason of the termination of such Participant’s employment with the Company or any of its Subsidiaries (but in no event to a date later than the expiration date of the Awards or the fifth anniversary of the transaction in which such facility closes or operating unit ceases). If the Committee takes no special action with respect to any disposition of a facility or an operating unit, then any cessation of employment resulting from such disposition will be treated as an ordinary cessation of employment as described in Section 11.

Section 14. Miscellaneous Provisions.

14.1. Non-transferability of Awards . Unless otherwise determined by the Committee, whether at the time of grant or thereafter, and except as provided in Sections 11.2 and 14.2, no Awards granted under the Plan shall be assignable, transferable, or payable to or exercisable by anyone other than the Participant to whom it was granted.

14.2 Beneficiary Designation. Unless otherwise determined by the Committee, whether at the time of grant or thereafter, each Participant may from time to time name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under the Plan is to be paid in the event of such Participant’s death before he or she receives any or all of such benefit. Each such designation shall revoke all prior designations by such Participant, shall be in a form prescribed by the Company, and will be effective only when filed by the Participant in writing with the Company during the Participant’s lifetime.

14.3. No Guarantee of Employment or Participation . Nothing in the Plan shall interfere with or limit in any way the right of the Company or a Subsidiary to terminate any Participant’s employment at any time, nor confer upon any Participant any right to continue in the employment of the Company or a Subsidiary. No employee shall have a right to be selected as a Participant, or, having been so selected, to receive any future awards.

14.4. Tax Withholding . The Company shall have the authority to withhold, or require a Participant to remit to the Company an amount sufficient to satisfy federal, state, and local withholding tax requirements on any Award under the Plan, and the Company may defer payment of cash or issuance of Shares until such requirements are satisfied. The Committee may, in its discretion, permit a Participant to elect, subject to such conditions as the Committee shall require, to have Shares otherwise issuable under the Plan withheld by the Company and having a Fair Market Value sufficient to satisfy all or part of the Participant’s estimated total federal, state, and local tax obligation associated with the transaction.

14.5. Governing Law . The Plan and all determinations made and actions taken pursuant hereto, to the extent not otherwise governed by the Code or Act, shall be governed by the law of the State of Illinois and construed in accordance therewith.

14.6. Effectiveness of Plan . The Plan became effective upon its approval by the shareholders of the Company on April 25, 1990; provided, however, that no Award requiring the issuance of Shares shall be exercised or paid out unless at the time of such exercise or payout (i) such Shares are covered by a currently effective registration statement filed under the Securities Act of 1933, as amended, if one is then required, or in the sole opinion of the Company and its counsel such issuance of Shares is otherwise exempt from the registration requirements of such act, and (ii) such Shares are listed on any securities exchange upon which the Common Stock of the Company is listed.

14.7. Termination of the 1975 Plan . The Company’s Restated 1975 Non-Qualified Stock Option Plan shall be terminated as of the date of Shareholder approval of this Plan, provided, however, that such termination shall not affect any Options or Stock Appreciation Rights outstanding thereunder, all of which shall remain subject to and be governed by such plan.

14.8. Unfunded Plan . Insofar as the Plan provides for Awards of cash, Shares, rights or a combination thereof, the Plan shall be unfunded. The Company may maintain bookkeeping accounts with respect to Participants who are entitled to Awards under the Plan, but such accounts shall be used merely for bookkeeping convenience. The Company shall not be required to segregate any assets that may at any time be represented by interests in Awards nor shall the Plan be construed as providing for any such segregation. None of the Committee, the Company or Board shall be deemed to be a trustee of any cash, Shares or rights to Awards granted under the Plan. Any liability of the Company to any Participant with respect to an Award or any rights thereunder shall be based solely upon any contractual obligations that may be created by the Plan and any Agreement, and no obligation of the Company under the Plan shall be deemed to be secured by any pledge or other encumbrance on any property of the Company.

14.9. Deferrals. The Committee may permit a Participant to defer such Participant’s receipt of the payment of cash or the delivery of Shares that would otherwise be due to such Participant by virtue of the exercise of an Option or SAR, the lapse or waiver of restrictions with respect to Restricted Stock or Phantom Stock, or the satisfaction of any requirements or goals with respect to Other Stock-Based Awards. If any such deferral election is permitted, the Committee shall, in its sole discretion, establish rules and procedures for such payment deferrals and the manner in which such deferral shall be accomplished.

GRAINGER

_________________

2001 LONG TERM STOCK INCENTIVE PLAN

As Amended July 26, 2006

_________________

W.W. Grainger, Inc.

100 Grainger Parkway

Lake Forest, Illinois 60045-5201

(847) 535-1000

W.W. GRAINGER, INC.

2001 LONG TERM STOCK INCENTIVE PLAN

As Amended July 26, 2006

Section 1. Objective.

The objective of the 2001 Long Term Stock Incentive Plan (the “Plan”) is to attract and retain highly qualified executives and other employees, to advance the interests of the Company by giving Employees a stake in the Company’s future growth and success, and to strengthen the alignment of interests between Employees and the Company’s shareholders through the ownership of shares of the Company’s Common Stock.

Section 2. Definitions.

2.1. General Definitions . The following words and phrases, when used herein, shall have the following meanings:

(a) “Act” - The Securities Exchange Act of 1934, as amended.

(b) “Award” - The grant of any Option, Stock Appreciation Right, Share of Restricted Stock, Share of Phantom Stock, Share of Stock, Other Stock-Based Award, or any combination thereof.

(d) “Change in Control” - Any one or more of the following events:

(i) approval by the shareholders of the Company of:

consolidation, of the then-outstanding Common Stock and Voting Power of the Company;

directors of the Company) whose appointment or election by the Board or nomination for election by the Company’s shareholders was approved or recommended by a vote of at least two-thirds of the Company’s directors then in office whose appointment, election or nomination for election was previously so approved or recommended or who were directors on the Effective Date; or

persons (or their affiliates) with whom such Participant has the written agreement cause the Change in Control to occur and, pursuant to the written agreement, such Participant has an equity interest (or a right to acquire such equity interest) in the resulting entity.

(e) “Code” - The Internal Revenue Code of 1986, as amended, including the regulations thereunder, as amended from time to time.

(f) “Committee” - The Compensation Committee of the Board or such other Committee of the Board appointed by the Board to administer the Plan. No Employee may serve as a member of the Committee. If the Committee does not exist or cannot function for any reason, the Board may take any action under the Plan that would otherwise be the responsibility of the Committee.

(g) “Common Stock” - The shares of common stock of the Company, and any shares into which such shares are converted, changed or reclassified.

(h) “Company” - W.W. Grainger, Inc., an Illinois corporation.

(i) “Disability” or “Disabled” - A Participant’s inability to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that can be expected to result in death or that has lasted for a continuous period of not less than twelve (12) months.

(j) “Effective Date” - The date the Plan is approved by the Company’s shareholders.

(k) “Employee” - Any person designated as an employee of the Company or a Subsidiary on the payroll records thereof. An Employee shall not include any individual during any period he or she is classified or treated by the Company or a Subsidiary as an independent contractor, a consultant, or any employee of an employment, consulting, or temporary agency or any other entity other than the Company or a Subsidiary, without regard to whether such individual is subsequently determined to have been, or is subsequently retroactively reclassified as, a common-law employee of the Company or a Subsidiary during such period.

(l) “Exempt Person” - Any one or more of the following:

(v) any estate of a Family Member who dies after the Effective Date or any trust established after the Effective Date by one or more Family Members or Existing Family Entities; provided that one or more Family Members, Existing Family Entities or charitable organizations which qualify as exempt organizations under Section 501(c) of the Code (“Charitable Organizations”), collectively, are the beneficiaries of at least 50% of the actuarially determined beneficial interests in such estate or trust;

(vi) any Charitable Organization which is established by one or more Family Members or Existing Family Entities (a “Family Charitable Organization”);

(m) “Fair Market Value” - The closing price of a share of Common Stock as reported in the Composite Tape for New York Stock Exchange listed stocks or any other national stock exchange or national market system on which the Common Stock is then traded, on the last day on which a trade occurred preceding the relevant date, or as otherwise determined by the Committee.

(n) “Option” - The right to purchase a specified number of shares of Common Stock at a stated price for a specified period of time. For purposes of the Plan, the option is a non-qualified stock option.

(o) “Other Stock-Based Award” - An award under Section 10 that is valued in whole or in part by reference to, or is otherwise based on, the Common Stock.

(p) “Participant” - Any Employee designated by the Committee to participate in the Plan.

(q) “Person” - Any individual, corporation, partnership, limited liability company, sole proprietorship, trust or other entity.

(r) “Period of Restriction” - The period during which Shares of Restricted Stock or Phantom Stock rights are subject to forfeiture or restrictions on transfer pursuant to Section 8 of the Plan.

(s) “Phantom Stock” - A right to receive payment from the Company in cash, stock, or any combination thereof, in an amount determined by the Fair Market Value of the Common Stock.

(t) “Restricted Stock” - Shares granted to a Participant which are subject to restrictions on transferability pursuant to Section 8 of the Plan.

(u) “Shares” - Shares of Common Stock.

(v) “Stock” - An Award of Shares granted under Section 9 of the Plan.

(w) “Stock Appreciation Right” or “SAR” - The right to receive a payment from the Company in cash, Common Stock, or any combination thereof, equal to the excess of the Fair Market Value of a share of Common Stock on the date of exercise over a specified price fixed by the Committee, but subject to such maximum amounts as the Committee may impose.

(x) “Subsidiary” - Any corporation, partnership, joint venture, limited liability company, or other entity in which the Company or any successor to the Company directly or indirectly owns securities representing a majority of the aggregate voting power or profits interest.

2.2. Other Definitions . In addition to the above definitions, certain words and phrases used in the Plan or any certificate, notice or agreement evidencing an Award may be defined elsewhere in the Plan or in such certificate, notice or agreement.

Section 3. Shares Subject to the Plan.

3.1. Number of Shares Available for Awards . Subject to the provisions of Section 3.3, the number of Shares deliverable under the Plan may not exceed 7,180,000 Shares, provided, however, that the number of Shares of Stock and Shares of Restricted Stock delivered under the Plan other than with respect to grants of Options or SARs may not exceed 600,000 shares. Notwithstanding the foregoing, the total number of Shares with respect to which Options or Stock Appreciation Rights may be granted to any Participant shall not exceed 600,000 Shares (proportionately adjusted pursuant to Section 3.3) in any calendar year.

3.2 Re-usage . If an Option or SAR expires or is terminated, surrendered, or canceled without having been fully exercised, if Restricted Stock is forfeited or cancelled, if Phantom Stock is forfeited or cancelled, if Shares otherwise deliverable upon (i) exercise of Options, (ii) exercise of SARs, (iii) vesting of Restricted Stock, or (iv) settlement of Phantom Stock, are not delivered by reason of payments of the Option exercise price pursuant to Section 6.5(b) hereunder or withholdings of Shares in satisfaction of tax obligations under Section 15.4 hereunder, or if any other grant results in any Shares not being delivered, the Shares covered by such Option, SAR, grant of Restricted Stock, grant of Phantom Stock or other grant, as the case may be, shall again be available for Awards under the Plan. Notwithstanding the foregoing, in cases of events, transactions or occurrences that would cause the Plan, in the event of such re-availability, to be deemed a “formula plan” within the meaning of Section 303A.08 of the New York Stock Exchange Listed Company Manual, as the same may be amended or interpreted by the New York Stock Exchange from time to time, the Shares shall again be available for Awards under the Plan only by reason of such events, transactions or occurrences within a period of ten years following the date of the original approval of the Plan by the shareholders of the Company or, if later, the date of the most recent approval of the Plan, including without limitation any amendment to the Plan to increase the number of Shares available for Awards thereunder, by the shareholders of the Company.

3.3 Adjustments . Subject to Section 5.3, in the event of any change in the outstanding Common Stock by reason of a stock split, stock dividend, combination, reclassification or exchange of Shares, recapitalization, merger, consolidation or other similar event, the number of SARs and the number of Shares available for Options, grants of Restricted Stock, grants of Phantom Stock, and Other Stock-Based Awards and the number of Shares subject to outstanding Options, SARs, grants of Restricted Stock, grants of Phantom Stock,

and Other Stock-Based Awards, and the price thereof, and the Fair Market Value, as applicable, shall be appropriately and equitably adjusted by the Committee and any such adjustment shall be binding and conclusive on all parties. Any fractional Shares resulting from any such adjustment shall be disregarded.

Section 4. Eligibility and Participation.

The Committee may grant an Award only to an Employee who is actively employed by the Company or any Subsidiary on the date the Award is made. The granting of Awards under the terms of this Plan is made at the discretion of the Committee and does not entitle a Participant to receive future Awards. The adoption of this Plan shall not be deemed to give any Employee any right to be granted an Award, except to the extent as may be determined by the Committee.

Section 5. Administration.

5.1. Committee . The Plan and all Awards granted pursuant hereto shall be administered by the Committee, which has sole and absolute discretion with respect to all decisions and determinations pertaining thereto. The members of the Committee shall be appointed by and shall serve at the pleasure of the Board, which may from time to time change the Committee’s membership.

5.2. Authority . The Committee shall have the sole and complete authority to:

(a) determine the individuals to whom Awards are granted, the type and amounts of awards to be granted and the time of all such grants;

(b) determine the terms, conditions and provisions of, and restrictions relating to, each Award granted;

(d) prescribe, amend and rescind rules, guidelines and regulations relating to the Plan;

(e) determine the content and form of all certificates, notices and agreements relating to Awards;

(f) determine all questions relating to Awards under the Plan;

(g) maintain accounts, records and ledgers relating to Awards;

(h) maintain records concerning its decisions and proceedings;

(i) employ agents, attorneys, accountants or other persons for such purposes as the Committee considers necessary or desirable; and

(j) do and perform all acts which it may deem necessary or appropriate for the administration of the Plan and to carry out the objectives of the Plan.

5.3. Additional Terms . The Committee may: (i) modify or restrict exercise procedures and any other Plan procedures; (ii) establish local country plans as subplans to this Plan, each of which may be attached as an Appendix hereto and to the extent that the Committee determines that the restrictions imposed by the Plan preclude the achievement of the material purposes of the Awards in jurisdictions outside the United States under such a subplan, the Committee will have the authority and discretion to modify those restrictions as the Committee determines to be necessary or appropriate to conform to applicable requirements or practices of jurisdictions outside the United States; (iii) take any action, before or after an Award is made, which it deems advisable to obtain or comply with any necessary local government regulatory exemptions or approvals; provided that the Committee may not take any action hereunder which would violate any securities law or any governing statute; and (iv) in the event of an extraordinary dividend or other distribution, merger, reorganization, consolidation, combination, sale of assets, split up, exchange, or spin off, or other extraordinary corporate transaction, the Committee shall make appropriate and equitable provision for a cash payment or for the substitution or exchange of any or all outstanding Awards of the cash, securities or property deliverable to the holder of any or all outstanding Awards based upon the distribution or consideration payable to holders of Common Stock upon or in respect of such event.

5.4. Delegation . The Committee may delegate to appropriate senior officers of the Company, or such other persons or committees as it deems appropriate, its duties under the Plan pursuant to such conditions and limitations as the Committee may establish.

5.5. Determinations . All determinations, interpretations, or other actions made or taken by the Committee pursuant to the provisions of the Plan shall be final, binding, and conclusive for all purposes and upon all persons. Neither the Committee nor the Board, nor any member of the Committee or the Board or anyone acting at the direction of the Committee or the Board, shall be liable for any action or determination made hereunder in good faith.

Section 6. Stock Options.

6.1. Type of Option . It is intended that only non-qualified stock options may be granted by the Committee under this Section 6 of the Plan.

6.2. Grant of Option . An Option may be granted to Participants at such time or times as shall be determined by the Committee. Each Option shall be evidenced by a certificate, notice or agreement that shall specify the exercise price, the duration of the Option, the number of Shares to which the Option applies, and such other terms and conditions not inconsistent with the Plan as the Committee shall determine.

6.3. Option Price . The per-share Option price shall be at least 100% of the Fair Market Value at the time the Option is granted.

6.4. Exercise of Options . Options awarded under the Plan shall be exercisable at such times and shall be subject to such restrictions and conditions, including the performance of a minimum period of service after the grant, as the Committee may impose, which need not be uniform for all Participants; provided, however, that no Option shall be exercisable for more than ten (10) years after the date on which it is granted.

6.5. Payment . The Committee shall determine the procedures governing the exercise of Options, and shall require that the per-share option price be paid in full at the time of exercise. The per-share option price shall be payable in full either: (a) in cash or its equivalent (acceptable cash equivalents shall be determined by the Committee); (b) unless otherwise determined by the Committee, by tendering previously acquired shares of Common Stock having an aggregate Fair Market Value at the time of exercise equal to the total option exercise price (provided that the shares of Common Stock which are tendered must have been held by the Participant for at least six (6) months prior to their tender); (c) unless otherwise determined by the Committee, pursuant to a “cashless exercise” procedure, as permitted under United States Federal Reserve Board’s Regulation T, subject to securities law restrictions; (d) by a combination of (a), (b) and (c); or (e) by any other means which the Committee determines to be consistent with the Plan’s purpose and applicable law.

6.6. Rights as a Shareholder . Until the exercise of an Option and the delivery of the Shares in respect thereof, a Participant shall have no rights as a Shareholder with respect to the Shares covered by such Option.

Section 7. Stock Appreciation Rights.

7.1. Grant of Stock Appreciation Rights . Stock Appreciation Rights may be granted to Participants at such time or times as shall be determined by the Committee and shall be subject to such terms and conditions as the Committee may decide. A grant of an SAR shall be made pursuant to a certificate, notice or agreement containing such provisions not inconsistent with the Plan as the Committee shall approve.

7.2. Exercise of SARs . SARs may be exercised at such times and subject to such conditions, including the performance of a minimum period of service, as the Committee shall impose. SARs that are granted in tandem with an Option may only be exercised upon the surrender of the right to exercise an equivalent number of Shares under the related Option and may be exercised only with respect to the Shares for which the related Option is then exercisable. Notwithstanding any other provision of the Plan, the Committee may impose conditions on the exercise of an SAR, including, without limitation, the right of the Committee to limit the time of exercise to specified periods.

7.3. Payment of SAR Amount . Upon exercise of an SAR, the Participant shall be entitled to receive payment of an amount determined by multiplying:

(a) any increase in the Fair Market Value of a Share at the date of exercise over the Fair Market Value of a Share at the date of grant, by

(b) the number of Shares with respect to which the SAR is exercised;

provided, however, that at the time of grant, the Committee may establish, in its sole discretion, a maximum amount per Share which will be payable upon exercise of an SAR.

Section 8. Restricted Stock or Phantom Stock.

8.1. Grant of Restricted Stock or Phantom Stock . The Committee may grant Shares of Restricted Stock or Phantom Stock rights to such Participants at such times and in such amounts, and subject to such other terms and conditions not inconsistent with the Plan as it shall determine. Each grant of Restricted Stock or Phantom Stock rights shall be evidenced by a certificate, notice or agreement setting forth the terms of such Award.

8.2. Restrictions on Transferability . Restricted Stock or Phantom Stock rights may not be sold, transferred, pledged, assigned, or otherwise alienated until such time, or until the satisfaction of such conditions as shall be determined by the Committee (including without limitation, the satisfaction of performance goals, the occurrence of such events as shall be determined by the Committee, or pursuant to a determination under Section 15.1). At the end of the Period of Restriction applicable to any Restricted Stock, such Shares will be transferred to the Participant free of all restrictions. At the end of the restriction period applicable to Phantom Stock, payment shall be made in the manner set forth in the applicable award agreement.

8.3. Rights as a Shareholder . Unless otherwise determined by the Committee at the time of grant, Participants holding Restricted Stock granted hereunder may exercise full voting rights and other rights as a Shareholder with respect to those Shares during the Period of Restriction. Holders of Phantom Stock rights shall not be deemed Shareholders and, except to the extent provided in accordance with the Plan, shall have no rights related to any Shares.

Section 9. Awards of Stock.

Subject to the provisions of the Plan, Shares of Stock may be awarded to Participants in such number, upon such terms, and at such time or times as the Committee shall determine in its discretion. Each grant of Stock may be evidenced by a certificate, notice or agreement setting forth the terms of such Award.

Section 10. Other Stock-Based Awards and Other Benefits.

10.1. Other Stock-Based Awards . The Committee shall have the right to grant Other Stock-Based Awards which may include, without limitation, the grant of Shares based on certain conditions, the payment of cash based on the performance of the Common Stock, and the payment of Shares in lieu of cash under other Company incentive or bonus programs. Payment under or settlement of any such Awards shall be made in such manner and at such times as the Committee may determine.

10.2. Other Benefits . The Committee shall have the right to provide types of Awards under the Plan in addition to those specifically listed utilizing shares of

stock or cash, or a combination thereof, if the Committee believes that such Awards would further the purposes for which the Plan was established. Payment under or settlement of any such Awards shall be made in such manner and at such times as the Committee may determine.

10.3. Substitution or Assumption of Awards. The Committee, from time to time, also may substitute or assume outstanding awards granted by another company, whether in connection with an acquisition of such other company or otherwise, by either (a) granting an Award under the Plan in substitution of such other company’s award, or (b) assuming such award as if it had been granted under the Plan if the terms of such assumed award could be applied to an Award granted under the Plan. Such substitution or assumption shall be permissible if the holder of the substituted or assumed award would have been eligible to be granted an Award under the Plan if the other company had applied the rules of the Plan to such grant. In the event the Company assumes an award granted by another company, the terms and conditions of such award shall remain unchanged, except that the exercise price and the number and nature of Shares issuable upon exercise of any such option will be adjusted pursuant to Section 424(a) of the Code, notwithstanding other provisions of the Plan. In the event the Company elects to grant a new Award rather than assuming an existing option, such new Award may be granted with a similarly adjusted exercise price.

Section 11. Amendment, Modification, and Termination of Plan.

Subject to the terms of the Plan, the Board at any time may terminate or suspend the Plan, and from time to time may amend or modify the Plan, except that no amendment or modification by the Board without shareholder approval shall increase the number of Shares available for delivery under the Plan, decrease the minimum per-share Option or SAR price or permit Employees to serve on the Committee. No amendment, modification, or termination of the Plan shall in any manner adversely affect any Award theretofore granted under the Plan to a Participant without the consent of such Participant.

Section 12. Termination of Employment.

12.1. Termination of Employment Due to Retirement . Unless otherwise determined by the Committee at the time of grant, in the event a Participant’s employment terminates by reason of retirement, any Option or SAR granted to such Participant which is then outstanding may be exercised at any time prior to the expiration of the term of the Option or SAR or within six (6) years following the Participant’s termination of employment, whichever period is shorter, and any Restricted Stock, Phantom Stock rights, or other Award then outstanding for which any restriction has not lapsed prior to the effective date of retirement shall be forfeited.

12.2. Termination of Employment Due to Death or Disability . Unless otherwise determined by the Committee at the time of grant, in the event a Participant’s employment is terminated by reason of death or Disability, any Option or SAR granted to such Participant which is then outstanding may be exercised by the Participant, the Participant’s designated beneficiary, the Participant’s legal representative or other person entitled thereto, at any time prior to the expiration date of the term of the Option or SAR or within six (6) years following the Participant’s termination of employment, whichever period is shorter, and any Restricted Stock, Phantom Stock rights, or other Award then outstanding shall become nonforfeitable and shall become transferable or payable, as the case may be, as though any restriction had expired.

12.3. Termination of Employment for Any Other Reason . Unless otherwise determined by the Committee, whether at the time of grant or thereafter, in the event the employment of the Participant shall terminate for any reason other than misconduct or one described in Section 12.1 or 12.2, any Option or SAR granted to such Participant which is then outstanding may be exercised by the Participant at any time prior to the expiration date of the term of the Option or SAR or within three (3) months following the Participant’s termination of employment, whichever period is shorter; any Restricted Stock, Phantom Stock rights, or other Award then outstanding for which any restriction has not lapsed prior to the date of termination of employment shall be forfeited upon termination of employment. If the employment of a Participant is terminated by the Company or a Subsidiary by reason of the Participant’s misconduct, any outstanding Option or SAR shall terminate and cease to be exercisable on the date of the Participant’s termination of employment; any Restricted Stock, Phantom Stock rights, or other Award then outstanding for which any restriction has not lapsed prior to the date of termination of employment shall be forfeited upon termination of employment. As used herein, “misconduct” means that the Participant has engaged, or intends to engage, in competition with the Company or a Subsidiary, has induced any customer of the Company or a Subsidiary to breach any contract with the Company or a Subsidiary, has made any unauthorized disclosure of any of the trade secrets or confidential information of the Company or a Subsidiary, has committed an act of embezzlement, fraud, or theft with respect to the property of the Company or a Subsidiary, or has deliberately disregarded the rules of the Company or a Subsidiary in such a manner as to cause any loss, damage, or injury to, or otherwise endanger the property, reputation, or employees of the Company or a Subsidiary. The Committee shall determine whether a Participant’s employment is terminated by reason of misconduct.

12.4. Accrual of Right at Date of Termination . The Participant shall have the right to exercise an Option or SAR as indicated in Section 12.3 only to the extent the Participant’s right to exercise such Option or SAR had accrued at the date of termination of employment pursuant to the terms of the Award and had not previously been exercised.

Section 13. Change in Control.

Except as otherwise provided at the time of grant in the certificate, notice or agreement relating to a particular Award, if a Change in Control occurs, then:

(ii) any unexercised Option or SAR, whether or not exercisable on the date of such Change in Control, shall thereupon be fully exercisable and may be exercised, in whole or in part.

Section 14. Effect of Disposition of Facility or Operating Unit.

In the event that the Company or any of its Subsidiaries closes or disposes of the facility at which a Participant is located or the Company or any of its Subsidiaries diminish or eliminate ownership interests in any operating unit of the Company or any of its Subsidiaries so that such operating unit ceases to be majority owned by the Company or any of its Subsidiaries, then, with respect to Awards held by Participants who subsequent to such event will not be employees of the Company or any of its Subsidiaries, the Committee may (i) accelerate the exercisability of Awards to the extent not yet otherwise exercisable or remove any restrictions applicable to any Awards and (ii) extend the period during which Awards will be exercisable to a date subsequent to the date when such Awards would otherwise have expired by reason of the termination of such Participant’s employment with the Company or any of its Subsidiaries (but in no event to a date later than the expiration date of the Awards or the fifth anniversary of the transaction in which such facility closes or operating unit ceases). If the Committee takes no special action with respect to any disposition of a facility or an operating unit, then any cessation of employment resulting from such disposition will be treated as an ordinary cessation of employment as described in Section 12.

Section 15. Miscellaneous Provisions.

15.1. Non-transferability of Awards . Unless otherwise determined by the Committee, whether at the time of grant or thereafter, and except as provided in Sections 12.2 and 15.2, no Award granted under the Plan shall be assignable, transferable, or payable to or exercisable by anyone other than the Participant to whom it was granted.

15.2. Beneficiary Designation. Unless otherwise determined by the Committee, whether at the time of grant or thereafter, each Participant may from time to time name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under the Plan is to be paid in the event of such Participant’s death before he or she receives any or all of such benefit.

Each such designation shall revoke all prior designations by such Participant, shall be in a form prescribed by the Company, and will be effective only when filed by the Participant in writing with the Company during the Participant’s lifetime.

15.3. No Guarantee of Employment or Participation . Nothing in the Plan shall interfere with or limit in any way the right of the Company or a Subsidiary to terminate any Participant’s employment at any time, nor confer upon any Participant any right to continue in the employment of the Company or a Subsidiary. No Employee shall have a right to be selected as a Participant, or, having been so selected, to receive any future Awards.

15.4. Tax Withholding . The Company shall have the authority to withhold, or require a Participant to remit to the Company an amount sufficient to satisfy federal, state, and local withholding tax requirements on any Award under the Plan, and the Company may defer payment of cash or issuance of Shares until such requirements are satisfied. Unless otherwise determined by the Committee, a Participant may elect, subject to such conditions as the Committee may require, to have Shares otherwise deliverable under the Plan withheld by the Company and having a Fair Market Value sufficient to satisfy all or part of such requirements or, if so determined by the Committee, the Participant’s estimated total federal, state, and local tax obligation associated with the transaction.

15.5. Governing Law . The Plan and all determinations made and actions taken pursuant hereto, to the extent not otherwise governed by the Code or Act, shall be governed by the law of the State of Illinois and construed in accordance therewith.

15.6. Effectiveness of Plan . The Plan shall become effective upon its approval by the shareholders of the Company; provided, however, that no Award requiring the delivery of Shares shall be exercised or paid out unless at the time of such exercise or payout (i) such Shares are covered by a currently effective registration statement filed under the Securities Act of 1933, as amended, if one is then required, or in the sole opinion of the Company and its counsel such issuance of Shares is otherwise exempt from the registration requirements of such act, and (ii) such Shares are listed on any securities exchange upon which the Common Stock of the Company is listed.

15.7. Unfunded Plan . Insofar as the Plan provides for Awards of cash, Shares, rights or a combination thereof, the Plan shall be unfunded. The Company may maintain bookkeeping accounts with respect to Participants who are entitled to Awards under the Plan, but such accounts shall be used merely for bookkeeping convenience. The Company shall not be required to segregate any assets that may at any time be represented by interests in Awards nor shall the Plan be construed as providing for any such segregation. None of the Committee, the Company or Board shall be deemed to be a trustee of any cash, Shares or rights

to Awards granted under the Plan. Any liability of the Company to any Participant with respect to an Award or any rights thereunder shall be based solely upon any contractual obligations that may be created by the Plan and any Agreement, and no obligation of the Company under the Plan shall be deemed to be secured by any pledge or other encumbrance on any property of the Company.

15.8. Deferrals . The Committee may permit a Participant to defer such Participant’s receipt of the payment of cash or the delivery of Shares that would otherwise be due to such Participant by virtue of the exercise of an Option or SAR, the lapse or waiver of restrictions with respect to Restricted Stock or Phantom Stock, or the satisfaction of any requirements or goals with respect to Other Stock-Based Awards. If any such deferral election is permitted, the Committee shall, in its sole discretion, establish rules and procedures for such payment deferrals and the manner in which such deferral shall be accomplished.

GRAINGER

___________________

DIRECTOR STOCK PLAN

AS AMENDED JULY 26, 2006

___________________

W.W. Grainger, Inc.

100 Grainger Parkway

Lake Forest, IL 60045-5201

(847) 535-1000

W.W. GRAINGER, INC.

DIRECTOR STOCK PLAN

AS AMENDED JULY 26, 2006

Article 1. Establishment, Objectives, and Duration.

1.1. Establishment of the Plan. W.W. Grainger, Inc., an Illinois corporation (the “Company”), hereby establishes its Director Stock Plan (the “Plan”).

1.2. Objectives of the Plan. The objectives of the Plan are to enhance the ability of the Company to attract and retain the best-qualified directors, to increase the identity of interest between directors and the Company’s shareholders, and to provide additional incentives for directors to maximize the long-term success of the Company’s business.

1.3. Duration of the Plan. The Plan became effective on April 30, 1997 (the “Effective Date”). Subject to the right of the Board to amend or terminate the Plan pursuant to Article 14, (i) Awards may be granted from time to time on or after the Effective Date so long as Shares reserved for delivery under Section 4.1 remain available and (ii) Compensation earned by the Outside Directors from time to time after the Effective Date may be deferred.

Article 2. Definitions.

2.1. “Account”: see Section 8.1.

2.2. “Award” means, individually or collectively, a grant by the Committee under this Plan of Options, Restricted Stock, Stock, and Stock Units, whether formula-based or otherwise.

2.3. “Annual Meeting” means an annual meeting of the shareholders of the Company.

2.4. “Award Agreement” means an agreement between the Company and an Outside Director setting forth the terms applicable to an Award. Except as otherwise provided in the Plan, the terms of an Award Agreement need not be the same for each Outside Director, nor for each grant, and may reflect distinctions based on the reasons for termination of Service.

2.5. “Board” means the Board of Directors of the Company.

2.6. “Change in Control” means any one or more of the following events:

(i) approval by the shareholders of the Company of:

(A) any merger, reorganization or consolidation of the Company or any Subsidiary with or into any corporation or other Person if Persons who were the beneficial owners (as such term is used in Rule 13d-3 under the Securities Exchange Act of 1934 (the “Act”)) of Common Stock and securities of the Company entitled to vote generally in the election of directors (“Voting Securities”) immediately before such merger, reorganization or consolidation are not, immediately thereafter, the beneficial owners, directly or indirectly, of at least 60% of the then-outstanding common shares and the combined voting power of the then-outstanding Voting Securities (“Voting Power”) of the corporation or other Person surviving or resulting from such merger, reorganization or consolidation (or the parent corporation thereof) in substantially the same respective proportions as their beneficial ownership, immediately before the consummation of such merger, reorganization or consolidation, of the then-outstanding Common Stock and Voting Power of the Company;

organizational documents of such Person (or its parent) that are applicable to such Transaction. For this purpose, “Transaction Agreement” means a written agreement that sets forth the terms and conditions of the Transaction;

(iii) the acquisition or holding by any person, entity or “group” (within the meaning of Section 13(d)(3) or 14(d)(2) of the Act, other than by any Exempt Person (as defined below), the Company, any Subsidiary, any employee benefit plan of the Company or a Subsidiary) of beneficial ownership (within the meaning of Rule 13d-3 under the Act) of 20% or more of either the Company’s then-outstanding Common Stock or Voting Power; provided that:

(C) no Change in Control shall be deemed to have occurred solely by reason any such acquisition or holding in connection with any merger, reorganization or consolidation of the Company or any Subsidiary which is not a Change in Control within the meaning of paragraph (i)(A) above.

2.7. “Committee” means the Compensation Committee of the Board, which shall be comprised entirely of Outside Directors.

2.8. “Company”: see Section 1.1.

2.9. “Compensation” means all retainer, meeting, committee, and chair fees payable in cash to an Outside Director for Service.

2.10. “Deferral Election”: see Section 10.2.

2.11. “Director” means any member of the Board.

2.12. “Distribution Election”: see Section 8.6.

2.13. “Effective Date”: see Section 1.3.

2.14. “Exempt Person” means any one or more of the following:

(vi) any Charitable Organization which is established by one or more Family Members or Existing Family Entities (a “Family Charitable Organization”);

2.15. “Expiration Date”: see Section 5.4.

2.16. “Fair Market Value” means, as of any specified date, the closing price of the Shares on the New York Stock Exchange, or any other national stock exchange or national market system on which the Shares are then traded, on the last trading day on which the Shares were traded prior to such specified date.

2.17. “Option” means an option to purchase Shares granted under Article 5.

2.18. “Option Price” means the price at which a Share may be purchased under an Option.

2.19. “Outside Director” means a Director who is not an employee of the Company or a Subsidiary.

2.20. “Period of Restriction” means the period established by the Committee in its discretion during which the transfer of Restricted Stock is limited in some manner, and the Shares are subject to a substantial risk of forfeiture, all as provided in Article 6.

2.21. “Person” means any individual, corporation, partnership, limited liability company, sole proprietorship, trust or other entity.

2.22. “Restricted Stock” means an Award granted under Article 6.

2.23. “Service” means an Outside Director’s service on the Board or any Board committee.

2.24. “Shares” means shares of common stock of the Company.

2.25. “Stock” means an Award of Shares granted under Article 7.

2.26. “Stock Units” means the units in which an Account is denominated. A Stock Unit is an unsecured obligation of the Company that is intended, subject to the terms of Article 8, to represent the economic equivalent of one Share.

2.27. “Subsidiary” means any corporation, partnership, joint venture, limited liability company, or other entity in which the Company owns directly or indirectly securities representing a majority of the aggregate voting power.

Article 3. Administration.

3.1. General. The Plan shall be administered by the Committee. Except as may be limited by law, the articles of incorporation or bylaws of the Company, or the Plan, the Committee shall have full power and discretion to determine the amounts, types and terms of Awards; to determine the terms of any Award Agreement; to construe and interpret the Plan and any Award Agreement; to establish, amend, or waive rules for the Plan’s administration; to make all other determinations which may be necessary or advisable for the administration of the Plan; and (subject to Section 14.3) to amend the terms of any outstanding Award. To the extent permitted by law, the Committee shall have the authority to delegate administrative duties to officers or Directors of the Company.

3.2. Decisions Binding. All determinations and decisions made by the Committee under the Plan shall be final, conclusive, and binding on all persons, including the Company, its shareholders, Outside Directors, and their respective estates and beneficiaries.

Article 4. Shares Subject to Plan.

4.1. Shares Available for Grants. Subject to adjustment as provided in Section 4.2, the number of Shares reserved for delivery under the Plan is 500,000.* If any Shares subject to any Award are forfeited or such Award otherwise terminates without the delivery of such Shares, the Shares subject to such Award, to the extent of any such forfeiture or termination, shall again be available for delivery under the Plan. Shares delivered pursuant to the Plan may be treasury stock or newly issued Shares.

4.2. Adjustments in Authorized Shares. In the event of any change in corporate capitalization (such as a stock split, stock dividend, spin-off, or other distribution of stock or property of the Company or a Subsidiary), or any merger, consolidation, separation, reorganization (whether or not tax-free) or any partial or complete liquidation of the Company, the Committee shall appropriately and equitably adjust the number and class of Shares which may be delivered under Section 4.1 and such adjustment shall be binding and conclusive on all parties.

_________________

* As adjusted to reflect the Company’s 1998 two-for-one stock split.

Article 5. Options.

5.1. Award of Options. Subject to the terms of the Plan, Options may be awarded to Outside Directors in such number, upon such terms, and at such time or times as the Committee shall determine in its discretion.

5.2. Award Agreement. Each Option shall be evidenced by an Award Agreement that shall specify the Option Price, the Expiration Date of the Option, the number of Shares subject to the Option, and such other provisions as the Committee may determine.

5.3. Option Price. The Option Price for each grant of an Option shall be at least 100% of the Fair Market Value of a Share on the date the Option is granted.

5.4. Duration of Options. Each Option shall expire at such time as the Committee shall determine at the time of grant (the “Expiration Date”), but in no event after the tenth anniversary of the date of such grant.

5.5. Exercise of Options. Each Option shall be exercisable at such times prior to the Expiration Date and be subject to such restrictions and conditions as the Committee shall determine in its discretion, including, without limitation, restrictions on the Shares acquired pursuant to the exercise of such Option.

5.6. Payment. Options shall be exercised by the delivery of a written notice of exercise to the Company, setting forth the number of Shares with respect to which the Option is to be exercised, and accompanied by full payment for the Shares. Upon the exercise of any Option, the exercise price shall be payable by any one or combination of the following means:

(i) cash or its equivalent,

(ii) with the prior approval of the Committee, delivery of Shares already owned by the Outside Director and valued at the Fair Market Value thereof at the time of exercise,

(iii) with the prior approval of the Committee, a cashless exercise through a broker-dealer approved for this purpose by the Company.

5.7. Termination of Service. Each Award Agreement shall set forth the extent to which the Outside Director shall have the right to exercise an Option after termination of Service, but in no event shall any Option be exercised after its Expiration Date.

5.8. Nontransferability of Options. Except as may otherwise be specified by the Committee in its discretion, no Option may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than (i) by will, (ii) by the laws of descent and distribution, or (iii) pursuant to a beneficiary designation in accordance with Article 11.

Article 6. Restricted Stock.

6.1. Award of Restricted Stock. Subject to the terms of the Plan, Restricted Stock may be awarded to Outside Directors in such number of Shares, upon such terms, and at such time or times as the Committee shall determine in its discretion.

6.2. Restricted Stock Agreement. Each Restricted Stock Award shall be evidenced by an Award Agreement that shall specify the Period of Restriction, the number of Shares of Restricted Stock granted, and such other provisions as the Committee may determine.

6.3. Nontransferability. Except as may otherwise be specified by the Committee in its discretion, Restricted Stock may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated until the end of the applicable Period of Restriction. Shares of Restricted Stock shall vest and become freely transferable after the end of the applicable Period of Restriction.

6.4. Other Restrictions. The Committee may impose such other conditions and/or restrictions on any Restricted Stock as it deems advisable, including without limitation a stipulated purchase price for any Share of Restricted Stock. The Company may retain possession of the certificates representing Shares of Restricted Stock until all conditions and/or restrictions applicable to such Shares have been satisfied.

6.5. Voting Rights. Shares of Restricted Stock shall have the same voting rights as unrestricted Shares.

6.6. Dividends and Other Distributions. Shares of Restricted Stock shall have the same dividend rights as unrestricted Shares; provided, however, that (i) the Committee may in its discretion provide that dividends shall be reinvested in additional Shares of Restricted Stock based on the Fair Market Value of the Shares on the applicable dividend payment date and on such other terms as may be determined by the Committee in its discretion and (ii) the Committee may impose any restrictions it deems appropriate on dividends payable in any form other than cash.

6.7. Termination of Service. The extent, if any, to which the Outside Director shall have the right to receive unvested Shares of Restricted Stock following termination of the Outside Director’s Service shall be set forth in each Restricted Stock Award Agreement and, subject to Section 14.3, may subsequently be modified by the Committee in its discretion.

Article 7. Stock.

7.1. Award of Stock. Subject to the provisions of the Plan, Shares of Stock may be awarded to Outside Directors in such number, upon such terms, and at such time or times as the Committee shall determine in its discretion.

7.2. Award Agreement. Each Stock Award may, but need not, be evidenced by an Award Agreement that shall specify the number of Shares to which the Award pertains, the purchase price (if any), and such other provisions as the Committee shall determine.

Article 8. Stock Units and Accounts.

8.1. Accounts. One or more accounts (each, an “Account”) shall be created and maintained on the books of the Company for each Outside Director to which shall be credited all Stock Units that may be attributed to such Outside Director from time to time in connection with (i) Awards of Stock Units by the Committee pursuant to Article 9, (ii) deferrals of Compensation by such Outside Director pursuant to Article 10, or (iii) the automatic reinvestment of dividend equivalents pursuant to Section 8.3. Accounts shall be maintained solely for accounting purposes and shall not require a segregation of any assets of the Company.

8.2. Vesting. Stock Units awarded by the Committee pursuant to Article 9 shall become vested and nonforfeitable upon such terms as the Committee may determine. Stock Units credited to an Outside Director’s Account by reason of his or her election to defer Compensation pursuant to Article 10 shall at all times be fully vested and nonforfeitable. Any additional Stock Units resulting from the crediting of dividend equivalents to an Outside Director’s Account or Accounts pursuant to Section 8.3 shall be vested and nonforfeitable to the same extent and at the same time or times as the underlying Stock Units giving rise to such dividend equivalents.

8.3. Dividend Equivalents. Dividend equivalents shall be earned on Stock Units and credited to an Outside Director’s Account as of any date (a “Dividend Payment Date”) on which the Company pays any dividend on the outstanding Shares (a “Dividend”). Such dividend equivalents shall be expressed as a number of Stock Units equal to:

(i) the number of Stock Units credited to an Outside Director’s Account as of the record date for such Dividend multiplied by the value of the per Share amount of such Dividend (as determined by the Committee in the case of dividends paid other than in cash),

divided by:

(ii) the Fair Market Value of a Share as of the Dividend Payment Date.

8.4. Amount of Payment. The amount of value payable to an Outside Director on account of a Stock Unit as of the date of any payment determined in accordance with Section 8.5 shall equal the Fair Market Value of a Share as of such date; provided, however, that if the event that gave rise to such the payment is the occurrence of a Change in Control, such amount of value shall equal the greater of (i) the Fair Market Value of a Share as of the date of the Change in Control or (ii) the average Fair Market Value of a Share calculated over the last 10 trading days on which the Shares were traded

on the New York Stock Exchange (or other stock exchange or national market system on which the Shares are then listed for trading) ended on the date of the Change in Control.

8.5. Timing and Method of Payment. The value of vested Stock Units shall be paid to an Outside Director in a lump sum as soon as administratively possible following the first to occur of (i) termination of such Outside Director’s service as a Director or such later date that an Outside Director may elect pursuant to a Distribution Election or (ii) the occurrence of a Change in Control. All payments on account of Stock Units shall be made in cash.

8.6. Distribution Elections. The Committee may in its discretion permit the Outside Director to specify in a written notice delivered to the Secretary of the Company (a “Distribution Election”) such Outside Director’s election with respect to (i) when payment to such Outside Director in respect of Stock Units (whether resulting from an Award under Article 9 or from deferrals pursuant to Article 10) shall commence (except as may otherwise be provided in Section 8.5), and (ii) whether such payment shall be in a lump sum or in such number of annual installments as the Outside Director may designate, subject to a maximum number of installments that the Committee shall determine from time to time, but not in excess of ten (10). To the extent the Committee permits Distribution Elections, an Outside Director may make or change such a Distribution Election as to the entire balance of his or her Account at any time or from time to time, but only by a Distribution Election filed with the Company no later than December 31 of the year next preceding such Outside Director’s termination of service as a Director. Any Distribution Election that is not made or changed timely shall be disregarded.

8.7. Nontransferability of Stock Units. Except as may otherwise be specified by the Committee in its discretion, no Stock Unit may be transferred in any manner other than (i) by will, (ii) by the laws of descent and distribution, or (iii) pursuant to a beneficiary designation in accordance with Article 11.

8.8. Unsecured Obligation. An Outside Director shall be a general unsecured creditor of the Company with respect to all Stock Units credited to his or her Account or Accounts. The Committee may, but is not required to, establish a so-called “rabbi” trust or similar mechanism to fund the Company’s obligations under this Plan; provided, however, that any funds contained therein shall remain subject to the claims of the Company’s general creditors.

Article 9. Award of Stock Units by the Committee.

9.1. Award of Stock Units. Subject to the terms of the Plan, Stock Units may be awarded to Outside Directors in such number, upon such terms, and at such time or times as the Committee shall determine in its discretion. Stock Units may be awarded in substitution for, or replacement of, the rights or interests (whether vested or unvested) of Outside Directors under other plans of the Company.

9.2. Award Agreement. Each Stock Unit Award shall be evidenced by an Award Agreement that shall specify the number of Stock Units to which the Award pertains, the vesting of such Stock Units, the extent (if any) to which a payment is to be made in respect of Stock Units that are unvested upon the termination of an Outside Director’s Service, and such other provisions as the Committee shall determine.

Article 10. Deferrals by Outside Directors.

10.1. Deferral Election. An Outside Director may elect to defer receipt of all or any specified portion of any Compensation payable to him or her, and to have such amounts credited to his or her Account in accordance with Section 10.3; provided, however, that the Committee may in its discretion (i) provide that any such election shall be subject to the prior approval of the Committee or (ii) suspend the right of all Outside Directors to defer receipt of Compensation to be received after the date of such suspension.

10.2. Timing of Deferral Election. A deferral election shall be made by written notice (a “Deferral Election”) filed with the Secretary of the Company:

(i) on or before the Effective Date (covering Compensation to be earned after the Effective Date),

(ii) no more than 30 days after an Outside Director is first elected or appointed to the Board (covering Compensation to be earned at any time after the filing of such election),

(iii) on or before the date of any Annual Meeting (covering Compensation to be earned after such Annual Meeting), or

(iv) on or before such other date or dates as may be approved in advance by the Committee (covering Compensation earned for such period or periods commencing after such other date as may be specified by the Committee).

Subject to Section 8.6, a Deferral Election may be accompanied by a Distribution Election. Subject to Section 10.1, any Deferral Election shall continue in effect (including with respect to the Compensation relating to subsequent periods) unless and until revoked or modified by a new Deferral Election filed with the Secretary of the Company. Amounts credited to an Outside Director’s Account prior to the effective date of any such revocation or modification of a Deferral Election shall not be affected by such revocation or modification. An Outside Director who has revoked a Deferral Election may file a new Deferral Election to defer Compensation relating exclusively to services to be rendered during the calendar year following the year in which such new Deferral Election is filed with the Company.

10.3. Deferrals Credited to Account. Any Compensation deferred by an Outside Director pursuant to this Article 10 shall be allocated to his or her Account and deemed to be invested in a number of Stock Units equal to (i) the amount of such Compensation divided by (ii) the Fair Market Value of a Share on the date Compensation would otherwise have been paid.

Article 11. Beneficiary Designation.

Unless the Committee in its discretion determines otherwise, each Outside Director may from time to time name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under the Plan is to be paid in the event of such Outside Director’s death before he or she receives any or all of such benefit. Each such designation shall revoke all prior designations by such Outside Director, shall be in a form prescribed by the Company, and will be effective only when filed by the Outside Director in writing with the Company during the Outside Director’s lifetime. In the absence of any such designation, benefits remaining unpaid at the Outside Director’s death shall be paid to his or her estate.

Article 12. Tax Withholding.

If any federal, state, and local tax withholding may be required in respect of the grant, vesting or exercise of any Award or the settlement of any Stock Unit (any such event, “Taxable Event”), the Company shall have the authority to withhold, or require an Outside Director to remit to the Company, an amount sufficient to satisfy such tax withholding. The Company may defer the payment of cash or delivery of Shares in connection with a Taxable Event until such withholding requirements have been satisfied. The Committee may, in its discretion, permit an Outside Director to elect, subject to such conditions as the Committee may require, to have the Company withhold Shares otherwise deliverable pursuant to the Plan and having a Fair Market Value sufficient to satisfy all or part of any Outside Director’s estimated total federal, state, and local tax obligation associated with a Taxable Event.

Article 13. Rights of Directors.

Nothing in the Plan shall interfere with or limit in any way the right of the Company’s shareholders to terminate any Outside Director’s Service at any time, nor confer upon any Outside Director any right to continue in Service.

Article 14. Amendment, Modifications, and Termination.

14.1. Amendment, Modification, and Termination. Subject to the terms of the Plan, the Board may at any time and from time to time, alter, amend, suspend or terminate the Plan in whole or in part without the approval of the Company’s shareholders, except that no such amendment shall increase the number of Shares available for delivery under the Plan, change the minimum Option Price or maximum term of an option, or change the requirements relating to the composition of the Committee.

14.2. Adjustment of Awards Upon the Occurrence of Certain Unusual or Nonrecurring Events. In connection with any unusual or nonrecurring events (it being understood that the events described in Section 4.2 shall result in mandatory adjustment) affecting the Company or of changes in applicable laws, regulations, or accounting principles, the Committee may in its discretion adjust:

(i) the terms of Options, Restricted Stock, Stock and Stock Units (including, without limitation, in the number, class and/or price of Shares or Stock Units subject to, or to be distributed in connection with, outstanding Awards or Stock Units) and

(ii) the criteria specified in the Award Agreements related to outstanding Awards,

whenever the Committee determines that such adjustments are appropriate in order to prevent dilution or enlargement of the benefits intended to be made available under the Plan.

14.3. Awards Previously Granted. Notwithstanding any other provision of the Plan to the contrary, no termination, amendment, or modification of the Plan shall adversely affect in any material way any previously granted Award, without the written consent of the Outside Director holding such Award.

Article 15. Nonalienability.

Except as may otherwise be specified by the Committee in its discretion, no Award, Stock Unit, nor any right to a payment of Stock Units pursuant to Section 8.5 shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment, or garnishment by creditors of the Outside Director or the Outside Director’s beneficiary, other than (i) by will, (ii) by the laws of descent and distribution, or (iii) pursuant to a beneficiary designation in accordance with Article 11.

Article 16. Successors.

All obligations of the Company under the Plan shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise, of all or substantially all of the business and/or assets of the Company. The Company and such successor shall be jointly and severally liable for all of the Company’s obligations under the Plan.

Article 17. Legal Construction.

17.1. Gender and Number. Except where otherwise indicated by the context, any masculine term used herein also shall include the feminine; the plural shall include the singular and the singular shall include the plural.

17.2. Articles and Sections. Except where otherwise indicated by the context, any reference to an “Article” or “Section” shall be to an Article or Section of this Plan.

17.3. Severability. If any part of the Plan is declared to be unlawful or invalid, such unlawfulness or invalidity shall not invalidate any other part of the Plan. Any part of the Plan so declared to be unlawful or invalid shall, if possible, be construed in a manner which will give effect to the terms of such part to the fullest extent possible while remaining lawful and valid.

17.4. Legal Compliance. If the Company determines that the exercise or nonforfeitability of, or delivery of benefits pursuant to, any Award or Deferral Election would violate any applicable provision of (i) federal or state securities laws or (ii) the listing requirements of any national securities exchange or national market system on which are then listed any of the Company’s equity securities, then the Company may postpone any such exercise, nonforfeitability or delivery, as applicable, but the Company shall use all reasonable efforts to cause such exercise, nonforfeitability or delivery to comply with all such provisions at the earliest practicable date. If the Company deems necessary to comply with any applicable securities law, the Company may require a written investment intent representation by an Outside Director and may require that a restrictive legend be affixed to certificates for Shares delivered pursuant to the Plan.

17.5. Governing Law. The Plan and all Award Agreements shall be construed in accordance with and governed by the laws of the State of Illinois, without regard to the conflict of laws principles thereof.

2005 Incentive Plan

W.W. Grainger, Inc.

As Amended July 26, 2006

Contents

Article 1. Establishment, Purpose, and Duration	1
Article 2. Definitions	1
Article 3. Administration	10
Article 4. Shares Subject to this Plan and Maximum Awards	11
Article 5. Eligibility and Participation	13
Article 6. Stock Options	14
Article 7. Stock Appreciation Rights	16
Article 8. Restricted Stock and Restricted Stock Units	18
Article 9. Performance Shares/Performance Units	20
Article 10. Cash-Based Awards and Other Stock-Based Awards	21
Article 11. Performance Measures	22
Article 12. Covered Employee Annual Incentive Award	24
Article 13. Nonemployee Director Awards	24
Article 14. Dividend Equivalents	24
Article 15. Beneficiary Designation	24
Article 16. Rights of Participants	25
Article 17. Change in Control	25
Article 18. Amendment, Modification, Suspension, and Termination	26
Article 19. Withholding	26
Article 20. Successors	27
Article 21. General Provisions	27

W.W. Grainger, Inc.

2005 Incentive Plan

As Amended July 26, 2006

Article 1. Establishment, Purpose, and Duration

1.1 Establishment . W.W. Grainger, Inc., an Illinois corporation (hereinafter referred to as the “Company”), establishes an incentive compensation plan to be known as the 2005 Incentive Plan (hereinafter referred to as the “Plan”), as set forth in this document.

This Plan permits the grant of Nonqualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Shares, Performance Units, Covered Employee Annual Incentive Awards, Other Stock-Based Awards, and Cash-Based Awards.

This Plan shall become effective upon shareholder approval (the “Effective Date”) and shall remain in effect as provided in Section 1.3 hereof.

1.2 Purpose of this Plan . The purpose of this Plan is to attract and retain highly qualified executives, Directors, and Employees, to advance the interests of the Company by giving Employees and Directors a stake in the Company’s future growth and success, to strengthen the alignment of interests of Employees and Directors with those of the Company’s shareholders through the ownership of Shares, and to provide additional incentives for Employees and Directors to maximize the long-term success of the Company’s business.

1.3 Duration of this Plan . Unless sooner terminated as provided herein, this Plan shall terminate ten (10) years from the Effective Date. After this Plan is terminated, no Awards may be granted but Awards previously granted shall remain outstanding in accordance with their applicable terms and conditions and this Plan’s terms and conditions.

Article 2. Definitions

Whenever used in this Plan, the following terms shall have the meanings set forth below, and when the meaning is intended, the initial letter of the word shall be capitalized.

2.1 “Affiliate” shall mean any corporation or any other entity (including, but not limited to, a partnership) that is affiliated with the Company through stock ownership or otherwise.

2.2 “Annual Award Limit” or “Annual Award Limits” have the meaning set forth in Section 4.3.

2.3 “Award” means, individually or collectively, a grant under this Plan of Cash-Based Awards, Nonqualified Stock Options, Incentive Stock Options, SARs, Restricted Stock, Restricted Stock Units, Performance Shares, Performance Units, Covered Employee Annual Incentive Awards, or Other Stock-Based Awards, in each case subject to the terms of this Plan.

2.4 “Award Agreement” means either (i) a written agreement entered into by the Company and a Participant setting forth the terms and provisions applicable to an Award granted under this Plan, or (ii) a written or electronic statement issued by the Company to a Participant describing the terms and provisions of such Award, including any amendment or modification thereof. The Committee may provide for the use of electronic, Internet or other non-paper Award Agreements, and the use of electronic, Internet or other non-paper means for the acceptance thereof and actions thereunder by the Participant.

2.5 “Beneficial Owner” or “Beneficial Ownership” shall have the meaning ascribed to such term in Rule 13d-3 of the General Rules and Regulations under the Exchange Act.

2.6 “Board” or “Board of Directors” means the Board of Directors of the Company.

2.7 “Cash-Based Award” means an Award granted to a Participant as described in Article 10.

2.8 “Change in Control” means any of the following events:

(i) Approval by the shareholders of the Company of:

(a)

Any merger, reorganization, or consolidation of the Company or any Subsidiary with or into any corporation or other Person if Persons who were the beneficial owners (as such term is used in Rule 13d-3 under the Exchange Act) of common stock and securities of the Company entitled to vote generally in the election of Directors (“Voting Securities”) immediately before such merger, reorganization, or consolidation are not, immediately thereafter, the beneficial owners, directly or indirectly, of at least sixty percent (60%) of the then-outstanding common shares and the combined voting power of the then outstanding Voting Securities (“Voting Power”) of the corporation or other Person surviving or resulting from such merger, reorganization, or consolidation (or the parent corporation thereof) in substantially the same respective proportions as their beneficial ownership, immediately before the consummation of such merger, reorganization, or consolidation, of the then-outstanding common stock and Voting Power of the Company;

(b)

The sale or disposition of all or substantially all of the consolidated assets of the Company, other than a sale or other disposition by the Company of all or substantially all of its consolidated assets to an entity of which at least sixty percent (60%) of the common shares and the Voting Power outstanding immediately after such sale or other disposition are then beneficially owned (as such term is used in Rule 13d-3 under the Exchange Act) by shareholders of the Company in substantially the same respective proportions as their beneficial ownership of common stock and Voting Power of the Company immediately before the consummation of such sale or other disposition; or

(c)

A liquidation or dissolution of the Company;

provided, however, that if the consummation of an event described in this paragraph (i) (a “Transaction”) is subject to an Other Party Approval Requirement (as defined below), the approval of such Transaction by the shareholders of the Company shall not be deemed a Change in Control until the first date on which such Other Party Approval Requirement has been satisfied. For this purpose, “Other Party Approval Requirement” means a requirement expressly set forth in a Transaction Agreement (as defined below) between the Company and another Person to the effect that such Person shall obtain the approval of one or more elements of the Transaction by the shareholders, members, partners, or other holders of equity interests of such Person (or of a parent of such Person) prior to the consummation of such Transaction in order to comply with the mandatory provisions of (x) the law of the jurisdiction of the incorporation or organization of such Person (or its parent) or (y) the articles of incorporation or other charter or organizational documents of such Person (or its parent) that are applicable to such Transaction. For this purpose, “Transaction Agreement” means a written agreement that sets forth the terms and conditions of the Transaction;

(ii)

The following individuals cease for any reason to constitute a majority of the Directors of the Company then serving: individuals who, on the Effective Date, constitute the Board and any subsequently appointed or elected Director of the Company (other than a Director whose initial assumption of office is in connection with an actual or threatened election contest, including a consent solicitation, relating to the election or removal of one or more Directors of the Company) whose appointment or election by the Board or nomination for election by the Company’s shareholders was approved or recommended by a vote of at least two-thirds of the Company’s Directors then in office whose appointment, election, or nomination for election was previously so approved or recommended of who were Directors on the Effective Date; or

(iii)

The acquisition or holding by any person, entity, or “group” (within the meaning of Section 13(d)(3) or 14(d)(2) of the Exchange Act, other than by any Exempt Person (as such term is defined below), the Company, any Subsidiary, any

employee benefit plan of the Company or a Subsidiary) of beneficial ownership (within the meaning of Rule 13d-3 under the Exchange Act) of twenty percent (20%) or more of either the Company’s then-outstanding common stock or Voting Power; provided that:

(a)

No such person, entity, or group shall be deemed to own beneficially any securities held by the Company or a Subsidiary or any employee benefit plan (or any related trust) of the Company or a Subsidiary;

(b)

No Change in Control shall be deemed to have occurred solely by reason of any such acquisition if both (x) after giving effect to such acquisition, such person, entity, or group has beneficial ownership of less than thirty percent (30%) of the then-outstanding common stock and Voting Power of the Company and (y) prior to such acquisition, at least two-thirds of the Directors described in (and not excluded from) paragraph (ii) of this definition vote to adopt a resolution of the Board to the specific effect that such acquisition shall not be deemed a Change in Control; and

(c)

No Change in Control shall be deemed to have occurred solely by reason of any such acquisition or holding in connection with any merger, reorganization, or consolidation of the Company or any Subsidiary which is not a Change in Control within the meaning of paragraph (i)(a) above.

Notwithstanding the occurrence of any of the events specified in paragraphs (i), (ii), or (iii) of this definition, no Change in Control shall occur with respect to any Participant if (x) the event which otherwise would be a Change in Control (or the transaction which resulted in such event) was initiated by such Participant, or was discussed by him with any third party, without the approval of the Board with respect to such Participant’s initiation or discussion, as applicable, or (y) such Participant is, by written agreement, a participant on his own behalf in a transaction in which the persons (or their affiliates) with whom such Participant has the written agreement cause the Change in Control to occur and, pursuant to the written agreement, such Participant has an equity interest (or a right to acquire such equity interest) in the resulting entity.

2.9 “Code” means the U.S. Internal Revenue Code of 1986, as amended from time to time. For purposes of this Plan, references to sections of the Code shall be deemed to include references to any applicable regulations thereunder and any successor or similar provisions.

2.10 “Committee” means the Compensation Committee of the Board or a subcommittee thereof, or any other committee designated by the Board to administer this Plan. The members of the Committee shall be appointed from time to time by and shall serve at the discretion of the Board. If the Committee does not exist or cannot function for any reason, the Board may take any action under the Plan that would otherwise be the responsibility of the Committee.

2.11 “Company” means W.W. Grainger, Inc., an Illinois corporation, and any successor thereto as provided in Article 20 herein.

2.12 “Consolidated Operating Earnings” means the consolidated earnings before income taxes of the Company, computed in accordance with generally accepted accounting principles, but shall exclude the effects of Extraordinary Items.

2.13 “Covered Employee” means any key salaried Employee who is or may become a “Covered Employee,” as defined in Section 162(m) of the Code, or any successor statute, and who is designated, either as an individual Employee or class of Employees, by the Committee within the shorter of (i) ninety (90) days after the beginning of the Performance Period, or (ii) twenty-five percent (25%) of the Performance Period has elapsed, as a “Covered Employee” under this Plan for such applicable Performance Period.

2.14 “Covered Employee Annual Incentive Award” means an Award granted to a Covered Employee as described in Article 12.

2.15 “Director” means any individual who is a member of the Board of Directors of the Company.

2.16 “Effective Date” has the meaning set forth in Section 1.1.

2.17 “Employee” means any person designated as an employee of the Company, its Affiliates, and/or its Subsidiaries on the payroll records thereof. An Employee shall not include any individual during any period he or she is classified or treated by the Company, Affiliate, and/or Subsidiary as an independent contractor, a consultant, or any employee of an employment, consulting, or temporary agency or any other entity other than the Company, Affiliate, and/or Subsidiary, without regard to whether such individual is subsequently determined to have been, or is subsequently retroactively reclassified as a common-law employee of the Company, Affiliate, and/or Subsidiary during such period.

2.18 “Exchange Act” means the Securities Exchange Act of 1934, as amended from time to time, or any successor act thereto.

2.19 “Exempt Person” means any one or more of the following:

(i)

Any descendant of W.W. Grainger (deceased) or any spouse, widow, or widower of any such descendant (any such descendants, spouses, widows, and widowers collectively defined as the “Grainger Family Members”);

(ii)

Any descendant of E.O. Slavik (deceased) or any spouse, widow, or widower of any such descendant (any such descendants, spouses, widows, and widowers collectively defined as the “Slavik Family Members.” The Grainger Family

Members and the Slavik Family Members are collectively defined as “Family Members);

(iii)

Any trust which is in existence on the Effective Date and which has been established by one or more Grainger Family Members, any estate of a Grainger Family Member who died on or before the Effective Date, and The Grainger Foundation (such trusts, estates, and named entity collectively defined as the “Grainger Family Entities”);

(iv)

Any trust which is in existence on the Effective Date and which has been established by one or more Slavik Family Members, any estate of a Slavik Family Member who died on or before the Effective Date, Mark IV Capital, Inc., and Mountain Capital Corporation (such trusts, estates, and named Entities collectively defined as the “Slavik Family Entities.” The Grainger Family Entities and the Slavik Family Entities are collectively defined as the “Existing Family Entities”);

(v)

Any estate of a Family Member who dies after the Effective Date or any trust established after the Effective Date by one or more Family Members or Existing Family Entities; provided that one or more Family Members, Existing Family Entities, or charitable organizations which qualify as exempt organizations under Section 501(c) of the Code (“Charitable Organizations”), collectively, are the beneficiaries of at least fifty percent (50%) of the actuarially determined beneficial interests in such estate or trust;

(vi)

Any charitable organization which is established by one or more Family Members or Existing Family Entities (a “Family Charitable Organization”);

(vii)

Any corporation of which a majority of the voting power and a majority of the equity interest is held, directly or indirectly, by or for the benefit of one or more Family Members, Existing Family Entities, estates, or trusts described in clause (v) above, or Family Charitable Organizations; or

(viii)

Any partnership or other entity or arrangement of which a majority of the voting interest and a majority of the economic interest is held, directly or indirectly, by or for the benefit of one or more Family Members, Existing Family Entities, estates, or trusts described in clause (v) above, or Family Charitable Organizations.

2.20 “Extraordinary Items” means (i) extraordinary, unusual, and/or nonrecurring items of gain or loss; (ii) gains or losses on the disposition of a business; (iii) changes in tax or accounting regulations or laws; or (iv) the effect of a merger or acquisition, all of which must be identified in the audited financial statements, including footnotes, or Management Discussion and Analysis section of the Company’s annual report.

2.21 “Fair Market Value” or “FMV” means a price that is based on the opening, closing, actual, high, low, or average selling prices of a Share reported on the New York Stock Exchange (“NYSE”) or other established stock exchange (or exchanges) on the applicable date, the preceding trading day, the next succeeding trading day, or an average of trading days, as determined by the Committee in its discretion. Unless the Committee determines otherwise, if the Shares are traded over the counter at the time a determination of its Fair Market Value is required to be made hereunder, its Fair Market Value shall be deemed to be equal to the average between the reported high and low or closing bid and asked prices of a Share on the most recent date on which Shares were publicly traded. In the event Shares are not publicly determined at the time a determination of their value is required to be made hereunder, the determination of their Fair Market Value shall be made by the Committee in such manner as it deems appropriate. Such definition(s) of FMV shall be specified in each Award Agreement and may differ depending on whether FMV is in reference to the grant, exercise, vesting, settlement, or payout of an Award; provided, however, that upon a broker-assisted exercise of an Option, the FMV shall be the price at which the Shares are sold by the broker.

2.22 “Freestanding SAR” means an SAR that is granted independently of any Options, as described in Article 7.

2.23 “Full Value Award” means an Award other than in the form of an NQSO, ISO or SAR, and which is settled by the issuance of Shares.

2.24 “Grant Price” means the price established at the time of grant of an SAR pursuant to Article 7, used to determine whether there is any payment due upon exercise of the SAR.

2.25 “Incentive Stock Option” or “ISO” means an Option to purchase Shares granted under Article 6 to an Employee and that is designated as an Incentive Stock Option and that is intended to meet the requirements of Code Section 422, or any successor provision.

2.26 “Insider” shall mean an individual who is, on the relevant date, an officer or Director of the Company, or a more than ten percent (10%) Beneficial Owner of any class of the Company’s equity securities that is registered pursuant to Section 12 of the Exchange Act, as determined by the Board in accordance with Section 16 of the Exchange Act.

2.27 “Net Earnings” means the Company’s net earnings as determined in accordance with generally accepted accounting principles and as reported to the Company’s shareholders.

2.28 “Net Income” means the consolidated net income before taxes for a Plan Year, as reported in the Company’s annual report to shareholders or as otherwise reported to shareholders.

2.29 “Nonemployee Director” means a Director who is not an Employee.

2.30 “Nonemployee Director Award” means any NQSO, SAR, or Full Value Award granted, whether singly, in combination, or in tandem, to a Participant who is a Nonemployee Director pursuant to such applicable terms, conditions, and limitations as the Board or Committee may establish in accordance with this Plan.

2.31 “Nonqualified Stock Option” or “NQSO” means an Option that is not intended to meet the requirements of Code Section 422, or that otherwise does not meet such requirements.

2.32 “Operating Cash Flow” means cash flow from operating activities as defined in SFAS Number 95, Statement of Cash Flows.

2.33 “Option” means an ISO or an NQSO, as described in Article 6.

2.34 “Option Price” means the price at which a Share may be purchased by a Participant pursuant to an Option.

2.35 “Other Stock-Based Award” means an equity-based or equity-related Award not otherwise described by the terms of this Plan, granted pursuant to Article 10.

2.36 “Participant” means any eligible individual as set forth in Article 5 to whom an Award is granted.

2.37 “Performance-Based Compensation” means compensation under an Award that is intended to satisfy the requirements of Section 162(m) of the Code and the applicable treasury regulations thereunder for certain performance-based compensation paid to Covered Employees. Notwithstanding the foregoing, nothing in this Plan shall be construed to mean that an Award which does not satisfy the requirements for performance-based compensation under Code Section 162(m) does not constitute performance-based compensation for other purposes, including Code Section 409A.

2.38 “Performance Measures” means measures as described in Article 11 on which the performance goals are based and which are approved by the Company’s shareholders pursuant to this Plan in order to qualify Awards as Performance-Based Compensation.

2.39 “Performance Period” means the period of time during which the performance goals must be met in order to determine the degree of payout and/or vesting with respect to an Award.

2.40 “Performance Share” means an Award under Article 9 herein and subject to the terms of this Plan, denominated in Shares, the value of which at the time it is

payable is determined as a function of the extent to which corresponding performance criteria have been achieved.

2.41 “Performance Unit” means an Award under Article 9 herein and subject to the terms of this Plan, denominated in units, the value of which at the time it is payable is determined as a function of the extent to which corresponding performance criteria have been achieved.

2.42 “Period of Restriction” means the period when Restricted Stock or Restricted Stock Units are subject to a substantial risk of forfeiture (based on the passage of time, the achievement of performance goals, or upon the occurrence of other events as determined by the Committee, in its discretion), as provided in Article 8.

2.43 “Person” shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a “group” as defined in Section 13(d) thereof.

2.44 “Plan” means the W.W. Grainger, Inc. 2005 Incentive Plan.

2.45 “Plan Year” means the calendar year.

2.46 “Prior Plans” means the Company’s 1990 Long Term Stock Incentive Plan, as amended April 28, 2004, 2001 Long Term Stock Incentive Plan, as amended April 28, 2004, Director Stock Plan, as amended December 9, 1998, and Office of the Chairman Incentive Plan.

2.47 “Restricted Stock” means an Award granted to a Participant pursuant to Article 8.

2.48 “Restricted Stock Unit” means an Award granted to a Participant pursuant to Article 8, except no Shares are actually awarded to the Participant on the date of grant.

2.49 “Share” means a share of common stock of the Company.

2.50 “Stock Appreciation Right” or “ SAR ” means an Award, designated as an SAR, pursuant to the terms of Article 7 herein.

2.51 “Subsidiary” means any corporation or other entity, whether domestic or foreign, in which the Company has or obtains, directly or indirectly, a proprietary interest of more than fifty percent (50%) by reason of stock ownership or otherwise.

2.52 “Tandem SAR” means an SAR that is granted in connection with a related Option pursuant to Article 7 herein, the exercise of which shall require forfeiture of

the right to purchase a Share under the related Option (and when a Share is purchased under the Option, the Tandem SAR shall similarly be canceled).

Article 3. Administration

3.1 General . The Committee shall be responsible for administering this Plan, subject to this Article 3 and the other provisions of this Plan. The Committee may consult with attorneys, consultants, accountants, agents, and other individuals, any of whom may be an Employee, and the Committee, the Company, and its officers and Directors shall be entitled to rely upon the advice, opinions, or valuations of any such individuals. All actions taken and all interpretations and determinations made by the Committee shall be final and binding upon the Participants, the Company, and all other interested individuals.

3.2 Authority of the Committee . The Committee shall have full and exclusive discretionary power to interpret the terms and the intent of this Plan and any Award Agreement or other agreement or document ancillary to or in connection with this Plan, to determine eligibility for Awards and to adopt such rules, regulations, forms, instruments, and guidelines for administering this Plan as the Committee may deem necessary or proper. Such authority shall include, but not be limited to, selecting Award recipients, establishing all Award terms and conditions, including the terms and conditions set forth in Award Agreements, granting Awards as an alternative to or as the form of payment for grants or rights earned or due under compensation plans or arrangements of the Company, and, subject to Article 18, adopting modifications and amendments to this Plan or any Award Agreement, including without limitation, any that are necessary to comply with the laws of the countries and other jurisdictions in which the Company, its Affiliates, and/or its Subsidiaries operate.

3.3 Delegation. The Committee may delegate to one or more of its members or to one or more officers of the Company, and/or its Subsidiaries and Affiliates or to one or more agents or advisors such administrative duties or powers as it may deem advisable, and the Committee or any individuals to whom it has delegated duties or powers as aforesaid may employ one or more individuals to render advice with respect to any responsibility the Committee or such individuals may have under this Plan. The Committee may, by resolution, authorize one or more officers of the Company to do one or both of the following on the same basis as can the Committee: (a) designate Employees to be recipients of Awards and (b) determine the size of any such Awards; provided, however, (i) the Committee shall not delegate such responsibilities to any such officer for Awards granted to an Employee who is considered an Insider; (ii) the resolution providing such authorization sets forth the total number of Awards such officer(s) may grant; and (iii) the officer(s) shall report periodically to the Committee regarding the nature and scope of the Awards granted pursuant to the authority delegated.

Article 4. Shares Subject to this Plan and Maximum Awards

4.1 Number of Shares Available for Awards .

(a)

Subject to adjustment as provided in Section 4.4 herein, the maximum number of Shares available for grant to Participants under this Plan (the “Share Authorization”) shall be:

(i)

9,500,000, of which 9,500,000 shall be eligible to be issued as Incentive Stock Options, plus

(ii)

Any Shares subject to outstanding awards under the Prior Plans as of the Effective Date (such Shares numbering approximately 9,200,000 as of such date) that on or after the Effective Date cease for any reason to be subject to such awards (other than by reason of exercise or settlement of the awards to the extent they are exercised for or settled in vested and nonforfeitable Shares).

(b)

To the extent that a Share is granted pursuant to a Full Value Award, it shall reduce the Share Authorization by two and thirty-six one hundredths (2.36) Shares; and, to the extent that a Share is granted pursuant to an Award other than a Full Value Award, it shall reduce the Share Authorization by one (1) Share.

(c)

Subject to the limit set forth in Section 4.1(a) on the number of Shares that may be granted in the aggregate under this Plan, the maximum number of shares that may be granted to Nonemployee Directors shall be four hundred fifty thousand (450,000) Shares, and no Nonemployee Director may receive Awards subject to more than ten thousand (10,000) Shares in any Plan Year.

(d)

Except with respect to a maximum of five percent (5%) of the Shares authorized in Section 4.1(a) as modified by Section 4.1(b), any Full Value Awards which vest on the basis of the Participant’s continued employment with or provision of service to the Company shall not provide for vesting which is any more rapid than annual pro rata vesting over a three (3) year period and any Full Value Awards which vest upon the attainment of performance goals shall provide for a Performance Period of at least twelve (12) months.

4.2 Share Usage. Any Shares related to Awards which terminate by expiration, forfeiture, cancellation, or otherwise without the issuance of such Shares, are settled in cash in lieu of Shares, or are exchanged with the Committee’s permission, prior to the issuance of Shares, for Awards not involving Shares, shall be available again for grant under this Plan. The Shares available for issuance under this Plan may be authorized and unissued Shares or treasury Shares.

4.3 Annual Award Limits. Unless and until the Committee determines that an Award to a Covered Employee shall not be designed to qualify as Performance-Based Compensation, the following limits (each an “Annual Award Limit” and, collectively, “Annual Award Limits”) shall apply to grants of such Awards under this Plan:

(a)

Options. The maximum aggregate number of Shares subject to Options granted in any one Plan Year to any one Participant shall be six hundred thousand (600,000) plus the amount of the Participant’s unused applicable Annual Award Limit for Options as of the close of the previous Plan Year.

(b)

SARs. The maximum number of Shares subject to Stock Appreciation Rights granted in any one Plan Year to any one Participant shall be six hundred thousand (600,000) plus the amount of the Participant’s unused applicable Annual Award Limit for SARs as of the close of the previous Plan Year.

(c)

Restricted Stock or Restricted Stock Units. The maximum aggregate grant with respect to Awards of Restricted Stock or Restricted Stock Units in any one Plan Year to any one Participant shall be two hundred thousand (200,000) plus the amount of the Participant’s unused applicable Annual Award Limit for Restricted Stock or Restricted Stock Units as of the close of the previous Plan Year.

(d)

Performance Shares or Performance Units. The maximum aggregate Award of Performance Shares or Performance Units that a Participant may receive in any one Plan Year shall be two hundred thousand (200,000) Shares, or equal to the value of two hundred thousand (200,000) Shares determined as of the date of vesting or payout, as applicable plus the amount of the Participant’s unused applicable Annual Award Limit for Performance Shares or Performance Units as of the close of the previous Plan Year.

(e)

Cash-Based Awards. The maximum aggregate amount awarded or credited with respect to Cash-Based Awards to any one Participant in any one Plan Year may not exceed six million dollars ($6,000,000) plus the amount of the Participant’s unused applicable Annual Award Limit for Cash-Based Awards as of the close of the previous Plan Year.

(f)

Covered Employee Annual Incentive Award. The maximum aggregate amount awarded or credited in any one Plan Year with respect to a Covered Employee Annual Incentive Award shall be determined in accordance with Article 12.

(g)

Other Stock-Based Awards. The maximum aggregate grant with respect to other Stock-Based Awards pursuant to Section 10.2 in any one Plan Year to any one Participant shall be two hundred thousand (200,000) Shares plus the

amount of the Participant’s unused applicable Annual Award Limit for Other Stock-Based Awards as of the close of the previous Plan Year.

4.4 Adjustments in Authorized Shares. In the event of any corporate event or transaction (including, but not limited to, a change in the Shares of the Company or the capitalization of the Company) after the Effective Date such as a merger, consolidation, reorganization, recapitalization, separation, stock dividend, stock split, reverse stock split, split up, spin-off, or other distribution of stock or property of the Company, combination of Shares, exchange of Shares, dividend in kind, special cash dividend, or other like change in capital structure or distribution (other than normal cash dividends) to shareholders of the Company, or any similar corporate event or transaction, the Committee, in order to prevent dilution or enlargement of Participants’ rights under this Plan, shall appropriately and equitably substitute or adjust, as applicable, the number and kind of Shares that may be issued under this Plan or under particular forms of Awards, the number and kind of Shares subject to outstanding Awards, the Option Price or Grant Price applicable to outstanding Awards, the Annual Award Limits, and other value determinations applicable to outstanding Awards.

The Committee shall also make appropriate and equitable adjustments in the terms of any Awards under this Plan to reflect or related to such changes or distributions and to modify any other terms of outstanding Awards, including modifications of performance goals and changes in the length of Performance Periods. The determination of the Committee as to the foregoing adjustments, if any, shall be conclusive and binding on Participants under this Plan.

Subject to the provisions of Article 18, without affecting the number of Shares reserved or available hereunder, the Committee may authorize the issuance or assumption of benefits under this Plan in connection with any merger, consolidation, acquisition of property or stock, or reorganization upon such terms and conditions as it may deem appropriate, subject to compliance with the ISO rules under Section 422 of the Code, where applicable.

Article 5. Eligibility and Participation

5.1 Eligibility . Individuals eligible to participate in this Plan include all Employees and Directors.

5.2 Actual Participation . Subject to the provisions of this Plan, the Committee may, from time to time, select from all eligible individuals, those individuals to whom Awards shall be granted and shall determine, in its sole discretion, the nature of, any and all terms permissible by law, and the amount of each Award.

Article 6. Stock Options

6.1 Grant of Options . Subject to the terms and provisions of this Plan, Options may be granted to Participants in such number, and upon such terms, and at any time and from time to time as shall be determined by the Committee, in its sole discretion; provided that ISOs may be granted only to eligible Employees of the Company or of any parent or subsidiary corporation (as permitted under Code Section 422).

6.2 Award Agreement . Each Option grant shall be evidenced by an Award Agreement that shall specify the Option Price, the maximum duration of the Option, the number of Shares to which the Option pertains, the conditions upon which an Option shall become vested and exercisable, and such other provisions as the Committee shall determine which are not inconsistent with the terms of this Plan. The Award Agreement also shall specify whether the Option is intended to be an ISO or an NQSO.

6.3 Option Price . The Option Price for each grant of an Option under this Plan shall be as determined by the Committee and shall be specified in the Award Agreement; provided, however, the Option Price must be at least equal to one hundred percent (100%) of the FMV of the Shares as of the date of grant.

6.4 Term of Options . Each Option granted to a Participant shall expire at such time as the Committee shall determine at the time of grant; provided, however, no Option shall be exercisable later than the tenth (10 ^th ) anniversary date of its grant. Notwithstanding the foregoing, for Options granted to Participants outside the United States, the Committee has the authority to grant Options that have a term greater than ten (10) years.

6.5 Exercise of Options . Options granted under this Article 6 shall be exercisable at such times and be subject to such restrictions and conditions as the Committee shall in each instance approve, which terms and restrictions need not be the same for each grant or for each Participant.

6.6 Payment . Options granted under this Article 6 shall be exercised by the delivery of a notice of exercise to the Company or an agent designated by the Company in a form specified or accepted by the Committee, or by complying with any alternative procedures which may be authorized by the Committee, setting forth the number of Shares with respect to which the Option is to be exercised, accompanied by full payment for the Shares.

A condition of the issuance of the Shares as to which an Option shall be exercised shall be the payment of the Option Price. The Option Price of any Option shall be payable to the Company in full either: (a) in cash or its equivalent; (b) by tendering (either by actual delivery or attestation) previously acquired Shares having an aggregate Fair Market Value at the time of exercise equal to the Option Price

(provided that except as otherwise determined by the Committee, the Shares that are tendered must have been held by the Participant for at least six (6) months (or such other period, if any, as the Committee may permit) prior to their tender to satisfy the Option Price if acquired under this Plan or any other compensation plan maintained by the Company, or have been purchased on the open market); (c) by a combination of (a) and (b); or (d) any other method approved or accepted by the Committee in its sole discretion, including, without limitation, if the Committee so determines, a cashless (broker-assisted) exercise.

Subject to any governing rules or regulations, as soon as practicable after receipt of written notification of exercise and full payment (including satisfaction of any applicable tax withholding), the Company shall deliver to the Participant evidence of book entry Shares, or upon the Participant’s request, Share certificates in an appropriate amount based upon the number of Shares purchased under the Option(s).

Unless otherwise determined by the Committee, all payments under all of the methods indicated above shall be paid in United States dollars.

6.7 Restrictions on Share Transferability . The Committee may impose such restrictions on any Shares acquired pursuant to the exercise of an Option granted under this Article 6 as it may deem advisable, including, without limitation, minimum holding period requirements, restrictions under applicable federal securities laws, under the requirements of any stock exchange or market upon which such Shares are then listed and/or traded, or under any blue sky or state securities laws applicable to such Shares.

6.8 Termination of Employment . Each Participant’s Award Agreement shall set forth the extent to which the Participant shall have the right to exercise the Option following termination of the Participant’s employment or provision of services to the Company, its Affiliates, and/or its Subsidiaries, as the case may be. Such provisions shall be determined in the sole discretion of the Committee, shall be included in the Award Agreement entered into with each Participant, need not be uniform among all Options issued pursuant to this Article 6, and may reflect distinctions based on the reasons for termination.

6.9 Transferability of Options .

(a)

Incentive Stock Options . No ISO granted under the Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or by the laws of descent and distribution. Further, all ISOs granted to a Participant under this Article 6 shall be exercisable during his lifetime only by such Participant.

(b)

Nonqualified Stock Options . Under no circumstances may a Participant transfer an NQSO to another Person for consideration. Subject to the

foregoing, and except as otherwise provided in a Participant’s Award Agreement or otherwise determined at any time by the Committee, no NQSO granted under this Article 6 may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or by the laws of descent and distribution; provided that the Board or Committee may permit further transferability, on a general or a specific basis, and may impose conditions and limitations on any permitted transferability. Further, except as otherwise provided in a Participant’s Award Agreement or otherwise determined at any time by the Committee, or unless the Board or Committee decides to permit further transferability, all NQSOs granted to a Participant under this Article 6 shall be exercisable during his lifetime only by such Participant. With respect to those NQSOs, if any, that are permitted to be transferred to another individual, references in this Plan to exercise or payment of the Option Price by the Participant shall be deemed to include, as determined by the Committee, the Participant’s permitted transferee.

6.10 Notification of Disqualifying Disposition . If any Participant shall make any disposition of Shares issued pursuant to the exercise of an ISO under the circumstances described in Section 421(b) of the Code (relating to certain disqualifying dispositions), such Participant shall notify the Company of such disposition within ten (10) days thereof.

Article 7. Stock Appreciation Rights

7.1 Grant of SARs . Subject to the terms and conditions of this Plan, SARs may be granted to Participants at any time and from time to time as shall be determined by the Committee. The Committee may grant Freestanding SARs, Tandem SARs, or any combination of these forms of SARs.

Subject to the terms and conditions of this Plan, the Committee shall have complete discretion in determining the number of SARs granted to each Participant and, consistent with the provisions of this Plan, in determining the terms and conditions pertaining to such SARs.

The Grant Price for each grant of a Freestanding SAR shall be determined by the Committee and shall be specified in the Award Agreement; provided, however, the Grant Price must be at least equal to one hundred percent (100%) of the FMV of the Shares as of the date of grant. The Grant Price of Tandem SARs shall be equal to the Option Price of the related Option.

7.2 SAR Agreement . Each SAR Award shall be evidenced by an Award Agreement that shall specify the Grant Price, the term of the SAR, and such other provisions as the Committee shall determine.

7.3 Term of SAR . The term of an SAR granted under this Plan shall be determined by the Committee, in its sole discretion, and except as determined otherwise by the

Committee and specified in the SAR Award Agreement, no SAR shall be exercisable later than the tenth (10 ^th ) anniversary date of its grant. Notwithstanding the foregoing, for SARs granted to Participants outside the United States, the Committee has the authority to grant SARs that have a term greater than ten (10) years.

7.4 Exercise of Freestanding SARs . Freestanding SARs may be exercised upon whatever terms and conditions the Committee, in its sole discretion, imposes.

7.5. Exercise of Tandem SARs . Tandem SARs may be exercised for all or part of the Shares subject to the related Option upon the surrender of the right to exercise the equivalent portion of the related Option. A Tandem SAR may be exercised only with respect to the Shares for which its related Option is then exercisable.

7.6 Settlement of SAR Amount . Upon the exercise of an SAR, a Participant shall be entitled to receive payment from the Company in an amount determined by multiplying:

(a)

The excess of the Fair Market Value of a Share on the date of exercise over the Grant Price; by

(b)

The number of Shares with respect to which the SAR is exercised.

The payment upon SAR exercise shall be in Shares.

7.7 Termination of Employment . Each Award Agreement shall set forth the extent to which the Participant shall have the right to exercise the SAR following termination of the Participant’s employment with or provision of services to the Company, its Affiliates, and/or its Subsidiaries, as the case may be. Such provisions shall be determined in the sole discretion of the Committee, shall be included in the Award Agreement entered into with Participants, need not be uniform among all SARs issued pursuant to this Plan, and may reflect distinctions based on the reasons for termination.

7.8 Transferability of SARs . Under no circumstances may a Participant transfer an SAR to another Person for consideration. Subject to the foregoing, and except as otherwise provided in a Participant’s Award Agreement or otherwise determined at any time by the Committee, no SAR granted under this Plan may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or by the laws of descent and distribution. Further, except as otherwise provided in a Participant’s Award Agreement or otherwise determined at any time by the Committee, all SARs granted to a Participant under this Plan shall be exercisable during his lifetime only by such Participant. With respect to those SARs, if any, that are permitted to be transferred to another individual, references in this Plan to exercise of the SAR by the Participant or payment of any amount to the

Participant shall be deemed to include, as determined by the Committee, the Participant’s permitted transferee.

7.9 Other Restrictions. The Committee shall impose such other conditions and/or restrictions on any Shares received upon exercise of an SAR granted pursuant to this Plan as it may deem advisable or desirable. These restrictions may include, but shall not be limited to, a requirement that the Participant hold the Shares received upon exercise of an SAR for a specified period of time.

Article 8. Restricted Stock and Restricted Stock Units

8.1 Grant of Restricted Stock or Restricted Stock Units . Subject to the terms and provisions of this Plan, the Committee, at any time and from time to time, may grant Shares of Restricted Stock and/or Restricted Stock Units to Participants in such amounts as the Committee shall determine. Restricted Stock Units shall be similar to Restricted Stock except that no Shares are actually awarded to the Participant on the date of grant.

8.2 Restricted Stock or Restricted Stock Unit Agreement . Each Restricted Stock and/or Restricted Stock Unit grant shall be evidenced by an Award Agreement that shall specify the Period(s) of Restriction, the number of Shares of Restricted Stock or the number of Restricted Stock Units granted, and such other provisions as the Committee shall determine.

8.3 Transferability . Except as provided in this Plan or an Award Agreement, the Shares of Restricted Stock and/or Restricted Stock Units granted herein may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated until the end of the applicable Period of Restriction established by the Committee and specified in the Award Agreement (and in the case of Restricted Stock Units until the date of delivery or other payment), or upon earlier satisfaction of any other conditions, as specified by the Committee, in its sole discretion, and set forth in the Award Agreement or otherwise at any time by the Committee. All rights with respect to the Restricted Stock and/or Restricted Stock Units granted to a Participant under this Plan shall be available during his lifetime only to such Participant, except as otherwise provided in an Award Agreement or at any time by the Committee.

8.4 Other Restrictions . The Committee shall impose such other conditions and/or restrictions on any Shares of Restricted Stock or Restricted Stock Units granted pursuant to this Plan as it may deem advisable including, without limitation, a requirement that Participants pay a stipulated purchase price for each Share of Restricted Stock or each Restricted Stock Unit, restrictions based upon the achievement of specific performance goals, time-based restrictions on vesting following the attainment of the performance goals, time-based restrictions, and/or restrictions under applicable laws or under the requirements of any stock exchange or market upon which such Shares are listed or traded, or holding requirements or

sale restrictions placed on the Shares by the Company upon vesting of such Restricted Stock or Restricted Stock Units.

To the extent deemed appropriate by the Committee, the Company may retain the certificates representing Shares of Restricted Stock in the Company’s possession until such time as all conditions and/or restrictions applicable to such Shares have been satisfied or lapse.

Except as otherwise provided in this Article 8, Shares of Restricted Stock covered by each Restricted Stock Award shall become freely transferable by the Participant after all conditions and restrictions applicable to such Shares have been satisfied or lapse (including satisfaction of any applicable tax withholding obligations), and Restricted Stock Units shall be paid in cash, Shares, or a combination of cash and Shares as the Committee, in its sole discretion shall determine.

8.5 Certificate Legend . In addition to any legends placed on certificates pursuant to Section 8.4, each certificate representing Shares of Restricted Stock granted pursuant to this Plan may bear a legend such as the following or as otherwise determined by the Committee in its sole discretion:

“The sale or transfer of Shares of stock represented by this certificate, whether voluntary, involuntary, or by operation of law, is subject to certain restrictions on transfer as set forth in the W.W. Grainger, Inc. 2005 Incentive Plan, and in the associated Award Agreement. A copy of this Plan and such Award Agreement may be obtained from W.W. Grainger, Inc.”

8.6 Voting Rights . Unless otherwise determined by the Committee and set forth in a Participant’s Award Agreement, to the extent permitted or required by law, as determined by the Committee, Participants holding Shares of Restricted Stock granted hereunder may be granted the right to exercise full voting rights with respect to those Shares during the Period of Restriction. A Participant shall have no voting rights with respect to any Restricted Stock Units granted hereunder.

8.7 Termination of Employment . Each Award Agreement shall set forth the extent to which the Participant shall have the right to retain Restricted Stock and/or Restricted Stock Units following termination of the Participant’s employment with or provision of services to the Company, its Affiliates, and/or its Subsidiaries, as the case may be. Such provisions shall be determined in the sole discretion of the Committee, shall be included in the Award Agreement entered into with each Participant, need not be uniform among all Shares of Restricted Stock or Restricted Stock Units issued pursuant to this Plan, and may reflect distinctions based on the reasons for termination.

8.8 Section 83(b) Election . The Committee may provide in an Award Agreement that the Award of Restricted Stock is conditioned upon the Participant making or refraining from making an election with respect to the Award under Section 83(b) of

the Code. If a Participant makes an election pursuant to Section 83(b) of the Code concerning a Restricted Stock Award, the Participant shall be required to file promptly a copy of such election with the Company.

Article 9. Performance Shares/Performance Units

9.1 Grant of Performance Shares/Performance Units . Subject to the terms and provisions of this Plan, the Committee, at any time and from time to time, may grant Performance Shares and/or Performance Units to Participants in such amounts and upon such terms as the Committee shall determine.

9.2 Value of Performance Shares/Performance Units . Each Performance Share shall have an initial value equal to the Fair Market Value of a Share as of the date of grant. Each Performance Unit shall have an initial value that is established by the Committee at the time of grant (for example, the Committee could grant 10,000 units to a participant and determine their value at $1.00 per unit). The Committee shall set performance goals in its discretion which, depending on the extent to which they are met, will determine the number and/or value of Performance Shares/Performance Units that will be paid out to the Participant.

9.3 Earning of Performance Shares/Performance Units . Subject to the terms of this Plan, after the applicable Performance Period has ended, the holder of Performance Shares/Performance Units shall be entitled to receive payout on the value and number of Performance Shares/Performance Units earned by the Participant over the Performance Period, to be determined as a function of the extent to which the corresponding performance goals have been achieved.

9.4 Form and Timing of Payment of Performance Shares/Performance Units . Payment of earned Performance Shares/Performance Units shall be as determined by the Committee and as evidenced in the Award Agreement. Subject to the terms of this Plan, the Committee, in its sole discretion, may pay earned Performance Shares/Performance Units in the form of Shares or in cash (or in a combination thereof) equal to the value of the earned Performance Shares/Performance Units at the close of the applicable Performance Period, or as soon as practicable after the end of the Performance Period. Any Shares may be granted subject to any restrictions deemed appropriate by the Committee. The determination of the Committee with respect to the form of payout of such Awards shall be set forth in the Award Agreement pertaining to the grant of the Award.

9.5 Termination of Employment . Each Award Agreement shall set forth the extent to which the Participant shall have the right to retain Performance Shares and/or Performance Units following termination of the Participant’s employment with or provision of services to the Company, its Affiliates, and/or its Subsidiaries, as the case may be. Such provisions shall be determined in the sole discretion of the Committee, shall be included in the Award Agreement entered into with each Participant, need not be uniform among all Awards of Performance Shares or

Performance Units issued pursuant to this Plan, and may reflect distinctions based on the reasons for termination.

9.6 Transferability of Performance Shares/Performance Units . Except as otherwise provided in a Participant’s Award Agreement or otherwise determined at any time by the Committee, Performance Shares/Performance Units may not be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or by the laws of descent and distribution. Further, except as otherwise provided in a Participant’s Award Agreement or otherwise determined at any time by the Committee, a Participant’s rights under this Plan shall be exercisable during his lifetime only by such Participant.

Article 10. Cash-Based Awards and Other Stock-Based Awards

10.1 Grant of Cash-Based Awards . Subject to the terms and provisions of this Plan, the Committee, at any time and from time to time, may grant Cash-Based Awards to Participants in such amounts and upon such terms, including the achievement of specific performance goals, as the Committee may determine.

10.2 Other Stock-Based Awards . The Committee may grant other types of equity-based or equity-related Awards not otherwise described by the terms of this Plan (including the grant or offer for sale of unrestricted Shares) in such amounts and subject to such terms and conditions, as the Committee shall determine. Such Awards may involve the transfer of actual Shares to Participants, or payment in cash or otherwise of amounts based on the value of Shares and may include, without limitation, Awards designed to comply with or take advantage of the applicable local laws of jurisdictions other than the United States.

10.3 Value of Cash-Based and Other Stock-Based Awards . Each Cash-Based Award shall specify a payment amount or payment range as determined by the Committee. Each Other Stock-Based Award shall be expressed in terms of Shares or units based on Shares, as determined by the Committee. The Committee may establish performance goals in its discretion. If the Committee exercises its discretion to establish performance goals, the number and/or value of Cash-Based Awards or Other Stock-Based Awards that will be paid out to the Participant will depend on the extent to which the performance goals are met.

10.4 Payment of Cash-Based Awards and Other Stock-Based Awards . Payment, if any, with respect to a Cash-Based Award or an Other Stock-Based Award shall be made in accordance with the terms of the Award, in cash or Shares as the Committee determines.

10.5 Termination of Employment . The Committee shall determine the extent to which the Participant shall have the right to receive Cash-Based Awards or Other Stock-Based Awards following termination of the Participant’s employment with or provision of services to the Company, its Affiliates, and/or its Subsidiaries, as the

case may be. Such provisions shall be determined in the sole discretion of the Committee, such provisions may be included in an Award Agreement entered into with each Participant, but need not be uniform among all Awards of Cash-Based Awards or Other Stock-Based Awards issued pursuant to this Plan, and may reflect distinctions based on the reasons for termination.

10.6 Transferability of Cash-Based and Other Stock-Based Awards . Except as otherwise determined by the Committee, neither Cash-Based Awards nor Other Stock-Based Awards may be sold, transferred, pledged, assigned, or otherwise alienated or hypothecated, other than by will or by the laws of descent and distribution. Further, except as otherwise provided by the Committee, a Participant’s rights under this Plan, if exercisable, shall be exercisable during his lifetime only by such Participant. With respect to those Cash-Based Awards or Other Stock-Based Awards, if any, that are permitted to be transferred to another individual, references in this Plan to exercise or payment of such Awards by or to the Participant shall be deemed to include, as determined by the Committee, the Participant’s permitted transferee.

Article 11. Performance Measures

11.1 Performance Measures. The performance goals upon which the payment or vesting of an Award to a Covered Employee (other than a Covered Employee Annual Incentive Award awarded or credited pursuant to Article 12) that is intended to qualify as Performance-Based Compensation shall be limited to the following Performance Measures:

(a)

Net earnings or net income (before or after taxes);

(b)

Earnings per share;

(c)

Net sales or revenue growth;

(d)

Net operating profit;

(e)

Return measures (including, but not limited to, return on assets, capital, invested capital, equity, sales, or revenue);

(f)

Cash flow (including, but not limited to, operating cash flow, free cash flow, cash flow return on equity, and cash flow return on investment);

(g)

Earnings before or after taxes, interest, depreciation, and/or amortization;

(h)

Gross or operating margins;

(i)

Productivity ratios;

(j)

Share price (including, but not limited to, growth measures and total shareholder return);

(k)

Expense targets;

(l)

Margins;

(m)

Operating efficiency;

(n)

Market share;

(o)

Customer satisfaction;

(p)

Working capital targets; and

(q)

Economic value added (net operating profit after tax minus the sum of capital multiplied by the cost of capital).

Any Performance Measure(s) may be used to measure the performance of the Company, Affiliate, and/or Subsidiary as a whole or any business unit of the Company, Affiliate, and/or Subsidiary or any combination thereof, as the Committee may deem appropriate, or any of the above Performance Measures as compared to the performance of a group of comparator companies, or published or special index that the Committee, in its sole discretion, deems appropriate, or the Company may select Performance Measure (j) above as compared to various stock market indices. The Committee also has the authority to provide for accelerated vesting of any Award based on the achievement of performance goals pursuant to the Performance Measures specified in this Article 11.

11.2 Evaluation of Performance. The Committee may provide in any such Award that any evaluation of performance may include or exclude any of the following events that occurs during a Performance Period: (a) asset write-downs, (b) litigation or claim judgments or settlements, (c) the effect of changes in tax laws, accounting principles, or other laws or provisions affecting reported results, (d) any reorganization and restructuring programs, (e) extraordinary nonrecurring items as described in Accounting Principles Board Opinion No. 30 and/or in Management’s Discussion and Analysis of financial condition and results of operations appearing in the Company’s annual report to shareholders for the applicable year, (f) acquisitions or divestitures, and (g) foreign exchange gains and losses. To the extent such inclusions or exclusions affect Awards to Covered Employees, they shall be prescribed in a form that meets the requirements of Code Section 162(m) for deductibility.

11.3 Adjustment of Performance-Based Compensation. Awards that are intended to qualify as Performance-Based Compensation may not be adjusted upward. The Committee shall retain the discretion to adjust such Awards downward, either on a formula or discretionary basis or any combination, as the Committee determines.

11.4 Committee Discretion. In the event that applicable tax and/or securities laws change to permit Committee discretion to alter the governing Performance Measures without obtaining shareholder approval of such changes, the Committee shall have sole discretion to make such changes without obtaining shareholder approval. In addition, in the event that the Committee determines that it is advisable to grant Awards that shall not qualify as Performance-Based Compensation, the Committee may make such grants without satisfying the requirements of Code Section 162(m) and base vesting on Performance Measures other than those set forth in Section 11.1.

Article 12. Covered Employee Annual Incentive Award

12.1 Establishment of Incentive Pool. The Committee may designate Covered Employees who are eligible to receive a monetary payment in any Plan Year based on a percentage of an incentive pool equal to five percent (5%) of the Company’s Net Earnings for this Plan Year. The Committee shall allocate an incentive pool percentage to each designated Covered Employee for each Plan Year. In no event may (1) the incentive pool percentage for any one Covered Employee exceed one hundred percent (100%) of the total pool and (2) the sum of the incentive pool percentages for all Covered Employees cannot exceed one hundred percent (100%) of the total pool.

12.2 Determination of Covered Employees’ Portions. As soon as possible after the determination of the incentive pool for a Plan Year, the Committee shall calculate each Covered Employee’s allocated portion of the incentive pool based upon the percentage established at the beginning of this Plan Year. Each Covered Employee’s incentive award then shall be determined by the Committee based on the Covered Employee’s allocated portion of the incentive pool subject to adjustment in the sole discretion of the Committee. In no event may the portion of the incentive pool allocated to a Covered Employee be increased in any way, including as a result of the reduction of any other Covered Employee’s allocated portion. The Committee shall retain the discretion to adjust such Awards downward.

Article 13. Nonemployee Director Awards

The Board or Committee shall determine all Awards to Nonemployee Directors. The terms and conditions of any grant to any such Nonemployee Director shall be set forth in an Award Agreement.

Article 14. Dividend Equivalents

Unless otherwise provided by the Committee, dividend equivalents shall be granted for each Full Value Award based on the dividends declared on Shares that are subject to such Full Value Award, to be credited as of dividend payment dates, during the period between the date the Full Value Award is granted and the date the Full Value Award is exercised, vests or expires. Such dividend equivalents shall be converted to cash or additional Shares by such formula and at such time and subject to such limitations as may be determined by the Committee. Under no circumstances may dividend equivalents be granted for any Option or SAR.

Article 15. Beneficiary Designation

Each Participant under this Plan may, from time to time, name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under this Plan is to be paid in case of his death before he receives any or all of such benefit. Each such designation shall revoke all prior designations by the same

Participant, shall be in a form prescribed by the Committee, and will be effective only when filed by the Participant in writing with the Company during the Participant’s lifetime. In the absence of any such designation, benefits remaining unpaid at the Participant’s death shall be paid to the Participant’s estate.

Article 16. Rights of Participants

16.1 Employment . Nothing in this Plan or an Award Agreement shall interfere with or limit in any way the right of the Company, its Affiliates, and/or its Subsidiaries, to terminate any Participant’s employment or service on the Board or to the Company at any time or for any reason not prohibited by law, nor confer upon any Participant any right to continue his employment or service as a Director for any specified period of time.

Neither an Award nor any benefits arising under this Plan shall constitute an employment contract with the Company, its Affiliates, and/or its Subsidiaries and, accordingly, subject to Articles 3 and 18, this Plan and the benefits hereunder may be terminated at any time in the sole and exclusive discretion of the Committee without giving rise to any liability on the part of the Company, its Affiliates, and/or its Subsidiaries.

16.2 Participation . No individual shall have the right to be selected to receive an Award under this Plan, or, having been so selected, to be selected to receive a future Award.

16.3 Rights as a Shareholder . Except as otherwise provided herein, a Participant shall have none of the rights of a shareholder with respect to Shares covered by any Award until the Participant becomes the record holder of such Shares.

Article 17. Change in Control

Except as otherwise provided at the time of grant in the certificate, notice or agreement relating to a particular Award, if a Change in Control occurs, then:

(i)

the Participant’s Restricted Stock, Restricted Stock Units, Performance Units, Performance Shares, Cash-Based Awards, Other Stock-Based Awards, or Covered Employee Annual Incentive Awards that were forfeitable shall, unless otherwise determined by the Committee, become nonforfeitable and, to the extent applicable, shall be converted into Shares; provided, that for any Award which is performance-based, it shall be assumed for purposes of determining such payout or conversion that performance was “at target” for the applicable Performance Period, and

(ii)

any unexercised Option or SAR, whether or not exercisable on the date of such Change in Control, shall thereupon be fully exercisable and may be exercised, in whole or in part.

Article 18. Amendment, Modification, Suspension, and Termination

18.1 Amendment, Modification, Suspension, and Termination . Subject to Section 18.3, the Committee may, at any time and from time to time, alter, amend, modify, suspend, or terminate this Plan and any Award Agreement in whole or in part; provided, however, that, without the prior approval of the Company’s shareholders and except as provided in Section 4.4, Options or SARs issued under this Plan will not be repriced, replaced, or regranted through cancellation, or by lowering the Option Price of a previously granted Option or the Grant Price of a previously granted SAR, and no amendment of this Plan shall be made without shareholder approval if shareholder approval is required by law, regulation, or stock exchange rule, including, but not limited to, the Securities Exchange Act of 1934, as amended, the Internal Revenue Code of 1986, as amended, and, if applicable, the New York Stock Exchange Listed Company Manual rules.

18.2 Adjustment of Awards Upon the Occurrence of Certain Unusual or Nonrecurring Events . The Committee may make adjustments in the terms and conditions of, and the criteria included in, Awards in recognition of unusual or nonrecurring events (it being understood that the events described in Section 4.4 shall result in mandatory adjustment) affecting the Company or the financial statements of the Company or of changes in applicable laws, regulations, or accounting principles, whenever the Committee determines that such adjustments are appropriate in order to prevent unintended dilution or enlargement of the benefits or potential benefits intended to be made available under this Plan. The determination of the Committee as to the foregoing adjustments, if any, shall be conclusive and binding on Participants under this Plan.

18.3 Awards Previously Granted . Notwithstanding any other provision of this Plan to the contrary (other than Section 18.4), no termination, amendment, suspension, or modification of this Plan or an Award Agreement shall adversely affect in any material way any Award previously granted under this Plan, without the written consent of the Participant holding such Award.

18.4 Amendment to Conform to Law. Notwithstanding any other provision of this Plan to the contrary, the Board of Directors may amend the Plan or an Award Agreement, to take effect retroactively or otherwise, as deemed necessary or advisable for the purpose of conforming the Plan or an Award Agreement to any present or future law relating to plans of this or similar nature (including, but not limited to, Code Section 409A), and to the administrative regulations and rulings promulgated thereunder.

Article 19. Withholding

19.1 Tax Withholding . The Company shall have the power and the right to deduct or withhold, or require a Participant to remit to the Company, the minimum statutory

amount to satisfy federal, state, and local taxes, domestic or foreign, required by law or regulation to be withheld with respect to any taxable event arising as a result of this Plan.

19.2 Share Withholding . With respect to withholding required upon the exercise of Options or SARs, upon the lapse of restrictions on Restricted Stock and Restricted Stock Units, or upon the achievement of performance goals related to Performance Shares, or any other taxable event arising as a result of an Award granted hereunder, Participants may elect, subject to the approval of the Committee, to satisfy the withholding requirement, in whole or in part, by having the Company withhold Shares having a Fair Market Value on the date the tax is to be determined equal to the minimum statutory total tax that could be imposed on the transaction. All such elections shall be irrevocable, made in writing, and signed by the Participant, and shall be subject to any restrictions or limitations that the Committee, in its sole discretion, deems appropriate.

Article 20. Successors

All obligations of the Company under this Plan with respect to Awards granted hereunder shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation, or otherwise, of all or substantially all of the business and/or assets of the Company.

Article 21. General Provisions

21.1 Forfeiture Events .

(a)

The Committee may specify in an Award Agreement that the Participant’s rights, payments, and benefits with respect to an Award shall be subject to reduction, cancellation, forfeiture, or recoupment upon the occurrence of certain specified events, in addition to any otherwise applicable vesting or performance conditions of an Award. Such events may include, but shall not be limited to, termination of employment for cause, termination of the Participant’s provision of services to the Company, Affiliate, and/or Subsidiary, violation of material Company, Affiliate, and/or Subsidiary policies, breach of noncompetition, confidentiality, or other restrictive covenants that may apply to the Participant, or other conduct by the Participant that is detrimental to the business or reputation of the Company, its Affiliates, and/or its Subsidiaries.

(b)

If the Company is required to prepare an accounting restatement due to the material noncompliance of the Company, as a result of misconduct, with any financial reporting requirement under the securities laws, if the Participant knowingly or grossly negligently engaged in the misconduct, or knowingly or grossly negligently failed to prevent the misconduct, or if the Participant is one of the individuals subject to automatic forfeiture under Section 304 of the Sarbanes-Oxley Act of 2002, the Participant shall reimburse the Company the

amount of any payment in settlement of an Award earned or accrued during the twelve- (12-) month period following the first public issuance or filing with the United States Securities and Exchange Commission (whichever just occurred) of the financial document embodying such financial reporting requirement.

21.2 Legend . The certificates for Shares may include any legend which the Committee deems appropriate to reflect any restrictions on transfer of such Shares.

21.3 Gender and Number . Except where otherwise indicated by the context, any masculine term used herein also shall include the feminine, the plural shall include the singular, and the singular shall include the plural.

21.4 Severability . In the event any provision of this Plan shall be held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of this Plan, and this Plan shall be construed and enforced as if the illegal or invalid provision had not been included.

21.5 Requirements of Law . The granting of Awards and the issuance of Shares under this Plan shall be subject to all applicable laws, rules, and regulations, and to such approvals by any governmental agencies or national securities exchanges as may be required.

21.6 Delivery of Title . The Company shall have no obligation to issue or deliver evidence of title for Shares issued under this Plan prior to:

(a)

Obtaining any approvals from governmental agencies that the Company determines are necessary or advisable; and

(b)

Completion of any registration or other qualification of the Shares under any applicable national or foreign law or ruling of any governmental body that the Company determines to be necessary or advisable.

21.7 Inability to Obtain Authority . The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company’s counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained.

21.8 Investment Representations . The Committee may require any individual receiving Shares pursuant to an Award under this Plan to represent and warrant in writing that the individual is acquiring the Shares for investment and without any present intention to sell or distribute such Shares.

21.9 Employees Based Outside of the United States . Notwithstanding any provision of this Plan to the contrary, in order to comply with the laws in other

countries in which the Company, its Affiliates, and/or its Subsidiaries operate or have Employees and/or Directors, the Committee, in its sole discretion, shall have the power and authority to:

(a)

Determine which Affiliates and Subsidiaries shall be covered by this Plan;

(b)

Determine which Employees and/or Directors outside the United States are eligible to participate in this Plan;

(c)

Modify the terms and conditions of any Award granted to Employees and/or Directors outside the United States to comply with applicable foreign laws;

(d)

Establish subplans and modify exercise procedures and other terms and procedures, to the extent such actions may be necessary or advisable. Any subplans and modifications to Plan terms and procedures established under this Section 21.9 by the Committee shall be attached to this Plan document as appendices; and

(e)

Take any action, before or after an Award is made, that it deems advisable to obtain approval or comply with any necessary local government regulatory exemptions or approvals.

Notwithstanding the above, the Committee may not take any actions hereunder, and no Awards shall be granted, that would violate applicable law.

21.10 Uncertificated Shares . To the extent that this Plan provides for issuance of certificates to reflect the transfer of Shares, the transfer of such Shares may be effected on an uncertificated basis, to the extent not prohibited by applicable law or the rules of any stock exchange.

21.11 Unfunded Plan . Participants shall have no right, title, or interest whatsoever in or to any investments that the Company, and/or its Affiliates, and/or its Subsidiaries may make to aid it in meeting its obligations under this Plan. Nothing contained in this Plan, and no action taken pursuant to its provisions, shall create or be construed to create a trust of any kind, or a fiduciary relationship between the Company and any Participant, beneficiary, legal representative, or any other individual. To the extent that any person acquires a right to receive payments from the Company, its Affiliates, and/or its Subsidiaries under this Plan, such right shall be no greater than the right of an unsecured general creditor of the Company, an Affiliate, or a Subsidiary, as the case may be. All payments to be made hereunder shall be paid from the general funds of the Company, an Affiliate, or a Subsidiary, as the case may be and no special or separate fund shall be established and no segregation of assets shall be made to assure payment of such amounts except as expressly set forth in this Plan.

21.12 No Fractional Shares . No fractional Shares shall be issued or delivered pursuant to this Plan or any Award. The Committee shall determine whether cash, Awards, or other property shall be issued or paid in lieu of fractional Shares or whether such fractional Shares or any rights thereto shall be forfeited or otherwise eliminated.

21.13 Retirement and Welfare Plans . Neither Awards made under this Plan nor Shares or cash paid pursuant to such Awards, except pursuant to Covered Employee Annual Incentive Awards, may be included as “compensation” for purposes of computing the benefits payable to any Participant under the Company’s or any Affiliate’s or Subsidiary’s retirement plans (both qualified and non-qualified) or welfare benefit plans unless such other plan expressly provides that such compensation shall be taken into account in computing a Participant’s benefit.

21.14 No Deferred Compensation. No deferral of compensation shall be permitted under this Plan. However, the Committee may permit deferrals of compensation pursuant to a separate plan or a subplan which meets the requirements of Code Section 409A. Additionally, to the extent any Award is subject to Code Section 409A, notwithstanding any provision herein to the contrary, the Plan does not permit the acceleration of the time or schedule of any distribution related to such Award, except as permitted by Code Section 409A and/or the Secretary of the United States Treasury.

21.15 Nonexclusivity of this Plan . The adoption of this Plan shall not be construed as creating any limitations on the power of the Board or Committee to adopt such other compensation arrangements as it may deem desirable for any Participant.

21.16 No Constraint on Corporate Action. Nothing in this Plan shall be construed to: (i) limit, impair, or otherwise affect the Company’s or an Affiliate’s or a Subsidiary’s right or power to make adjustments, reclassifications, reorganizations, or changes of its capital or business structure, or to merge or consolidate, or dissolve, liquidate, sell, or transfer all or any part of its business or assets; or, (ii) limit the right or power of the Company or an Affiliate or a Subsidiary to take any action which such entity deems to be necessary or appropriate.

21.17 Governing Law . The Plan and each Award Agreement shall be governed by the laws of the State of Illinois excluding any conflicts or choice of law rule or principle that might otherwise refer construction or interpretation of this Plan to the substantive law of another jurisdiction. Unless otherwise provided in the Award Agreement, recipients of an Award under this Plan are deemed to submit to the exclusive jurisdiction and venue of the federal or state courts of Illinois to resolve any and all issues that may arise out of or relate to this Plan or any related Award Agreement.

21.18 Effect of Disposition of Facility or Operating Unit . In the event that the Company or any of its Affiliates and/or Subsidiaries closes or disposes of the facility at which a Participant is located or the Company or any of its Affiliates and/or Subsidiaries diminish or eliminate ownership interests in any operating unit of the Company or any of its Affiliates and/or Subsidiaries so that such operating unit ceases to be majority owned by the Company or any of its Affiliates and/or Subsidiaries, then, with respect to Awards held by Participants who subsequent to such event will not be Employees, the Committee may, to the extent consistent with Code Section 409A (if applicable), (i) accelerate the exercisability of Awards to the extent not yet otherwise exercisable or remove any restrictions applicable to any Awards and (ii) extend the period during which Awards will be exercisable to a date subsequent to the date when such Awards would otherwise have expired by reason of the termination of such Participant’s employment with the Company or any of its Affiliates and/or Subsidiaries (but in no event to a date later than the expiration date of the Awards or the fifth anniversary of the transaction in which such facility closes or operating unit ceases). If the Committee takes no special action with respect to any disposition of a facility or an operating unit, then the terms and conditions of the Award Agreement and the other terms and conditions of this Plan shall control.

21.19 Indemnification. Subject to requirements of Illinois law, each individual who is or shall have been a member of the Board, or a Committee appointed by the Board, or an officer of the Company to whom authority was delegated in accordance with Article 3, shall be indemnified and held harmless by the Company against and from any loss, cost, liability, or expense that may be imposed upon or reasonably incurred by him in connection with or resulting from any claim, action, suit, or proceeding to which he may be a party or in which he or she may be involved by reason of any action taken or failure to act under this Plan and against and from any and all amounts paid by him in settlement thereof, with the Company’s approval, or paid by him in satisfaction of any judgment in any such action, suit, or proceeding against him, provided he shall give the Company an opportunity, at its own expense, to handle and defend the same before he undertakes to handle and defend it on his own behalf, unless such loss, cost, liability, or expense is a result of his own willful misconduct or except as expressly provided by statute.

The foregoing right of indemnification shall not be exclusive of any other rights of indemnification to which such individuals may be entitled under the Company’s Certificate of Incorporation of Bylaws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless.

Exhibit 11

W.W. Grainger, Inc. and Subsidiaries

COMPUTATIONS OF EARNINGS PER SHARE

	Six Months Ended June 30,
BASIC:	2006	2005

Weighted average number of shares outstanding	89,490,188	89,942,454

Net earnings	$ 179,972,000	$ 154,381,000

Earnings per share	$ 2.01	$ 1.72

DILUTED:

Weighted average number of shares outstanding	89,490,189	89,942,454

Potential Shares:

Shares issuable under outstanding common stock equivalents	9,228,986	10,177,385

Shares which could have been purchased using
the proceeds from common stock equivalents exercised, based on the average market value for the period	(6,477,073)	(8,372,522)

	2,751,913	1,804,863

Dilutive effect of exercised options prior to being exercised	52,461	22,745

	2,804,374	1,827,608

Adjusted weighted average number of shares
outstanding	92,294,563	91,770,062

Net earnings	$ 179,972,000	$ 154,381,000

Earnings per share	$ 1.95	$ 1.68

CERTIFICATION

Exhibit 31(a)

I, R. L. Keyser, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of W.W. Grainger, Inc.;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 1, 2006

By:	/s/ R. L. Keyser
Name:	R. L. Keyser
Title:	Chairman and Chief Executive Officer

CERTIFICATION

Exhibit 31(b)

I, P. O. Loux, certify that:

1.	I have reviewed this Quarterly Report on Form 10-Q of W.W. Grainger, Inc.;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 1, 2006

By:	/s/ P. O. Loux
Name:	P. O. Loux
Title:	Senior Vice President, Finance and Chief Financial Officer

Exhibit 32(a)

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, R. L. Keyser, Chairman and Chief Executive Officer of W.W. Grainger, Inc. (“Grainger”), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

The Quarterly Report on Form 10-Q of Grainger for the quarter ended June 30, 2006, (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Grainger.

/s/ R. L. Keyser
R. L. Keyser
Chairman and
Chief Executive Officer
August 1, 2006

Exhibit 32(b)

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

I, P. O. Loux, Senior Vice President, Finance and Chief Financial Officer of W.W. Grainger, Inc. (“Grainger”), certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Grainger.

/s/ P. O. Loux
P. O. Loux
Senior Vice President, Finance
and Chief Financial Officer
August 1, 2006