Greetings, and welcome to the W.W. Grainger Second Quarter 2025 Earnings Conference Call. Please note that this conference is being recorded. I will now turn the conference over to your host, Kyle Bland, Vice President, Investor Relations. Thank you. You may begin.

Good morning. Welcome to Grainger's Second Quarter 2025 Earnings Call. With me are D.G. Macpherson, Chairman and CEO; and Dee Merriwether, Senior Vice President and CFO. As a reminder, some of our comments today may include forward-looking statements that are subject to various risks and uncertainties. Additional information regarding factors that could cause actual results to differ materially is included in the company's most recent Form 8-K and other periodic reports filed with the SEC. Results for the second quarter of 2025 are consistent on both a reported and adjusted basis, but will be compared to adjusted results from the prior year period, which were normalized for restructuring costs incurred in the second quarter of 2024. Definitions and full reconciliations of our non-GAAP financial measures with their corresponding GAAP measures are found in the tables at the end of this presentation and in our earnings release, both of which are available on our IR website. We will also share results related to MonotaRO. Please remember that MonotaRO is a public company and files Japanese GAAP, which differs from U.S. GAAP and is reported in our results one month in arrears. As a result, the numbers discussed will differ from MonotaRO's public statements. Now I'll turn it over to D.G.

Thanks, Kyle. Good morning, everyone, and thank you for joining today. In the second quarter, the external environment continued to present a degree of uncertainty. What we're observing in the field though is largely business as usual with a sharp focus on execution. Customers are seeking reliable partners who can help them manage the current complexity, and Grainger is proud to be that partner. I recently spent some time with manufacturing and industrial customers in Salt Lake City. These conversations consistently focused on how Grainger can help them drive efficiencies, lowering their purchasing costs, and improving inventory management. In times of uncertainty, our role becomes even more important, and we are uniquely positioned to help our customers strengthen their purchasing processes and overall operations. To that end, we continue to collaborate closely with our supplier network to uphold our standard of getting customers the right products when and where they need them. We've built a strong foundation anchored by a world-class supply chain and enhanced by strategic investments in product information and digital capabilities. These efforts, combined with our scale, deep supplier relationships, and ability to provide alternative product solutions, allow us to deliver unmatched value in any environment. Beyond serving our customers' operations, we also recognize a broader responsibility to the communities we serve. In times of need, we remain steadfast in our commitment to supporting local communities with emergency response and recovery efforts. It's a part of who we are and how we show up every day. I am proud of the resilience and dedication demonstrated across our organization and remain confident that our team will continue to deliver value for our customers, our communities, and our shareholders. In the second quarter, we delivered solid results that in total were largely in line with our May verbal guide. Total company reported sales for the quarter were nearly $4.6 billion, up 5.6% or 5.1% on a daily constant currency basis. Operating margins for the company were 14.9% and diluted EPS finished the quarter up $0.21 to $9.97. Operating cash flow came in at $377 million, which allowed us to return a total of $336 million to greater shareholders through dividends and share repurchases. Importantly, while the headline results for the second quarter played out largely as expected, they do reflect our estimate of tariff-related LIFO inventory valuation headwinds. As Dee will discuss, without this LIFO impact, our operating margin would have been flat year-over-year in the period. As we look ahead, we anticipate the continued LIFO headwinds, along with further price/cost timing pressures, will impact our performance in the back half of the year. And as a result, we are updating our earnings outlook for 2025, which Dee will detail in a moment. Importantly, these accounting and timing impacts are mostly transitory, and our expectation is that gross margin will begin to recover over time as we work back toward our price cost neutrality target. And with that, I'll turn it over to Dee to go through the details.

Thank you, D.G. Turning to Slide 7. You can see the high-level second quarter results for the total company, including $4.6 billion in sales, up 5.1% on a daily constant currency basis. Within the period, we saw gross margin softness from segment mix and from the aforementioned tariff-related impacts within the High-Touch business, including noise from LIFO inventory accounting. This led to total company operating margins of 14.9% for the quarter, down 50 basis points compared to 2024, but roughly in line with our communicated expectations. Diluted EPS for the quarter of $9.97 was up $0.21 or 2.2% higher compared to the prior year period. Moving to segment level results, the High-Touch Solutions segment delivered solid growth in the quarter. In total, sales were up 2.5% on a reported basis or up 2.8% on a daily constant currency basis, with growth across all geographies and local days, local constant currency. Results were driven by continued volume growth and modest price inflation in the segment. From an end market perspective, our indicators suggest the MRO market remained muted but was softer than expected. We saw strong performance with contractor and healthcare customers, which helped to offset slower growth in other areas of the business. For this segment, gross profit margin finished the quarter at 41%, down 70 basis points versus prior year. In the quarter, we saw a negative price/cost spread as we progressed negotiations with suppliers and elected not to pass any off-cycle price increases on to our customers. This caused timing-related lumpiness in the period. However, as pricing catches up, starting with our regular September cycle, we expect price/cost will begin to recover. Further, because we are on LIFO, we had to pull through the current estimated impact of all effective cost increases known to date, putting further pressure on margins in the quarter. These two tariff-related impacts were only partially offset by favorable mix and freight in the period. And I would note that if we were not on LIFO, our gross margin rate would have been flat compared to the prior year quarter. On SG&A, we slightly delevered in the quarter as we continue to invest in marketing. These costs, along with our annual merit increases that went live to start the quarter, were only partially offset by productivity gains and sales leverage. Taking all of this together, operating margin for this segment finished at 16.6%, down 90 basis points versus the prior year quarter. Now focusing on the Endless Assortment segment. Sales increased 19.7% or 16.3% on the daily constant currency basis, which normalizes for the FX tailwinds realized in the period. Zoro U.S. was up 20%, while MonotaRO will achieve 16.4% growth in local days, local constant currency. At a business level, Zoro continues its strong momentum driven by growth from its core B2B customers, along with improving customer retention rates. At MonotaRO, sales growth remained strong with continued growth from enterprise customers coupled with solid acquisition and repeat purchase rates with small and midsized businesses. On profitability, operating margins for the segment increased by 200 basis points to 9.9%, with both businesses contributing to the favorability. MonotaRO's margins remained strong at 13.2% as they continue to gain operating leverage. At Zoro, operating margins accelerated sequentially and were up 380 basis points year-over-year to 5.8%, aided by gross margin flow-through and strong top line leverage. As sales comps become more pronounced for Zoro in the back half of the year, we do anticipate this margin outperformance will moderate slightly as the year continues. Beyond the results, you will see in the appendix that the team took steps in the period to optimize Zoro's assortment. Specifically, net SKUs declined by $1.1 million in the quarter, driven by the elimination of some low volume, low service items. This near-term reduction is part of the ongoing effort to further improve the customer experience at Zoro and has no impact on our go-forward strategy or expected financial performance. Looking forward, our optimization efforts will continue over the next several quarters, but we expect net assortment growth for the business over time. Overall, we had an exceptional first half across Endless Assortment, and we remain confident in the team's ability to continue delivering strong results going forward. As we look to the back half of the year, I thought it would be helpful to share a brief update on where we are with tariffs. As we shared during our first quarter earnings call, we took initial pricing actions in May, primarily related to Section 232 and the first wave of announced tariffs on China. These initial pricing actions only apply to a small portion of our products, largely those where Grainger is importing the product directly. As part of this initial wave, we did not take any pricing action on the reciprocal escalations. Consequently, we expect our initial pricing actions to hold as they relate to tariff levels that remain in place today. At this point, it's a bit early to get an accurate elasticity read, but as the full competitive set takes price through the cycle, we still expect these price actions will approach the previously discussed 1% to 1.5% net annualized price inflation run rate for the high touch business. Of the vast majority of our remaining products where Grainger is not the direct importer, we continue to work with our supplier partners regarding tariff-related cost increases. We've finalized negotiations on a number of impacted SKUs but expect conversations to be iterative throughout the balance of the year as the tariff environment remains highly fluid. Looking ahead to the third quarter, we expect to adhere to our regular cycle with our next pricing action slated to go live in early September. This route will include some further increases on products directly imported by Grainger to reflect current tariff rates, which are higher than what we passed in May. The September cycle will also include initial pricing actions on supplier imported products where we have finalized negotiations. The past price from this route is expected to result in net annualized incremental price of 2% to 2.5% on a run rate basis for the high touch business. Note that these run rate price figures are annualized and on a cumulative basis, we'll lay across the full year 2025 to deliver close to 1% price in total for the High-Touch business. As we wait on pricing actions until September, we do anticipate continued headwinds from price costs and further LIFO inventory valuation impacts in the third quarter. But as we pass price, we expect gross margin will recover to more normal levels over time. The team continues to stay nimble as the cost environment evolves, and we take actions as needed over the remainder of the year and into 2026. Despite the anticipated lumpiness, we remain focused on adhering to our two core pricing tenants to remain price competitive and to achieve price cost neutrality over time. Now moving to the updated outlook for the remainder of 2025. First, we're adjusting our sales outlook to reflect both the latest FX rates and the aforementioned pricing actions, the latter of which we expect will contribute around 1% in total for the High-Touch business in 2025. These tailwinds are partially offset by the softer-than-expected MRO market we've seen to date, which we don't expect will recover in the back half of the year. More notably, as D.G. mentioned at the beginning of the call, we're updating our outlook to reflect the tariff-related price/cost timing headwinds and our current full year estimate for the LIFO valuation impact. Consequently, we've lowered our gross margin guide with the total company now expected to be between 38.6% and 38.9% or down 80 to 50 basis points year-over-year. Our SG&A outlook remains largely unchanged, and therefore, this gross margin pressure will flow through to operating margins where we now expect the Total Company will finish between 14.7% and 15.1%. This all translates to earnings per share between $38.50 and $40.25, up roughly 1% year-over-year at the midpoint. Updates were also made to our supplemental guidance, which included a $100 million increase in expected capital expenditures due to the timing of DC network investments and the related offset to our share repurchase outlook. This updated outlook assumes no changes to the effective tariff schedule as of July 31st. The third quarter is off to a solid start with preliminary total company July sales up slightly north of 6% on a daily constant currency basis and aided by softer comps in the prior year period. We expect growth will moderate as the quarter goes on and anticipate total company sales for the third quarter to be up north of 5% on a daily constant currency basis. As discussed, gross margin will see further pressure in the quarter, driving a sequential decline in total company operating margin to around 14.5%. With that, I'll turn it back to D.G.

Thanks, Dee. Overall, I'm encouraged by how the team continues to manage through this uncertain and evolving environment. Although we did slightly lower our 2025 outlook, it is primarily the result of a softer-than-expected market and transitory impacts on gross margin, neither of which changed our view of how the business is operating overall. I remain confident in our strategy and our ability to drive long-term value for all stakeholders. And with that, we'll open it up for Q&A.

And your first question comes from David Manthey with Baird.

Can you explain the impact of LIFO accounting on operating income? It seems to be around 50 basis points. If you were using average cost accounting, has your outlook for the second half changed, or is this just a timing issue related to LIFO and price increases?

So our performance as we were on FIFO would have been different, as you noted. However, as it relates to the outlook, our outlook would not have included the negative impacts of LIFO. But our underlying operations, I will say, are still very similar. When you look at our ability to estimate the price increases outside of the LIFO impact and the timing of our cost changes. Those things, I believe, will remain the same. So the only real difference is that we would not have had this LIFO accounting impact flow through COGS and through the P&L in the way it is flowing through today. So when you look at, specifically, our EPS year-over-year just comparing ourselves to ourselves instead of being up 2, EPS would have been up north of 6%.

That makes sense. And then as we're looking forward, Dee, you gave us some insight into third quarter. I think you said gross margin would step down again in the third quarter and operating income would come in at 14.5%, if I heard you correctly. Could we think about the progression from there? So I know operating income usually takes a step down seasonally in the fourth quarter, but not necessarily gross margin. So anything directionally you can talk to us about, how the P&L is going to move from the third quarter to the fourth quarter, just so we incorporate that correctly?

Yes. I do believe seasonally stepping from Q3 to Q4, we will still see the revenue trend through normal seasonality, but the point you make related to pricing, pricing will continue to build, with our September pricing change heading into the fourth quarter. And so we will start to see improvement in gross margins and expect to exit the year with improved price cost. And that's what helps with Boeing operating earnings at the end of the year.

Your next question comes from Tommy Moll with Stephens.

It sounds like there was a judgment call made on the timing of when you're going to push through the second batch of inflationary factors here. And I think you referenced that you're just going to take it on the normal cycle in September. I'm just curious what went into that decision-making process. Did you consider pushing in a more real-time fashion? Have you seen others do that in the marketplace? What were some of the gives and takes there on arriving at the decision you did?

Yes. So we considered all kinds of different options here. We decided to keep our price increase on a normal schedule. We think it's the best thing from a customer stability standpoint, and we're hearing very good things from our customers about that decision. We will be a little bit upside down on price/cost, but there are other factors that are actually moving sort of positively as well. And as we discussed, really the LIFO impact is the biggest impact on our GP right now. And so we felt like ex that, we could manage this by going to prices at the right time.

Following up on Zoro. Good update this quarter. It sounds like you did some pricing optimization and then also reduced the SKU count, if you can bring us into that decision-making process, how long have those initiatives been under consideration? And what's the lay of the land there as we go forward?

Yes, the pricing decision has been in development for most of the year. We have been evaluating this and made some adjustments based on our experiences. We approached pricing differently, which enhances the customer experience. Regarding the SKU count, with millions of products, it's essential to identify which ones are unnecessary and do not contribute positively to customer satisfaction. We pinpointed a significant number of products that we eliminated, and we will keep broadening our assortment, ensuring that we do so in ways that genuinely enhance the customer experience. That’s the essence of our approach.

Your next question comes from Chris Snyder with Morgan Stanley.

D.G., in your opening remarks, you mentioned that during uncertain times, customers tend to rely more on Grainger. We observed this during COVID and the subsequent supply chain disruptions, but it appears we aren't experiencing the same effect in the current period of disruption. Growth remains slow, and there seems to be less confidence in raising prices to reflect the value of being a supply chain partner. Perhaps you have a different perspective, so I'd like to know why you think we're not seeing the same positive influences as in previous disruptions.

Well, I think the pandemic disruption was very much a supply disruption, which is less the case this time. I think there haven't been many challenges getting supply. So we may have seen some tailwinds there. I would say a couple of things. One is, I don't think we have any lack of confidence in passing price. I think we're just trying to time it correctly for customers and marry it up, so it actually makes sense. And so we still feel like we're going to be able to pass price through this period. We may not see as much cost as others as well. So our headline prices might not be as big, but there are mix issues and all kinds of things that drive that. And in terms of share gain, actually, the second quarter looks better from a high touch share gain, and we continue to see significant disruption between our internal metric and the one unit metric, the external one. And the internal one would suggest we gained quite a bit of share in the second quarter, and there have been surveys from your peers that have suggested the market was down 2% or 3% even in the quarter. So I think actually share gain, we feel pretty good about again. So I don't know that we feel like we're not gaining share. We do feel like we're gaining share.

I appreciate that. And then I guess just on the gross margin, the 50 basis points guide down. Could you just kind of maybe talk about how that splits between the LIFO pressures, which it sounds like are higher than we're expected in April despite general de-escalation versus how much of that pressure is just some price/cost timing into the back half?

So I just want to step back a little bit. So thanks for that question. I think it ties back to the last question too, a little bit, which is back in Q1 when we were looking at the guide, there was information in the market related to tariffs. One piece of information looked like China's tariff was like at 135%, which it is nowhere near today. And so when D.G. talked about being really prudent about the timing of when we're going to take price, this is what we mean. Like if we would have taken that assumption, which was very high level, very hard to measure at that point in time and then roll that through our estimates, we would have had some drawing changes to guidance then and now having had a whole quarter of better information, a little bit more certainty around tariffs and then being able to actually estimate their near-term impacts, I think has put us in a better position. And then that has also allowed our pricing team to take that information and then make better pricing decisions with our customers at this time. Back to your question related to how much is LIFO versus how much is price cost. The vast majority of the impact to us or like as an example, to High-Touch in this quarter is the LIFO impact. It's like 80 basis points. And so there is impact to price/cost, but much smaller than the impact of LIFO. And we believe that will continue to be the case as we move through the year because as we've noted, we will, in September, be updating for the incremental increase that had been announced on aluminum and steel for some of the other changes that have occurred. And so that will also continue to flow through as subsequent LIFO adjustments. But as it relates to gross margin, none of that reverts unless we have deflation, which we don't see any coming, but gross margin will improve since we're on LIFO because pricing will start to take hold. And so if there's one thing to walk away with those of us that are on LIFO, have a hotter impact or more negative impact on gross margin at the beginning of these cycles because we restate our entire inventory to the latest price or cost of goods, and that flows through the P&L immediately. Over time, as pricing takes hold and that LIFO impact normalizes, our gross margin starts to recover and improve. Different than those on FIFO, who have the opportunity to flow through their lower cost inventory while they're taking price leading to higher gross margin that then starts to mitigate through the cycle. So over time, our gross margins will become much more comparable to others based upon the differences in our accounting treatment. So we expect our gross margin and specifically our price cost, which is not the biggest impact here. It is a timing difference to moderate as we go through the end of 2025 and into early 2026 as we continue to take price.

Your next question comes from Jacob Levinson with Melius Research.

I understand that these tariffs are constantly changing, but with a 30% tariff on imports from China today, which differs from other major manufacturing locations, is the economic landscape for private label products shifting in comparison to branded products? It seems like it might not be a simple situation since branded products are also produced in China or Vietnam. I'm trying to understand if there has been a significant change in the economics of private label products.

Yes, first of all, we have a significant amount of U.S. private label production, which remains unaffected. However, the China component of private brands could be impacted, depending on detailed analysis at the SKU level. Some SKUs may become less competitive with a 30% tariff compared to national brands, while many others will still retain competitiveness from China. We are closely monitoring the situation, and I believe that after the next quarter, we will have more insights on the cost increases affecting our private brand. The impact will vary significantly by SKU, and we will gain a clearer perspective over time.

Okay. That makes sense. And just on a brighter note, Zoro seems to be hitting its stride there. I know Tommy asked about it as well. But can you just help us understand like what's really changed in that business? I know there's been a lot of cross-pollination with MonotaRO, but it seems like they're finally kind of getting the flywheel going there.

Yes, yes. I think I'd point to a few things. One is I think they've done a nice job of improving who they target to acquire and then getting to repeat business with those customers. And that includes how they think about what products they promote, how they think about evaluating customers initially, and then how they think about basically marketing to those customers that are attractive. And so a lot of what MonotaRO has done to be successful, they built and ported over the logic. It's a little bit different in this context. But to basically get to that repeat business. And that repeat rate is really, really important. That's up about 200 basis points year-over-year, which is a big deal to that business. The other thing I'd say is, as they grow, they had already built out a lot of the capabilities, they get really good leverage when they grow at this point because they don't need to add nearly as much cost. So those two things are really working in their favor.

Your next question comes from Ryan Merkel with William Blair.

So it sounds like a key message here on gross margin is that the update is more about LIFO than it is price/cost. So my question is, the new 50 basis point headwind to gross margin for the year, how much of that is LIFO and how much of that is price cost timing?

I will say the majority of that is LIFO. And again, I think we'll really start to see the price cost portions of that unwind into 2026. There is a component there, but as I noted, I kind of noted the impact of High-Touch in this quarter is significant. It is the main event when you look at the year-over-year decline to High-Touch gross margin.

Yes. I would just say, we've said this a few times, RGP would have been flat year-over-year, which is actually better than we expected to start going into the year if we didn't have LIFO. So while we have some price cost headwinds, we have other things that have been positive as well. And so LIFO on the math basis is the entirety of what we're seeing right now.

Okay. That's helpful. And then my follow-up, this might be kind of a hard question, but there's new tariffs being announced today. And one of the questions I'm getting from clients is, is there going to be more price cost risk now in the second half if you have more tariff-driven inflation?

Hard to tell. So I mean, clearly, China is the most significant trade partner we have at this point. So some of the countries that are being announced have much smaller impacts than China does. And Mexico hasn't changed. They are significant trade partners as well. So it just depends on which countries have that happen to them. And right now, there's obviously risk depending on what happens or opportunity as well, depending on what happens going forward. But China is the biggest one we have to watch. And so, so far, I don't think the things that have been announced today would have a huge impact on us.

Your next question comes from Christopher Glynn with Oppenheimer & Company.

So you mentioned a great description of the decision-making process with deferring on price a bit, and you talked about the customer benefits and the good feedback there. I wanted to talk about maybe what long-term strategic goals you might have had in mind there along the way as well. Is this sort of a nice arrow in the quiver as you go through next rounds of contract negotiations and display into the wallet share strategy?

I believe our long-term strategy for market share is focused primarily on delivering outstanding service, assisting customers in reducing costs, guiding them through their purchasing process, and supporting inventory management. We understand that winning the tariff transition is not our main priority. Our focus is on undertaking the right actions for our customers while ensuring we foster loyalty and trust. This is a significant aspect of our operations, and we believe it will benefit us in the long run. While we are not specifically aiming for immediate market share gains, we do believe that this approach will contribute positively over time.

Okay. Great. And just a follow-up on Zoro. It's had tremendous sequential momentum in the last few quarters. I think the high end of your guidance has kind of flattish through the back half. Is that just conservatism relative to 2Q?

Yes. Last year, they're cycling some tough comps. So it's just a modest deceleration but nothing to worry about. We're still very bullish on their outlook.

Your next question comes from Deane Dray with RBC Capital Markets.

I'd like to circle back on the Zoro SKU pruning. I consider this to be a very healthy process. But I'd love to hear just a bit more detail on the algorithm, the approach here? Is it simplification? Do you look at returns by SKU, the volume that's being done, and frequency of ordering? It's probably all of the above, but what is the net impact?

The net impact is basically nothing. These are SKUs that basically weren't moving. And frankly, we're probably not helping searchability on the website. And so these are very low risk, like no risk financial decisions that were made in the quarter.

Great. Will you be implementing a similar approach with the core Grainger offerings? Have you made any significant cuts to the SKUs? Can you provide us with an overview of that process?

We do that on an ongoing basis. That is not new for us. We probably have 80,000 SKUs followed every year, roughly or something like that, and then we add a little bit more than that to get to the net assortment number. But that is a very well-trod path and the analytics to make those decisions a very clear have been in place for a long time. I think with Zoro, the difference is you added so many so fast. We've added things that we didn't know if they were going to sell or not. And so if they didn't, then we made the decision.

Your next question comes from Christopher Dankert with Loop Capital Markets.

I apologize for returning to the topic of pricing, but regarding High-Touch pricing specifically, you indicated a target price of 1 to 1.5 points for the quarter, yet we ended up essentially flat. Was this completely counterbalanced by a negative mix, or did it reflect weak price realization?

When we discussed our expectations for realizing 1% to 1.5%, we were referring to an annualized run rate. You're correct that for the quarter, we need to consider how much of that will be realized in the next quarter. The actions we implemented in May didn't cover the entire quarter, which affects the results. Additionally, when we compare to actions from the previous year, the increases we had last year were greater than those taken this year, which also impacts the year-over-year comparison. Furthermore, our sales team is adjusting prices for different SKUs at various times, making it challenging to assess price elasticity. However, the trend this month shows improvement, giving us the belief that we will reach the 1% to 1.5% on an annualized basis. For September, with our ongoing confidence and additional pricing adjustments due to tariffs and negotiated costs, we aim to pass through enough to achieve an additional 2% to 2.5% on an annualized run rate to offset those increases. As we mentioned earlier, for all of 2025, we anticipate realizing about 1%, combining both factors with the timing, especially since we are seeing more competitors increasing their prices. We expect a return to a more normalized environment, which will enable us to realize results more in line with our historical performance.

I guess just as a follow-up here. I noticed you moved about $100 million from the buyback towards CapEx investment in the guide here. Just maybe some color on what we're spending on, what kind of projects are moving forward here that look more attractive today?

Yes. I would say that the majority of that is related to supply chain investment, and it presented an opportunity for future growth. This isn't something that will have immediate effects, but it is part of our long-term strategy. We are focusing on the future evolution of our network, and we saw a chance to increase our budget.

Our next question comes from Sabrina Abrams with Bank of America. Yes. What I would say is the vast majority of that is in supply chain investment, and there was an opportunity to make an investment for the future. It's not going to be near term, but it's longer term. So we're thinking about the longer-term network evolution, and there was just an opportunity to add some money to the budget.

Apologies, I'm also going to go back to pricing. But if I look at like the government pricing data for nondurable wholesalers, like the smaller machinery equipment and supplies wholesalers. The industry data is closer to like mid-single digits up year-over-year. And I just want to understand maybe it's something in the definition of how you report pricing. But just want to understand like maybe the difference between what the government data suggesting inflation is running at versus reported pricing for you guys?

Yes, I think it's an interesting situation. We believe we have better scale and the opportunity to avoid some of the cost increases that others might face. We usually align our costs with our pricing, and that’s what you can expect from us in the coming years. However, we anticipate a run rate of 3% to 4% by the end of this year. You will see us raise prices, but we may not implement those increases as quickly as others do. This has been our typical approach during periods of inflation.

The High-Touch volume performed better than my forecast for the quarter. We seem to have some monthly sales, and in July, it appeared to improve due to easier comparisons. Is there anything noteworthy about the demand trends this quarter? I realize you don't have significant exposure to major capital projects, but it seems some other manufacturers are feeling more optimistic about the macroeconomic environment in July. Could you provide any insights on that?

Yes, it's challenging to discuss the macro environment. I believe the macro situation has been consistent. As I mentioned earlier, we are gaining market share and our volume share performance was quite solid this quarter. We anticipate that will continue into July. Overall, it seems there hasn't been a significant shift; the demand environment remains somewhat subdued, but we feel we are managing reasonably well under these circumstances.

Your next question comes from Ken Newman with KeyBanc Capital Markets.

Maybe to follow up on that last question. It sounds like you are confident about the net price realization for the second half based on the negotiations that have already been finalized. Is this confidence rooted in the expectation that volumes won't be negatively affected when you implement these price increases, or do you believe there is also a level of stickiness among your current customers when it comes to volumes today?

We believe that price increases and overall inflation will affect market demand. We are noticing that market demand is not performing as well in the second half compared to the first half. This is where we see the impact. However, we do not feel that we are uniquely affected by this; we think the same applies to everyone in the market. Therefore, we are confident in our ability to implement price increases despite the lower market demand.

Yes. You do have that right. And again, we talked a little bit earlier about the fact that some of it is the comp that Zoro is cycling through because they had a stronger back half last year after some of the actions they took the prior year. And so when you look at it on a two-year basis, we feel like the numbers are in the right realm. So it's really a comping issue for EA.

And your next question comes from Patrick Baumann with JPMorgan.

One quick one on gross margin. So it looks like the exit rate on gross margin in the fourth quarter is maybe in the high 38% range. Given the timing of the price increases coming through, which I think you said are going to annualize at 3% to 4%, maybe that hits at some point in '26, but starting in late '25, I guess. And then also the LIFO impacts to '25, do you think 2026 will be a year of gross margin expansion back to that 39% level just based on all those things and this LIFO dynamic that sounds like it's timing related?

I would say that would be reasonable, all things equal and no other dramatic changes there and things like that are announced.

Today, we would say that would be very likely. But obviously, things could change. But yes, that is the way it should flow.

I mean I'll take that as an encouraging sign because I actually wasn't really expecting a response from you on that. The next question was on government customer dynamics. It looks like things were relatively stable in the quarter after slowing a bit in the first quarter. Can you talk about whether you've seen contract cancellations at all impact your business there and whether you've been able to backfill that with other activities? Just any dynamics within government customer federal versus state, local versus military, however, you want to talk to it?

Yes. We haven't had any contracts canceled and we usually handle small orders with our customers. The non-military federal business has definitely been struggling, while the military sector has performed well. State and local business has been mixed; some states are thriving while others are not. Overall, aside from a small portion, our business is comprised of 70% state and local and 30% federal. Most of our work is in federal and military areas, which have not been significantly impacted. The small portion that is affected is minimal.

And there are no further questions at this time. So I'll hand the floor back to management for closing remarks.

Thank you for joining us today. We truly appreciate it. This is an interesting time for us. From our perspective, Endless Assortment had a successful quarter and has significant momentum. We believe the High-Touch model is gaining market share, and the volume appears strong. Our overall performance would have been quite good if not for LIFO; however, we are currently dealing with LIFO. As a result, we have adjusted our guidance based on this, and it will take several quarters for this issue to resolve. Additionally, we expect market demand to be somewhat subdued, reflecting our outlook on the impact of tariff price increases. We view this as temporary. None of these factors alter our perspective on the business or how we operate. As I mentioned, our focus remains on long-term health and success. We feel confident in our strategies and execution, and we appreciate your participation today. Thank you.

This concludes today's conference. All parties may disconnect. Have a good day.