QVC Group - Earnings Call - Q2 2020

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by. Welcome to the Qurate Retail, Inc. 2020 Quarter Two earnings call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press star one on your telephone. As a reminder, this conference is being recorded today, August 10th. I would now like to turn the conference over to Courtnee Chun, Chief Portfolio Officer and Senior Vice President of Investor Relations. Please go ahead.

Courtnee Chun (SVP of Investor Relations)

Thank you. Before we begin, we'd like to remind everyone this call includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual events or results could differ materially due to a number of risks and uncertainties, including those mentioned in our most recent Forms 10-K and 10-Q, filed by our company and QVC with the SEC. These forward-looking statements speak only as of the date of this call, and Qurate Retail expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein to reflect any change in Qurate Retail's expectations with regard thereto, or any change in events, conditions, or circumstances on which any such statement is based. On today's call, we will discuss certain non-GAAP financial measures, including adjusted OIBDA margin, free cash flow, and constant currency.

Information regarding the comparable GAAP metrics, along with required definitions and reconciliations, including preliminary note and schedules one through three, can be found in the earnings press release issued today on our website or the earnings presentation, which are available on our website. Today, speaking on the call, we have Qurate Retail Executive Chairman Greg Maffei, President and CEO Mike George, and Qurate Retail Group CFO Jeff Davis. Please note we've published slides to accompany the earnings release. These slides are available on our website. Now, I'd like to turn the call over to Greg.

Greg Maffei (Executive Chairman)

Thank you, Courtnee, and welcome to all of our listening audience. Let me also start by thanking the Qurate Retail team members on their exceptional results, truly reflective of their dedication and perseverance. Mike and Jeff will be on shortly to provide more details. Let me begin with some corporate updates. We know capital return strategy has been an ongoing topic among our investors as we paused buybacks last year. Our historical buybacks have not been as successful as we'd like, largely due to the market's more negative outlook of Qurate Retail's terminal value. While our view may differ, our management and board looked into and explored alternative approaches for return of capital to deliver sustained benefits to shareholders.

Given the strength in Qurate Retail's free cash flow and our confidence in its business fundamentals, we intend to return capital to shareholders via a special dividend consisting of two pieces: a one-time cash dividend of $1.50 a share and a preferred stock dividend of $3 a share. The proposed one-time cash dividend will total approximately $633 million, and we arrived at this amount in reviewing the projected 2020 free cash flow, the expected proceeds from the sale of our Solana Generating Station, and cash built in part from our pause in share buybacks over the past year. This could be important also in terms of having this dividend now because it might be optimal timing in the event tax rates increase in the coming years. The proposed preferred stock dividend will have a total base of approximately $1.3 billion. Why did we choose a preferred stock dividend?

Effectively, we're dividing Q's common stock into a more bond-like instrument and a more levered common equity. In line with many of the other things we've done in terms of providing investor choice, this should increase investor choice as well, much as our tracking stock and SpinCos have done. Unlike the recurring common dividend, which forces common shareholders to receive a distribution, this provides shareholder flexibility. You can hold an income-paying security or monetize your preferred stock and maintain a net position in a more levered common equity. We think this could be an attractive and innovative security for those who elect to hold it. It generates compelling after-tax income at a rate which is appealing compared to bond choices out there and other alternatives, and a relatively low-leverage entity given significant cash generation and coverage.

As I mentioned, the rate is favorable to comparable securities, and it will yield the highest after-tax yield of all of Qurate Retail's debt-like instruments. It's a long 10 years maturing in the Q1 of 2031. This preferred stock will also highlight our management and board director's confidence in the strong free cash flow generation at Qurate Retail. We also hope it might be able to attract a new investor base. The preferred might be, should be a good fit for income-oriented investors seeking yield. John and I are both enthusiastic about this preferred stock and intend to be long-term holders. I'd also note for some of you with a historical bent, Liberty has had some success issuing these preferreds in the past, although admittedly, it was a fair time ago.

Over the longer term, we expect the preferred stock and common equity in aggregate, after giving effect to the cash dividend, to trade in excess of the current trading price. As we move to the balance of 2020 and in future years, we will actively consider additional forms of capital return given the substantial cash generation that Qurate has. We retain the ability to deploy this cash commensurate with Qurate Retail's past shareholder practices. To be clear, buybacks are not off the table in 2020 and beyond. In any future, buybacks will be against a more levered upside in the business. We also intend to manage the detail, the deferred tax liability on our exchangeable bonds, as well as the near and midterm debt maturities. You should expect some future repurchases of some of the exchangeable bonds as we have done in recent years.

Finally, given the ongoing pandemic, we have decided that Liberty's investor day this year will be virtual and be broken into two days. And so, as much as we love Zoom, no one should have to be on a call that long. On Thursday, November 19th, we will cover Liberty Media and Liberty TripAdvisor, and on Friday, November 20th, we'll include Qurate Retail, Liberty Broadband, and GCI Liberty. Both days will run from 11:00 A.M.-12:00 P.M. Eastern. More details will be provided on our website, but please mark your calendars. And with that, I'll turn it over to Mike.

Mike George (President and CEO)

Thank you, Greg, and good afternoon, everyone. Thank you for joining us. We are certainly living through a period of unprecedented challenge fueled by the ongoing impacts of the global pandemic and the renewed outcry for racial and economic justice. I want to start today's call by summarizing the actions we've taken in response to these extraordinary events, and then I'll review our results and our outlook for the future. In terms of our actions, first, our primary focus remains on protecting the health and the financial well-being of our team members. All team members who can work from home will continue to do so until at least early next year, and some will work from home permanently, most notably in customer service. Social distancing, mandatory mask requirements, and stringent cleaning regimes are in effect at all of our sites.

We've provided a variety of special pay, leave, and medical and other benefits, along with work-from-home allowances for our team members. Second, we continue to support our local communities. We're especially proud of our Small Business Spotlight, giving small businesses impacted by COVID visibility across QVC, HSN, and Zulily, and we'll shortly launch a new series focused on black-owned small businesses. Our record-setting Beauty with Benefits program on QVC and HSN delivered a projected $2.5 million for Cancer and Careers, with $500,000 directly supporting COVID-related grants and programs. And we donated over $1 million to the Equal Justice Initiative. Altogether, the COVID relief commitments facilitated in support of our communities, for our team, along with our commitments to combat racial injustice, total $40 million. Third, we rapidly pivoted our product programming, events, and marketing to be in tune with what consumers most care about now.

We aspire to be her refuge, a place for advice, entertainment, and community, and a source of joy, hope, and inspiration. Fourth, we executed a significant strategic pullback on promotional activity across all businesses to provide a better foundation for healthy, sustainable, long-term growth and also to manage elevated demand. Fifth, we simplified and streamlined our operating structure and better aligned resources with the biggest growth opportunities. Unfortunately, this necessitated separating with 450 valued team members. Additionally, we closed multiple customer contact centers as we shifted those positions to permanent work from home. And finally, we further strengthened our balance sheet with prudent inventory reductions, more conservative consumer installment payment practices, and our new trade payables program. We are enormously grateful to our 25,000 team members who navigated these changes with determination and resilience, committed to helping our customers and helping each other get through this crisis.

I've also been inspired by the outpouring of care and concern from our team in response to the death of George Floyd and other recent instances of racial injustice. We are committed to creating a culture of belonging for all team members, and we are redoubling our efforts to provide multicultural product assortments, ensure broad representation in our marketing, digital, and on-air activities, and establish a more diverse supplier base. These actions we took in response to the pandemic, coupled with continued progress on our strategic priorities and the favorable macro trends from the stay-at-home shift, led to outstanding results in the quarter. Revenue and adjusted EBITDA increased 10%, with every business unit and every geographic market demonstrating strong revenue growth. Free cash flow grew to $1 billion year-to-date and an increase of nearly $800 million compared to last year. And this growth was fueled by record-setting new customer gains.

We welcomed 2 million new customers to QRG, a 60% increase over the prior year, with double-digit new customer growth in every business unit and every market. We also enjoyed strong growth in reactivated and occasional customers, all fueling a 14% growth in the total customer count across the company. We're especially encouraged by the strong performance across our QVC and HSN brands globally. Growth was powered by high demand for home-related products and consumer electronics, partially offset by softness in apparel and jewelry. In mid-May, we made the decision to pull back substantially on a variety of promotional activities to provide a better foundation for healthy long-term growth while moderating the immediate sales surge, which we were struggling to keep up with. On an order-of-demand basis, we saw low-to-mid teens growth before the pullback and low-to-mid single-digit growth after, but at more attractive margins.

Our total active customer base increased significantly at 14% at QXH and 9% at QVC International. We attracted record levels of new customers, coupled with strong increases in reactivated and occasional customers. However, sales from our best customers, those who make over 20 purchases per year, declined modestly. They increased their home and electronics purchases, but this was offset by a sharp pullback in apparel, where they significantly over-indexed. Throughout this challenging time, we have stayed committed to advancing our strategic priorities, which we see as critical for long-term growth. First, we remained focused on curating special products at compelling values as we strive to be a source for unique, innovative, and exclusive merchandise, inspiring consumers and fueling serendipitous discovery.

These actions include the recent launches of our new QXH merchandising organization and our regional QVC International merchandising function, the growth of our proprietary design, development, and sourcing team, including adding additional categories like home. Highlights from this team include the successful launch of August & Leo, the new home decor brand with Giuliana Rancic, as well as the relaunch of the Iman Lifestyle brand. New categories that reflect shifting consumer demand, like our new social distancing category, which offers masks, digital thermometers, enhanced sanitizers, and much else. Rapid expansion improved with 37 new offerings in Q2. Expanding our size-inclusive offerings with two major launches this quarter, All Worthy by Hunter McGrady at QVC and Fitty Britttty by HSN, along with expanding our size range to five times to 5x in all apparel lines.

As a result of our push on product freshness and programming diversity at QVC, at QVC US, we introduced 44 new on-air brands in Q2, that's up from 18 the prior year, devoted 132 programming hours in the quarter to new shows, up from 80 last year. And our top 25 items per day represented just under 38% of our sales on the day, down from 41% last year. We're also making great strides on our second strategic priority, extending our video reach and relevance across all the video platforms that matter to today's consumer. TV, of course, remains critical. Our viewership on traditional pay TV is up, even as the number of pay TV homes declines. At QXH, we saw a strong 10% gain in homes viewing one of our networks on any given day.

We're benefiting from the shift to stay-at-home, and we're rapidly pivoting our programming to the themes most relevant in this environment, reflecting the agility of our model. We are also expanding on digital pay TV services, or virtual MVPDs, most notably launching on Hulu this quarter, following our AT&T Now launch late last year, and we're on track to find more digital carriers in the back half. We also added more than two million over-the-air households in the quarter. Altogether, we now reach 95 million TV homes in the U.S., including 76 million traditional MVPD homes, 4.5 million virtual MVPD homes, and 14 million over-the-air homes. In addition to these gains in TV viewership and distribution, we're highly encouraged by progress on our streaming shopping services that we make available across multiple digital platforms.

Consumer adoption of video streaming services has significantly accelerated during the pandemic, and there's a great deal of buzz about live stream shopping as an alternative to physical shopping. We're pleased with this validation of our unique model and aim to extend our significant leadership position. We continue to enhance and expand our core streaming shopping service, which brings together our QVC and HSN networks, along with a variety of specialized and unique on-demand content. This service is now available on 45 million Roku and Fire TV homes, and over 3.6 million homes have downloaded our app. That's a 100% year-over-year increase with strong growth and unique visitors and minutes streamed. We're accelerating our investments in specialized content for this service that can attract new audiences, including 10-part series such as the upcoming launch of our Curtis Stone Travel and Food series.

We're progressing on the next generation version of this service, which will feature embedded transactional capabilities. We're also expanding the reach of our networks to other over-the-top devices, such as Comcast's new Xfinity Flex streaming service, available to their broadband subscribers who don't purchase Comcast Video. Into a growing range of over-the-top services, including those offered by Samsung TV Plus, Xumo, and LG Channel Plus, with more on the way. Finally, we continue to expand our presence on social video sites. We recently launched a dedicated Facebook page that features live streaming of all our QVC networks, integrated with compelling social content and conversation. On YouTube, our new collaboration with Estée Lauder drove 1.3 million minutes viewed and hundreds of new subscribers to our Beauty IQ YouTube channel to check out Estée Lauder's expert tips.

Our third priority is to reimagine daily digital discovery and bring to our e-commerce platforms the same level of engagement and inspiration that characterizes our video platforms. We recently launched a new engagement tool which uses machine learning to present personalized messages on the websites at key moments in the shopper's journey, creating excitement and urgency while staying true to our brand voice. We realized strong growth in all e-commerce metrics in the quarter. At QXH, digital sessions grew 36%, purchases of off-air products, those that are not featured that day on the video platform, grew 24%, and e-commerce penetration was just shy of 60% of total sales of 440 basis points year-over-year, and QVC International experienced even stronger results, with e-commerce penetration up 650 basis points.

Zulily also delivered strong revenue growth on record new customer additions, as we benefited from the overall macro shift to e-commerce, coupled with strong progress on our turnaround initiatives. We've taken an important strategic pivot. The organization refocused all consumer-facing activity on its original target of moms with kids at home. The team leaned into Zulily's core brand attribute of fresh finds at amazing values, adding more than 800 new vendors in the first half, supported by topical events relevant to the stay-at-home customer. Fabric face masks have been one of their most successful offerings, selling over 3 million units, as the team was able to move quickly to secure supply early in the crisis. Zulily also made great strides refocusing its marketing programs, significantly reducing friction in clients from Facebook, improving lookalike targeting, and enhancing outbound marketing.

After a difficult year, we're encouraged to see the team's hard work to reposition the Zulily business, gaining traction, buoyed by the e-commerce tailwind, reinforcing, in our view, the fundamental attractiveness of the Zulily value proposition. Cornerstone delivered outstanding results with strong growth at Frontgate, Ballard Designs, Grandin Road, and the home segment of Garnet Hill. The business benefited greatly from the stay-at-home trend, coupled with significant work over the last two years to develop more updated, relevant, and proprietary assortments, while shifting resources from catalog to online marketing. I want to close my comments by directly addressing the question on everyone's mind: can we sustain growth and healthy margins as the economy reopens?

While we certainly recognize that the outsized gains that we achieved this quarter are likely not sustainable, we are more confident than ever that our business can generate healthy long-term growth and revenue, profits, and cash flow for a number of reasons. First, we anticipate that many COVID-related trends will continue over 2020 and, to some extent, become part of the new normal, including greater consumer engagement with live streaming video content, the accelerated shift to e-commerce, the difficulty of creating engaging experiences in brick and mortar, given the limitations on customer interaction, and the refocus on a more home-centered life. Second, we believe we're uniquely suited to benefit from this environment. We feature broad and diverse product ranges and can rapidly flex our mix for current and emerging home categories at QVC, HSN, and Zulily.

In Q2, we were able to be there for her as she moved from cleaning to fitness and self-care to home office to entertainment and puzzles to indoor decor to pool and garden to food to cookware and gadgets to masks, sanitizers, and air purifiers, and our focus on unique, differentiated, and exclusive products with compelling personalities and a focus on the entrepreneur keeps us out of the commoditized, price-driven e-commerce race and appeal to the spirit of the times. We are one of the world's largest shopping platforms under one roof, shipping over 220 million packages per year with the benefits of scale, experience, and efficiency, and QVC and HSN, and Zulily as well, are centered on relationships, community, authenticity, and engaging experiences, attributes that matter in these trying times more than ever.

It's why we enjoy a level of loyalty and purchase frequency that is virtually unmatched in retail. And third, our confidence in driving long-term growth stems from the traction we're seeing on our strategic priorities, which perfectly intersect with these macro forces. This progress is reflected in key metrics we follow. For example, we're seeing gains in product curation and programming diversity, as measured by the success of the new on-air brands and programs I mentioned, and the reduced concentration of top items. Our video programming is accessible and viewed in more and more places to offset cord cutting.

Growth in virtual MVPD and OTA households, unique visitor growth at Roku and Fire, growth in video views on our web and mobile app platforms, are all up strongly, even as our traditional TV viewership has consistently outperformed the underlying erosion in pay TV homes, and that's been going on for many years. E-commerce engagement continues to strengthen. We're seeing growth in daily visitors, growth in offered product assortments, and increased e-commerce penetration, metrics that were all moving positively before the pandemic and are now accelerating. And most importantly, we're seeing growth in our active customer base. Our strong new and reactivated customer growth benefited significantly by the stay-at-home trend.

But if our value proposition wasn't highly attractive to consumers, we simply would not have seen so many non-customers convert from merely watching our programming or visiting our websites to becoming active customers, with all early indicators pointing to these new customers having strong lifetime values. With existing customers, we're highly encouraged by the surge in spending among occasional customers, but also cautious about the slowdown from best customers. Expect these two to play off each other to some extent, with occasional customer growth continuing due to strength in home, but likely moderating over time, and best customer growth gradually resuming as she eventually reengages with fashion products.

And finally, Jeff will further discuss why we see opportunities to continue improving OIBDA margins and free cash flow yields as we start to see the benefits of the investments of the last 18 months. As a global community, we undoubtedly have difficult days ahead of us. With the pandemic far from over, the U.S. election season in full force, and the economic outlook uncertain, nonetheless, we are confident that we are and will continue to be one of the winners in this new normal. And with that, I will turn it over to Jeff.

Jeff Davis (CFO)

Thank you, Mike, and good morning. Good afternoon, everyone. As Mike mentioned, QRG's net revenue grew 10% for the quarter, with all segments delivering mid-single to high-teens growth. OIBDA improved 10% and included several discrete items, including an incremental $10 million of severance across all business segments and a $5 million inventory provision at Cornerstone, partially offset by a $10 million reduction in sales tax accrual at Zulily that was originally recorded at the time of acquisition. Let's start with QXH.

QXH returned to net revenue growth on a foundation of new customer growth and strong e-commerce performance. As Mike said, we have a broad product portfolio, which enabled us to meet customer demand. As you'll see on Slide 11 in the earnings presentation, we experienced a sizable shift in category mix from apparel, accessories, and jewelry to home and electronics. While the team responded well to these changes in customer demand to drive revenue growth, it placed substantial gross margin pressure. For the quarter, QXH total customer grew 14%, with existing customers up 4%, reactivated customers up 29%, and new customers growing 74%. We are encouraged by early indicators of our new customers' behavior. 30- and 60-day retention rates have increased, while 30- and 60-day post-initial purchase spend is largely consistent with prior year levels. Let me provide additional detail on individual category performance. Home increased 22%.

Demand for our gourmet food offerings led the way, nearly doubling. We also experienced strong growth in gardening, fitness, floor care, cleaning, and personal care. Consumer electronics grew 25%, driven primarily by increased interest in home office, entertainment, and gaming. Trends moderated later in the quarter as we reduced the installment payment options available to manage that debt risk. Beauty returned to growth, up 2%. We continue to see success with our efforts to nurture emerging brands such as Beekman, Isle of Paradise, Fleet, and Lancer. But this was partially offset by continued declines in major national brands. In apparel, accessories, and jewelry businesses, we're highly challenged. We were down 12%, 1%, and 11%, respectively. Customers pulled back significantly on their clothing, handbag, and footwear purchases. The apparel decline moderated through the quarter but remained challenged.

However, we are seeing pockets of strength, including active and athleisure, along with loungewear and intimate apparel. Adjusted OIBDA declined 2%, and adjusted OIBDA margin declined 180 basis points. Excluding $9 million of incremental severance year-over-year, adjusted OIBDA was up modestly. Let me share a little bit more of the details behind the margin decline. First, gross margin. We declined 90 basis points, driven by two of its major components: product margin and fulfillment. This were down 25 basis points and 60 basis points, respectively. With respect to product margin, recall last quarter, Mike indicated the shift in category mix led to a 150-200 basis points decline in initial margin in April. In the back half of the quarter, we were able to moderate product margin pressures for three primary reasons.

One, most importantly, we made strategic adjustments to our promotional offers, resulting in greater shipping and handling revenue and more products sold at a regular price. Two, the pressures from category mix lessened as the quarter progressed and our prior year apparel sales were lower in June. And three, we benefited from lower customer returns. With respect to fulfillment, the 60 basis point decline was primarily associated with premium pay to our fulfillment center team members, along with lower productivity due to COVID protocols, lower pack factor, general freight rate increases, and higher drop shipments, partially offset by reduced returns and sales leverage. The lower pack factor was a result of several elements, including delays in the implementation of our common warehouse management system and the ramping of our network optimization efforts, the operating protocols, and product mix shifts. Moving to operating expenses, which were 20 basis points favorable.

This improvement was predominantly due to a 35 basis point of tailwind from commissions, primarily from increased digital penetration, not subject to variable sales commissions. SG&A was unfavorable by 105 basis points, with marketing and administrative costs comprising 55 basis points and 40 basis points, respectively. Marketing reflected expanded support to deliver new customer growth and retention. It also included one-time investments in various brand marketing pilots. Administrative costs benefited from sales leverage. This benefit was more than offset by increased incentive compensation accruals and severance. I would like to share some of the trends we're seeing as we wrap up our July results. However, these trends should not be construed as guidance for the remainder of the quarter. In addition, while these references to demand sales approximate customer purchases, actual ship sales may differ. QXH demand sales through July were up low single digits on reduced promotional activity.

We've experienced similar category trends with growth in home and softness in apparel, accessories, and jewelry. Customer growth remained strong with double-digit growth in new customers, albeit levels below second quarter. Moving to Adjusted OIBDA, we expect sequential quarterly improvement in margins in Q3, largely driven by improvement in product margins due to our reduction in promotional activities and vendor negotiations. We anticipate ongoing margin headwinds and fulfillment as productivity and freight rates remain under pressure, and we continue to invest in marketing while carefully monitoring returns. With respect to obsolescence, we are refreshing inventory levels to take advantage of new home and apparel opportunities for fall and winter, and we expect to increase obsolescence reserves accordingly. Finally, we expect a continued tailwind as commissions, as well as modest improvement in bad debt and fixed cost leverage. Now let's move to QVC International.

With accelerated first quarter momentum, with broad-based growth across all markets, extraordinary new customer growth and retention, and the continuation of strong e-commerce penetration. My comments going forward will focus on the constant currency results. We generated growth in all markets led by Germany and the U.K., with Japan achieving two-year stack growth of 17%. From a category perspective, we experienced sales growth in electronics, which was up 41%, home was up 24%, and beauty was up 18%. Adjusted OIBDA increased 13% with gains in all markets. Adjusted OIBDA margin increased 10 basis points with very similar themes as QXH. Gross margins were lower, primarily due to product margin pressure from category mix shift, obsolescence provisions from closure of retail stores that provide a sales outlet for slow-moving inventory, higher drop ship penetration, and premium pay for on-site team members.

Favorable trends in operating expenses were primarily coming from commissions and customer service, reflecting an expanded e-commerce penetration and sales leverage. Administrative expenses were largely favorable due to sales leverage, despite absorbing provisions for increased incentive bonus. Recall QVC France terminated operations in March of 2019 and recorded a $2 million adjusted OIBDA loss and approximately $17 million operating loss in Q2 2019, primarily related to closure costs. Looking at the second half, demand sales for July trended up into the mid- to high-single-digit range, with strong strength across Europe and Japan. As a reminder, last year, we experienced double-digit growth in Japan in Q3, as we saw significant sales pull forward in September in advance of the consumption tax increase. Accordingly, we expect Japan sales to moderate significantly in the back half of Q3. Moving to Zulily, which delivered exceptional return to growth.

Total customers grew 15%, and new customers grew 54% in the second quarter. Customer acquisition costs declined more than 50%, driven by e-commerce tailwind and adjustments to our marketing strategies. Adjusted OIBDA increased $38 million, which included a $10 million reduction in sales tax accrual I referenced earlier and was originally recorded at the time of acquisition. Gross margin increased primarily from strong product margin gains, driven by strategic vendor negotiations. These gains were partially offset by fulfillment pressure, primarily from higher freight costs, as well as COVID-related delivery pressure, which improved by quarter end. Zulily also benefited from sales leverage of marketing and administrative costs, and looking at the second half, July demand sales trended up in the low teens. Moving to Cornerstone Brands, which delivered a record second quarter performance.

Revenue grew 18% as the business experienced strong consumer demand for home furnishings, office, storage, pool, and outdoor products. The home brands were well positioned to capitalize on increased demand for home furnishings and outdoor products. Ballard Designs, Grandin Road, achieved record second quarter revenue, and Adjusted OIBDA and Frontgate generated 23% revenue growth. The strong gains in home brands were partially offset by a decline at Garnet Hill, mainly in the women's apparel category across dresses, footwear, and swimwear. Although Cornerstone retail stores remained closed for much of the quarter, it was able to offset this pressure through its online channels. E-commerce revenue grew 32%, and e-commerce penetration improved more than 800 basis points. Adjusted OIBDA increased $7 million. Gross margins improved primarily due to the strength in the home brands, partially offset by promotional pressure at Garnet Hill and a $5 million inventory provision at Ryllace.

Ryllace is a nascent, innovative apparel brand. Given the general pressures on apparel-related COVID, Garnet Hill's replenishment team made a decision to focus resources on the core apparel products and development of a new strategy for Ryllace in this new environment. SG&A improved primarily from leverage of marketing and administrative expenses, partially offset by higher incentive compensation accrual. Quarter-to-date sales demand is trending consistent with the second quarter. Let's quickly take a look at our balance sheet and cash flow. CapEx was $63 million through the quarter and $108 million year to date. We anticipate our 2020 CapEx to be in the range of $250 million-$295 million. TV distribution payments are comprised of multi-year carrier contracts. We have less contract renewal activity this year, and year-to-date TV distribution payments were only $10 million. We expect this to increase in the second half of the year.

We generated strong free cash flow in the first half of 2020. As Mike said, year-to-date, free cash flow was approximately $1 billion, an increase of nearly $800 million. This strong gain was primarily driven by improved working capital, lower TV distribution payments, and reduced CapEx. Additionally, we had favorable timing and tax payments, which were primarily reversed in Q3, driven by provisions in the CARES Act. Looking at our debt profile, we have a zero balance on the QVC Inc. revolver and $2.9 billion of available capacity. We have nearly $950 million in cash and cash equivalents, and our near-term maturities on our senior secured notes.

We do not have anything maturing until 2022 and 2023. Our leverage ratio with the borrowing in the QVC revolving credit facility was 2.0 at June 30th. In closing, we are well positioned to continue building on the momentum built in Q2. The strength of our balance sheet and free cash flow gave us a solid base to invest in growth opportunities and continued execution of our strategic plan. With that, we appreciate your continued interest in Qurate Retail. We hope you stay safe and healthy, and now I'd like to open the call for questions and send it back to the operator.

Operator (participant)

Thank you. If you'd like to ask a question on today's call, please press star one on your telephone keypad. Once again, that's star one to join the question queue. We'll take our first question from Edward Yruma with KeyBanc Capital Markets. Please go ahead.

Kasey O’Brien (Equity Research Associate)

Hi, this is Kasey O'Brien for Edward Yruma. First, what plans do you guys have in place to retain the new customers you've acquired? And then looking at that cohort of new customers, are there any differences in profile or consumer behavior you've observed thus far?

Mike George (President and CEO)

Thank you for the question. This is Mike. We're thrilled with the quality of the new customers we're seeing, and we do have multiple initiatives underway to keep them. So let me start with kind of the quality and the profile. Broadly, I would say these new customers look and act like new customers in past years. We just have a lot more of them. We grew new customers in every single product category. We grew new customers both in our off-air business as well as our on-air business. So they're engaging in coming to us both with sort of the more traditional TV programming as well as the digital programming. The key metrics we look at to assess value, like propensity to keep those customers at the 14, 30, 60-day mark, will all be at or above prior year performance.

We even look at what percentage of new customers become best customers in their very first couple of months. And on that major look, as good or better than prior classes. Probably the only modest difference is she's slightly younger, maybe a year or two younger than we typically see with new customers. But other than that, this looks like a very strong profile. That said, we don't want to take it for granted.

So we've got a number of programs underway to market back to her, a variety of sort of personal outbound marketing programs to present her with products she'd be interested in based on her purchase profile. We're doing some programs through Facebook to expose her to kind of product carousels of products that, again, the data would say she'd be interested in. So, kind of encouraged by the team's efforts to have a full court press on retaining these new customers.

Operator (participant)

Thank you. And we'll go ahead and take our next question from Oliver Wintermantel with Evercore. Please go ahead.

Oliver Wintermantel (Managing Director and Equity Research Analyst)

Yeah, thanks. Good afternoon, guys. My question was regarding inventory growth or inventory decline, I should say. It was down about 14% in the quarter. So it looks like your inventory is clean heading into the third quarter, which probably there's not a lot of discounting going on into back to school or the second half. But I was just wondering, did you have problems acquiring inventory into the third quarter, or was that deliberate because of what do you expect in the end of the third quarter? So just a little bit of commentary about the decline in inventory would be helpful.

Mike George (President and CEO)

Thank you, Ollie. I would say that decline, it's actually a couple of things. First is just that, obviously, sales exceeded our expectations, so we were able to move through a lot of inventory. And then we also did take a fairly cautious posture just to make sure we weren't overbought in a very uncertain time. But it was balanced because we did want to make sure we have fresh receipts going through the year at a time when other retailers have probably cut back more substantially. So I think we can get a really nice job of managing those dynamics through Q2. And now we're gradually rebuilding inventories to make sure we're fully assorted going into the fall and holiday season, as Jeff mentioned.

That's all good that we'll have fresh receipts in fall apparel, as an example, in case she does start to want to reengage with apparel products. I'd say the only category that might be a modest watch-out for us is we are seeing the pressures really from the first phase of the pandemic in China, which really disrupted supply in consumer electronics, coupled with the high demand for consumer electronics.

And I would say we're working hard with our partners to make sure we've got a full assortment in electronics for the holiday season. A little bit of risk there, but we're a preferred partner for many, and I think we'll be able to navigate that. But that would be the one area where we might have some modest risk. Otherwise, we do think the inventories are clean, and it'll help us sort of maintain this conservative posture on promotions through the year.

Oliver Wintermantel (Managing Director and Equity Research Analyst)

Got it. And if I may, maybe a second question regarding e-commerce. The growth this quarter was very strong. If you could maybe talk a little bit about where that growth is coming from e-commerce, how much of that is organic? And organic, I mean directly through the website without people watching the program, or is the majority really driven by people watching the program and then offering? If you could give us a little bit of details there, that would be helpful. Thank you.

Mike George (President and CEO)

Yeah, sure. As you know, it's hard for us to be able to perfectly ascertain cause and effect between TV and e-commerce. But probably the metrics that are most important to us on that question would be looking at the mix of sales on e-commerce and how much of it is the core products we're featuring on video and how much of it is products that we're not featuring on video, which we call off-air products. So as I mentioned in my remarks, those off-air products were up north of 20%, so grew much faster than the overall business results. And they represent roughly 40% of total sales and total sales for the business unit and a substantial share of the sales for e-commerce.

So that doesn't mean that the e-commerce customer isn't engaging with the TV product by any means, but we're certainly getting a lot of sales, a majority of sales on items that aren't featured on-air. Those sales are growing rapidly. We're certainly seeing disproportionate e-commerce performance with new customers. So we do think we're seeing a lot of new customers come in and make their first purchases through a more conventional e-commerce experience, and then some of them becoming more broad-based customers of the brand.

Oliver Wintermantel (Managing Director and Equity Research Analyst)

Got it. Thanks very much. Good luck.

Greg Maffei (Executive Chairman)

Can I add one thing here? Which is, Oliver, when you say that the organic, it's funny because I would argue flip it on its head. Organic for us is people who see the TV. It's a fixed cost, fairly fixed cost that we run, a huge brand builder, a huge loyalty builder, and a huge continuous promoter for us. For us, inorganic is where we have to buy online, Google, Facebook, cost per click. And frankly, that's where it has a variable cost, and it's less attractive. So I'd almost flip it on its head. We love the stuff where it's been promoted from the TV, right? We've already paid for that once. Thank you very much.

Oliver Wintermantel (Managing Director and Equity Research Analyst)

Thank you.

Operator (participant)

We'll go ahead and take our next question from Jason Bazinet with Citi. Please go ahead.

Jason Bazinet (Managing Director and Senior Equity Research Analyst)

Just had a couple of questions for Mr. Maffei. I appreciate the choice that you're giving investors with this preferred. I suspect a lot of investors are going to look at this move and say that it sort of lays the groundwork for you to go private, actually. So can I just ask three questions? Day one, when this preferred, if it goes through, is it right to say your $4.8 billion market cap will go down by $1 billion for the preferred and then go down $630-some-odd million for the special? And so the market cap sort of dangles in place.

Greg Maffei (Executive Chairman)

Let me take one at a time. Jason, let me take one at a time. Our hope would be no. Our hope is our equity market cap will decline by less than the combined value of those because we've shown not only the earning capability of the business, but that we can sustain preferred and that some of the excess benefit will prove to come.

Jason Bazinet (Managing Director and Senior Equity Research Analyst)

Understood. Second, what happens to your basis in the asset after this preferred gets issued if it goes through?

Greg Maffei (Executive Chairman)

So if I could just add on the first point.

Jason Bazinet (Managing Director and Senior Equity Research Analyst)

Sure.

Greg Maffei (Executive Chairman)

I know you suggested in the past that when actions were taken, we were going to take the business private, some of them which would have been illegal. And we try not to do things that are illegal. Very assiduously try hard not to do things that are illegal. So again, we certainly didn't do this with an intent to take it private. And if you take the first point that I made, which we truly do intend that the combined value would go up, it's probably not in our interest to do this as well if that was our intent to take it private. So I just wanted to say that is not our intent. Our intent is to create shareholder value for all shareholders. Sorry, go ahead.

Jason Bazinet (Managing Director and Senior Equity Research Analyst)

That's good. So what happens to your basis in the asset after the preferred is issued?

Greg Maffei (Executive Chairman)

Depending on who you are, generally, it's complicated, but it will generally split between the two entities. There may be some cases in which it goes to more to the common. This is one of the, I would say, consult your tax advisor.

Jason Bazinet (Managing Director and Senior Equity Research Analyst)

Okay. And then my last one, what happens in 2031 when the preferred sunsets mechanically? What happens at that juncture?

Greg Maffei (Executive Chairman)

We pay it off or we issue some other kind of instrument, I guess, in exchange of it. But generally, like most debt securities, we would pay it off.

Jason Bazinet (Managing Director and Senior Equity Research Analyst)

Okay. Thank you.

Greg Maffei (Executive Chairman)

Thank you.

Operator (participant)

We'll go ahead and take our next question from Carla Casella with J.P. Morgan. Please go ahead.

Carla Casella (Managing Director and Senior Analyst)

Hi. I'm wondering if you could give us some color on, as we're coming out of COVID, if you're seeing much change in the big business segment, meaning home versus personal care, etc.

Mike George (President and CEO)

Thanks, Carla, for the question. It's been surprisingly consistent. So I would say that the categories that are doing well have been largely consistent through the pandemic. The specifics within those categories obviously change with the seasons, but home just remains very dominant. You can see that in a Cornerstone business, which is all home, continuing to grow at the same rates that it grew through Q2. So she shifted from gardening and outdoor stuff to now indoor furniture and kind of getting ready for the fall, but very much a strong focus across really all home categories. Probably the only area that has shifted somewhat is the consumer electronics is much softer for us.

That's a little bit self-imposed because the promotional pullback that I mentioned most severely impacted the consumer electronics business, which tends to be the most promotionally driven category. So that's probably a little bit more on us than the broad market. But otherwise, we're seeing pockets of positive performance in apparel and some of the more comfort and casual wear. But I would say in the main, apparel and jewelry remain challenged. Accessories and beauty are okay. And really, across the home, with maybe the exception of consumer electronics, we're continuing to see strength.

Carla Casella (Managing Director and Senior Analyst)

Okay. Great. And then just one follow-up on, given the transactions you mentioned with the stock, any change in your view on how much leverage you're comfortable with at the QVC entity?

Mike George (President and CEO)

Greg, do you want to take that or Jeff?

Greg Maffei (Executive Chairman)

I think, sure. I'll let Ben Oren, our new treasurer, comment as well. We've set forth ratings at the Q level, I believe, at two and a half times. We also have some three and a half times, not maintenance covenants, but covenants on our bonds, some of our bonds. Those are certainly targets we're trying to stay within. I don't know, Ben, what would you add?

Ben Oren (EVP and Treasurer)

Yeah, I would repeat that our stated leverage target for QVC is two and a half times. In addition, just to be specific, our aggregate family leverage, or our ability to draw on our revolver, is subject to a three and a half times leverage. So we currently retain most, if not all, of the QVC revolver capacity.

Carla Casella (Managing Director and Senior Analyst)

Okay. Great. Thank you very much.

Greg Maffei (Executive Chairman)

Those are certainly impacted on targets. But we do believe the business could actually maintain higher leverage given its high free cash flow capabilities, but we obviously may want to access at various times of that revolver.

Carla Casella (Managing Director and Senior Analyst)

Okay. Great. Thank you.

Greg Maffei (Executive Chairman)

Thank you.

Operator (participant)

Thank you. And we'll take our last question from Elliot Alper with D.A. Davidson. Please go ahead.

Elliot Alper (Senior Research Associate)

Great. Thanks. Could you talk more about what drove the strong performance as we rolled through the quarter, as well as what drove the new customer growth? Curious if you're seeing this new customer being correlated with the continued push into your OTT distribution efforts. And then secondly, to what extent, if at all, are you seeing any correlation between geographies that are reopening and traffic trends? Thanks.

Mike George (President and CEO)

Thanks for the question. I'm really, really proud of that team's work. After having had a pretty tough year and kind of off the track record of growth we've been on, the team really took the time to reexamine all aspects of the value proposition, really just get refocused on the core mom target, which we probably strayed away from a little bit in the last bit. In the pursuit of growth, really refocused marketing on going after new customers as opposed to trying to get more out of existing customers, and with a number of innovations across marketing, new outbound marketing programs, building up a kind of influencer network to reach into new audience segments through influencers, a lot of hard work with Facebook to remove some inefficiencies in the Facebook interface, all of which I think we're seeing the benefit of.

A number of sort of reforms to the storefront just to make it a little bit more exciting, energizing, more self-service capabilities to improve the service levels of the brand, and then just a huge focus on new brands, and while we're shy about mentioning specific names, with department stores being closed, I think the team did a really nice job getting a lot of product that might have normally been on the specialty or department store channel to Zulily, and we think that that benefit can maintain, so clearly, there's an overall tailwind of e-commerce growing and other e-commerce retailers growing.

But I think the kind of 40-point swing we saw at Zulily from the declines in Q1 to the growth in Q2 has absolutely benefited from that broad tailwind of e-commerce, but that intersected with just a number of these fundamental efforts to improve and strengthen the value proposition. On the question of what's the impact of various states reopening, we're studying performance by geography, by state, very carefully, as you would expect, to try to understand those dynamics. And I think what's broadly true is those states that shut down early and kind of staged shutdown through May and June, probably in the early days of the pandemic, we got a little bit more of a lift from them in that early April surge than other states that had taken a slower posture on shutdown.

But since about early mid-June, I would say performance is more consistent across states than anything else, so even as some states have seen resurgence, other states have seen improvement. It doesn't seem to be meaningful in the results we're seeing, and I would even extend that to say, if you look to Europe and Asia, which has arguably had more success containing the virus, not perfectly, but more success and stores opening earlier, we've maintained fairly consistent performance across Europe and Asia in that mid to high single-digit range that Jeff mentioned.

So it feels like we're kind of at a new level where these underlying stay-at-home trends are fairly stable and not that subject to the ups and downs of the virus surging. Let's see how long that lasts. But it's one of the things that gives us confidence that we're able to continue to grow this business and there's some staying power to these trends. So with that, I believe that was our final question. So I want to thank everyone for joining us.

Greg Maffei (Executive Chairman)

I agree. This is Greg. I want to thank everyone. And I know there will surely be questions about the preferred, which is an unusual instrument. We look forward to trying to educate you. We think it's a high-value instrument, and we hope we can convince you as well. Thank you very much.

Operator (participant)

Once again, that does conclude today's conference. Thank you very much for your participation. You may now disconnect your phone.