QVC Group - Earnings Call - Q3 2020

Transcript

Operator (participant)

Ladies and gentlemen, thank you for standing by. Welcome to the Qurate Retail, Inc 2020 Q3 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 signal by pressing star one on your telephone keypad. As a reminder, this conference is being recorded. November 5th. I've now turned the conference over to Courtnee Chun, Chief Portfolio Officer. Please go ahead.

Courtnee Chun (Chief Portfolio Officer)

Thank you. Before we begin, we'd like to remind everyone that 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 the most recent Forms 10-K and 10-Q filed by our company, Qurate Retail, Inc, 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 now speaks. On today's call, we will discuss certain non-GAAP financial measures, including adjusted OIBDA, adjusted OIBDA margin, free cash flow, and constant currency.

Information regarding the comparable GAAP metrics, along with required definitions and reconciliation, including preliminary note and schedules one through three, can be found in the earnings press release issued yesterday on our earnings presentation, which are available on our website. Please remember to register for our virtual Liberty Investor meetings. On Thursday, November 19th, we will cover Liberty Media and Liberty TripAdvisor, and Friday, November 20th, we will include Qurate, GCI Liberty, and Liberty Broadband from 11:00 A.M. to 2:00 P.M. Eastern on both days. After the presentations on both days, John Malone and Greg Maffei, along with presenting CEOs, will host a Q&A session. Please pre-submit questions by Friday, November 13th, to [email protected]. You can find the link to register and all of these details on our homepage.

Today, speaking on the earnings call, we have Qurate Retail President and CEO Mike George, Qurate Retail Group CFO Jeff Davis. Available during Q&A, we'll have Qurate Retail's Executive Chairman, Greg Maffei. Please note that we've published slides to accompany the earnings release. These slides are available on our website. Now I'll hand the call over to Mike George.

Mike George (President and CEO)

Thank you, Courtnee, and welcome everyone. We had a tremendous Q3 with strong revenue, OIBDA, free cash flow, and customer gain across all our businesses. These results reflect our ability to execute well in the near term while building a foundation for sustained long-term growth. We aligned product assortments, programming, and events with rapidly shifting consumer demand. Our home-related assortments generated strong gain while apparel remained soft, consistent with overall marketplace trends. We strategically managed promotions and pricing across our businesses. In mid-May, we made the decision to pull back on a variety of promotional activities to set a better foundation for healthy growth. These efforts continued in Q3 and led to significantly improved product margins, contributing to the outstanding OIBDA gain. We stayed focused on advancing our long-term strategic growth initiatives to ensure we emerge from this pandemic better positioned than when we went into it.

We look forward to sharing progress on these priorities at Liberty's Investor Day on November 20th. We also launched an expanded corporate responsibility program, which encompasses three broad commitments: to protect the environment through sustainable packaging, energy-efficient operations, shipping, and logistics. To curate, source, and manufacture products responsibly. And finally, to champion empowerment and belonging by promoting diversity, equity, and inclusion in our organization and with our customers and partners. You can find more information on these commitments at the Qurate Retail Group website. We've continued to grow our customer base with gains in every customer cohort in every business, with especially strong increases in new customer acquisition. We generated $1.5 billion of free cash flow in the first nine months, that's a $1.1 billion increase year-over-year.

We returned capital to shareholders in the form of a special cash dividend and the creation of a preferred security with an attractive yield. For tax reasons, we were unable to buy back shares in Q3. Most importantly, our primary focus remained on protecting the health and financial well-being of our team members. We continue to expand programs to support our team, including alternative work arrangements to help families juggling competing work and personal challenges, greater access to home care help, added resources to support mental health, and special bonuses for many team members, among a number of other initiatives. As the number of COVID cases surges around the world, we are monitoring the situation closely and working with local authorities to ensure we're taking all appropriate actions to keep our team members as safe as possible.

Additionally, all team members who can work from home will continue to do so until at least May. I remain in awe of the dedication and resilience of our team and their unwavering commitment to each other and to our customers while dealing with all the challenges of this extraordinary year. Turning now to our business unit results, on our last two calls, we provided in-period performance commentary due to volatility surrounding the pandemic. We are reverting to our historic practice and will not be providing current quarter commentary on this call. As video commerce businesses, QxH and QVC International sustained strong revenue growth along with significant expansion in OIBDA yield and grew their customer base across all cohorts with particularly strong growth in new and reactivated customers.

Each continued to adapt to the increasing demand on digital platforms, with e-commerce revenue growth in the double digits and penetration up more than 300 basis points at each business. Our sustained growth at QxH was driven by customer and category dynamics largely similar to Q2. We saw strong sales gains in culinary, home decor, and home innovations among new, reactivated, and occasional customers. Additionally, we were encouraged to see best customer sales increase modestly following a decline in Q2. We know that best customer spend is heavily weighted towards the fashion category, putting pressure on their spend in Q2. The spend on fashion also declined in Q3, but at a lesser rate and was more than offset by continued strong increases in their home spend. In our last call, we shared that July demand trends were up in the low single digits.

The stronger net revenue growth we posted for the full quarter was up with a combination of sales acceleration in September, as consumer electronics began to recover from the difficult start to the quarter, lower than expected customer returns, and strong shipping and handling revenue, as we maintained our tighter promotional posture. Throughout 2020, we have remained focused on the strategic priorities that are foundational to long-term growth. We'll share more insight at Liberty Investor Day. For now, let me provide a few examples on our progress, starting with daily digital discovery, focused on creating the same level of engagement and inspiration on our digital platforms that we see on our video platforms. Over the last four months, we've been piloting an incentive tool that uses machine learning to inspire customers to purchase through personalized urgency-driven messages.

Results are well ahead of expectations, and we're expanding the use of this capability across our websites. We advanced our priority to extend video reach and relevance across all video platforms. We continue to grow viewership on traditional TV in Q3, with total minutes watched up 7% and the number of homes tuning in daily up 9%. Additionally, at quarter end, we reached more than 50 million homes through our streaming service, primarily over Roku and Fire TV. Last month, we launched on LG's Shop Time app with 7 million active monthly users, providing the live streams of our QVC network, as well as on-demand programs, curated products, special deals, and personality-led content. We're leaning into innovation on the streaming platform with a particular focus on seamlessly integrating transaction capabilities.

We partnered with LG to create a text-to-buy experience on their Shop Time app, and we intend to add this capability to the QxH streaming service as well. This is one step among several anticipated innovations to enable frictionless commerce through deep transactional integration into the video viewing experience. We're also investing in destination programming and special deals to attract audiences to our video platforms. QVC and the Food Network are collaborating to attract new audiences and leverage their respective reach. QVC is promoting the Food Network app through a special offer on its culinary shows, app, and website, and the Food Network app is featuring live cooking shows hosted by QVC food experts David Venable and Mary DeAngelis. Recently, Mary joined Geoffrey Zakarian on Food Network's Emmy-nominated series, The Kitchen, to promote the collaboration.

In October, Travel, Cook, Repeat with Curtis Stone launched exclusively on the QVC and HSN streaming platforms. This new original series follows celebrity chef Curtis Stone as he visits regions of the world in search of new flavors and recipes and returns home to teach viewers how to prepare the recipes. The series' first six episodes can be viewed anytime on demand and have quickly become among our top-viewed programming on Roku. Curating special products with compelling values is central to our strategy as we strive to be a source for innovative, compelling merchandise. We recently introduced MAC Cosmetics with a digital-only launch, leveraging influencers and digital marketing to attract a younger customer. We followed the successful digital launch with an on-air premiere that drove multiple sellouts. We continue to focus on size inclusivity across all apparel lines, and we hosted a first-ever size-inclusive and body-positive summit in September.

This virtual event provided attendees with the opportunity to engage with some of the most influential women in body positivity through fireside chats, a beauty panel, and fitness sessions. It built on our 30-plus year commitment to size-inclusive fashion and provided an inspirational forum to educate consumers and capitalize on our leadership in this area, and a fun example, our toy business is up more than 50% in Q3, in part due to the standout success of The Child, a Baby Yoda from Mattel. Our buyers were quicker to jump on this new product, enabling us to offer the toy on an advanced order basis, both on-air and online during Christmas in July, where it quickly sold out. We provide vendors with highly attractive platforms that connect with loyal customers.

To date in 2020, we've launched more than 1,000 new brands on QVC and HSN, that's up 30% from last year. Growing our passionate community is the next strategic priority. Our strong new customer acquisition and the growth of our total customer base are a testament to the relevance of our media assets and retail platforms. We recently welcomed Brian Beitler as Chief Marketing Officer for QxH. In this newly created role, Brian will be responsible for all facets of customer acquisition and engagement. He brings 20 years of strong experience in marketing, business development, and strategy from retailers such as J.Jill, Lane Bryant, and Kohl's. Now, before discussing our other businesses, let me reiterate our confidence in sustaining healthy long-term growth across QxH and QVC International.

We combine a powerful portfolio of media assets with exceptional product curation capabilities, a highly loyal customer base, and a scaled distribution network, and we're successfully evolving to a multi-platform, digitally led, and personalized video streaming model that is difficult to replicate, especially at our scale. We're well-positioned to capitalize on the growing popularity of video selling as consumers look for virtual ways to replicate and enhance the experience of physical stores. In the near term, we believe there are several paths to continue our growth. We expect to sustain growth in the home categories across all customer cohorts while continuing to convert these large new customer classes to high-value lifetime customers. Over time, we anticipate home growth may moderate, but we should see fashion categories begin to recover, supporting a continued re-acceleration of best customer growth.

Finally, by resetting our promotion and pricing practices over the last two quarters, we have more room to deploy additional promotions, if necessary, to support growth, with those costs potentially covered, at least in part, as fashion categories return to growth at their higher margin rates. Moving now to Zulily, which generated strong Q3 results. The team leaned into its core brand attributes of serving moms with fresh finds at amazing values. Zulily added several key brands, such as Emeril Lagasse, Lee Jeans, and Purple. Home and hardline categories continued to grow 25% year-over-year as customers maintained spending on their homes. Zulily capitalized on lower costs to acquire customers and advanced its marketing initiatives. Going forward, Zulily will continue to experiment and invest in new marketing channels, such as affiliates, influencers, text programs, and bloggers.

We're excited by the traction Zulily has gained in the past two quarters and believe it signifies the attractive nature of Zulily's core brand attributes to both customers and vendors. Cornerstone generated an outstanding quarter with record results at Frontgate, Ballard Designs, and Grandin Road. Garnet Hill also saw strong growth for its home products. We recently appointed Ryan McKelvey as president of Cornerstone. Ryan joined Cornerstone in 2000, most recently leading Ballard Designs and overseeing Cornerstone service operations. He has done an outstanding job at Ballard, expanding its footprint and adding key services. We're confident in his ability to lead Cornerstone and continue its strong momentum. In closing, let me provide a quick look at our holiday season.

In anticipation of an elongated holiday shopping season driven by the need to reduce store crowding during traditional holiday peaks and manage constrained shipping capacity, we've expanded and accelerated key events and promotional periods. We started October with a Black Friday Countdown at QVC and Black Friday Jump Starts at HSN, and both brands launched fully into gift programming with the holiday look and feel for the broadcast and digital platforms in mid-October, and later October, we began offering Black Friday previews. We feel good about our holiday lineup, and we'll stay agile, adjusting our event cadence as we see how customers are shopping through the quarter. I look forward to speaking with all of you at Liberty's Investor Day on November 20th, and with that, I will turn it over to Jeff to review our financial results.

Jeff Davis (CFO)

Thank you, Mike, and good morning to everyone.

As Mike mentioned, we delivered another strong quarter of revenue and order growth across our businesses. Our especially strong consolidated order performance outpaced revenue by a magnitude of more than two times on a constant currency basis. So let's jump right in and start with QxH. Revenue grew through strong new customer and e-commerce gains, as well as our ability to offer in-demand products. For the quarter, total customers grew 8%, with existing customers up 5%, reactivated up 15%, and new growing 27%. We continue to be encouraged by new customer subsequent purchase behavior, with 30- to 60-day repurchase rates consistent with prior years. As illustrated on slide six of our earnings presentation, we once again had a sizable shift in category mix from apparel and beauty to home.

Home increased 22% as consumers maintained their focus on nesting, families, and well-being, with a strong demand for food, seasonal decor, fitness and wellness, floor care, and household products. Moving to consumer electronics, which declined 6%, reflecting a lower demand for smart home products and supply constraints for tablets, computers, and televisions, as well as our intentional promotional actions to reduce the number of installment payment options for our Easy Pay and FlexPay app plans. The team's worked diligently during the quarter with our brand partners to secure additional products, which led to improved sales performance in September. We believe supply constraints for many products have improved for the holiday season. With respect to our fashion categories, beauty declined 2% as color cosmetics are in less demand during the pandemic while we're wearing masks. However, our customers remain interested in self-care, and we experienced gains in haircare, bath, and body products.

Apparel and jewelry remain challenged, down 7% and 5% respectively, in line with general market conditions. And finally, accessories, which was a bright spot, had a nice 10% rebound from strong demand in loungewear, athleisure, and non-leather handbags. Adjusted OIBDA grew 10%, and Adjusted OIBDA margin expanded 50 basis points. Let me share the detail as outlined on page nine of the presentation. First, gross margin increased 70 basis points. In contrast to last quarter, we were able, more than able, to offset the product margin pressure from the category mix shift. Product margin expanded 220 basis points from lower customer returns, higher shipping and handling revenue, vendor negotiation, and a greater penetration of regular sale price sales.

Fulfillment costs increased 90 basis points, primarily due to general freight rate increases, duplicate costs associated with opening our Bethlehem Fulfillment Center, increased wage rates attributed to heightened competition for labor, and lower pack factor. Moving to the last component of gross margin obsolescence, it increased 65 basis points, primarily related to the transition to our new warehouse management system, which will be completed in the next couple of quarters. We also recorded a modest increase in the reserve as we replenished inventory levels in advance of the holiday season. Moving to operating expenses, which were 40 basis points favorable, predominantly due to 30 basis points of commission tailwinds, reflecting higher digital penetration, not subject to variable commission, and finally, SG&A, which was a net 65 basis points unfavorable, as comprised by the following.

Administrative expense was 105 basis points unfavorable, driven by higher incentive compensation accruals, partially offset by net revenue leverage. Marketing contributed 35 basis points of pressure, reflecting enhanced acquisition and retention strategies for new customers and retargeting efforts to increase customer lifetime value. These headwinds were partially offset by 75 basis points of favorability from bad debt, which primarily reflected favorable provision adjustments and recoveries. Let me provide a brief update on our fulfillment center network optimization. Overall, the pandemic delayed our progress, yet we successfully installed the Common Warehouse Management System in Rocky Mount, North Carolina, and Bethlehem, Pennsylvania. While productivity at these sites has not reached pre-pandemic expectations, we are experiencing sequential improvement. Our Lancaster facility has not been fully decommissioned, as it is primarily processing customer returns, which is contributing to the duplicate occupancy and labor costs that we referenced earlier.

Moving to QVC International, which continues to generate growth across all markets, strong new customer growth and retention, and increased e-commerce penetration. My comments this morning will focus on constant currency results. Revenue grew 8% with gains in all markets, with particular strength in the UK and Germany. Separately, Japan achieved a two-year stacked growth rate of nearly 20%. Recall Japan benefited last year from actions to accelerate demand in the event of a consumption tax increase on October 1st, making this year's growth even more impressive. Overall, e-commerce growth grew 17%. In the third quarter, total customers grew 6%, with existing customers up 3%, active up 11%, and new growing 26%. From a category perspective, we experienced strong growth in home and electronics, with gains in mid-single-digit range and other categories. Adjusted AOV increased 21%, and adjusted AOV margin improved 200 basis points.

Excluding a retroactive refund to customers in Q3 of last year from a change in shipping and handling policy, Adjusted OIBDA would have increased in the low teens this quarter. Gross margin improved 90 basis points, primarily due to higher product margins, which reflected favorable product returns and shipping and handling revenue. Operating expenses were favorable by approximately 50 basis points, primarily due to lower commissions, reflecting expanded e-commerce penetration and net revenue leverage. SG&A costs were favorable 65 basis points, primarily due to net revenue leverage, including absorbing provisions for increased incentive compensation. Moving to Zulily, which generated another strong quarter. Revenue grew 10%, driven by a 7% increase in average selling price and a 5% increase in unit volume. In the third quarter, total customers grew 3%, new customers grew 23%, and reactivated grew 13%.

An Adjusted OIBDA increase of $19 million, led by gross margin increasing 150 basis points, primarily due to higher product margins, partially offset by higher freight costs from its international product mix and fulfillment center wages. Zulily continues to benefit from lower marketing costs as customer acquisition costs declined nearly 50%, driven by e-commerce tailwind and the diversification and enhancement of its marketing initiatives. Moving to Cornerstone, [it] delivered outstanding results. Frontgate, Ballard Designs, and Grandin Road generated record revenue and orders too. Overall, Cornerstone grew 26%, driven by strength in home brands with a robust demand for outdoor furniture, pool accessories, and interior furnishings, and e-commerce revenue grew 30%, with e-commerce penetration improved more than 200 basis points. These strong gains were partially offset by a decline within select women's apparel categories within the Garnet Hill brand.

I'm proud to announce that Adjusted OIBDA increased $31 million against $4 million last year for the same period. Gross margin improved nearly 500 basis points, primarily due to the strength in home brands and less liberal promotional activity. Despite revenue declines, Garnet Hill was able to deliver expanded gross margins, although through reduced promotional activity and improved home category mix. SG&A improved primarily from effective use of digital marketing and leveraging administrative costs. We anticipate Cornerstone will incur increased gross margin pressure in the fourth quarter from third-party carrier surcharges on large parcels. Let's quickly look at our balance sheet and cash flow. CapEx was $57 million through the quarter and $165 million through the third quarter. We anticipate 2020 CapEx for the year to range between $270 and $280 million.

Year-to-date distribution payments, TV distribution payments, were $41 million, reflecting an off-cycle year for multi-year contract renewals. As Mike had mentioned, we generated $1.5 billion of Free Cash Flow in the first nine months of the year, an increase of $1.1 billion, led by higher cash flow from operations. Year-over-year, working capital benefited from comping several one-time tax items at the corporate level, in addition to benefits from the operating businesses, namely the extension of vendor payment terms enacted since March of 2020, a strategic pullback in customer installment payments, reduced inventory, and increased accruals associated with management incentive bonus and returns. Separately, in 2020, we received $267 million in pre-tax proceeds from the sale of a green energy investment, of which $262 million was received this quarter.

Looking at our debt going Q3, we raised $500 million of 4.375% senior notes due 2028, and used the proceeds along with cash on hand to redeem $500 million of senior notes due 2022. At quarter end, we had a zero balance on our QVC, Inc. revolver, with $2.9 billion of capacity and roughly $1 billion in cash and cash equivalents. On September 30th, our leverage ratio defined in the QVC revolving credit facility was 2.0 times. As Mike mentioned, on September 14th, we returned $4.50 of capital to shareholders in the form of a $1.50 special cash dividend and a $3 newly issued preferred stock dividend. Due to the mandatory redemption and cash settlement of the preferred stock, it is accounted for as a liability at its liquidation value. The preferred stock pays an 8% dividend, which we classified as interest expense.

In closing, we maintained our momentum in Q3 across all of our business units. We believe we are well-positioned to sustain profitable growth. The strength of our balance sheet and ability to generate strong free cash flow provides a foundation on which to build, and we continue to execute our strategic priorities. We appreciate your continued interest in Qurate Retail, and with that, I'd like to open it up for questions.

Operator (participant)

Thank you. And if you would like to ask a question, please signal by pressing star one on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. If you find your question has been answered, you may remove yourself by pressing star two. As a reminder, it is star one if you would like to ask a question. And we'll take our first question from Eric Sheridan from UBS. Please go ahead.

Eric Sheridan (Managing Director and Senior Equity Research Analyst)

Thanks so much for taking the question. Very good progress on continued evolution towards e-commerce and mobile commerce in the quarter. Mike, let me know if we could better understand how some of your digital marketing channels continue to sort of evolve, what that means, or what we should take away from it in terms of lifetime value of the customers you're getting as your marketing channels continue to evolve, and how we think that, how we should maybe even be thinking about that from a margin profile over the medium to long term for the business. Thanks so much for the color.

Mike.

Mike, the wind is you.

Mike George (President and CEO)

Sorry, I had trouble getting off of mute there, Eric. Thank you for those questions. Let me start with the second part of the question, which is looking at the lifetime value of the new customers. We have just been incredibly encouraged by the quality of these very large classes of new customers that are coming in through the pandemic. On every metric we can track, they are of equal lifetime value to previous classes. And about 40% of those new customers are coming in through digital marketing. So it's great to see the majority still coming in organically. But even with this higher percentage that are coming in through digital marketing, that lifetime value is holding very strong. And remember that we measure that a couple of ways.

We measure it based on what history tells us about what categories they're buying, whether they're buying digital-only assortments or buying from the on-air programming, we see they're buying from all categories, all platforms in a very healthy way. And then most importantly, we look at their behavior. And their behavior based on 14, 30, 60-day repeat purchase rates, their behavior based on the value of their repeat purchases, the behavior even within the last few months of graduating to kind of best customer status. All those things are holding with historic trends. So really, outstanding quality despite the high surge in new customers and the growing mix of customers that came in through paid marketing. And I think that reflects the diversity of ways we're able to attract these customers. We're learning a lot about paid social as a way to find very high-quality customers.

The power of influencer networks, which are growing in our media mix, so getting networks of influencers to be talking about us, but we're also seeing the effectiveness of paid marketing just in areas like getting people to download a Roku app, and once they've downloaded a Roku app, to do marketing with Roku to kind of promote our channels and our experience, and that's another way to bring new customers in, so I feel really encouraged that we're finding an array of tools that leverage paid marketing to expand new customers and to keep the overall quality of those new customers at historic levels.

Operator (participant)

We'll take our next question from Carla Casella from JPMorgan. Please go ahead.

Sarah Clark (Analyst)

Hi. This is Sarah Clark on for Carla Casella. I was wondering if you could give us a little bit more detail on your capital allocation plans going forward and how you plan to think about any potential M&A activity. Are you seeing any attractive valuations out there and looking at acquiring any potential brands? Thanks.

Greg Maffei (Executive Chairman)

Mike, do you want me to take a cut at this?

Mike George (President and CEO)

Yeah, let's take the cut.

Greg Maffei (Executive Chairman)

So this is Greg Maffei. Look, we during the course of 2020 have utilized a couple of different tools for capital allocation which have been outside our usual path. That included a preferred dividend and a large one-time cash dividend. I think we have said in the past that we look continually for ways to invest in a business which are smart and generate a high return on invested capital. We would look for ways outside the business but parallel to it in e-commerce or other areas which would also generate synergistic high return on invested capital. And we'll continue to look for ways to go outside the business and return capital to shareholders. Over the recent time, as you've heard, we were prohibited from buying back shares for a variety of reasons.

But we are now actively looking at multiple tools for shareholder returns going forward, including buyback and special dividends. And we will take into account many factors, including the share price, ongoing Free Cash Flow expectations for the business, of which we are increasingly positive, and one-time cash receipts, for example, when we sold the Solana property earlier this year. So all of those will be taken into account. And certainly, acquisitions are not off the table. We will look for them in this environment. But in general, it's been hard to find things which are attractive. So we've looked for things outside the business, recognizing the high Free Cash Flow generating capabilities of the business. Mike, I don't know if you had anything.

Mike George (President and CEO)

No, that's great. Nothing else to add.

Greg Maffei (Executive Chairman)

Thank you.

Sarah Clark (Analyst)

Thank you.

Thank you. That was really helpful. If I may, just one more. Do you have any early outlooks on holiday? I know you commented on makeup coming back a little bit more towards, say, apparel versus home. Are you expecting to see some of that normalization around the holiday period, or is that really a look into 2021?

Mike George (President and CEO)

Yeah, I don't want to get specific on our current selling trends, but what I would say is all the early indicators of holiday that we saw in the Q3 time period were encouraging, and in the Q3 time period, we really leaned into holiday decor, early gifting, and those all performed really nicely in Q3. We definitely saw a modest rebound in apparel in Q3, largely around the comfort side of apparel, casual sweaters, loungewear, some active wear. We think that will continue during the holiday time period, but the holiday time period really, even in a normal year, is distorted towards home. Apparel tends to be a smaller part of the mix in the holiday time period, so I think we'll have to get to next year, early next year, to see kind of the pace of the rebound in apparel.

I expect on balance, it will remain somewhat soft with these pockets of growth that are related to the stay-at-home lifestyle until we get fully through the pandemic. But on the flip side, I expect the home business to remain quite healthy and to see no signs of slowing in home across any of our business units through Q3.

Sarah Clark (Analyst)

Great. Thank you. Very helpful.

Mike George (President and CEO)

Thank you.

Operator (participant)

We'll now take our next question from Oliver Wintermantel from Evercore ISI. Please go ahead.

Oliver Wintermantel (Managing Director and Senior Equity Research Analyst)

Yeah. Hi. Good morning, guys. I had a question regarding inventories and margins, and then a longer-term question to follow that, so inventories, it looks like they were down again in the quarter, but I think I don't know if it was Mike or Jeff. I think you started buying more inventory for the quarter, so just some color on what the inventory levels are, and then regarding margins, it looks like you guys benefited from nesting like many other retailers and promotions where I think you said you pulled back on it. It looks like holiday might be a little bit more promotional, a longer dragged-out time frame this year versus the last few years, so maybe a comment on gross margin, what you'd expect, and then longer-term, you gained a lot of customers new or reactivated customers during the second and third quarter.

Looking out for the next, especially next year, how do you think you're going to keep these customers? Do you think they're permanently coming to you, or was that just driven by the pandemic? Thank you.

Mike George (President and CEO)

Thanks, Oli. Jeff, you want to take the first part of that, and then I'll talk more about the customer side?

Jeff Davis (CFO)

Absolutely. So Oli, as we think about our inventories, our inventories have been down second quarter, third quarter, and it's really driven by a couple of things. One is just strong demand across a number of categories and our ability to keep that replenishment going at the rate of customer demand. We've also taken the opportunity to adjust our inventory levels against some of the categories and products that have not been in strong demand. As you had mentioned, coming out of Q2 into Q3, we were anticipating that we would have to replenish our levels, especially as we thought about early fall and into the holidays, so you actually did see an increase in our inventories going from Q2 to Q3, but still overall down mid-teens% as it relates to just year-over-year. We believe that we are in good position.

As I had mentioned in my remarks that our buyers are working very diligently with our brand partners to get certain items back in stock, as well as finding additional alternative items that have been identified as key items for customers in gift giving and in home decor and even across many of these categories that were previously in pressure as it relates to consumer electronics. So I think we're in good shape going into the quarter, and a lot of the sort of inventory reduction year-over-year is really just driven by increased demand and also with the reduced levels in those product categories that are in lesser demand on a year-over-year basis.

Mike George (President and CEO)

I would add on, again, your margin question, Oli. Our goal is to remain conservative in our promotional practices. Holiday time period is always intrinsically more promotional, and that's kind of built into the base of the business. But in terms of year-over-year trends in product margins and promotional activity, our goal would be to take the kinds of year-over-year improvements we saw in Q3 and try to hold those as best we can in Q4. I mean, every holiday season is increasingly promotional, even in normal times. So we're trying to stay out of that frame and just offer a relaxing refuge during the holiday season and a place to get great items at great values and feel good about how we're positioned. In terms of the new customers, I'd make a couple of comments.

First, as I mentioned a minute ago, we definitely think the customers that we're bringing in will stay with us in a consistent way with what past classes have done. So the fact that these current classes are much larger, that just gives us tailwind that will benefit from over the next couple of years as those elevated levels of new customers that we're currently seeing kind of settle in to become good long-term customers. But in addition to that, we're confident that we can continue to bring in larger new customer classes going forward for a couple of reasons. First, just this broad macro shift to home, which we don't see changing anytime soon. You naturally bring in more new customers in home categories. The hardest category to bring in a new customer on is apparel. The easiest is our home categories.

And so we're confident with that mix shift to home that will be a great business in new customer acquisition. And then we add to that our progress on digital marketing that we also chatted about a moment ago and just the ability to continue to leverage digital marketing to bring in more new customers. And as we maintain this conservatism on promotional practices, that actually frees up a few more dollars that we can redeploy in marketing if we choose to bring in high-quality new customers with good lifetime value while protecting the overall yield. So we just see lots of optionality for continuing to bring in more new customers. And then the final point I'd make is we're just available in more places today.

We talked about Roku and LG Shop Time and Facebook Live, and it could go on and on all the ways that consumers can find us today that feels different than a couple of years ago. So all those point to good new customer acquisition going forward.

Oliver Wintermantel (Managing Director and Senior Equity Research Analyst)

Thank you very much. Good luck.

Mike George (President and CEO)

Thank you.

Operator (participant)

We'll now take our next question from Edward Yruma from KeyBanc Capital Markets. Please go ahead.

Edward Yruma (Managing Director and Senior Equity Research Analyst)

Hey, guys. Thanks for taking the question. A bigger picture question. Last time you guys had a similar surge of new customers, you had driven a lot of them through price, and I think the postmortem was they didn't exhibit the behaviors that you wanted. How do you ensure that some of the new customers you're gaining today exhibit kind of the strong lifetime value versus maybe what happened two years ago? And then as a follow-up, I know you mentioned shipping at Cornerstone. Are you anticipating shipping difficulties during the season? Thank you.

Mike George (President and CEO)

Yeah. Thanks, Ed. As I've kind of mentioned, we're really confident in the quality of these new customers. And I think what you're referring to is we definitely saw at Zulily two years ago the team kind of lean into new customers, and we were finding that they were not of the quality we anticipated. That led to the downturn in performance that we saw in the 2019 period as the anniversary built. So that's a very baked-in learning at Zulily. We've got new marketing leadership at Zulily, and that team is just doing a terrific job trying to really get refocused on the fundamentals of good customer acquisition, going to the right channels, making sure these are customers that are of high quality. But I would note that that was quite isolated to the Zulily experience.

If you look more broadly across QxH and QI, we really never at any point in our history had a surge of new customers that did not perform consistent with our long-term expectations, so all the current data says they will. And again, we've never had an experience that didn't fit that model, so we had one issue at Zulily. I believe we've adjusted that. We're very good about the quality of new customers we're bringing in across QxH. In terms of shipping, the benefit of our size and scale is we have very deep relationships with our partners. We're a very meaningful customer of the major shipping carriers, and so we've been able to negotiate agreements that enable us to meet all the demand that we anticipate. We're not going to be capped like others are.

That said, there is certainly pressure to get all the boxes out of our own four walls and getting boxes to the carrier network. So we're sensitive to that. It could create a little bit of pressure on the margin, but we believe we have a good plan. We believe we'll be. We should be fine and be able to meet our typical service commitments and get through the holidays quite well.

Edward Yruma (Managing Director and Senior Equity Research Analyst)

Thank you.

Mike George (President and CEO)

Thanks, Ed.

Operator (participant)

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

Jason Bazinet (Managing Director and Senior Equity Research Analyst)

I just have two questions. Do you all have a target leverage or a maximum leverage figure that you keep in mind? And if you do have a figure, is that at the Qurate Retail Group level consistent with the two turns of leverage in the release, or is that at the corporate level? And then my second question is, you talked about some of the restrictions on buying back stock. As of today, November 5th, are those restrictions all lifted? Thank you.

Jeff Davis (CFO)

I'll take a shot at that. At the QVC level, we maintain a leverage target of two and a half times. We do not have a stated Qurate level leverage target, but we have stated our two and a half times target or below for QVC proper. Exactly when we're released out of our blackout window, which is normal, I'm not going to comment on. Next question. Thanks.

Jason Bazinet (Managing Director and Senior Equity Research Analyst)

Thank you.

Operator (participant)

We'll now take our next question from Phil Terpolilli from B. Riley Securities. Please go ahead. Phil, your line is open. Again, Phil, your line is open. Due to no response, we will go to our next question. We'll take our next question from William Brewster from Sullimar Capital Group. Please go ahead.

William Brewster (Analyst)

Hey, guys. Good morning. And I'd say great quarter, but I think that that would understate it. And I want to say thank you, guys, for your hard work. I wanted to drill in, if possible, on something that Greg had said. Within the internal capital allocation priorities, Mike, I was hoping that maybe you could talk to performance marketing and what you're seeing there. And Greg, if you could expand on any of your priorities, that'd be great. Thanks, guys.

Mike George (President and CEO)

Yeah. Thanks. Thanks. Appreciate the comment. I'll hit performance marketing and then let Greg go from there. We continue to invest in performance marketing. It's generally been increasing on a year-over-year basis in the 40-50 basis point range, a little bit offset by lower commission rates because as folks gravitate to digital, our TV-based commissions tend to decline every year. We'll continue to lean into that investment as long as we're getting a good return on it. We expect performance marketing to be net positive within a year as we measure the value of the new customers that come into it. So at least we'll get about our ability to reinvest back in the business in performance marketing, in efforts like network optimization, in expanding our presence on all sorts of digital platforms so that more and more folks can find our live streams.

Those are our priorities for both expense dollars and capital dollars. And I believe we're using those effectively to really widen the digital footprint, both the way people find us and the way that we can push people to our new platforms. Greg, do you want to make any other comments on capital usage?

Greg Maffei (Executive Chairman)

Yeah. I would say we don't have a religious view about which is the preferred method. Historically, because of tax efficiency, we have favored buybacks. Candidly, they have not worked as successfully as we would like, partly due to some diminution of the growth of the business, but in large part due to a reduction of the multiple in the marketplace not truly following or believing in it. This year, we tried some other methods of returning capital, including that one-time cash dividend and the preferred dividend, which we thought had the benefit of opening up choice, more choice for investors who wanted a continuing stream versus those who wanted more levered equity. I think those have largely been successful. We are not anti-buyback. It's certainly not been the Liberty posture. And we will use that and look at that as one of our tools going forward.

We'll look at the ways to best deliver value to shareholders. We are also cognizant of changing tax rates, which may influence our views, but we'll weigh them all. I don't think we have a bias one way or another. Our goal, obviously, is, like most of you would hope agree, is to return the best amount of capital we can to shareholders in the most efficient way.

William Brewster (Analyst)

Thank you, guys, for the hard work. I hope you enjoy a small victory here at the heck of a quarter. Take care.

Mike George (President and CEO)

Thank you.

William Brewster (Analyst)

Thank you.

Operator (participant)

We'll now take our next question from Phil Terpolilli from B. Riley Securities. Please go ahead.

Phil Terpolilli (Senior Equity Research Analyst)

Great. Thanks. I apologize. I got tripped in. It's Phil. So Mike, congrats on the continued improvement at Zulily and Cornerstone across the board. I wanted to get your thoughts on the current state of your consumer. So I feel like working for her and working for you is the state of the stock market and home values. At the same time, I'm concerned about maybe it's too short-term in nature, but a high level of distraction given what's going on with the election and things of that nature. So I'd appreciate your thoughts on the current state of your consumer. Thanks.

Mike George (President and CEO)

Thanks, Jeff, for the question. We feel good about this consumer. I think she is amazingly resilient, and to your point, we benefit from a somewhat higher income and certainly higher household wealth consumer, so she is in a better place financially. We're not as driven by issues like government stimulus and unemployment rates. We also know that all consumers, including ours, have been increasing their savings rates, so they do have some money in savings. Quite frankly, as we've pulled back on the use of installment payments, that gives her more open to buy with us because she hasn't been using credit to the same level in her purchasing, or I shouldn't say credit, but our installment payment programs that she's used in the past, so she has resources. She has savings, and she's proven to be resilient. Certainly, the election is a distraction.

But I think it also plays to our strategy, which is to be that place she can turn to on the dial or on the web to get away from election news, to get some joy, to get some inspiration, to get some distraction, to be among friends and a virtual community that she cares about. And so I think by not being in the promotional fray, just to be there for her as she's looking for distraction from the election is all positive. Obviously, we hope and expect that this election gets resolved shortly, which it appears that it will. We'd love to be behind it. But I think through the pandemic, through the fight over racial justice, through the election, this consumer has continued to turn to us. And we're encouraged by that.

Phil Terpolilli (Senior Equity Research Analyst)

Great. Thank you, Mike.

Mike George (President and CEO)

Thank you.

Operator (participant)

We will now take our last question from Steve Lipp from 4010 Capital. Please go ahead.

Steve Lipman (Managing Member and Portfolio Manager)

Yeah. Thanks. I apologize for asking another buyback question. But when I look at your company, you guys are hitting on all cylinders. You've got tremendous free cash flow. Your leverage is low. You're incredibly well-positioned as a retailer. You could literally buy back your entire company in three years at current prices. So I'm not sure I understand why not just spend all of your free cash flow right now to repurchase stock while you've got the opportunity. Thanks.

Greg Maffei (Executive Chairman)

This is Greg again. I appreciate the confidence in the business and the observations about the strength of the business and the strength of the cash flows. I don't disagree with a lot of your points. I reiterate that historically, we've been very buyback-central, buyback-focused, and that has not proceeded as well. During the recent quarter, we were prohibited, as we noted for some tax reasons, from doing buyback. As we said, we are certainly not taking buyback off the table and certainly not looking at removing buyback as one of the tools from which we will utilize. Thanks for the observations and don't disagree with them.

Steve Lipman (Managing Member and Portfolio Manager)

Okay. Thank you.

Greg Maffei (Executive Chairman)

Thank you.

Mike George (President and CEO)

Thank you.

Jeff Davis (CFO)

Yeah, Mike, you're going to have to. You can wrap it up. Go ahead.

Mike George (President and CEO)

Yeah. That's our last call, but thanks, everyone, for your time and interest today, and we look forward to connecting with you virtually at the investor day. Thanks, everyone.

Jeff Davis (CFO)

Thank you.

Operator (participant)

And with that, that does conclude today's call. Thank you for your participation. You may now disconnect.