Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Revolve Group Inc (NYSE:RVLV)
Q2 2020 Earnings Call
Aug 12, 2020, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon and welcome to Revolve Group Second Quarter 2020 Earnings Conference Call. [Operator Instructions] And we have allocated one hour for prepared remarks and Q&A.

At this time, I would like to turn the conference over to Erik Randerson, Vice President of Investor Relations at REVOLVE. Thank you. You may begin.

Erik Randerson -- Vice President, Investor Relations

Good afternoon, everyone and thanks for joining us to discuss Revolve's second quarter 2020 results. Before we begin, I would like to mention that we have posted a presentation containing Q2 2020 financial highlights to our Investor Relations website located at investors.revolve.com.

I would also like to remind you that this conference call will include forward-looking statements. These statements include our current expectations regarding the continued impact of the COVID-19 pandemic on our business, operations and financial results, and our outlook for net sales, gross margin, operating expenses, diluted share count and capital expenditures for the second half of this year.

These statements are subject to various risks, uncertainties and assumptions, that could cause our actual results to differ materially from these statements, including the risks mentioned in this afternoon's press release as well as other risks and uncertainties disclosed under the caption, Risk Factors and elsewhere in our filings with the Securities and Exchange Commission, including without limitation, our Annual Report on Form 10-K for the year ended December 31, 2019 and subsequent filings, all of which can be found on our website at investors.revolve.com. We undertake no obligation to revise or update any forward-looking statements or information, except as required by law.

During our call today, we will also reference certain non-GAAP financial information, including adjusted EBITDA, free cash flow, and adjusted diluted earnings per share. We use non-GAAP measures in some of our financial discussions, as we believe they more accurately represent the true operational performance and underlying results of our business. The presentation of this non-GAAP financial information is not intended to be considered in isolation or as a substitute for or superior to the financial information prepared and presented in accordance with GAAP. And our non-GAAP measures may be different from non-GAAP measures used by other companies.

Reconciliations of GAAP to non-GAAP measures as well as the description, limitations and rationale for using each measure can be found in this afternoon's press release and in our SEC filings. Joining me on the call today are, our Co-Founders and Co-CEOs, Mike Karanikolas and Michael Mente: as well as Jesse Timmermans, our CFO. Following our prepared remarks, we'll open the call for your questions.

With that, I'll turn the call over to Mike.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Thanks, Erik. Good afternoon, everyone and thanks for joining us today. We hope each of you and your families are in good health. I look forward to the day when we can see many of you in person again. So much has changed in just the past three months. On our Q1 conference call, we discussed the negative impacts of the COVID-19 pandemic that led to a year-over-year decline in net sales of nearly 50% in the final weeks of March. Almost overnight the shelter-in-place mandates put an abrupt pause on the special social occasions that often serve as a catalyst for customers to buy from REVOLVE.

We took swift and aggressive action to protect our people and to adjust our cost structure for what quickly became a highly uncertain demand environment. I'm extremely proud of how well our team is executed against our priorities, despite the continuing unprecedented headwinds brought on by COVID-19. As we prepared for the worst, the teams reengineered our entire approach to brand marketing and merchandising to position REVOLVE for success, amid significant changes in consumer buying behavior.

There are three key highlights of our second quarter results that I hope each of you will take away from my remarks. First, we delivered record EPS of $0.20 per share, and record adjusted EBITDA of $21 million in the second quarter, each of these measures grew double-digits year-over-year during the worst economic climate in decades. Second, we delivered record free cash flow of $53 million in the second quarter alone, that's more cash flow than we generated for the entire year of 2019.

Third, a key contributor to the exceptional free cash flow generation was our meaningfully higher inventory turns in the second quarter. Inventory turns in our REVOLVE segment increased approximately 30% year-over-year, reaching our highest level in six years. Impressive collaboration and agility by our team drove the strong financial and operational results. Despite the very difficult macro environment and with most of our teams continuing to work-from-home, we nonetheless realized efficiencies throughout the business while maintaining exceptional service levels for our customers.

With that, I'll continue with the discussion of our second quarter results. Our monthly net sales in Q2 improved throughout the quarter. In fact, June was our first month of positive year-on-year growth in net sales since the pandemic began. We believe the net sales improvement in the past few months reflects a better overall consumer spending environment, combined with our effective marketing and merchandising strategies to capitalize on at home categories like beauty, loungewear, intimates and accessories. That said, we did experience some pockets of softness late in the quarter as states reopened and COVID cases increased, especially in those states with higher COVID numbers.

Shifting to the balance sheet and cash flows. Recall that when we began to feel the severe impacts of COVID-19 in March, we immediately adjusted our inventory buys for a scenario that assumed no sales recovery in the remainder of 2020. As a result, our reduced inventory buys combined with the better-than-expected net sales led to a 37% decrease in our inventory balance year-over-year in the second quarter. The significant decline in inventory coupled with a better-than-expected 12% decline in net sales translated to a significant increase in inventory turns year-over-year.

Working through our inventory position and improving inventory turns has been a key goal we have outlined for the past several quarters, so we're very pleased with our progress. The higher inventory turns had a very positive impact on our cash flows for the quarter. As mentioned, we generated $53 million in free cash flow during the second quarter, up from $2 million in the prior year. We now have $151 million in cash on the balance sheet, which we believe positions us to navigate through this uncertain time, reinvest in inventory to support future demand and further invest in the business to drive long-term growth. The strong results and significantly improved cash position led us to quickly unwind many of the reductions to our cost structure that we discussed on last quarter's conference call.

During the peak of COVID-19 uncertainty, we made the very difficult decision to adjust personnel costs, primarily through furloughs and reductions in salary, wages, and hours as well as layoffs. I'm very pleased to report that we have now brought back the majority of furloughed employees and that by the end of this week, substantially all active employees including executives as well as our independent board members will have their compensation back to the pre-COVID run rate. I again want to thank all of our employees for their sacrifice and agility during this difficult time.

With the better-than-expected sales trends, we have rapidly moved from a mode of trying to reduce inventory receipts at the beginning of the second quarter to now pursuing inventory opportunities to make sure we have the right mix, right level of inventory in the second half of the year and as we enter 2021. Aside from the strong Q2 financial results, I'm encouraged by the innovation and positive impacts that are moving our business forward. Our operations team delivered phenomenal results, delivering their most efficient quarter in the past seven quarters is the efficiency gains from the investments we've made over the last 18 months continue to provide benefits.

In early 2019, we invested in an expanded and consolidated distribution center and throughout 2019, we layered in incremental automation. During this past quarter, we automated another key process in the distribution center, which is already having a positive impact on our distribution process. And with capacity in our current facility for over 4 times our current unit levels we have more room for improvement over the longer term.

Continuing on the topic of running the business as efficiently as possible, our buying and planning team was able to pivot quickly from initially reducing our inventory commitments and then quickly shifting back into investment mode as demand picked up. We have also moved very quickly to merchandise into categories that are more aligned with the sudden change in consumer preference. For example, within just days after the CDC recommended the consumers wear masks in public, we had masks available on the site for purchase. Today, we have approximately 100 styles of masks across third-party brands and own brands and it's grown into a low seven digit net sales business in attractive margins.

Through leveraging our read and react strategy, technology and team of data analysts, the buying and planning team was able to drive our merchandise reorders to a record high in July, when expressed as a percentage of total net sales. Product reorders are very important because reorders improve inventory dynamics and reduce inventory risk, since we only reorder those products that are selling well. In fact, oftentimes the reordered product is already ordered by customers and reserved for them by the time the merchandise reaches our facility.

Arguably most important from my vantage point, we are keeping our customers very happy. Our customer satisfaction levels continue to surpass our high standards with the warehouse operating safely and efficiently fulfilling orders with the same best-in-class service levels, despite everything going on in the world around us. Customer inquiries are handled by customer service agents capably working from their homes without missing a beat, continuing to drive brand loyalty for our valued customers.

Making our customers happy is with personally brings me the most joy. Since I firmly believe businesses exist to serve customers and the customer satisfaction is key to long-term success. Having Co-Founded the company with a customer-centric mindset from day one to this day, I still read every single piece of customer feedback. Our very strong customer satisfaction metrics are a direct result of this organizational focus on the customer that is built into our DNA.

Now, shifting to the more recent trends in the third quarter to date. The positive year-over-year net sales growth in June carried through to July and early August with the quarter-to-date period showing low-single digit growth on a year-over-year basis. It's important to note that our net sales growth rate remained in the same general range in the last several weeks of July, and into August averaging low-single digit year-over-year growth and remaining in positive growth territory, despite the recent resurgence of COVID-19 cases and the reversal of many cities and states reopening. These COVID-19 setbacks led to a decline in US consumer confidence in July that adds uncertainty to the slope and timing of a future recovery.

By geography, in July, international net sales continued to remain stronger than net sales in the US. This aligns with the trend we have witnessed in the second quarter with international outperforming the US. Michael will share a detailed breakdown of our net sales by product category in July, which demonstrates that customer shopping and purchasing behavior continues to be significantly influenced by the global pandemic. A positive outcome of the category mix shift is a reduction in the percentage of merchandise returned, which benefits net sales and reduces certain operational expenses such as shipping and fulfillment costs.

I'm extremely pleased with our ability to navigate through these challenging times. Time and time again, we have asked a lot of our team and they have delivered. So, thanks to all of our team members for your hard work and sacrifice, for staying nimble, and for your dedication to exceeding our customers' expectations. We're not out of this yet and there will be challenges ahead, but I'm confident that we have the team in place and the organizational discipline to manage our way through this and come out stronger on the other side.

With that, I'll turn it over to Michael.

Michael Mente -- Co-Chief Executive Officer and Director

Thanks, Mike and hello, everyone. We have experienced a lot in our 17 years of operating REVOLVE, but the past few months have been by far the most challenging. We entered this period as a brand known for travel, music festivals and social gatherings, with an inventory position prepped for prime time starting with REVOLVE Festival that had been scheduled for April. And nearly overnight our customers couldn't travel, gather in large groups, and in many cases couldn't socialize and were locked down at home.

But with the strength of our business, the power of our brand, and most importantly the sacrifice, commitment and execution of our team, we are able to deliver our most profitable quarter ever. I'm so deeply proud of what the team has accomplished in this face of fierce adversity and dramatic uncertainty. I will focus my remarks on the opportunities we have to deepen our customer relationships through merchandising, marketing and using the power and voice of our brand.

Starting with our merchandise. The dramatic shift toward more stay-at-home lifestyle has allowed us to further deepen the relationship with our consumer by highlighting our offering of incredible fashion and design, in areas that were not focal in times past. Nascent categories such as beauty, intimates, activewear and loungewear have grown into key needs that our customer has begun to love coming to us for. It's clear that we have been able to nurture and expand what REVOLVE is all about.

By enhancing our merchandising strategy, we believe we can expand our share of wallet over the long term. Incredibly important to us that whatever our customer needs, she can always come to REVOLVE as her trusted source of style. For instance, in July, we generated year-over-year growth rate in net sales of approximately 30% in denim, 80% in intimates and nearly 100% growth in accessories.

On the other hand, social distancing restrictions result in fewer opportunities to purchase outfits for special occasions outside the home, such as dresses, which is REVOLVE's largest product category. Importantly, net sales trends in dresses have improved in recent months, although year-over-year comparisons remain negative.

To give you some guideposts, dresses decreased year-over-year as a percentage of REVOLVE segment net sales by about 6 percentage points in July. However, this year-over-year decrease in July is less than half of the year-over-year decrease in dresses as a percentage of REVOLVE segment net sales that we experienced in the month of April 2020.

We are very excited about the opportunity in the beauty category. The demand for REVOLVE Beauty products has been phenomenal, with net sales increasing approximately 140% year-over-year in July. This is the fourth straight month that the Beauty category net sales have increased more than 100% year-over-year. Beauty is especially compelling because it is nearly all sold at full price with very little returns and is an incredible way to acquire new customers and expand our wallet of share with our existing customers.

With a base of over 5,000 of the most highly coveted beauty products, we believe that there is even more room for growth. Major beauty brands that had traditionally relied on department stores for distribution are increasingly seeking to sell their coveted merchandise through REVOLVE. These brands recognize the clear shift in consumer preference to buying online at a time when the number of mall-based department stores is expected to further decline by more than 50% by the end of 2021, according to published estimates.

Our brand marketing strategy has dramatically evolved this summer with the changing times. Despite being dealt a tough hand with an entire calendar of activations canceled, we've found powerful new ways to engage our customers on social media, adapting to a new lifestyle of spending more time at home. As shared last quarter, we shifted our entire brand marketing focus to creating engaging and inspirational live content shows featuring influencers, designers and celebrities. Since the pandemic began, we have now produced over 140 videos that have been viewed a 11 million times on Instagram Live or IGTV.

The new content strategy has been highly efficient as demonstrated by our customer acquisition metrics in the second quarter. We drove exceptional increases in marketing efficiency during the quarter, as we nearly acquired the same number of new customers in the second quarter as we had in the prior-year period, despite our total marketing spend decreasing by 41% year-over-year. This marketing efficiency was a key driver of our strong profitability in the quarter.

I'm incredibly proud of how quickly and effectively the team responded by expanding our marketing playbook, enabling us to prove out an exciting new content strategy in creating video content on Instagram Live and IGTV. I look forward to once again hosting in-person brand marketing events when it is safe to do so and continuing with our powerful new digital content strategy that has proven to be both highly engaging and extremely cost effective. We believe this combination will be a powerful driver of growth over the long term.

The latest example of our marketing innovation is the virtual REVOLVE Summer, a three-week series of events that kicked-off in mid-July. In years past, we have held REVOLVE Summer for weeks at a time in Bermuda, the Hamptons and Cuixmala, Mexico. This year brings as curated virtual REVOLVE Summer event that has allowed us to bring the REVOLVE community together and inspire customers with new looks, all from the comfort of their homes. 125 influencers from around the world have participated as brand ambassadors in these special events that include designers launching new collections exclusively available on REVOLVE.

Stepping back and looking at the long-term opportunity, there was already a seismic shift happening in the broader retail landscape even before COVID-19. Purchasing power has been shifting to the next-generation consumer and shopping is moving to the digital world with overall retail growth being driven purely by e-commerce. We believe that this shift, particularly the digital transformation has been accelerated in the last several months and will continue to shift further post pandemic.

With our pure play digital strategy and focus on the next-generation consumer, we believe REVOLVE sits squarely at the intersection of these two powerful shifts. We believe this powerful shift, combined with our strong brand, deep connection with our customer and the strong foundation that we have built over the last 17 years, positions us well to capitalize the opportunities ahead.

Now, I'll turn it over to Jesse for more detail on the financial results and trends.

Jesse Timmermans -- Chief Financial Officer

Thanks, Michael. It's been a tough few months, but we're proud to have executed well against the key priorities we outlined last quarter of protecting our people and protecting our balance sheet. Our significantly bolstered cash position further increases our confidence that we are well positioned and have the levers to manage through the current environment.

Now, starting with the second quarter results. Net sales were $143 million, a decrease of 12% year-over-year, but in this very fluid environment, it's important to look at the intra-quarter trends behind these quarterly figures. We were pleased that the monthly net sales improved each month throughout the second quarter and our year-over-year growth turned positive in June.

Drilling into the top line. By segment, the REVOLVE Segment and FORWARD segment net sales in Q2 each decreased 12% year-over-year. Similar to the overall net sales trends on a monthly basis, year-over-year net sales comparisons for each segment improved each month from April to June. Active customers were 1.5 million, an increase of 13% year-over-year.

Recall that since active customers is a trailing 12-month metric, performance on this metric is not directly comparable to traditional quarterly metrics like orders placed or average order value. As mentioned on previous calls, as we cycle through the high customer growth periods of late 2018 and into early 2019 and layer on the impact of COVID, the active customer growth has and will continue to decrease sequentially until we cycle out of this period.

Orders placed were 1.2 million, a decrease of 10% year-over-year. Average order value was $204, a decrease of 26% from $275 in the prior year and consistent with the April AOV trends we discussed on the Q1 earnings call. The significant decline in average order value reflects a shift in net sales mix to at home product categories such as beauty, accessories and loungewear with lower average price points.

On the other hand, the dresses category which carries the highest average selling price, decreased as a percentage of our net sales mix by 9 points year-over-year. This has a disproportionate impact since dresses is our largest category. Also, as we expected and communicated on our Q1 call, we experienced a lower mix of full-price sales and lower margin within our marked down product, both of which negatively impacted AOV.

As a reminder, orders placed and average order value are gross metrics, which means they are calculated prior to the effect of merchandise returns. Speaking of returns, partially offsetting the lower number of orders year-over-year and the lower average order value was a meaningful decrease in the percentage of merchandise returned year-over-year.

The reduction in return rates is due to a number of factors working in our favor. First, we do believe there may be a broader change in customer behavior in response to the uncertainty caused by COVID-19 as it relates to returns, with customers being more discerning in their purchase decision making process. This is evidenced by the fact that return rates, even at a category level have decreased.

Second, there is a positive impact to merchandise returns as a result of the changing merchandise mix. For instance, the return rate for the currently fast-growing beauty category is typically in the low-single digits, and return rates for other currently fast-growing categories like intimates and accessories are also much lower than the overall average.

Dresses, which has historically been our largest category by a wide margin, has a meaningfully higher return rate than the average. And finally, there is also a positive impact on returns from the higher mix of markdown sales, particularly final sale items. International net sales increased 3% year-over-year, outperforming the 15% year-over-year decline in net sales in the US. By region, positive trends in Western Europe have been partially offset by headwinds in certain Asian markets such as Hong Kong.

Moving to gross profit. Consolidated gross margin was 50.5% for the second quarter, a decrease of approximately 530 basis points over the prior year and directionally consistent with our commentary last quarter predicting gross margin headwinds for the balance of 2020. Within the REVOLVE segment, we delivered gross margin of 52.2% in Q2, down approximately 530 basis points year-over-year.

The REVOLVE Segment margin was impacted primarily by a lower percentage of REVOLVE segment net sales at full price; deeper markdowns within the markdown product; and a lower mix of Owned Brands, as we have shifted a greater percentage of merchandise buys to third-party products with lower initial purchase quantities in order to maximize our flexibility in the pandemic.

As we discussed on our Q4 2019 investor call, we started to recalibrate the Owned Brand platform to better refine the assortment. With that, we expected Owned Brand mix to compress. With the additional pressures felt as a result of COVID-19, we expected further Owned Brand mix compression in the short term. To give you some guide posts, the Owned Brand mix was down around 9 points year-over-year in the second quarter.

As we comp the Owned Brand mix ramping in the prior year and as we cycle through the significant COVID-19 reductions we made in the second quarter of this year, we expect the mix of Owned Brands to decline by a greater magnitude on a year-over-year basis in the second half of 2020. Owned Brands are core to our long-term strategy and we have already started to ramp up design and reinvest in Owned Brand styles that will flow through to new inventory and subsequent sales.

Within the FORWARD segment, we delivered gross margin of 36.8%, a decrease of approximately 540 basis points year-over-year. The FORWARD segment operates within what has become a highly promotional environment in the luxury goods space. This led to a lower percentage of FORWARD segment net sales at full price as well as lower margin on the markdown product.

And now moving to the cost structure, starting with Fulfillment, which reflects the costs incurred to staff and operate our distribution center. Fulfillment costs totaled $3.8 million, or 2.7% of net sales, as compared to 3.3% in the second quarter of 2019. This leverage was better than we expected, particularly since a lower average order value is typically a headwind for fulfillment costs as a percentage of net sales.

The team did an outstanding job driving efficiencies and balancing the scheduling of team members within a dynamic demand environment that in the end, proved to be much better than our working assumptions. We also benefited from a reduced return rate and efficiencies gained from the automation investments we made last year. All the while, we have invested in maintaining our primary focus of ensuring worker safety and social distancing for all of our team members.

Selling and distribution costs, which consist primarily of shipping, merchant processing fees and customer service were $19.1 million, or 13.3% of net sales, a decrease from 14.6% of net sales in the second quarter of 2019. Once again, the efficiency was better than we planned for and benefited from efficiencies in shipping costs due to lower returns and to a lesser extent, efficiencies in payment processing and customer service costs. Great job to the team for delivering our best efficiency performance in more than two years.

Marketing costs were $14.6 million, or 10.3% of net sales, as compared to 15.4% of net sales in the second quarter of 2019. As discussed on the Q1 investor call, the second quarter is typically the peak for brand marketing investments, driven by the REVOLVE Festival that in prior years we have invested millions of dollars to host. None of that was possible this year, so by necessity, we shifted into highly effective digital brand marketing content at a much lower cost of production. As a result, our brand marketing spend decreased by $6.6 million year-over-year and performance marketing spend decreased by the remaining $3.7 million.

General and administrative costs, which primarily consist of salaries and wages were $15.8 million, or 11% of net sales in the second quarter, as compared to 11.6% of net sales in the second quarter of 2019. The year-over-year reduction in G&A spend reflects the cost reduction actions announced on last quarter's conference call.

Fortunately, net sales trends improved from the lows we experienced in late March and April and have overall, been much better than initially feared, so we moved rather quickly to restore salaries and wages that had been temporarily reduced. We started making these adjustments in May and by the end of this week, substantially all full-time active employees, including executives, and our independent board members will have their compensation back to the pre-COVID run rate.

For the second quarter of 2020, we achieved record net income of $14.2 million, or $0.20 per diluted share, an 11% increase compared to $0.18 in adjusted diluted EPS in the prior year. Adjusted EBITDA was $20.9 million, an increase of 10% year-over-year, for a margin of 14.6%.

Moving to the cash flow statement, we had an incredibly powerful quarter for cash flow generation. The combination of increased net income and a $37 million decrease in our inventory balance enabled us to generate $53.8 million in cash from operations and $53 million in free cash flow for the second quarter of 2020. In the 12 months since REVOLVE has been a public company, we have generated more than $80 million of free cash flow.

The strong cash flow generation significantly strengthened our balance sheet and liquidity. Cash and cash equivalents as of June 30, 2020 were $151 million, an increase of $47 million during the second quarter. As of the end of the Q2, $24 million remained drawn on our revolving credit line, a decrease from the $30 million balance as of March 31, 2020.

We ended the quarter with $65 million in inventory, a decrease of 37% year-over-year. By comparison, our net sales decreased year-over-year by only 12%, which highlights that inventory turns improved significantly year-over-year. As Mike mentioned, inventory turns improved approximately 30% year-over-year in our core REVOLVE segment. While the cost of carrying inventory is low for us and we have the ability to hold merchandise for multiple seasons, we also targeted lower inventory and higher turns as we entered 2020. This initiative became even more important as we navigated through the impacts of COVID-19.

With sales performance that has been better than we initially expected, we actively shifted our efforts to reinvest more aggressively into inventory purchases to support the improved trends in consumer demand. These investments are over indexed on third-party inventory and are very focused on the categories that have performed well during the COVID-19 period and those categories we expect will drive sales in the back half of the year.

Now, let me talk about business trends since the second quarter ended on June 30. As Mike mentioned and consistent with the month of June, net sales in July and August to date are in positive territory on a year-over-year basis. Average order value in July was slightly higher than the second quarter, reflecting the improvement in the dress category, but was still well below prior-year levels. The return rate is still well below the pre-COVID level, but has increased from the low point earlier in the second quarter as we are seeing a slight mix shift back to full price and as the dress category has performed sequentially better.

We believe we are in a much better place than we were just three months ago, as illustrated by our return to growth, significantly stronger balance sheet and improved inventory dynamics. Nonetheless, the duration and extent of the pandemic remains highly uncertain and the economic impact could last much longer. So given the fluid environment, we're still not comfortable offering traditional guidance. However, I will provide some additional information to help in your modeling.

Net sales, as we mentioned, we are operating in a very fluid and uncertain time with a number of factors that play can impact consumer demand and our top line results. While net sales improved sequentially on a monthly basis through Q2, it is important to note that the last several weeks of July and into August have been in the same general zone with low-single digit positive growth year-over-year. As such, and based only on what we know today, I would not expect significant improvement from our current levels in the near term.

Gross margin, the Q2 performance was better than our initial expectations, but we continue to believe gross margin will be challenged through the balance of the year and lower on a year-over-year basis. While gross margins have improved from the peak of the COVID-19 uncertainty earlier in the second quarter and we do expect promotional pressure to abate, we are still operating in an uncertain environment and historically our gross margins in the back half of each year are typically lower than the first half.

For our selling and distribution and fulfillment cost line items, as pleased as I'm with our fulfillment and selling and distribution cost efficiency in Q2, for modeling purposes, I would not guide anyone to expect this very high level of efficiency on these line items going forward. These variable cost line items will largely fluctuate with net sales in the near term.

We do expect continued efficiency gains over the next several years, particularly in the fulfillment line item as we grow into our capacity and continue to realize the benefits of automation, but we also continue to face ongoing external headwinds and will be exposed to additional cost pressures as the product mix and return rates continue to evolve in these uncertain times.

Marketing, we will continue to manage our marketing investment efficiently. Without the opportunity to activate large scale in person events as we have done in prior years, we expect marketing as a percentage of net sales to continue to be lower year-over-year in the second half of 2020. Note that the magnitude of the year-over-year decline in marketing spend in the second half will be much smaller than it was in the second quarter because historically, Q2 has the highest amount of brand marketing investment by a wide margin.

General and administrative, as mentioned, we realized leverage on this line item in the second quarter with the aggressive cost reductions we made. As we unwound most of those cost reductions over the course of June, July and August, we would expect to see a sequential increase in G&A for the third and fourth quarters when compared to the second quarter.

Note that we don't expect to return to the pre-COVID run rate in the current year as we did have a number of layoffs and made other non-headcount cost reductions that will continue to benefit the cost structure in the current year. Finally, we don't expect significant movement in our diluted share count or capital expenditures from what we communicated last quarter.

Now, I'll turn it back over to Michael to close out our prepared remarks.

Michael Mente -- Co-Chief Executive Officer and Director

Thanks, Jesse. COVID-19 has brought incredible challenges, but true to our resiliency and entrepreneurial spirit, our team has responded very quickly by protecting our employees and our balance sheet while, at the same time, launching innovative new ways to engage with the consumer and deepen customer relationships.

Seeing our team execute so well while further expanding our growth potential at a time when many industry companies are just trying to survive making me more even confident in our future. We believe our agile team, strong brand, differentiated technology and deep customer connection, coupled with our balance sheet strength and flexible business model, positions us to thrive over the long term.

With that, I'll turn it over to the operator for your questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question will come from Michael Binetti with Credit Suisse. Your line is open.

Michael Binetti -- Credit Suisse -- Analyst

Hey, guys. Congrats on a really nice quarter in a tough backdrop there. So I wanted to ask about the inventories and perhaps if this is the new normal do you see anything in the business model as you think you could run it at these higher inventory turns. I know you said this is the highest, it's been in a few years just over 3 times. I know we've talked a few times about why the inventory turns for a digital model, driven by the data that you guys have and doesn't turn inventories faster.

I think your language on that has been, we don't have the urgency of having to turn shelf space as quickly and we can let inventory that we think is good, sit there for a while and some of the DCs, but I wonder if anything you've seen as you've split up the inventories and move through inventory at a really fast-paced here, has told you that you could operate this at faster terms going forward?

Mike Karanikolas -- Co-Chief Executive Officer and Director

Yeah, definitely. Mike Karanikolas, here. I think both sides of that argument are actually true. So we do have a lower carrying cost of carrying inventory, which means we can turn slower. We believe without impacting margins and profits is the same -- in the same way as a traditional retailer. But it's also very true that we believe we can inventory at a much faster rate with fairly minimal impact to revenue in demand.

So it's all about balancing those two factors. And I think the nice aspect of our business model is that we do have the flexibility to run in both ways. And of course, we prefer to be closer to the zone we're in right now versus zone we are in a couple of quarters ago, but it's about strength of our balance between those two end points.

Operator

Our next question comes from Mark Altschwager with Baird. Your line is open.

Mark Altschwager -- Baird -- Analyst

Good afternoon and a nice job executing through this environment. In terms of the quarter-to-date trends you're seeing. I wanted to dig into that a little bit further just to understand some of the drivers. I guess any shifts from a category perspective, versus what you've seen in recent months. Just maybe help us understand the recovery addresses versus the incremental demand in some of these emerging categories. And then secondarily, just with the leaner inventory, has the leaner inventory been a limiting factor in the quarter-to-date trends so far? Thanks.

Michael Mente -- Co-Chief Executive Officer and Director

Yeah. Hi, Michael Mente here. With regards to the category shift, the pandemic hit lifestyle shift, you definitely saw a new overnight shift in certain categories where, of course, going out dresses and whatnot or heavily on the hardest but then [Indecipherable] over a lot of the categories that we've already mentioned perform quite well. As we've seen the consumer come back, we've seen continued strength in those more at home categories, but we've also seen a rebound in some of the more going out category. So it's kind of a healthy balance for us, where the newly developed categories are continuing to perform quite, quite well and continue to have our highest turn, we also see the core categories coming back as well.

Operator

Our next question comes from Simeon Siegel with BMO Capital Markets. Your line is open.

Simeon Siegel -- BMO Capital Markets -- Analyst

Great. Thanks. Good afternoon, everyone, I hope you and your families are doing well through all this. Congrats on the meaningfully better returns that was great to see. Can you elaborate on your view, whether that's a new norm or onetime pandemic side effects, so just talk about if you can, how was the return cadence over the quarter and then really encouraging to hear on the net sales growth, due to beyond how our gross sales quarter-to-date? Thank you.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Yeah, definitely. So with regards to the return rates, we believe the impacts there are primarily due to the shifts in consumer behavior that have happened with the pandemic. I mean we have started to see that interim rate come back up. It's still far below historical norms, but we have seen starting to come back up is consumer behavior starts to return closer to the norm. As far as to what extent any of that behavior continues for the long term, I think it's too early to say there's certainly some aspects that may continue over the longer run.

We're very hopeful that our shift in product mix can represent an expanded wallet share. So in addition to performing really well in high return categories like dresses were hope over the longer term that our gains in beauty and some other categories also become drivers for us and that would have an impact on return rate. And there is a few other things we done on the return rate side as well, but I think high level, it's too early to say.

And with regards to trends on net sales and gross sales, as you might imagine with net sales in the low-single digits, but we -- the lower return rates year-over-year that means our gross sales are still deeply lower year-over-year and we believe that this consumer purchasing behavior much more purposeful in terms of making a purchase that they have confidence that they're going to keep. But we have seen as return rates creep back up a little bit some improvement in sales numbers.

Simeon Siegel -- BMO Capital Markets -- Analyst

Great. Thanks so much. Best of luck for the rest of the year.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Thank you.

Operator

Our next question comes from Kimberly Greenberger with Morgan Stanley. Your line is open.

Kimberly Greenberger -- Morgan Stanley -- Analyst

Thank you so much. Sorry about the background noise. I wanted to just follow-up on the inventory composition question. Do you feel like you got the right composition? And are you having to chase, or are you running out of the categories that are returning faster, in other words, with maximized revenue, if you race against little bit in lifestyle. And then I have a follow-up question.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Yeah. So in terms of the inventory composition, we feel much better about it certainly than we did entering into Q2. I think there is some level of opportunity cost in terms of popular categories that we're chasing and there has been a shift between third-party in owned brand as we noted, but we feel like we're positioned well and we think there is opportunities in the back half of the year. If we can chase harder into some of those popular categories.

Kimberly Greenberger -- Morgan Stanley -- Analyst

And then just to follow up on the marketing cost. Is there any sort of magnitude that you can guide us to on second half reduction? And are you seeing any sort of change in payment behavior among consumers are they utilizing after pay for example, a little bit more or I noticed you said there were some savings on the credits or the transaction cost. So I just wanted to follow up on what the driver was there? Thanks.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Yeah, sure. Thanks, Kimberly. 2Q we are comping our peak marketing period in the year. So in 2Q of '19 it was 14.6%, I think 14.5% of net sales, much lower this year given where we're at. And then, it starts to go down in the back half of the year as we don't have the magnitude of in-person events in the prior year's. Q3 is relatively high as compared to Q4 with revolve summer. So you'll see some savings there going forward, but the magnitude in 2H will be lower than that of -- that we saw in Q2. So just keeping that in mind for modeling.

And then on the customer payment types, we have seen a shift over time with the advent of the instalment players out there. So a shift from the traditional VISA-Mastercard, Amex to the instalment payments, which do carry higher fees. So we've seen some pressure on those costs over the last, call it, a year to 18 months. But there is a benefit in the quarter, not only from comping that but also from the returns -- the lower return rate. So we saw, call it, a 30 basis point improvement there on credit card fees and the way the customers are purchasing.

Operator

Our next question comes from Ed Yruma with KeyBanc Capital Markets. Your line is open.

Abbie Zvejnieks -- KeyBanc Capital Markets -- Analyst

Hi. This is -- I'm Abbey on for Ed. I had two questions and so how do you expect the promotional environment to change in the back half, I mean, I know you said you'll still see gross margin pressure, but do you think promotions will be less deep or there'll be less items on sale? And then second, quickly, do you think you will develop in owned brand and beauty since you've seen such good trend?

Jesse Timmermans -- Chief Financial Officer

Yeah. This is Jesse. Maybe I'll take the first part of that and talk about margins and promotional pressure and then, and then pass it on. We do expect to see a year-over-year compression in gross margin continuing into the second half, but as we mentioned, less so than the second quarter. And just to backup and remind, we are comping a record high margin in 2Q of '19. So that's where we will see that compression subside a bit in 2H, still year-over-year decline.

And then the promotional pressure, I think it's an extension of what we've seen already in the second quarter were that promotional pressure wasn't as great as we first anticipated early in the COVID pandemic. And as we get, -- as we've cycled through some of the markdown inventory and start to get the new inventory in the well performing categories. We feel good about that full-price mix coming back slightly. And I think that was -- and I guess just to focus on the revolve segment, we do see increasing promotional pressure in that luxury segment of FORWARD in that, that we expect to continue in the near term.

Michael Mente -- Co-Chief Executive Officer and Director

And with regard to own brand that's something in the mix of long-term. I think there's a lot of other higher priority things particularly in the Apparel segment that will continue to develop and make investments in. But own brand long-term is definitely an opportunity for us. We're carrying a lot of emerging brands and a lot of excitement in that. I think that's exactly what we did successful in manufacturing on the apparel side, so exciting opportunity for us.

Operator

Our next question comes from Oliver Chen with Cowen. Your line is open.

Oliver Chen -- Cowen -- Analyst

Hi. Thank you. Regarding average order value, how do you see that trending in the back half and as it relates to some of the category shifts that you're seeing now? And my second follow-up question was just the changes that you're witnessing and executing on in marketing. Could you speak to which ones will stick for the long term and your own view on the longer term, how marketing as a percentage of sales may change and evolve as you engage in what seems like really successful online customer acquisition techniques as well? Thanks.

Jesse Timmermans -- Chief Financial Officer

Yeah. I'll take that. This is Jesse. Thanks, Oliver. I will take the first part of that and then pass it on to Michael for the longer term marketing comments. That average order value significant decline in the current quarter that 26%, we have seen it tick up slightly in July and August as the mix has shifted back, not only to that largest category addresses with a higher average selling price, but also a slight uptick in the full price sales. Again as we cycle through some of that markdown inventory. So, we'd expect to see, I'll call it a slight increase in average order value as we exit Q2, on a sequential basis still lower year-over-year, but we did see some improvement there on a sequential basis.

Oliver Chen -- Cowen -- Analyst

Okay. And Jesse on that topic, with gross margins and markdowns next quarter, will markdowns be less or more than last year next quarter given that dynamic?

Jesse Timmermans -- Chief Financial Officer

Probably, slightly -- slightly more on the markdown downside year-over-year, but better on a sequential basis, again as we cycle through that Q2 inventory.

Oliver Chen -- Cowen -- Analyst

Thank you.

Michael Mente -- Co-Chief Executive Officer and Director

And with regards to the marketing mix, we're very, very thrilled with what the team has been able to do in terms of expanding our playbook. These are things that are, of course, driving short term customer acquisition, but also long-term kind of arrows in our quiver. We're, of course, looking forward to the world opening up a bit for our consumer be out and about travel and by withstands and whatnot. And when that's an important part of their lifestyle, we will subsequently return.

It'll be a hybrid mix, which is very exciting, when it comes to the overall brand marketing in particularly it really will be a contingent of kind of the health of the overall business. Of course, we're a very conservative at the moment, but as opportunity comes, the consumer comes in the macroeconomic environment improves. We'll definitely be ramping up as far as where it was in relation to historic times. It's really kind of contingent to speaking about what the market is like, what our business is like in such. There will be a lot of flexibility there.

Oliver Chen -- Cowen -- Analyst

Thank you. Great quarter.

Jesse Timmermans -- Chief Financial Officer

Thank you.

Michael Mente -- Co-Chief Executive Officer and Director

Thank you.

Operator

Our next question comes from Justin Post with Bank of America Merrill Lynch. Your line is open.

Joanna Zhao -- Bank of America Merrill Lynch -- Analyst

Hi, thanks for taking my question. This is Joanna Zhao for Justin Post. So I have two questions for you. One is, can you comment on like the trend of the percentage of pool price item sales in second quarter. Do you see there's an improvement in the trend month over month since the pandemic started? And then my second question is from the strategy. Shifting away from third party brands into -- sorry. Shifting away from own brands into third party brands. And what do you see that mix, sort of be the goal of that mix for the second half of 2020 for both REVOLVE and FORWARD.

Jesse Timmermans -- Chief Financial Officer

Yeah. Sure. This is Jesse, again. On the full price still meaningfully lower than the prior year, that's important to call out. Again, we are comping a record high gross margin and that was really driven by both owned brand mix as well as full-price sales, which were really high in the prior year, so meaningfully lower this year, in the second quarter. That said, we did see slight improvement as trends picked up and as we have sorted into the new inventory into July and August. But I'll emphasize that slight and still being year-over-year flat to down on a full-price markdown ratio as where there is more markdowns this year than prior year.

And then on the owned brand mix we had commented in the prepared remarks that owned brand is approximately 9 points lower year-on-year, than we were in the prior year. So again stepping back to the prior year, we are ramping aggressively on the owned brand front and then earlier this year, we had communicated the recalibration of that owned brand platform to reassort into different categories and really refine that platform.

So with that, and then the added pressure of COVID-19, we took that down significantly and that led to that 9 point reduction. We expect that year-over-year decline in owned brand mix to be greater in the second half than it was in the second quarter, again as we cycle through that inventory and just start to redesign and reassort into the back half of this year and early 2021.

Joanna Zhao -- Bank of America Merrill Lynch -- Analyst

Great. Thanks and congrats on the results, again.

Jesse Timmermans -- Chief Financial Officer

Thank you.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Thank you.

Operator

Our next question comes from Ralph Schackart with William Blair. Your line is open.

Ralph Schackart -- William Blair -- Analyst

Good afternoon. Maybe just on the customers in terms of newer cohorts and comparing them to older cohorts, any color you could add on spending patterns, how they're behaving, and are you observing any new customers coming in for example purchasing loungewear it may be -- if you could highlight your incremental opportunities for you to advertise newer categories for them, such as dresses going forward? Thanks.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Yeah, definitely. Yeah. We think that's one of the most exciting aspects of these newer categories, you're not just expanding wallet share with existing customers, but they are agreeing avenue for new customer acquisitions, particularly on the beauty side. So we saw that that category engine was very beneficial on the new customer acquisition side, which I think is why we saw some pretty decent new customer acquisition numbers given the environment and given the really sharp reduction in marketing spend that we had during the quarter.

Ralph Schackart -- William Blair -- Analyst

Okay. Great. Thank you.

Operator

Our next question comes from Bob Drbul with Guggenheim. Your line is open.

Bob Drbul -- Guggenheim -- Analyst

Hi, guys. Good afternoon. Just a couple of questions from me. The first one is, can you comment a little bit more on the international sales performance in the second quarter, may be quarter-to-date. I don't know if you could talk, month-to-month and even quarter-to-date would be helpful. The second question is on shipping costs, there's been a lot of discussion around surcharges heading into the back half of the year. Just wondered if, is that something you guys expect in the coming quarters? Thanks.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Yeah, definitely. So on the international side, in Q2, we saw strength there versus the domestic, where the international was growing call it, moderately faster than the domestic market. We've seen that continue into Q3 with maybe a little bit of acceleration on the international side, but it's still early. And then with regards to shipping costs and surcharges, there is potential risk there that something that we're actively kind of working on and doing work behind the scenes and still TBD how that plays out. But I think working in our favor is that we are not a very seasonal shipper, which is very good for the carriers. We normally slammed in Q4. And in contrast to most others Q4 is not biggest quarter. So we [Indecipherable].

Bob Drbul -- Guggenheim -- Analyst

Great.

Operator

Our next question comes from Ross Sandler with Barclays. Your line is open.

Thomas -- Barclays -- Analyst

Hey. This is Thomas [Phonetic] on for Ross. What are the customer acquisition trend like in 2Q and in 3Q? And how might [Indecipherable] in your business. Also any update on the Facebook ads performance the company has been flagging e-commerce as a strong area? Thanks.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Yeah. So with regards to customer acquisition trends in Q2, as I mentioned, given the sharp reduction in marketing spend, we're very happy with how that's trended. That said, as we've seen -- starting to see some increases in the traffic costs as the macro environment has recovered somewhat, there has been a little bit of a contraction there, but in general, very happy with results.

And with regards to Tik-Tok, Tik-Tok is still a very nascent marketing channel for us. So it's an area where we do have this amount of activity, but a very nascent in terms of delivering results. So we don't expect any meaningful impact from whatever it ends up happening with Tik-Tok. And in fact what we're particularly excited about is with Instagram reals, the Tik-Tok competitor since they've launched that we've had some really meaningful traction there. Actually, I believe, over 1.5 million views in just couple of days since the team mobilized on Instagram real. So if anything, it might be an opportunity that opens up depending on we workings on Tik-Tok.

And then the third part of your question, I had trouble hearing you can you state it?

Thomas -- Barclays -- Analyst

Just any updates on the Facebook ad performance, they were flagging e-commerce as a strong area, it was just a last one.

Mike Karanikolas -- Co-Chief Executive Officer and Director

Yeah. So Facebook ad performance, it's been similar to the overall market where we've seen cheaper traffic earlier in the quarter and then increases throughout the quarter as the macro environment recovered.

Operator

We have time for one more question. Our final question comes from Susan Anderson with B. Riley, FBR. Your line is open.

Susan Anderson -- B. Riley FBR -- Analyst

Hi. Good evening. Thanks for hitting in and nice job on managing the quarter. I guess on the supply chain front, I was curious if you're seeing any issues such as delayed deliveries for the back half. And then also, are you seeing lower product cost for the back half? And then just a quick follow-up on the third-party brands. It sounds like you're picking up kind of a few in home and beauty and as serious processing for footwear and apparel?

Jesse Timmermans -- Chief Financial Officer

Sure. Yeah. Hi, Susan. Thanks. This is Jesse. In regards to the supply chain, we did see an initial impact in some delayed deliveries, particularly for fall, but since then it's been relatively stable. There's probably a little bit of lack of supply just given that nobody's at 100% right now, but not a significant impact from our perspective. And then product costs, not a meaningful decrease in product cost in the second half either. There is -- for us, in particular, a shift in the category mix as we absorbed into those categories that are performing well during the COVID pandemic. So there is definitely a product cost component there, but not on a like-for-like basis.

Operator

This concludes our allotted time for the Q&A session. I will now turn the call back over to management for closing remarks.

Michael Mente -- Co-Chief Executive Officer and Director

So definitely an extremely challenging quarter, but again really, really proud of how the team executed. There was a lot of sacrifice on a personal level, a lot of sacrifice with working from home, and really the rapid-rapid shift behind themes were incredible. The operational staff did an incredible job to maintain customer service levels, which Mike mentioned extremely, extremely important to us. And I think in these challenging times we feel very confident about and we'll continue to acquire new customers, deepening the relationship with our existing customers.

And with the competitive dynamic, we also feel that exiting these challenging times, we're positioned incredibly, incredibly well. Of course, it's not for a lot of people out there, but we are similar to our positioning in the last downturn. We really view this as a brush fire clearing out that some of the growth to really provide and pave the way for what's coming. So challenging times in great, great work of the team, the features will be incredible and exciting for us.

Operator

[Operator Closing Remarks]

Duration: 58 minutes

Call participants:

Erik Randerson -- Vice President, Investor Relations

Mike Karanikolas -- Co-Chief Executive Officer and Director

Michael Mente -- Co-Chief Executive Officer and Director

Jesse Timmermans -- Chief Financial Officer

Michael Binetti -- Credit Suisse -- Analyst

Mark Altschwager -- Baird -- Analyst

Simeon Siegel -- BMO Capital Markets -- Analyst

Kimberly Greenberger -- Morgan Stanley -- Analyst

Abbie Zvejnieks -- KeyBanc Capital Markets -- Analyst

Oliver Chen -- Cowen -- Analyst

Joanna Zhao -- Bank of America Merrill Lynch -- Analyst

Ralph Schackart -- William Blair -- Analyst

Bob Drbul -- Guggenheim -- Analyst

Thomas -- Barclays -- Analyst

Susan Anderson -- B. Riley FBR -- Analyst

More RVLV analysis

All earnings call transcripts

AlphaStreet Logo