Service Corporation International (SCI) Q2 2019 Earnings Call Transcript

Finally, other revenue predominantly general agency revenue, fell a little more than $2 million quarter over quarter, primarily due to a decrease in preneed funeral insurance sales production coupled with a lower cremation rate. While the commission rate was lower in the quarter, the general agency cremation rate for the first six months is in line with our expectations and prior year. From a profit perspective, operating profit was essentially flat and operating margins decreased 30 basis points to 19.5%. Considering the limited revenue growth for the quarter, I was proud of our teams’ focus on managing our variable and fixed costs, which afforded us the ability to match last year’s profitability.

The good news is that we continue to focus on cost-reduction initiatives, which we believe will have a continuing benefit throughout the remainder of 2019. Finally, total preneed funeral sales production, which gets deferred into our backlog, grew 3% for the quarter. The increase was primarily driven by SCI Direct, which grew an impressive 15.5%, again reflecting that our sales team is back to full strength. Preneed sales at our core locations were relatively flat to the prior year quarter as trust production grew offsetting the insurance production decline.

However, keep in mind that we’re up against the tough comparison as last year we reported a 10.4% increase in preneed sales at our core locations compared to the second quarter of 2017. Now turning to cemetery operations. Comparable cemetery revenue grew $2.4 million or just under 1% for the quarter. This consisted of operating revenue growth of about 3%, which is partially offset by lower perpetual care trust fund income due to the timing of distributable capital gains.

In terms of the breakdown of cemetery revenues, recognized preneed revenue grew $8 million or nearly 4%. This growth is primarily due to the higher revenue recognition rates. Recall that higher recognition rates means more of what we’re selling is getting recognized in earnings. This higher rate is a result of our sales team selling a larger percentage of existing developed property versus undeveloped as well as achieving the down payment criteria for some of the strong sales production from the first quarter.

Cemetery preneed sales production was lower by $7 million or 2.9% against a tough comp as the second quarter of 2018 was the strongest production quarter we have reported in several years. The largest decline was in the large property sales category, which as we have explained before can ebb and flow from quarter to quarter. While we’re not pleased with our second-quarter sales production, the preponderance of the missed expectation was isolated to a few big markets. But for the most part, regulatory or structural challenges created temporary setbacks, and we are confident improved performance is on the way.

Additionally, on a global basis, we implemented some healthy long-term focused behavioral changes around sales goals, discounting and customer relationship management tools that may have been temporarily distracting during the quarter, which should drive improved efficiencies and productivity in the back half of the year and for years to come. For the first six months of 2019, our cemetery preneed sales production has grown about $6 million or 1.3%. It is our belief with momentum into the back half of 2019, we should be able to achieve the lower end of our annual cemetery preneed sales guidance of 4% to 6%. Finally, as it relates to revenue, we experienced a $5.9 million decrease in perpetual care trust fund income following a $7.5 million favorable increase in the first quarter of 2019.

As we said before, the timing of capital gain distributions compared quarter to quarter. Comparable cemetery operating profits grew $2.3 million or 2.4% and margins expanded 50 basis points to 30.4%, primarily resulting from the operating revenue increases I just described. The benefit from various ongoing cost-reduction initiatives helped to offset the decline in high margin trust fund revenue and prevent additional growth in fixed costs. So to wrap it up, we delivered on the more challenging ebb of 2019 on a comparable basis, especially in light of the challenging first quarter funeral volumes.

We would expect the second half to generate a double-digit percentage increase in earnings per share, driven by a profit growth in the funeral segment in both quarters, profit growth in the cemetery segment predominantly in the fourth quarter as the third quarter of 2018 had a significant revenue impact from completing construction projects that will be lighter in the coming third quarter as well as lower general and administrative costs in the back half of the year. Higher comparable tax rates should meet the impact somewhat, but we should still show very impressive earnings-per-share growth. We continue to believe that we’re on track to deliver solid results for the full-year 2019 and are updating our adjusted annual earnings per share range to $1.90 to $2 with a midpoint of $1.95. The $1.95 represents a 9% increase over adjusted 2018 earnings per share of $1.79 sales even as we expect a slightly higher tax rate for this year.

We’re confirming our adjusted operating cash flow guidance of $550 million to $610 million, and Eric will talk more about this shortly. In the meantime, we’ll continue to pursue our three core strategies of growing our revenues, leveraging our scale and deploying capital in a disciplined manner toward the highest and best use for the long-term benefit of our company and our shareholders. With that, I’ll turn the call over to Eric.

Eric Tanzberger — Senior Vice President and Chief Financial Officer

Thanks, Tom. Good morning, everybody. I’m going to now give you some color on our cash flow results during the quarter, I also want to provide some insights on our trust funds, I’ll cover our capital deployment for the quarter and then more importantly, I’ll touch on our financial position and our outlook for the remainder of the year. So as you saw in the press release, we have generated adjusted operating cash flow of $84 million in the quarter, this is in line with our expectations.

It was down about $20 million from the prior year quarter as growth and operating profit was more than offset by anticipated both higher cash tax payments as well as higher cash interest from the debt refinance activity that we did during the quarter. Quarter over quarter, cash tax payments increased $20 million, and as I said that was expected. In the first half of 2019, we have incurred $50 million of cash taxes as compared to about $25 million in the first half of last year. So we refined our estimates for the full year.

We now believe cash tax payments will be closer to $90 million for the full year of 2019, which is a $10 million reduction from what we previously guided in terms of cash tax payments. Therefore, looking at the balance of the year, we estimate $40 million of cash taxes in the back half of 2019 compared to $30 million, which was spent in cash taxes in the back half of 2018. Now also related to taxes, we noted in our press release an adjusted effective tax rate for the quarter of 23.3%, which declined from 26.7% in the prior year as we primarily benefited from higher excess tax benefits on increased exercises of stock options. Keep in mind though as you compare the second half of ’19 versus the second half of ’18, we are expecting an adjusted effective tax rate of around 25%, which compares unfavorably to the back half of 2018, which is about 20% that again was reduced by unusually high excess tax benefits last year.

Cash interest payments increased about $8 million during the quarter, about $2 million of this was expected due to the higher interest rates on our floating rate debt, but the remainder related to our recent financing transaction that I’ll now address. So in May, we issued new $750 million of 5.125% senior notes, they are 10-year notes due in 2029 and we use these proceeds to pay off $425 million of our of 5.375% notes that are due in 2022 as well as refinance about a little over $300 million on our credit facility. We also entered into a new $1.65 billion five-year credit agreement consisted of $1 billion revolving credit facility and a $650 million of funded term loan. These transactions significantly enhanced our liquidity as well as our debt maturity profile, while reducing our floating interest rate exposure.

This again sets us up nicely to execute our capital deployment plans going forward. So by converting from the 2022 notes with interest payments that would have been made in January 2020 next year to the new notes that will pay interest in December of 2019, therefore we will experience a onetime pull forward of cash interest of about $7 million to $8 million for calendar year 2019, which essentially washes the reduction and cash taxes for fiscal year ’19 that I just noted. From an earnings perspective, interest expense rose $6.6 million year over year in the first half of 2019, driven in large part from interest on our floating rate debt increasing from 3.5% in the first half of 2018 to 4% now in the first half of 2019. With the benefits from the refinancing, we expect the interest on our floating rate debt to be 4% in the second half of 2019 and to also be generally flat to the second half of 2018.

Now if the fed does elect to reduce rates, depend on what you believe 25 or 50 basis points, we could have a tailwind here of about $0.01 in the second half of 2019, again all else being equal. So now let’s move on to free cash flow. Maintenance in cemetery and development capex combined, which again are the two components that we define as capex in our free cash flow calculation was approximately $50 million for the quarter or flat to the prior year quarter and generally in line with our planned spending. We did not use recuring capex items from cash flow, we calculate our free cash flow in the quarter to be about $33 million.

For year to date, our free cash flow calculates to almost $175 million. So usually before I move on to capital deployment, I’m going to take some time to address some of the trust-related metrics for the quarter. First I’ll talk about perpetual care trust fund income in the cemetery segment, which Tom also mentioned as well. Our cemetery segment was impacted by $6 million reduction in perpetual care trust fund income during the second quarter, this compares to a $7 million increase in the first quarter of 2019.

So on a year-to-date basis, we are slightly up compared to the prior year and in line with our expectations. Similar to what I mentioned last quarter, the second quarter was impacted by fluctuations related to the timing of capital gains and other distributions. But looking forward to the balance of the year, while we don’t expect large swings, the timing of distributions from perpetual care funds not held in our total return stage is somewhat uncontrollable as portfolio managers have the discretion to trigger capital gains that are then generally distributed to us and recognized as earnings in most states. So now I’d like to spend a moment addressing our preneed funeral and cemetery trust funds.

As you saw in the press release, they’re up a healthy 13% year to date. After a tough fourth quarter of 2018, where our trust funds dropped about 10%, we have projected some recovery in our trust returns during the first half of 2019 in excess of our typical mid-single digit growth expectations of about 6% nominal return prior to fees. The actual returns we have experienced though, again the 13%, have exceeded our expectations by around 5%. So using our rule of thumb of about $1.25 million of EBITDA impact for 1% return change, again this is above or below the trailing 10-year 6% return, this would equate to just over $6 million on an annual basis, half of which should occur in the second half, holding all else equal.

So now moving on to capital deployment during the quarter. We deployed about $88 million toward acquisitions, new location builds, dividends and share repurchases. Also included are some open market debt repurchase as we continue to — are focused on modest deleveraging. So let’s talk about the breakdown of the components.

First, we deployed $14 million toward acquisitions in real estate purchases during the quarter, which included several funeral homes purchased in New Jersey, Saskatchewan and Ontario. We believe acquisitions like these continue to be our highest and best use with mid-teen after-tax returns. I’d like to welcome these associates to the SCI and the Dignity Memorial family. Year to date, we’ve invested $33 million toward acquisitions, and we continue to guide this spend to about $50 million to $100 million for the full year given the acquisition pipeline we currently have.

In the quarter, we also invested additional $10 million or $4 million over prior year on a new build and expansion of several funeral homes, including new funeral homes in Texas, Florida, Colorado, California and Georgia. This increase in growth capital really has been a trend for us over the past several quarters and is intentional. These new builds not only provide us with great low double-digit returns, but also expand our footprint into desirable markets to meet the needs of a customer increasingly looking to celebrate life. Over the latter part of 2019, you can expect continued increased deployment on these types of projects by just under $5 million over five prior year levels.

Dividend payments in the second quarter totaled $33 million, represented an increase of about 5% over the prior year, this reflects the $0.01 per share or 6% increase in our dividend to $0.18 per share per quarter, which we announced in February. Next, we returned $15 million of capital to investors in the form of open market share repurchases, which are approximately 337,000 shares at an average cost of about $44 per share. Our current number of shares outstanding is just over 182 million at the end of the quarter. And today, we have about 160 million of remaining share repurchase authorization.

Finally, we repurchased almost $16 million of debt in the open market to manage the leverage as well as reduce some higher interest expense debt, interest will benefit by almost $600,000 associated with these repurchases in the second half of 2019. And on the topic of leverage, we began the year toward the higher end of our desired range of 3.5 to four times net debt-to-EBITDA during the robust capital deployment that we had in 2018. This capital deployment was driven in part by almost $195 million of acquisitions last year that are financed with cash. Our quarter end leverage was about 3.89x.

And when we look toward the second half of this year, we expect to nationally delever as our performance grows when compared to the second half of 2018. This will provide us with the flexibility to deploy capital to the best use for the remainder of the year, which will include share buybacks, but also will get us closer to our expectation of 3.75 midpoint of our leverage target range by the end of the year. We also finished the quarter with tremendous liquidity of about $1.2 billion, consisting of just under 244 — $250 million of cash on hand and just under $1 billion availability on our new revolver. So in closing, cash flow results continue to be strong.

Through the first half of ’19, we’re aligned with our expectations and I’d like to thank all of our 24,000 of our SCI Associates for helping to achieve these stellar results. While we have not changed our 2019 guidance range for adjusting cash flow of $550 million to $610 million, we have updated the component slightly by taking into account the $10 million of lower anticipated cash taxes that substantially offset by almost the same amount of higher cash interest payments. Our cash flow, in addition to $1.2 million of liquidity that I just mentioned, sets us up very nicely to deploy capital over the remainder of the year by investing in highly accretive acquisitions as well as new build projects, while funding the dividend and returning capital to our shareholders in the form of share repurchases. So with that, operator, that concludes our prepared remarks.

We’ll now go ahead and turn the call over to you to take questions.

Questions & Answers:

Operator

Thank you, sir. [Operator instructions] And from Oppenheimer, we have Dignity Memorial family. Please go ahead.

Scott Schneeberger — Oppenheimer — Analyst

Thanks. Good morning, everyone. I guess I would like to start out on the lower cemetery preneed growth in productions, specifically in the quarter. Tom, could you go over again, please, the drivers of that? Maybe give us a sense of magnitude of each? And then some thoughts about the corresponding turn in benefit in the second half and thereafter? Thanks.

Tom Ryan — Chairman and Chief Executive Officer

Sure, Scott. Thank you. First of all, I guess, I’d level set with and I think I had in the prepared comments. If you look back at the second-quarter 2018, it’s our highest production quarter for cemetery — preneed cemetery in the last five years for sure, may be for ever.

Same quarter is always generally a very strong quarter on a seasonal basis. So we had a high hurdle to get over. The second thing we did, and I’ve touched upon a little bit but didn’t go into great detail, with regards to some changes that we made associated with our target. One, we raised the targets for achievement in order to get bonuses.

We recognized the fact that interest rates are — can be a form of discount. And so in equating that to the way that we compensate the sales force and driving fair interest rates as we finance these things over time. And then finally, some discipline around utilizing the Salesforce product, which the customer relates to your management. So we did a lot of things that are tough, good behavioral changes that I think is going to drive productivity, enhance our sales force ability to sell.

And again, when you do those things and we did these predominantly in April and May, they can be temporarily distracting. And so I think that had an impact, but again, as I mentioned, I think those are things that are going to benefit Q3 and Q4 when you think about our ability to achieve those production levels. And then we just mentioned again that from time-to-time, you’re going to have markets and particularly big markets we mentioned in the first quarter, some challenges in Vancouver as it relates to reaching targets of previous years. And those things just are going to happen from time-to-time and we’ve got plans that we believe are going to allow us to lift our game even in the bigger markets.

So we’re excited about the back half of the year. I think we are confident that, number one, we’re generating probably the best leads we’ve ever generated in the history of the company. They are going to be very productive as you think about the back half of the year, by the way these leads cost less than they used to cost, they’re better leads. We’re now globally on a customer relation management system that kind of allows us to be more productive in handling those leads and managing them over time.

And so we feel really, really good about the momentum as we enter the back half of the year. Tough second quarter, but I think we made some changes that are positive for the long-term benefit of our company and our sales consumption.

Scott Schneeberger — Oppenheimer — Analyst

Thanks. I appreciate that, Tom. The cemetery recognized revenue was certainly elevated and benefited the quarter, I suspect that might be a little bit more volatile in the back half. Could you please discuss that a little bit?

Tom Ryan — Chairman and Chief Executive Officer

Sure, Scott. I think — first of all, when you think about cemetery construction projects, a higher proportion of them tend to occur in the back half of the year, particularly in the fourth quarter and a lot of it just has to do with weather, obviously a lot of work can get done in the summer months, when you think about certain markets. And so a lot of the completions will occur, that’s what will be the case, we expect it to be the case. Last year, we had an unusual amount of hit in the third quarter.

And so I just kind of highlighted for you guys, we don’t believe we’ll see the same level of constructed revenue recognized in the third quarter. So we think our production will be great, but the GAAP revenues probably will be closer to flat or slightly down. But in the fourth quarter, I think, we’ll pick that back up. So lot of the reasons why we can recognize more revenue today is because we’ve invested in these cemetery projects.

I mean, we’ve now gone multiple years of significant development of great projects and to now there is more inventory on the ground to sell, and we’re selling it so we can recognize it faster. So I think that’s a little bit of what you’re seeing in the first half of this year. And so to smooth it out a little bit, as you think about having a full country’s worth of good existing inventory to sell.

Scott Schneeberger — Oppenheimer — Analyst

One more, if I could, I’ll leave the funeral side for others to ask, but the cost savings initiatives that benefited the quarter, could you touch upon that a little bit more? And perhaps how that should affect second half?

Tom Ryan — Chairman and Chief Executive Officer

I think some of it, I’ve touched upon, we’ve done a really good job of finding more efficient ways to generate leads through digital leads that are cheaper than historical. We’ve got significantly more leads in the quarter related to seminars. We’ve lowered the cost and the effectiveness of our direct mail programs. So a lot of things around lead generation that have helped, we also have seen from a customer facing cash cost perspective, we’ve had initiatives both in the field and in the home office to reduce the, what we call, noncustomer facing cost.

So think of travel, entertainment, things of that nature, and we have seen successes to the level of 20% to 30% type of reductions year over year. So again, I think, what we’re really doing to the company is to say, look, we’re going to begin to invest in some new and exciting things that relates to digital strategy, focusing on driving more customer behavior, let’s find ways to fund these investments that we see coming. Another thing, I think, we’ll talk a little bit more because this happened in the third quarter, but we purchased cemetery land — raw cemetery land for the first time in a long time in some of our — couple of our key markets that again we want in the long-term make sure that we have the right type of inventory to continue to sell. So as you think about putting capital to work organically in some of these markets now even in some cemeteries, this is just really an effort to rally everybody around, let’s generate cash to invest in our future and continue to lead the industry in a direction we want to go.

Scott Schneeberger — Oppenheimer — Analyst

OK. Thanks. We’ll be balancing maybe some sales of cemetery now that you mentioned that you’re purchasing some land or is it just opportunistic and one-off’s you think?

Tom Ryan — Chairman and Chief Executive Officer

Yes. I think the land that we purchased is really around the long — having a long-term footprint that works in some of these big markets. So think of the LAs, the Houstons, places like that where we have significant presences, big cemeteries, lot of growth in those markets and just making sure that we’ve got developed property to meet the needs of those consumers, their wants and needs. So I think these are kind of one-offs, they’re not big ones, but these are the types of things that and like I mentioned before kind of the digital strategy that we’re embarking upon from generating leads to also adjust the customer experience, finding ways to fund those projects with our hard-earned dollars and making sure that our shareholders get the right returns.

Scott Schneeberger — Oppenheimer — Analyst

Thanks very much. I’ll turn it over.

Operator

From Bank of America, we have Joanna Gajuk. Please go ahead.

Joanna Gajuk — Bank of America Merrill Lynch — Analyst

Good morning. Thank you for your time. Great. OK. So I guess, on the — first on the core, on the funeral segment, the core cremation shifted 170 basis points so that’s better than 200 basis points you talked about in Q1.

So I guess, maybe can you just flag to us the items you’re talking about the last two quarters in terms of the impact of the acquisitions and also on actions that were impacting the last two quarters in terms of what was the magnitude of the impact this quarter?

Tom Ryan — Chairman and Chief Executive Officer

Sure, Joanna. So I think last quarter, we talked about this and we saw a 200 basis points shift and my comments were around it. We believe 30 to 40 basis points of that shift was associated with some changes we made in selected markets. I think we had 30 markets where we made changes to, I would say, the starting at pricing as it relates to the cremation consumers in those markets.

And we saw volume less in those markets associated with it. Another 30 to 40 basis points, we believe, was the mix of acquisitions, as I think I mentioned before, the average cremation rate and the acquisitions over last two years was probably about 65% higher than our traditional. So those two things we thought combines, and I tell you that that’s proving out I believe to be accurate. What we’re seeing now is, for instance, even within the quarter, Joanna, you saw the 170 basis points.

In June, it was significantly lower than that, and that’s just anniversary comparison. We made these changes throughout the year last year. So you’re seeing some year-over-year overlap now as it relates to that pricing being in place in those markets and therefore, you’ve gotten your initial lift and you’ve maintained it. So we still believe that the cremation mix in our business is probably changing about 100 to 150 basis points give or take a quarter.

And the additional volume or I should say mix that’s been driven is incremental volume where we’re getting customers we weren’t getting before. So that’s why even though the mix changes there, we’re pretty excited about at it and we think it’s adding to profitability versus detracting product.

Joanna Gajuk — Bank of America Merrill Lynch — Analyst

Right. So you’re saying that there is still — or did you anniversary the impact of the changes you’re making in the 30 markets? Are you still not anniversarying it fully?

Tom Ryan — Chairman and Chief Executive Officer

I think you’ll probably see it fully sometime in the fourth quarter. I think there is probably still a shift, again shifting more to normalized trends in the third quarter, but you still got some anniversary pricing that we did in the fourth quarter of 2018 that will impact that. And again, I’m not perfectly familiar with the cadence of our acquisitions, but again, I think, you will see it normalize back within that 100 to 150 basis point range, probably at the top of that in the third quarter and again may be to the midpoint by the time you get to the fourth quarter that would be an expectation.

Joanna Gajuk — Bank of America Merrill Lynch — Analyst

All right. That’s helpful. And, I guess staying on the funeral segment. So the margins declined year over year, and I guess, the decline was not as severe as in Q1 and to your point the revenues — the comparable revenues was actually up nicely.

So what kind of revenue growth do you need to keep margins flat in that segment?

Tom Ryan — Chairman and Chief Executive Officer

I mean if you look at the second quarter, we’re down, I think, 30 basis points on the margin percentage. And we did it with, I think, 1% revenue growth. I think if you can get in the — closer to 1.5% then you can begin to grow your revenues on that side of the business. So as you think about the back half of the year to the extent we can flatten out the average and continue to grow volumes, which, again, I think we feel like that’s something that can be achieved then you will see margin growth in the back half of the year.

Joanna Gajuk — Bank of America Merrill Lynch — Analyst

All right. And then, if I may, follow-up on the statements you’re making in terms of your investments in digital strategy. So can you flash out a little bit more in terms of what you’re doing different or it’s just a continuation of what we heard before in terms of certain end optimization, improving your website, anything new or anything you’re accelerating?

Tom Ryan — Chairman and Chief Executive Officer

Well, really the digital strategy is going to be a longer-term transformation that’s probably going to take multiple, multiple years and will ultimately also be about the customer experience and how we handle the entire process from onboarding a customer until we receive the feedback from that customer. But what I’m talking about now that we’re spending some time and money on was the updated websites and the effect of that because we’ve seen, for instance, in the first half of the year, we’ve grown about 33% over 61 million sessions on our websites. We also have had a acute focus on our online reputation and done some things to again solicit feedback from our customers to see those ratings, we’re driving those of course up which again then drives more traffic and more search engine results for us when you think about on a paid basis and even again on a nonpaid basis. So it’s things like that, that are, we believe, is going to generate more leads, more effective leads, build our reputation and so allow us to compete more effectively and obviously against our competitors, which always don’t have the ability to do some of these things.

So that’s really what we’re talking about and today I think we’ll do more as it relates to customer segments and being able to find ways to engage with consumers and drive more customers to our business as time goes on. And again it will continue when you think about the way that we interact and service our customers. It’s just going to be continued stream of investment that, I think, is going to again put a further gap in our performance versus what’s the rest of the industry can do.

Joanna Gajuk — Bank of America Merrill Lynch — Analyst

So over time, will you be able to kind of pinpoint to any changes in market as a result of these? Or, I guess, you quoted some stuff in terms of the visits on your website, but anything you will track over time and report back to us in terms of how does it impact your market share?

Tom Ryan — Chairman and Chief Executive Officer

That’s certainly the goal, Joanna. I think it’s really early days, but I think we talked a little bit about this customer segmentation study that we’ve done, and we’ve completed that. We’ve had multiple groups study this, looking at different ways that we can take this information and use it to our advantage to service customers better and focus on the things that we can do to drive future behavior. And we mentioned a couple of things that I don’t think are secrets to your industry, but we believe based upon our study that there is a higher preponderance of people that want to celebrate enough more and we think there is a higher preponderance of people that wanted more simplified versus complicated.

So taking those learnings and saying how can we better communicate, provide information, transparency to the consumer where they view us as the place to go when you want to celebrate. They view us as the place to go, because it’s simple. And that’s easily said, hard to do, and I think now what we’re trying to do is articulate that strategy, develop ways to engage the consumer. And to the extent, we can do that, I believe, that’s going to drive market share for us in differential ways, we’re going to continue to compete like we are, I still believe preneed is a huge driver of future market share and we’re the best at it and we’re going to continue to get better.

So think of that combined with what I just said and you get excited about what the future could hold for SCI.

Joanna Gajuk — Bank of America Merrill Lynch — Analyst

Thank you. I’ll go back to the queue.

Operator

From Credit Suisse, we have A.J. Rice. Please go ahead.

A.J. Rice — Credit Suisse — Analyst

Thanks. I got a couple of questions, if I could. On the numbers around the perpetual care trust fund reserves and obviously year-to-year headwind of 10% of this year, for this quarter, I know part of what’s been going on there as you’ve been restructuring some of the portfolio for your total return strategy, is that pretty much played out? And may be is this level what we’re likely to see? Or do you think this was unusually soft relative to what you’d expect going forward?

Tom Ryan — Chairman and Chief Executive Officer

I think more of the latter, A.J. Again, it was volatile in the first quarter in a positive direction, it was volatile in the second quarter in a negative direction. Lot of that has to do with timing of the capital gains that are distributed like I talked about in the remarks. This relates to the trust funds that are still in the old type portfolios with the fixed income-oriented asset allocation as opposed to the total return portfolios, which are about and we saw returns probably up to 40%, 45% of the total assets, it’s not played out yet.

We hope to have some larger states come online next year or the following year that would may even put us above 50%. But on the portfolio, that is the old asset allocation, again the way it works under the state laws is the portfolio manager can decide to trigger capital gains. And from that, it then gets distributed to us and its then earnings and cash flows to us from those examples. So the more you go to total return, the more you reduce the old fixed income portfolio and the less volatile it will be.

But all else being equal, it’s generally about $70 million, $75 million of earnings for us each year coming out of the perpetual care funds and they’re somewhere between — $10 million or $20 million of that will be capital gains. So there is that much volatility through it, and you saw that going opposite directions in Q1 and Q2, but normalized for the entire first half versus prior year.

A.J. Rice — Credit Suisse — Analyst

OK. All right. And then same thing about the agency fees, I guess, that was a drag this quarter, it had been positive in the first quarter, I think in that first half, you’re up about 3%. Is that just normal ebb and flow in your mind? Or is there anything going on that made it a drag in the current quarter? And what do you think about the back half there?

Tom Ryan — Chairman and Chief Executive Officer

I think it will normalize in the back half. I think that ebbs and flows and it sometimes you have a mix change between what is being sold in states that are selling predominantly trust fund-oriented PAF versus insurance contracts. Now the general statement, our insurance going into our backlog, our PAF sales are somewhere around 70%, 75%, is a very general statement, but depending on geographically which states are selling what and how the 90-day quarter goes, it can’t ebb and flow. And when it does ebb and flow like it did this quarter and we actually had less of a mix of insurance funded contracts, that can to a less — to some extent although it never really would be material, I think, in my mind, could affect your general agency revenues.

So we really expect that to be normal as you’ve seen it in the back half of this year.

A.J. Rice — Credit Suisse — Analyst

OK. Any update on the Beacon initiative?

Tom Ryan — Chairman and Chief Executive Officer

There really isn’t that much of a change in facts that I described to you before from last quarter. Just to refresh everybody’s memory, funeral is coming first, cemetery is coming second. We had funeral up to about 75% of eligible contracts being sold and 75% of usage, that’s not new information. And then we pivoted our resources toward the cemetery segment, which again is a little bit more difficult because each property in the cemetery that needs to go into the system is different and unique, but more importantly, there is a lot more vendors and a lot more merchandise to be able to put into the system as well.

As I described to you last quarter, we continue to test just a handful of cemeteries as we build the application, that will continue, and it’s kind of going to be the same message till we get to 2020, and really start seeing some of the testing results and go from there.

A.J. Rice — Credit Suisse — Analyst

And just my last thing. So this is just a conceptual question, if we look at the earnings trajectory in the first half, it’s been in the single-digit range, if you blend the two quarters together. And then the expectation is that you move into the low double-digit range in the back half of the year, it sounds like a lot of that is just easier comps, but there is a lot of other moving parts. Is there a handful of things? Or one or two things that you would point to, specifically that give you confidence that you can see that acceleration and that return to double-digit growth is within reach?

Eric Tanzberger — Senior Vice President and Chief Financial Officer

Yes, A.J. I think two things. On the funeral side, because we believe the comp volume situation is going to be better, we feel like funeral revenues will surprise a little bit to the upside, combine that with we’ve got SCI Direct back on the track of growth. So put those two things together with our cost initiatives, we think funeral profits grow in both the third and the fourth quarter, that’s going to be one significant driver.

Cemetery sales, we feel really good about. I mentioned at the third quarter from a GAAP perspective will be more of a challenge because of the completed construction. But when you combine it with the fourth quarter, we see cemetery driving a lot of that improvement. We also think there is — general and administrative cost will go down, you may recall last quarter’s third quarter, we had a huge adjustment to our PUP accrual because the stock price went up.

So we think we got a favorable comparison when you think about general and administrative expenses in the back half of the year. And it would be even greater except for the fact that Eric already mentioned, our tax rate is probably going to be about 500 basis points higher as it relates to last year because we had a low tax rate. So even with that high tax rate of 500 basis points increase, we see earnings per share growing double digits in the back half of the year. So a lot, firing on all cylinders as it relates to segments and G&A cost and just little bit of a drag on tax.

A.J. Rice — Credit Suisse — Analyst

OK. All right. Thanks a lot. Thank you again.

Operator

[Operator instructions] And from Wells Fargo, we have Duncan Brown. Please go ahead.

Duncan Brown — Wells Fargo Securities — Analyst

He. Good morning. I wanted to go back to cremation to make sure I understand you right. So the two sort of drags would be M&A and with assets that have higher commission rates than the broader portfolio and then the 30 markets that you targeted to sort of expand the cremation focus.

And if I’m hearing you right, most of that annualizes, we think, by Q4 and then after that we get back to a more normalized cremation rate of 100 to 150?

Tom Ryan — Chairman and Chief Executive Officer

That’s our expectation, Duncan, correct, you hit the nail on the head, I think — and again it is just — as we get further in the year, you got less year over year of change though.

Duncan Brown — Wells Fargo Securities — Analyst

Great. Thank you. And I guess the follow on to that is, it sounds like what you did with those 30 markets was successful, are there another 30 that you’re looking at that we might see a rollout on or some thoughts?

Tom Ryan — Chairman and Chief Executive Officer

I don’t know that there is 30, but there is probably more that we will test. These were markets where we started off with markets where we felt like we were losing some share, particularly around that, I would say, starting at price point for cremation. As you’ll recall, Duncan, years ago, we kind of took a strategy that said, we’re going to let our core funeral homes service at a service level that’s high service level at a price point that is a little bit higher and we can service these customers through SCI Direct and that’s worked pretty well. But what we found is there is still a consumer that values going to that funeral home that has a price point that may be a little bit below where we were in serving these markets.

The test proved out. We saw that by lowering a little bit of that price, we saw the volume come in. And so we’re constantly — we’ve got a team that full-time dealt with this is, looking at what’s the optimum pricing in some of these markets. Sometimes, it’s we can raise prices and sometimes it’s we’re going to be lower to be more competitive.

So I don’t foresee a wave of changes that we saw happen in the latter part of last year and the early part of this year in our future, but, I think, there will be some tinkering around that as we go forward.

Duncan Brown — Wells Fargo Securities — Analyst

OK. That’s helpful. And then, I think it was in your prepared remarks, Tom, you talked about some regulatory issues on cemetery preneed, I may have misunderstood, but can you give us some color on that?

Tom Ryan — Chairman and Chief Executive Officer

Well, I think when — I was generalizing in certain markets, but as an example, I think, we talked about in Vancouver last time, two things are, I would say, impacting confidence in that market. I don’t want to tell you that it directly correlates to our performance at Vancouver, but there’s two things people are to be aware of. One is, there is a foreign buyers tax that’s been implemented in Vancouver, and it’s to deal with affordability of housing in the Vancouver market. So what’s that done is the Chinese and the Hong Kong buyers that are coming in, they were a big part of our growth in the Vancouver market, it’s tougher #1, it’s more expensive and you may see less of a migration over the last couple of years.

And then I think the other piece that again kind of touches upon regulatory is that there has been a real clamp down on money moments out of China and again this is a population of Chinese descent and are either immigrants or relatives of immigrants and that’s again, I think, put a damper on confidence in the Vancouver market. And so while we don’t think it’s dollar for dollar correlated, it’s just a fact that we’re dealing with and you have from time-to-time things like that, that occur in different markets. And that’s what we meant by that kind of general term of regulatory.

Duncan Brown — Wells Fargo Securities — Analyst

Gotcha. Last one for me. You mentioned or it’s in the press release, you buyback some bonds in the open market. Why don’t you tell us, which tranche and if that sort of signals the new appetite for you all to look at buying in the open market? Or it’s just opportunistic?

Tom Ryan — Chairman and Chief Executive Officer

I think it’s opportunistic, but I wouldn’t be surprised if it continues. I told you in my remarks, Duncan, that I think we want to work ourselves down around 3.75, got up to the upper end of the range on purpose last year, because we had wonderful acquisitions to deploy capital and used a lot of our revolver to do it. Those were our 2027 notes which carried a coupon at 7.5%. So a little bit opportunistic as well in terms of bringing that higher interest rate down by taking those particular tranches out.

But ultimately, it’s a value proposition and you look at where everything is trading at as you know so well and try to kick off in the open market the ones with the best value for us.

Duncan Brown — Wells Fargo Securities — Analyst

Great. Thank you.

Operator

No further questions at this time. We’ll now turn it back to SCI management for closing remarks.

Tom Ryan — Chairman and Chief Executive Officer

Thank you, everyone, for being on the call today. We’ll talk to you on our third-quarter release in late October. Have a great week.

Operator

[Operator signoff]

Duration: 56 minutes

Call participants:

Debbie Young — Director of Investor Relations

Tom Ryan — Chairman and Chief Executive Officer

Eric Tanzberger — Senior Vice President and Chief Financial Officer

Scott Schneeberger — Oppenheimer — Analyst

Joanna Gajuk — Bank of America Merrill Lynch — Analyst

A.J. Rice — Credit Suisse — Analyst

A. J. Rice — Credit Suisse — Analyst

Duncan Brown — Wells Fargo Securities — Analyst

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