Earnings Call Transcript - STN Q2 2020

Operator, Operator

Good day everyone. Welcome to Stantec's Second Quarter 2020 Earnings Results Call. Leading the call today are Gord Johnston, President and Chief Executive Officer; and Theresa Jang, Executive Vice President and Chief Financial Officer. Stantec invites those dialing in to view the slide presentation, which is available in the Investors section at stantec.com. Today's call is also webcast. Please be advised that if you have dialed in, while viewing the webcast, you should mute your computer as there is a 20-second delay between the call and the webcast. All information provided during this conference call is subject to the forward-looking statement qualification set out on slide 2, detailed in Stantec's Management Discussion and Analysis and incorporated in full for the purposes of today's call. All amounts discussed in today's call are expressed in Canadian dollars and are generally rounded. And with that, I'm pleased to turn the call over to Mr. Gord Johnston. Please go ahead.

Gord Johnston, CEO

Good morning and thank you for joining us. I'll begin our call today with a review of our second quarter performance. Theresa will then delve deeper into the financial results before I return to provide an update to our outlook for the remainder of 2020. We delivered a solid second quarter with net revenues in line with the outlook we provided during our Q1 call. Our results continue to demonstrate the resilience of our business model, which is bolstered by geographic and business line diversification. Effectively managing our business and controlling costs has allowed us to deliver a 4% year-over-year increase in Q2 adjusted EPS, even though the pandemic has had an unfavorable impact on our Q2 gross margin. Productivity, as measured by utilization, has remained strong and is above typical seasonal levels. Our record backlog of CAD4.7 billion at the end of Q1 held stable through Q2 and continues to represent approximately 12 months of work. At the end of our presentation today, I'll review how the four value creators, the people, excellence, innovation, and growth that we presented in our 2020 strategic plan continue to underpin our activities through the pandemic to enhance shareholder value. We delivered net revenues of CAD951 million in the second quarter, which is comparable to the same period last year. Net revenue grew organically by 2.3% in the U.S., but contracted in our Canadian and global geographies, resulting in an overall organic contraction of 2.1% in Q2. In addition to our geographic diversity, the diversity of our business lines bolstered our resilience in the second quarter, while certain areas contracted. Water and Energy & Resources generated organic growth. As expected, Infrastructure revenue contracted slightly. Transportation delivered solid performance, while Community Development work slowed due to the pandemic. And while we've seen growth in work for healthcare facilities and e-commerce fulfillment centers, the pivot to these sectors was not sufficient to overcome the negative impact to the commercial, airport, and hospitality sectors, and the Q2 slowdown in buildings was a bit deeper than expected. In Water, we saw healthy activity in the United States, the United Kingdom, and also Australia. This was a result of significant project awards in the U.S., the AMP7 framework awards we received in the U.K., and a multi-year framework award in Australia. And we've also just won the contract for the Irish Water engineering design services seven-year framework. This is our first major win in Ireland, which will allow us to establish a long-term presence and provide a framework for our other business lines to grow in the region. The retraction in Environmental Services is mostly related to Canada, where field work was impacted by project slowdowns related to COVID-19. Finally, Energy & Resources generated solid organic growth as a result of increased midstream oil and gas work in the second quarter. Our worth providing project management services on the Trans Mountain Expansion Project continued in the second quarter under a memorandum of understanding. Subsequent to the quarter, we signed a contract to continue to provide new services for the duration of the project. Last quarter, we spent some time reviewing our expectations for how we believe our business units might be impacted by the pandemic. We continue to believe that these expectations remain valid in the longer term. In the second quarter, our U.S. operations achieved net revenue organic growth of 2.3%. This was driven by project opportunities in Water, Mining, Power, and Environmental Services, which were partially offset by a contraction in Buildings and Community Development. Gross margin as a percentage of net revenue decreased 2.3% in the quarter to 52.9%. The decrease as a percentage of net revenue was due to inefficiency that rose due to pandemic-related disruptions, as well as the shift in our project mix, which was driven primarily by major projects in Transportation and Power and Dams. In Canada, slowing economic growth was amplified by the COVID-19 pandemic. Net revenue contracted 6.8% in the quarter and 2.6% year-to-date, and was particularly evident in Buildings and Community Development. Our Environmental Services business was impacted by project slowdowns, while pandemic-related mine shutdowns contributed to lower activity in mining. This was partially offset by growth in our oil and gas and transportation businesses due to the Trans Mountain Expansion pipeline project and several large light-rail transit projects in Edmonton, Montreal, and the Greater Toronto area. Gross margin decreased 2.7% as a percentage of net revenue in the quarter to 48.5%. In addition to pandemic-related disruptions, the decrease as a percentage of net revenue was also driven by an increase in the volume of lower-margin work related to the midstream oil and gas sector. This midstream work contributed to a margin decrease in Energy & Resources and Environmental Services. However, despite the lower margins of this work, it drives high utilization and a similar EBITDA contribution as our other business line. Global net revenue retracted 7.9% in the quarter and was consistent year-to-date with reduced work volumes during the pandemic, partly offset by increased project opportunities in some markets. Project slowdowns were most pronounced in our U.K. and Australia Buildings and European Environmental Services business. Pandemic-related mine closures in Latin America and large project wind-downs in Power & Dams further contributed to revenue retraction. Partly offsetting this still was the ramp-up of Transportation projects in New Zealand and continued strong performance in our U.K. Infrastructure and Water business. We also saw a higher volume of work in our Australian Water business, with several large municipal panel contracts gaining traction in Q2. And just last week, we were named Water Industry Consultant of the Year in the U.K. Gross margin as a percentage of net revenue decreased 4.8% in the quarter to 51.7%. Margins were impacted by the pandemic, project mix, some ongoing pricing pressures in the U.K. and Europe, and a couple of localized challenges on some projects. I'll now turn the call over to Theresa for a review of financial performance.

Theresa Jang, CFO

Thank you, Gord, and good morning, everyone. Adjusted net income from continuing operations increased 3% to $58 million in the second quarter, and adjusted earnings per share increased 4% to $0.52 per share. This is largely due to an 8% decrease in administrative and marketing expenses and a 29% reduction in net interest expense. Gross margin for the quarter decreased 5% to $490 million. As a percentage of net revenue, gross margin was 51.5%. The pandemic has created a degree of disruption in our operations and our clients' operations, causing some inefficiency in project execution. We also saw higher than anticipated growth in revenue from our lower-margin midstream oil and gas projects. As demonstrated by our solid adjusted EBITDA margin of 15%, we are managing the business carefully and have taken steps to mitigate these margin impacts on the cost side. Our balance sheet remains strong. As of June 30th, net debt to adjusted EBITDA was at the bottom of our targeted range at 1.0 times. We remain in full compliance with all financial covenants. Days sales outstanding was 82 days at quarter end compared to our target of 90 days. DSO decreased four days since Q1 as a result of our ongoing focus on invoicing and collection activities, and we've not seen any notable impact due to the pandemic. Given our strong mix of public sector clients and the high quality of our private sector clients, we do not believe our credit risk has increased meaningfully as a result of the pandemic. Moving on to liquidity and capital allocation. Our free cash flow for the quarter improved by 83% compared to Q2 2019. Operating cash flows from continuing operations were $251 million, an $89 million improvement compared to Q2 2019. The improvement was driven by an increase in cash proceeds from clients, lower payments to suppliers, and the benefit of various pandemic tax deferral programs which included the deferral of $35 million in cash payments that are now due at various states before the end of Q1 2021. Cash flows used in investing activities were $11 million, a $7 million decrease compared with Q2 2019, mainly driven by reduced capital expenditures. We used $100 million for net financing activities compared with $83 million in Q2 2019. Cash used in financing activities included $62 million in repayments and drawing on a revolving credit facility and $32 million in payments for these obligations, partly offset by $19 million in proceeds from the exercise of stock options. With that, I'll turn the call back to Gord to review our 2020 outlook.

Gord Johnston, CEO

Thanks, Theresa. Given the unprecedented circumstances brought on by the pandemic, we withdrew our 2020 guidance in May. That said, we continue to reevaluate our anticipated financial performance on an ongoing basis. So even though we're not in a position to provide concrete guidance, we are providing our current outlook for 2020 based on the best information available to us at the present time. In the U.S., we expect a nominal retraction in revenues in Q3 relative to Q2 across all businesses except Water, where we see growth. With project slowdowns and typical downtime related to cold weather and seasonality, we expect Q4 net revenues in the U.S. to be sequentially lower. Full year 2020 U.S. net revenues are expected to be comparable to 2019 in U.S. dollars when combined with our strong results for the first half of the year and we also expect some additional uplift from foreign exchange. In Canada, Q3 revenues are expected to be stable relative to Q2, while Q4 revenues, like the U.S., are expected to experience the typical seasonal downturn. Even though weak outlook for Canada before the pandemic, we expect a normal retraction in revenue for this geography for 2020 compared to last year. Net revenues in the Global business are projected to improve modestly from Q2 to Q3 and stabilize at that level in Q4. The strength of the Water business in the U.K. and Australia and the Transportation sector in New Zealand are expected to offset the impacts of project slowdowns in other business resulting in full year 2020 revenues being comparable to 2019. Overall, we expect Q3 and Q4 revenues to decline marginally compared to the same periods in 2019. Taken together, we expect full year net revenue, adjusted net income, and adjusted EPS to be comparable to 2019. We now expect roughly 55% of our earnings to be concentrated in Q2 and Q3, down from the 60% estimate we previously provided. Our balance sheet is strong and we continue to have excellent liquidity. Our capital allocation priorities have not changed. We're committed to returning capital to shareholders with the payment of our dividend and we'll continue to repurchase shares opportunistically. We continue to execute on our three-year strategic plan, which we rolled out to our employees and the investment community in December of last year. Our solid second quarter results are a credit to all of our people around the world, and I want to thank our employees for their continued commitment to executing our client-centric strategy in the midst of the unprecedented disruption caused by the pandemic. As we begin our phased office remobilization, the health and safety of our people will always come first. We're also taking steps in this period to maintain the integrity of our workforce in order to position ourselves for the economic recovery that will come. We are committed to both continuing and expanding upon our long-term support for the Black, Indigenous, and people of color communities around the world. And while we've been engaged for many years with organizations that refer to the interest of these communities, both financially and more importantly through the volunteer efforts of our employees, we know that there is more that we can do. We've engaged with our internal inclusion and diversity council to develop additional areas of support and to focus our financial commitments and our employee engagements to make a long-term lasting impact. We're being thoughtful and deliberate in how we manage our business. We're mitigating the compression of gross margin to decrease administrative and marketing costs. Through our reshaping efforts in 2019, ongoing cost reduction initiatives, and significant reduction in discretionary spending during the pandemic, we've been successful in protecting our industry-leading adjusted EBITDA margins. We continue to develop innovative new solutions for ourselves and our clients to meet the challenges posed by the COVID-19 pandemic. For example, internally we've launched a virtual marketing and business development toolkit to enhance our client relationships in a socially distanced world. Externally, across North America and Eastern Europe, we're using our proprietary financial planning software to advise utilities and optimize their 2020 and 2021 capital spending scenarios and rate plans in response to COVID-19 impacts on water demands, sales tax, income tax, fees, and other shared revenues. While the pace of acquisition is currently challenged by travel restrictions, our growth aspirations have not changed, and the acquisition pipeline remains strong. In the meantime, we've increased our account management focus on key client accounts, leading to a 7.4% organic growth in net revenue from our named accounts compared to Q2 2019. While the world remains in uncharted territory, we're confident in the resilience of our business model, and we will remain vigilant in monitoring the potential impact on our clients, communities, and most importantly, our employees. And with that, we'll open the call to questions. Operator?

Operator, Operator

Thank you. We'll take our first question from Benoit Poirier from Desjardins Capital Markets.

Benoit Poirier, Analyst

Yes. Thank you very much and good morning, everyone. Congratulations on the good quarter. Especially, looking at the gross margin you were successful in maintaining the EBITDA margin despite the contraction in gross margin. So more looking specifically at Canada and International, could you talk a little bit about the key levers that drove the decline in gross margin, specifically, for those two regions? And what should we expect going forward in terms of gross margin?

Gord Johnston, CEO

Thanks, Benoit. Good morning. I want to emphasize that we are managing the company for both long-term growth and performance, particularly in terms of EBITDA margin and EPS. Gross margin is one of the key factors we are focusing on. We are effectively managing administrative and marketing costs to offset the pressure on gross margin and achieve the solid returns we experienced in Q2. Several factors contributed to the gross margin decline in Q2. While our utilization as a measure of productivity remains strong and above typical seasonal trends, we are facing some integration inefficiencies in project delivery due to remote work. For example, when working on a project, there are times we need input from clients or partner agencies, and the response time has increased, causing us to work less efficiently. We have noticed that some larger clients are requesting fee reductions, which is not significantly affecting gross margin right now, but it is a trend we are observing. Additionally, the project mix has influenced this quarter's results. For instance, the Trans Mountain expansion project has a lower gross margin; however, utilization rates are nearly 100%, and there were no administrative or marketing costs incurred. Thus, the overall EBITDA contribution is similar to other projects across different business lines. We are actively addressing these challenges, and it's important to recognize that we are managing the entire business to ensure consistent performance. While gross margins are a key metric for us, we are also balancing workforce management and controlling discretionary costs to achieve strong EBITDA and EPS results moving forward.

Benoit Poirier, Analyst

Okay. That's great color, Gord. And could you provide maybe also an update on the M&A in light of the pandemic here?

Gord Johnston, CEO

Absolutely. It seems like it's been much longer, but it's actually been just under four months since we shifted to remote work in mid-March. When we moved home in the third week of March, our clients also transitioned to remote work. We noticed that many firms we were engaging with, including both the acquirer and potential acquisition targets, took a step back to focus on managing their businesses during the pandemic. We also had concerns about how we would conduct final due diligence due to travel restrictions. Now, we recognize that these travel challenges may persist longer than expected. For instance, Australia may keep its borders closed for non-essential travel for the rest of the year. Therefore, we are concentrating on how to continue the M&A process by leveraging more of our resources available in-country. We believe we are in a good position to do this, especially considering the integration of MWH four years ago. In the UK, for example, Cath Schefer leads our Global Group and has been with MWH for four years, along with Peter Brett. They are well-integrated into Stantec and can assist with sourcing acquisitions, conducting deeper due diligence, and managing integration efforts. The same holds true in Australia, where the MWH team has been present since 2016 and is now complemented by strong leadership from Wood Grieve Engineers. This is important because during the last quarter, there was a general pause as everyone focused on their own operations. Now, we are seeing interest in resuming discussions, and we are increasingly looking to our in-country leadership to aid us in the M&A processes moving forward.

Benoit Poirier, Analyst

Okay. That's great. And the last question for me. Could you talk a little bit about buildings? How should we be looking at organic growth following the 8.7% decline in net revenues in the quarter, whether there was anything specific? And whether we are poised for slow recovery or, let's say, a worse scenario than Q2? Thank you.

Gord Johnston, CEO

Yes. We do not observe a significant decline compared to our position in Q2. In the Buildings Group, as mentioned, we are transitioning to focus more on healthcare and e-commerce projects. However, in Q2, this shift was insufficient to offset the decline in commercial activities. We are now seeing numerous healthcare opportunities, particularly in Canada, more than we have in a long time. I believe the Building sector will rebound strongly, but I anticipate it will stabilize moving forward. There may be a slight retraction in the future, but hopefully not to the extent we experienced in Q2.

Benoit Poirier, Analyst

Perfect. Thank you very much and congrats again.

Gord Johnston, CEO

Thanks, Benoit.

Operator, Operator

Our next question comes from Sabahat Khan with RBC Capital Markets.

Sabahat Khan, Analyst

Thanks and good morning. Just a follow-up on your commentary on the Buildings segment. I guess you stated that some strength in water across a couple of markets for the rest of 2020. I'm thinking more for Environmental Services and Energy. Should we expect similar performance to Q2 being down year-over-year through the rest of the year being more than offset by Water and Infra? What are your thoughts at a high level across end-markets globally?

Gord Johnston, CEO

Yeah. So overall, as you know, I think we expect our 2020 net revenue to finish similar to what we saw in 2019. So while there may be a little retraction in some of these going forward for the remainder of the year, we're going to see that strong growth, I think, continue through Water. If you remember looking back over the last couple of years, it means we spent a lot of focus on building backlog in Water. And so, now we've had positive organic growth in Water overall for the last four or five quarters. And I think we'll see that continuing. So Environmental Services had really strong growth last year, so we're coming off a bit of a high comp there, but I don't know certainly anything in Western Canada. If we look at the work on Trans Mountain, of course, gas and so on, that'll be stable work for many years for Environmental Services and our oil and gas group, but again it's not huge and the margin work is not great. But again, we have virtually 100% utilization and no business development or admin costs. So it generates a pretty good EBITDA margin.

Sabahat Khan, Analyst

Okay. Thanks for that. And then your commentary on the overall U.S. market for comparable revenue in 2020. And I guess part of that is driven by the Water market. Are you assuming for the operating backdrop there’s still a bit of uncertainty out there, according to what you said. Are you assuming there is a bit of stimulus or extra dollars put in, or is this all really just based on what you have in your backlog?

Gord Johnston, CEO

Yeah. For 2020, we're not really forecasting any significant stimulus. There certainly has been a lot of talk about putting together bipartisan stimulus bills, and we really hope that that comes to fruition. But against the backdrop of an election year, we're wondering if that might be difficult. So the numbers that we put up for the U.S. do not include any additional stimulus in 2020. We think that if that comes out, it would be a tailwind going into 2021.

Sabahat Khan, Analyst

Okay. And then one last one from me, I think in the commentary you mentioned somewhat moderating your thoughts on valuations for potential M&A. I guess is that just based on your outlook on what you're willing to pay for the foreseeable future? Or is that more along the lines of no target feeding at this point might be expecting to have a multiple versus what you think is reasonable? Some additional color on that.

Gord Johnston, CEO

Well, there is always that tension as you look to establish valuation for various firms. No one is exactly sure what the shape of this recovery is going to look like. So we certainly know historic performance and profitability numbers for these various firms. But everyone, I think, is really thinking about what it looks like going forward. So what we really thought is that this really isn't the time to pay high multiples on historic earnings. So there is a bit of attention. And so, we'll continue to talk about where all reasonable parties are talking through what it's going to look like going forward in terms of recovery, recovery on profitability, and so on. So we haven't seen really good numbers; there have been virtually no transactions in our space since the pandemic hit. So, it's hard to get a feel for what the multiples are going to look like. But in our discussions, we haven't seen a lot of stop in, but it's still early days.

Sabahat Khan, Analyst

Great. Thank you.

Gord Johnston, CEO

Great. Thanks for your questions.

Operator, Operator

We have a question from Devin Dodge with BMO Capital Markets.

Devin Dodge, Analyst

All right. Thank you. Good morning, guys.

Gord Johnston, CEO

Good morning, Devin.

Devin Dodge, Analyst

It seems like from the COVID-related restrictions, there could have been a boost to your admin and marketing expense control, things like lower travel and training costs. I also suspect voluntary turnover would have been relatively low in the quarter. Just can you talk about the sustainability of these cost benefits into the back half of the year and even into 2021?

Theresa Jang, CFO

Sure. It's something that we are certainly thinking about, because you're right, the degree to which we've been able to bring those costs down in the second quarter. We didn't have a really strong sense as we enter the quarter. And so we can certainly see what's achievable, but as we started to reopen our offices and we are seeing in some geographies wanting to start to travel again, the level that we're at today isn't sustainable. And I would say overall, not good for the business because those expenditures are useful. We're starting to see more discussion around spending on marketing dollars again, for systems. And so where those costs were low in the second quarter, we'll keep some of that starting to come back fully over the second half of the year. So, for us, it’s an expectation that there will be some increases, but we're not expecting it to be a dramatic increase over the rest of the year. It's really going to be a big move into our plan for 2021, a determination of how far back the pendulum swings. And it was certainly our desire that that will be demonstrated that we can operate and operate quite successfully at a lower cost level. Our expectations would be that we set that threshold or expectations lower than we have historically. So we do believe that there is opportunity there, but that work for what is sustainable going forward is just beginning now.

Devin Dodge, Analyst

Okay. Thanks for that. Maybe just switching gears. U.S. state and local governments have been a focal point for some investors. I think some of your peers have been suggesting that award activity has been good in Q2, and there has actually been a good level of RFPs. But they are expecting kind of new awards to slow in the second half until we get better clarity on federal funding, effectively trying to get projects to be shovel-ready in terms of that stimulus. I guess what are you seeing in your business?

Gord Johnston, CEO

We have observed strong ongoing RFP activity, although some clients are taking longer to make decisions. Notably, we are seeing increased opportunities in U.S. federal work. We have shared some recent U.S. Federal awards in our press releases, with more that we haven't highlighted yet. While state and local entities are still issuing RFPs, they may not be awarding contracts as quickly. Overall, there is a noticeable increase in the volume of U.S. federal work we are undertaking. After a slight slowdown in RFP activity at the start of the pandemic in March, we noted an uptick in opportunities in our sales funnel regarding both dollar value and quantity during April, May, and June. Looking ahead to the rest of the year, I am optimistic that our backlog will remain stable. This perspective is based on the current absence of significant government stimulus funding. We are uncertain about the passage of such measures through Congress and the potential revenue impact for us in 2020.

Devin Dodge, Analyst

Okay. That's good color. I'll turn it over. Thank you.

Gord Johnston, CEO

Great, thank you.

Operator, Operator

And we have a question from Bryan Fast with Raymond James.

Bryan Fast, Analyst

Yes, thanks. Good morning, guys. Just maybe touch on your outlook for the back half of the year. Has it changed at all since last quarter? And then, maybe what has changed to allow you to be more comfortable to provide the guidance?

Gord Johnston, CEO

We have been collaborating closely with our business and geographic leaders globally, not just in Canada and the U.S., to identify opportunities and project awards we can start working on. We are quite confident in the numbers we provided as our guidance for the second half of the year. We anticipate a slight decline going forward, particularly in the fourth quarter in some colder regions due to weather impacts. However, overall, we feel positive about the outlook we have shared for the second half of the year.

Bryan Fast, Analyst

Okay. Thanks. And then, maybe I guess have your thoughts changed in respect to the preservation of workforce since last quarter?

Gord Johnston, CEO

No, we are working hard to balance our workforce with the available work, while also ensuring we maintain our team for the anticipated recovery. We have furloughed employees, except for our Board, senior leadership, and executive leadership, who have all taken a 10% pay cut. We have not requested hourly fee reductions from others, although some are using vacation or taking unpaid leave. We are trying to manage staffing as effectively as we can to ensure we have the right people in place to move forward.

Bryan Fast, Analyst

Okay. Thanks. That's it from me. I'll turn it over.

Gord Johnston, CEO

Okay. Thanks, Bryan.

Operator, Operator

And we have a question from Mona Nazir from Laurentian Bank.

Mona Nazir, Analyst

Good morning and thank you for taking my questions. I'm just wondering, in light of COVID, so many companies are pivoting or looking to pivot to reduce their downside exposure and capture greater opportunity. You commented on increased demand within the medical field. You have been equipped to service that increased demand. I'm just wondering where you're seeing other potential pivots, and whether that would be the public-private mix exposure, geographic or even vertical focus, or anything else I’m missing? Thank you.

Gord Johnston, CEO

Yeah. Thanks, Mona. One thing that we did in terms of limiting downside exposure is one of the things we talked about as part of our strategic planning process last year. When we had looked at our significant exposure to land development leading up to 2008 and our significant exposure to oil and gas leading up to 2014, that's where we made the statement as part of our strategic plan last year that in terms of limiting potential downside exposure, we would not have our exposure to revenue exposure to the cyclic markets oil and gas and mining to exceed 15%. So, that's really I think limited, if we do see a downside there. But in terms of pivots, you're right we see a lot of work in healthcare. We still see significant work in public transportation, doing a lot of work in the Greater Toronto Area. But, we still see a lot of good opportunities coming there. And I think from a global perspective, we're seeing more and more coming out for both healthcare, public transit, and roadways in general. I think those are the beneficiaries of any stimulus programs that come along too. We’re also seeing that as more work comes out over the last quarter, it has been more weighted on the public side than the private side. And so, will that be a trend going forward? Perhaps, I would think for the second half of the year. We'll continue to see that. And then, depending on how the recovery comes, we'll see how that balances out going into 2021. But I think we feel our areas that could pivot for more work include healthcare, public transit, and transportation. We're very strong in those areas, and well-situated to capture more than our fair share of the additional work that comes in those areas.

Mona Nazir, Analyst

Thank you. That's very helpful. And just secondly, I'm wondering if you could share with us the magnitude of pricing concessions on the customer side. Is that largely in the Buildings or Energy segments or other areas?

Gord Johnston, CEO

It's primarily where we see synergies with very large public transportation agencies. And what they're looking for is like in the 2% to 3% range. And while we have seen some large oil and gas companies take similar approaches, the numbers that they've been looking for are about the same for those same sorts of areas. Sometimes we've had to agree to that for a limited term as well, but I think the industry in general, not just us, has faced pushback, and they’re not going to get 10%. I mean, there is a 10% for anybody. So, we seem to be settling in that couple-of-percent range. And some of them who come forward are asking, could you take a 2% cut for the next six months? So, they put a time limit, which is easier for us to sound like, as well, because we don't have to fight to get it back at the end.

Mona Nazir, Analyst

That's perfect. That was my follow-up. I was going to ask about the length of negotiations. So, that's great. Thank you.

Gord Johnston, CEO

Great, thanks, Mona.

Operator, Operator

We'll move on to Michael Tupholme with TD Securities.

Michael Tupholme, Analyst

Thank you. You were asked earlier about some of the factors that weighed on gross margin percentage in the quarter. I just wonder if you can comment on how you see the gross margin evolving in the back half relative to where you were in Q2. Are there some factors that you expect to provide some relief and improve any gross margins?

Theresa Jang, CFO

I think that for the back half of the year, we're going to expect gross margin to improve modestly, but I think that the reasons that we've described for what we saw in Q2 will largely continue in the back half of the year. Whether it's overall connectivity on the side of our operations or our clients, or the heavier weighting that we have going into the second half of the year with the increased work on the midstream project and some of our large transportation ECB projects that are moving to a stage of the projects where margins are pricing lower. So that and a bit of these pricing concessions that Gord mentioned all combined tell us that it's likely going to stay around the territory that is just down.

Michael Tupholme, Analyst

Okay, that's helpful. With that in mind and then thinking about the fact that it sounds as though admin and marketing costs, which were quite well contained in the second quarter? Those may start to creep higher as you've got people back to the office. So just thinking about gross margin being maintained at these kinds of levels, possibly some escalation in the admin and marketing. Is there anything else you're able to do with respect to admin and marketing costs to try to offset whatever escalation you might expect in the second half?

Theresa Jang, CFO

Yes, I mean I think there is always the opportunity there. And we are really focused on it, not only within operations but within our functional support side of our business as well. So initiatives to look at where we've been able to reduce costs have been significant. And so when we started all of those at the end of the first quarter, there were some questions about how long we wanted these initiatives to extend? And now we are looking at having these initiatives continue through the rest of the year. So, I think what we are able to do on admin and marketing has been really positive and we expect that to continue. I'll just point out that usually in Q3 is when we see our most profitable quarter and you see kind of a step-up there. That's because people are working in the field. We don't run significant training programs. There’s a lot of downtime in Q3. And so it tends to improve, and then it sets down in Q4. We think that pattern will still show up this year. Overall, we think that we'll be able to bring in admin costs. Will we be able to fully offset all the compression we're seeing gross margins? I think that remains to be seen, but as Gord said, it's really a focus on the long-term and maintaining the specialized expertise that we have. And the tailwind we're getting from favorable interest rates and from having a pretty low balance drawn on a revolving credit facility, all of those things collectively will drive us, we believe, to a pretty good outcome for earnings.

Michael Tupholme, Analyst

Okay, that's great. Thank you.

Gord Johnston, CEO

Yes, I agree, Michael. We were already working on this before the pandemic, and now we are having several discussions about it. We surveyed a large portion of our employees to understand their thoughts on the future. As Theresa mentioned earlier, when the pandemic began, many employees were excited to work from home and stated they wouldn't return to the office. However, after a month or two, the majority of our staff expressed a desire to go back to the office. They are asking if they could work from the office part-time, one or two days a week. We are examining how this would alter our real estate needs. Our view is that if someone is working full-time in the office, they will have a designated workspace, but for those coming in a few days a week, it might lean more towards a hoteling arrangement. Many of our leases will be up for renewal in the next three years, so we are considering the new office footprint. I believe we will see some reduction in our overall space in the long run, but even without impairing our leases over the next three years, we can adjust a significant portion of our portfolio.

Michael Tupholme, Analyst

Okay, that's helpful. Thank you.

Gord Johnston, CEO

Thanks, Michael.

Operator, Operator

And it appears we have no further questions today. I would like to turn the conference back over to Gord Johnston for any concluding remarks.

Gord Johnston, CEO

Well, I just want to say thank you again for joining us on the call. We look forward to speaking with you in the near future about our continued progress. And everyone, have a great day and stay healthy. Thanks very much.

Theresa Jang, CFO

Thank you.

Operator, Operator

And once again, ladies and gentlemen, that does conclude today's conference. We appreciate your participation today.