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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning and welcome to the Cactus Q1 2020 Earnings Call. My name is Mae and I will be facilitating the audio portion of today's interactive broadcast. All lines have been placed on mute to prevent any background noise. For those of you on the stream, please take note of the options available in your event console.
At this time, I would like to turn the call over to Mr. John Fitzgerald, Director of Corporate Development and IR. Sir, please go ahead.
Thank you and good morning, everyone. We appreciate your participation in today's call. The speakers on today's call will be Scott Bender, our Chief Executive Officer; and Steve Tadlock, our Chief Financial Officer. Also joining us today are Joel Bender, Senior Vice President and Chief Operating Officer; Steven Bender, Vice President of Operations; and David Isaac, our General Counsel and Vice President of Administration. Yesterday we issued our earnings release, which is available on our website.
Please note that any comments we make on today's call, regarding projections or our expectations for future events, are forward-looking statements covered by the Private Securities Litigation Reform Act. Forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control. These risks and uncertainties can cause actual results to differ materially from our current expectation. We advise listeners to review our earnings release and the risk factors discussed in our filings with the SEC. Any forward-looking statements we make today are only as of today's date and we undertake no obligation to publicly update or review any forward-looking statements.
In addition, during today's call, we will reference certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included in our earnings release.
With that, I will turn the call over to Scott.
Thanks, John. Good morning to everyone. This year Joel and I will mark over 40 years in the wellhead and related pressure control business. And I'd venture to say that few management teams have witnessed much less navigated the vicissitudes of this industry to the same degree. For example, I can recall all too vividly the first half of 1986 when the U.S. rig count declined 65% within the span of six months as the Saudis dramatically increased production in an attempt to recapture lost market share. Clearly, today's confluence of facts makes the inevitable market correction far more complicated. Nonetheless, the lessons learned from that period and later downturns remain valid.
Those service providers who benefited most during the subsequent recovery had aggressively reduced systemic costs and operated in segments that it addressed overcapacity through proactive consolidations. While painful in the near term, I believe that a sharper downturn may lead to a more substantial recovery for those who prioritize the interest of their shareholders.
On today's call we'll briefly discuss our first quarter results and then provide some color on the current environment. Q1 was a strong quarter for Cactus. Although the U.S. rig count was down 4% sequentially, we achieved impressive relative outperformance once again.
In summary, first quarter revenues were $154 million, up 10% sequentially. Adjusted EBITDA was $54 million, up 12% sequentially. Adjusted EBITDA margins were approximately 35%. Our cash balance increased by $28 million to $230 million. And we paid a quarterly dividend of $0.09 per share.
So I'll now turn the call over to Steve Tadlock, our CFO, who will review our first quarter financial results. And following his remarks I'll provide some thoughts on our outlook for the near term before opening the lines for Q&A. Steve?
Thanks, Scott. In Q1 revenues of $154 million increased 10% sequentially. Product revenues at $87 million were 4% higher sequentially, despite the 4% decline in the U.S. onshore rig count. Our relative outperformance was achieved due to greater market share. Product gross margins were nearly 36% of revenues, down slightly on a sequential basis due to the full impact of Section 301 tariffs and the non-cash increase in our inventory obsolescence reserve. Excluding this inventory reserve, gross margins would have been 160 basis points higher.
Rental revenues were $36 million, up 28% from the fourth quarter. The increase was attributable to higher industry completion activity and better-than-expected growth from our recent innovations. Rental gross profit margins increased 110 basis points sequentially due primarily to leverage of the fixed cost base.
Field service and other revenues in Q1 were $31 million, up 8% from the fourth quarter. This represented just over 25% of combined product and rental-related revenues during the quarter, slightly ahead of expectations. Gross margin increased 710 basis points sequentially, as utilization improved following the holiday season.
SG&A was up $1 million sequentially at $13.7 million for the quarter. The increase was attributable to higher foreign exchange losses as well as higher stock-based compensation. Given cost reduction measures implemented to date, we would expect SG&A to be $10 million to $11 million in Q2, 2020, with stock-based compensation expense running at approximately $2 million during the quarter. Due to headcount reductions announced in March we recorded $1 million of severance expense in Q1, 2020.
First quarter adjusted EBITDA was $54 million, up 12% from $48 million during the fourth quarter. Adjusted EBITDA for the quarter represented 35% of revenues. Adjustments during the first quarter of 2020 include only $1 million related to the severance expenses and $2 million in stock-based compensation. We like to keep formal adjustments to a minimum. And to be clear we did not adjust for $600,000 non-cash provision for credit losses a $1.4 million non-cash inventory obsolescence provision and approximately $1 million related to foreign exchange losses during the period. Had we added these additional items back adjusted EBITDA would have been $57 million with an adjusted EBITDA margin of 37%.
We recently began layering in balance sheet hedges to address some of the FX volatility. Our public or Class A ownership was relatively stable in 1Q and was 63% at the end of the quarter. This should result in an effective tax rate of approximately 19% in Q2 2020 assuming no changes in our public ownership percentage.
GAAP net income was $33 million in Q1 2020. Internally, we prefer to look at adjusted net income and earnings per share which were $31 million and $0.41 respectively compared to $28 million and $0.37 per share in Q4 2019. We estimate that adjusted EPS in 2020 will reflect an effective tax rate of 26%, due to relatively higher contributions from our foreign operations year-over-year.
During the first quarter, we paid out $6.5 million resulting from our quarterly dividend of $0.09 per share. The Board also approved a dividend of $0.09 per share to be paid in June of this year. Net of the dividend and associated distribution payments our cash position increased by $28 million during the quarter to over $230 million at March 31, highlighting the strong free cash flow generation of the company.
For the quarter operating cash flow was $45 million and our net CapEx spend was $8 million. Regarding working capital, due to production curtailments amid the extended Chinese New Year at our Suzhou facility, significant decreases in inventory offset a decline in accounts payable during the quarter. With accounts receivable representing a cash outflow total net working capital was a use of case. We would expect working capital to be a source of cash for the remainder of the year, primarily driven by accounts receivable.
Our Chinese facility is back up and running with no noticeable disruption to our operations. As announced in early April, we reduced our 2020 capital expenditure budget range to $20 million to $30 million down approximately 50% from 2019. Our CapEx is expected to be first half weighted this year with the annualized run rate approaching $10 million by year-end.
That covers the financial review. And I will now turn you back to Scott.
Thanks Steve. Although the dramatic decline in activity has been well documented analysts' forecast for a fall of over 60% for March through the end of Q2 maybe optimistic. Given the lack of crude storage capacity available we further expect completion activity to materially underperform the rig count in the mid-term. However, the more aggressively the production is shut-in in conjunction with the dramatic decline in new wells – the greater the long-term impact to supply. For this reason we're optimistic regarding the eventual recovery and activity required although the timing remains uncertain.
The Cactus playbook will be similar to that implemented during the 2015 and 2016 downturn in which the company maintained adjusted EBITDA margins above 20% and generated free cash flow despite over $20 million in annual interest payments. I remind you that, Cactus is a variable cost business at heart and our continued focus will be to actively manage those costs that we can control without compromising, our attention to safety and execution. This was evidenced by our decision to reduce executive and board compensation by 25% to 50% back in mid-March.
Additionally, we made the decision in late March to reduce associate salaries on a company-wide scale and cut U.S. headcount by nearly 30% resulting in $35 million in annualized cost savings $5 million of which was related to SG&A.
In April we've implemented additional rounds of cost savings. These have resulted in a U.S. headcount reduction of an additional 28% and have increased our expected annualized payroll-related cost savings to be $60 million $25 million above the amount announced in early April. These cost-cutting efforts are immediately effective and come at limited cash cost to the company as evidenced by the $1 million in severance expense recorded during the first quarter in association with the first $35 million of savings. Given where activity appears headed in the near term further cuts are planned.
On top of these savings, the company's discretionary bonus payment is expected to be dramatically reduced this year. This payment totaled $8 million in 2019 half of which was allocated to SG&A.
Looking to our product business, we expect revenue to be down by more than the rig count during the second quarter as the installation of production trees is being deferred primarily due to takeaway and storage limitations.
In response to volume declines, we're able to flex associated variable or direct expenses, which are largely material costs and freight. We believe these direct costs make up approximately 80% of our total cost in the product business with indirect costs reduced accordingly.
From a market share perspective, we're proud to achieve 32.9% share during the first quarter a company record. Given the large rig count drops witnessed on a week-to-week basis near-term figures are expected to be volatile as customers are simply dropping rigs as quickly as they can.
Recall downturns have historically provided Cactus with significant opportunities to increase market share. From year-end 2014 to year-end 2016 Cactus's market share went from less than 10% to over 20%. Operators increased focus on efficiency gains in nonproductive time tends to open doors and we've historically enjoyed a high success rate once we're able to go on trial with a potential customer.
As a consequence, we're optimistic that the current downturn will provide meaningful opportunities to pick up new business. During the first quarter, we commenced work with one of the majors. Given our balance sheet, our ability to manage variable costs and our supply chain, we believe Cactus will be able to weather the downturn more successfully than many of our peers.
Regarding our Chinese supply chain facility capacity returned to more normalized levels at the end of the first quarter and we're not currently witnessing any notable disruptions. Keep in mind that our Suzhou plant boasts extremely modest levels of fixed cost, which reduces the impact of decline in utilization.
On the rental side of the business, we were extremely pleased with customer adoption for our suite of innovations during the first quarter as evidenced by innovations representing over 20% of rental revenue during the period. Unfortunately operators are cutting any and all activity in the near-term given limited ability to move barrels to market.
In this environment, we are not willing to pursue business at significantly lower prices and compromise the value proposition our equipment and services provide. Thus, while the near-term environment will be extremely difficult, we remain confident in the value proposition and potential of our rental business once activity resumes and more customers acknowledge that the benefits resulting from efficiency gains far exceed the incremental costs.
Regarding field service, the first quarter witnessed a recovery in margins following the seasonally impacted fourth quarter. Revenues in this segment continue to be driven by both our product and rental activity. An under-appreciated attribute of Cactus is the low capital requirements of the business as highlighted by our ability to reduce our 2020 CapEx budget to between $20 million and $30 million, down approximately 50% from 2019 levels.
We typically have a three to four-month lead time between commitment and the subsequent deployment of equipment; thus we expect the annualized CapEx run rate to drop below $10 million by the end of the year and we expect to generate significant free cash flow in 2020.
I'd like to close by highlighting a few items before opening the line to questions. Although it has not had a direct impact on our operations in the field, COVID-19 has without a doubt had an indirect impact on all of our associates. I want to thank our team for their focus, dedication, commitment to safety and excellence during these unprecedented circumstances.
Many in our industry are being forced to shutter business units, write down investments and record large impairment charges; this points to a more favorable environment for those who survive this downturn. And the absence of these issues at Cactus highlights our organization's longstanding commitment to prudent investment strategy.
Management are long-term investors in this business. So while the macro backdrop provides ample reason for caution, we remain confident in our ability to execute. More importantly, our business model and historic focus on cash and returns have placed us in the enviable position of being able to fully participate in the eventual recovery.
Internationally we continue to believe that our strategy to expand into targeted markets will bear fruit in 2021 as we continue to identify and develop viable business opportunities outside of the U.S. despite emerging pricing pressures. In Australia, our work is predominantly natural gas-focused and we expect this activity to hold up better than the U.S.
Regarding capital allocation, our management team's compensation philosophy remains uniquely aligned with our shareholders and we'll continue to make decisions regarding the business in this light. We set our dividend level with the industry cyclicality and our ability to flex costs and expenditures in mind. Given the unprecedented nature of this downturn, we'll carefully evaluate this and all decisions with a focus on shareholder returns. So in summary, Cactus is well-positioned to navigate this challenging market environment.
And with that, I'll turn the call back over to the operator and we can begin Q&A. Operator?
Thank you, sir. [Operator Instructions] We have our first question from the line of Tommy Moll from Stephens. Your line is now open.
Thanks for taking my questions.
Good morning, Tommy.
Scott, you hit on the market share issue and how you were able to take a significant amount of share in the last downturn so I wanted to start there. The trial period as you indicated is often key to getting your foot in the door and expanding the relationship. So sounds like you're on trial or maybe have advanced further with one of the majors. So anything you could give us there?
But then as you look to the downturn in second quarter anyway it seems like it might be premature for operators to even start trialing new vendors. But just as you look forward, how long of a process is it to get those conversation going as the industry goes through a downturn? And then how long to convert that into a more substantive relationship?
Yes Tommy. I can only speak historically to that. Right now you can't -- it's actually difficult as you know to get into a customer's office since the customers aren't in their offices right now. So, you're now seeing the benefit of work that we did last year and the beginning of this year.
Once we're able to present to a customer you're looking at somewhere between 30 to 60 days for us to begin work. And then once we begin work maybe 90 days thereafter for them to fully evaluate the benefits of the system.
Your next question is from the line of George O'Leary from Tudor, Pickering, Holt & Co. Your line is now open.
Good morning guys.
Hey George, how are you?
I'm hanging in there. Hope you guys are doing well too in all this craziness. You guys have better relationships than most with your customers. So, there's an argument out there being posited by some people and you've seen some E&Ps mention this in their press releases around activity and cuts and things of that nature that they may go on a 'frac holiday' in the second quarter only to add activity back later in the year.
I was just curious to the extent you guys are having any dialogue with your customers about that and whether or not that seems realistic or if that's more kind of hopeful that crude oil prices are better in the back half of the year and ramping activity into those better prices. Any color there would be greatly appreciated?
George you're not going to like the answer to that question, but I'm going to give it to you straight. The frac holiday is well underway. So, that's undeniable. And although we are hearing that work could commence again, I'm obviously doubtful.
I think that it's undeniable that we're going to have a lot of DUCs that are going to have to be addressed. But the timing I would be very wary of counting on a specific month. Maybe by the fourth quarter maybe, but I wouldn't look to see a resumption in the third quarter frankly.
No, I think that's actually helpful. That was kind of the more honest answer I was actually looking for. You guys as part of your business will put -- and please excuse me if I get the term wrong, but temporary abandonment caps on wells on occasion. You mentioned selling less production equipment. Are we starting to see that where a guy's maybe completed a well but they're not actually going to go ahead and turn that inline and you're throwing those caps on for longer than you typically do?
Yes.
Awesome. Thanks for the color guys. I'll stick with my two questions.
We have our next question from the line of Scott Gruber of Citigroup. Your line is now open.
Yes, good morning.
Good morning Scott, how are you?
Doing okay. As well as can be. Thanks. Thinking about how your cost structure splits between variable and fixed can you provide some color on kind of how your COGs split along those line and also the cost savings how you're thinking about addressing the more variable but also more fixed? I realize there's a lot of variable that you can move. But just some color on that front would be appreciated.
So, Steve you want to address that?
Yes, I think I'll just kind of skip to the punch line of decrementals. I mean as Scott mentioned in the script there, obviously, it's very highly variable and we're addressing those aspects certainly as activity comes down and then and payroll as you can see with the announced reductions. And then even to the fixed costs we have a pretty low fixed cost base anyway. But wherever we can get some relief we're going for it obviously.
So, kind of moving to decrementals I think the best way to think about them simplistically is just to view them as a bit higher than our current EBITDA margins. So, in products you would see in the 40s; in rental you would see in the 70s; and field service probably high 30s maybe low 40s. So, all-in with SG&A you're probably looking at mid-40s decrementals.
If you look back at our 2016 historical margins, I think that's sort of a good place to start. But obviously that was a much slower steadier downturn. Felt bad at the time. But this is much, much faster. So, we're getting to that 2016 level in a more rapid pace.
And I think the only difference here is that we have public company costs obviously and so the challenge will be kind of keeping that total line below the SG&A above that 20% that we had historically.
Got it. A lot of good color there. So, maybe I'll ask you an unrelated follow-up. You have $230 million of cash on the balance sheet. Scott how are you thinking about M&A in this environment?
Not thinking about it right now Scott. It's really we're busy running this business right now. And I wanted to add something to what Steve mentioned. We made very, very substantial headcount reductions. And I can't speak for all of our peers. But we tend to make these on an anticipatory basis. So we don't really make them retrospectively or reactively. We're looking at the next few weeks. Because of the flat nature of this business I feel like we're closer with our customers certainly with our field people.
So these are pretty dramatic reductions but we're trying to stay ahead of the curve a little bit. M&A it just doesn't make sense right now. First of all it doesn't make sense to spend any money; I think you'd agree. And secondly it doesn't make sense for us to detract from our current focus which is running this business and preparing the business for what we think will be a much more prosperous future perhaps at the end of – sometime late next year, so just not on the radar right now.
And since you touched on it the $60 million in costs do you think you'll be able to take those out in 2Q? Like how long does that take?
It's immediate. So those reductions were only payroll-related reductions. So we didn't include the non-payroll-related cost cuts that we've implemented. So those have immediate effect.
Yes. The first round, the first announced would be the whole quarter. The second announcement would be throughout the month of April and second two months. So virtually immediate.
Thank you.
Next question is from the line of Praveen Narra from Raymond James. Your line is now open.
Thanks. Good morning, guys.
Good morning, Praveen. How are you?
I am doing okay. I hope you guys are doing well. I guess just given layoffs at the customer level, can you talk about how the decision points within those E&Ps are changing and how that changes your eventual market share gains as it rolls over?
I really can't. I can't comment on what our customers are doing in terms of personnel because frankly I don't know. But I haven't seen much in the press. Have you?
No. I mean I guess our base assumption that we're seeing decision points move up in the structure within E&Ps. And I didn't know whether that would be beneficial or how that would flow through to Cactus' ability to sell into those customers.
Yes I don't think – we haven't seen any change in that regard.
Okay. That's fair. So then I guess when we think about the pricing that inevitably we're seeing how should we think about that and whether there's any changes to how you guys may think about bonus payments or other pricing structures you see as we come through the cycle?
So I'm a little bit unclear as to your question. Are you asking me about our incentive compensation?
No. I guess I'm saying it from the customer side. Obviously many of them are asking for pricing concessions because of the downturn activity. Are you guys contemplating changing the way you price any of your products, whether it's including more bonus payments or more incentive comp from the customers? How do you think about how that's moving?
I would say just historically it is volume-related. The more volume a customer does with us the more – potentially, if they have 20 rigs, they're going to likely get a better deal than if they got two rigs running. And as far as pricing itself, we never comment on that just from a competitive standpoint.
Thank you very much guys.
We have our next question from the line of Connor Lynagh from Morgan Stanley. Your line is now open.
Thanks, good morning.
Good morning.
I was wondering if you could comment maybe less so on pricing but just more competitive dynamics. Some business you operate I know are a little less transparent to us. Are there competitors that you feel have been relatively weak and will be exiting the business or at least scaling down significantly on either the product or the rental side of the business?
So let me just speak in general terms. I think I mentioned in the narrative that the competitive landscape, I have absolutely no doubt will be much more constructive on the other end of this. So you may have heard me say before, this is a fairly bifurcated industry where you have a small group of large players and then you have lots and lots of smaller players many of whom I just frankly don't think will survive.
And I think that's probably more true in the frac space, frac rental space than it is in the wellhead space. But it's equally true in the wellhead space. There's just absolutely no way, if you don't have a strong balance sheet, if you don't have the ability to flex your costs, I just don't see survival for that lower tier group of competitors.
That's fair. If you had to guess would you say that sort of smaller competitive set makes up 10%, 30% of the market? Just how big is this potential group?
Well in the frac space it's a much larger percentage. So I'm looking at my other team members here. In the frac space, I think the smaller guys are 50% maybe more. I mean, I would have suggested maybe 60%. But maybe 50% to 60%, in the wellhead space maybe 20% to 30%.
Got it, all right. Thank you.
Next in line is Blake Gendron from Wolfe Research. Your line is now open.
Thanks good morning. Just wanted to follow up on the working capital comments. You mentioned it was going to be a source of cash for the next three quarters. But I'm trying to compare, I guess to the last downturn. It was a pretty modest source of cash in 2016. If it's warranted do you mind just going through the major drivers of working capital here and what we should expect in the second quarter versus the second half of this year as it relates to cash contribution?
Sure. I think you know 2016, if you're just looking 2015 to 2016 probably part of why you're not seeing a big working capital release is because you had a more gradual downturn. This one happening sharper you would see more of a release quicker. And then on top of that 2016 you saw recovery in the back half of the year. So that would have been a use of working capital.
So I think that may be why -- it's not kind of as clear just looking at the one year. If you look at what we expect for Q2 and beyond I'm not going to get into specifics because we're not providing any kind of activity guidance. But clearly AR is the one that will release the fastest. AP will adjust accordingly along with days.
We talked about the China impact on AP as well as the purchasing programs we take advantage of in terms of fast pay sometimes brings the days down in downturns. But inventory is the one that's not as big a release of working capital. So I would focus more on the AR side maybe you have a slight slippage in days but hopefully nothing too severe. And that's going to be your primary release.
Got it. That's helpful. Your business was also growing on a relative basis I guess through the last downturn as well. Shifting focus to supply chain it seems like China's normalized to this point. You had already diversified fairly well out of China into other parts of the world. And I know the near-term focus right now is just right sizing the business and focusing on operations. But I was wondering if you've maybe thought about the longer term potential shift away from Chinese manufacturing.
Maybe it's just sentiment-driven now just given what's going on and there's not a whole lot of visibility into what U.S. firms are going to do. But I'm wondering if it's something that you've discussed and maybe have a view on at this point.
Yes. I don't think that -- clearly that was the direction we were headed. And we'd be foolish not to accelerate that initiative. So to be clear China is still the most competitive source of equipment. But if I had to look down the road in five years, it'll be less important to Cactus than it is today.
Got it. Appreciate the color. Thanks.
Next in line is Jacob Lundberg of Credit Suisse.
Hey good morning. Thanks for taking my question. I guess could we just go back to the earlier discussion on market share? Just thinking about some of the individual drivers of that. So if we were to bucket it sort of between winning more business with your existing customers, adding customers which you obviously referenced in the prepared remarks, as well as simply your customers' rig counts outperforming the broad market. I'm curious how you'd kind of attribute recent market share gains not particularly just Q1 among those three buckets.
And to the degree that the last of those three or your customers or accounts outperforming the broad market has been a driver do you think there's any risk of seeing any reversal in market share as we go through the year?
That's a very, very interesting question because it's going to surprise you maybe not when I tell you that the large E&Ps with whom we do business were the most aggressive in cutting rigs early. So we saw much more dramatic reductions from those. And I don't know if it's because of investor sentiment investor pressure but it was fairly dramatic.
So we see that plateauing. We see maybe the later cycle drops being more the smaller players which comprise as you know a smaller percentage of what we do. But the short answer is we have just -- we've added rigs not so much with existing customers we've added rigs with new customers.
Okay. Thank you. That's helpful. And then my second question would be just around any COVID-related kind of safety measures that you guys are taking at the Bossier facility. I imagine maybe needing extra spacing on the floor. Anything like that? And would you expect that to have any cost impact?
We've actually taken -- we took those precautions probably over a month or so ago. We actually have a protocol in place before all of our employees enter the facility for their different shifts. In addition to that we've kind of spread people out. So you have guys in the machine shop the assembly guys. We've opened up some additional bays for testing. So we have spread out. And to date, I'm happy to say that we have not had any issues at the facility. And the cost to do this was really negligible.
Thank you very much.
Thank you.
Next question is from the line of Chase Mulvehill from Bank of America Securities. Your line is now open.
Hey, good morning, everybody.
[Indiscernible]
No, no. It's bit longer. So hope you guys are doing all right.
Personally, we're all doing great. Thank you.
Good to hear. Good to hear. So Stephen, I guess on the call, it was mentioned about some FX hedges. Maybe it's kind of worth taking a minute and just reminding us how much of your cost base is exposed directly to renminbi and if there's any other material FX exposure that we should be aware of?
Yes. So the losses were really related to remeasurement of Australian USD payables and Chinese USD receivables. And really the culprit here was actually Australia. They experienced sort of a wild currency movement during the quarter as much as 17% at one point. So all we've done is layer on balance sheet hedges to address this in the future so that those remeasurement gains and losses will be offset. We've done things like on a cash flow side, we've done things like prepayments in the past. And we have board authorization to do cash flow hedges in the future, but we don't intend to do that given the uncertainty around purchases and needs and things of that sort. And then just getting to your kind of base question, about 50% of our product generally is coming from China. So that's the exposure there. So whatever our receivables with our subsidiary over there are as well as a few other vendors.
Okay. All right. Appreciate the color. And I guess Scott, if we think about R&D spend through this downturn, how are you guys approaching R&D spend as we kind of go through this downturn? And I mean, it seems like that maybe some of your competitors might pull back on R&D. Do you also expect to kind of pull back, or do you think you can take advantage of this and kind of broaden your lead, when you think about the technology versus your peers?
The latter. So although, no departments have been immune from rationalization, we protected those involved in R&D and we intend to continue to protect those in R&D. But you also have to remind yourself that R&D has always been a fairly small percentage of our revenue and cost. But the short answer is, no we don't have any intention of relaxing our efforts in that area.
Okay. Appreciate the color. You guys stay safe.
Thanks.
Thank you.
Next question is from the line of Sean Meakim from JP Morgan. Your line is now open.
Thank you. Good morning.
Hey, Sean. How are you?
Great. Thank you.
Thanks. So you mentioned the market structure gets better through the downturn particularly in frac rental. And I think that makes sense you'll see casualties among the smaller competitors. But if they're maybe 50% of the market today when activity comes back, how does that equipment look in 6, 12, 18 months? How viable is that equipment to come back in a better market?
Well, it don't get better with age, I can tell you that unless you take care of it. And if you don't have the money to take care of it most of the -- if you drive around the Permian, you'll see that most of it is stored outside. You're going to have some attrition in that area to be sure. Plus, a lot of the manufacturers who produce that of questionable origin, I don't think are going to be in business as well, which is going to make spare parts problematic as well. So there'll be some significant attrition I think.
Got it. Yes, that's helpful. And then so similar question for wellheads. [Technical Difficulty] issues to work through before you start following more rigs, or would you expect activity to pick up just in time as rigs start standing up again?
So we never ask our customers to buy in advance. So our customers don't have any inventory. They don't hold any Cactus inventory whatsoever.
Okay. Great.
So there's no restocking. Yeah.
I appreciate that. Thank you.
Ladies and gentlemen, this concludes today's conference call. Thank you all for participating. You may now disconnect.
Thanks everybody. Be safe.