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TERMS & CONDITIONS Information furnished in all reports produced by PacWest may be used by Client for internal purposes, as Client deems beneficial, as long as due care is taken to hold the information confidential within Clients organization and PacWest is not liable for the information provided.
All rights to the information remain with PacWest. PacWest represents that it will not breach any obligation of confidentiality with respect to information contained in the study. PacWest will maintain in confidence and not disclose any information related to Client, without prior written consent of the Client. PacWest will not disclose to any person, including, without limitation, any of the Clients competitors or suppliers, the fact that Client has engaged PacWest in this project scope, the scope of the assignment or any other information relating to Client.
PacWest Consulting Partners 920 Memorial City Dr, Suite 160 Houston, TX 77024
Contents
1. PacWest Snapshot 2. Operator Vertical Integration 3. PacWest Market Intelligence Offerings
Client Confidential
PacWest is a boutique strategy consultancy and market intelligence firm that specializes in unconventional oil & gas
Firm Overview & Capabilities Consulting & Advisory
Provide strategy consulting and advisory services to Oil & Gas Strength in Oil & Gas supply market - Often work with operator supply chain groups analyzing supply/demand, developing sourcing strategies, building capabilities, etc. With oilfield suppliers, often work at C-Level or business lead
All key staff come from top-tier strategy firms; consulting and market intelligence capabilities reinforce/inform each other
Client Confidential PacWest 2011 | All rights reserved | 3
A sampling of some of PacWests recent projects demonstrate our depth of experience in North American and international shale
Sample of Recent PacWest Consulting Projects
PacWest Project
Analyzed Bakken & Eagle Ford supply/demand; conducted demand planning exercise to develop new pressure pumping sourcing/contract strategy
Client Outcome
Operator avoided completion delays, avoided significant additional costs
Developed Poland unconventional market entry, product/service, and JV strategy for a potential shale service company for a private equity client
Developed an innovative economic and strategic analysis of operator all-in water management costs over 20-year timeframe, for Bakken & Eagle Ford assets Conducted a study of frac pump market focused on supplier strategic plans, manufacturing capabilities, and supply chain capabilities Conducted study of evolving service company landscape in Poland, including equipment, resources, and expansion plans
PE firm focused on high-growth segments only, with the right strategic partners
Operator understood cost implications, made optimal economic decisions Equipment manufacturer developed optimal strategic investment plans Operator made better informed contract award decision
We have resources in nearly every major unconventional country/region to support international shale needs
Client Confidential PacWest 2011 | All rights reserved | 4
Contents
1. PacWest Snapshot 2. Operator Vertical Integration 3. PacWest Market Intelligence Offerings
Client Confidential
Contents
1. PacWest Snapshot 2. Operator Vertical Integration Drivers Integrated Operators Integrated Services
Client Confidential
As oil/liquids-driven activity has increased, vertical integration has become the hot new sourcing strategy amongst some operators
New Sourcing Strategy or Near-term Solution?
Some operators have been increasing pursuing vertical integration for key goods/services - Is this a sourcing fad or new operator best practice? - What is driving this trend?
Client Confidential
Vertical integration is driven by two primary factors: pricing and challenges obtaining equipment/services when needed
Drivers of Vertical Integration
Pricing pressures continue - Supply/Demand fundamentals have driven major pricing increases across nearly every product/service - Significant price escalation is projected to continue through 2012 - Some operators boast significant well cost savings from vertical integration Security of supply is challenged - US onshore operators continue to announce record breaking drilling programs - Large backlogs of uncompleted wells exists for nearly every major onshore player - Infrastructure challenges in key operating regions cause additional supply chain constraints (e.g., Bakken) - Service companies are forced to prioritize supply of key products/services to their key customers
In addition to securing supply, some operators boast significant average well cost savings from vertical integration
Client Confidential PacWest 2011 | All rights reserved | 8
Contents
1. PacWest Snapshot 2. Operator Vertical Integration Drivers Integrated Operators Integrated Services
Client Confidential
: Project Scope
A significant number of small- to medium-sized operators are currently pursuing vertical integration strategies
Vertically Integrated Operators
The following peers have pursued vertical integration in one or more services:
Client Confidential
Note: List of firms does not include all firms that are vertically integrated Source: PacWest analysis, company presentations, company 10-Ks
The production base (i.e. cash flows) of operators pursuing vertical integration varies significantly
2010 Production (MMboe)
300 250 200 150 100
70 273
42 21
15
PXD
SD
Lewis
OAS
The scale of activity that vertically integrated operators are undertaking also varies significantly
2010 Capital Spend and Wells Drilled US Land Capex ($billion)
CHK EOG SWN OXY PXD Lewis SD OAS 0.0
US Wells Drilled
CHK EOG SWN OXY
PXD
SD Lewis OAS 8.0 10.0
Average = 2.5
4.0 6.0
Note: Data is estimated for some operators as not all peers provide sufficient granularity in capital spending guidance; SWN wells drilled figure includes 9 gross wells drilled in Arkoma Conventional asset; Lewis Energy wells estimated based on Oasis wells/spend ratio Source: PacWest analysis, company presentations, company 10-Ks, Oil and Gas Investor
Client Confidential PacWest 2011 | All rights reserved | 12
Contents
1. PacWest Snapshot 2. Operator Vertical Integration Drivers Integrated Operators Integrated Services
Client Confidential
Some operators have chosen to vertically integrate across just a handful of service categories
Vertical Integration by Operator & Category
Operator Pressure Pumping Proppant Coiled Tubing Rigs Logistics
Four operators own a total of 15 pressure pumping fleets (by mid-2012) with an estimated total of 530,000 HHP
Pressure Pumping Vertical Integration
Chesapeake owns pressure pumping subsidiary Performance Technologies Performance operates 2 fleets/60,000 HHP in MidCon and adding another 2 fleets/80,000 HHP by EOY 2011 Also has 15% stake in Frac Tech Services (more of a financial/hedging strategy) Pioneer currently owns 8 fleets/225,000 HHP that it operates in Spraberry (5 fleets), Eagle Ford (2 fleets), and Barnett (1 fleet) Expects delivery of 3 additional fleets by mid-2012; plans to deploy them to Spraberry Also owns/operates 4 CT units in Eagle Ford and Raton Basin Spending $24 million to launch Oasis Well Services subsidiary Lewis Energy owns 2 fleets/60,000 HHP of pressure pumping capacity that it operates in the Eagle Ford
Committed to buying 1 single frac fleet to operate in the Bakken; likely plans to add additional fleet once it has ramped up operations
Client Confidential
EOG and Southwestern have each brought a frac sand quarry online in the last few months
Proppant Vertical Integration
EOG
Spent $65 million to set up a frac sand quarry and plant in Chippewa, Wisconsin, with a capacity of 1.7 million tpa Sand planned for use in Eagle Ford where C&J is doing the majority of pumping under a dedicated contract Rail contract in place with Progressive Rail and Union Pacific and trucking handled by a local company, Chippewa Sand Transport Estimates savings of $0.5 million/well Also operates a 2nd frac sand quarry near Ft. Spunky in Texas that it bought in 2007 H1 for Barnett pumping
Client Confidential
Southwestern
Spent $30 million in 2008 to acquire reserves in Arkansas and set up a plant Quarry currently yielding 0.65 million tpa Quarry went live in 2009 Q2 and supplies an estimated 70% of company sand demand Estimates savings of $150,000 per well
Five operators own/operate a total of nearly 200 drilling rigs across their US operations
Rigs Vertical Integration
Owns a total of ~115 drilling rigs across 2 drilling rig subsidiaries Nomac owns ~95 rigs; launched in 2001 with $26 million investment Acquired Bronco Drilling (22 rigs) in Apr 2011 for $315 million Plans to add another ~30 newbuild by 2013; goal is to own 2/3rds of total rigs Currently owns/operates 15 rigs in the Spraberry, 40% of its total rig count Also owns/operates 2 additional rigs in its Raton Basin asset Owns a small fleet of workover rigs Recently added 3 drilling rigs to bring total company-owned rig count to 13 All rigs are operating in South Texas Set up a drilling subsidiary in 2005, DeSoto Drilling Inc. (DDI), which owns 11 rigs DDI owns/operates 11 rigs, all but one of the horizontal rigs in play; remaining rig is on monthto-month contract Owns 20 drilling rigs total: 14 in Permian, 5 in MidCon, and 1 in WTO
Client Confidential
Contents
1. PacWest Snapshot 2. Operator Vertical Integration Drivers Integrated Operators Integrated Services
Client Confidential
Pioneers 2011 capital spend is forecast to be $2.1 billion, with 62% allocated to Permian and 13% to vertical integration
Pioneer 2011 Capital Spend ($billion) US Land Capex
EOG
Pioneer Capex
6.4
CHK
APC OXY DVN PXD
HES
APA MRO NBL MUR 0.0
$1.30
$0.30
0.9
0.3
2.0 Average = 2.6 4.0 6.0 8.0 Alaska Barnett Combo Other Vertical Int./Facil. Eagle Ford Spraberry
Note: Data is estimated for some peers are not all peers provide sufficient granularity in capital spending guidance Source: PacWest analysis, company presentations, company 10-Ks
Client Confidential PacWest 2011 | All rights reserved | 19
Pioneers vertical integration strategy extends to rigs, pressure pumping equipment, and various other surface equipment
Pioneers Vertical Integration Approach
Pioneer has chosen to vertically integrate (i.e. own and operate) many of its critical services that are typically delivered by service companies and are generally the largest spend categories
Pioneer has pursued vertical integration in all of its core unconventional assets that it is currently developing
Pioneer Assets
PXD Asset Permian Raton Basin Details Largest operator in the Spraberry trend and is one of the most active developers in the Permian Largest operator in the Raton CBM basin where it is focused on shale resource development
Vertical Integration
Owns 310,000 gross acres which it is aggressively developing Owns significant assets in the wet gas zone of the play in the NW; currently developing
Entered the North Slope in 2002 and discovered the Oooguruk gas field in 2003, which it brought online in 2008 45% interest owner with PetroSA in offshore asset that now produces small amount of gas Operates 600+ gas wells and has working interest in 1200+; owns majority of gathering/processing infrastructure; new development activity minimal until gas prices recover Long history in the trend; development minimal until gas prices recover
PacWest 2011 | All rights reserved | 21
Spraberry is Pioneers core asset accounting for nearly two-thirds of capex and it has pursued vertical integration most aggressively here
Pioneer Spraberry Development
2011 Wells Put on Production
250 230 200 235
Supply Discussion
Quarter-by-quarter supply chain activity: - Q1: 4 frac fleets (3 company-owned, 1 dedicated 3rd party) - Q2: in May increased to 6 frac fleets (4 company-owned, 2 dedicated 3rd party)
- Q4: Adding 5th company-owned frac fleet The company owns 14 drilling rigs (40%) As of Q4, the company will own 5 frac fleets, representing 71% of capacity, in addition 2 dedicated fleets with Baker Hughes - Ordered an additional 3 fleets which it expects to receive in mid-2012
50
Q1
Rigs 30
Q2
35
Q3E
Q4E
45 by YE
The company also owns 23 pulling units and various other equipment, including water hauling trucks, frac tanks, BOPs, construction equipment, and fishing tools
PacWest 2011 | All rights reserved | 22
Source: PacWest analysis, company presentations (in some cases, exact well counts are estimates)
Client Confidential
Pioneer is running 12 rigs in the Eagle Ford and has deployed companyowned frac fleets and coiled tubing units in the play
Pioneer Eagle Ford Development
2011 Wells Put on Production
40 35 30 35
Supply Discussion
Quarter-by-quarter supply chain activity: - Q2: deployed 1st company-owned frac fleet in addition to dedicated fleet - Q3: brought 6th and 7th CGPs online - Q4: Adding 2rd company-owned frac fleet; bringing 8th CGP online
20 18 10
As of Q4, the company will own 2 frac fleets, representing 67% of capacity, in addition to a dedicated frac fleet with Weatherford - Second company-owned fleet is expected to be delivered during Q4
Rigs
Q1
8
Q2
10
Q3E
12
Q4E
12
The company also owns a single coiled tubing unit and expects delivery of a second CT unit during Q4
Testing white frac sand (10 wells) in shallower areas; generating $700 million savings/well
PacWest 2011 | All rights reserved | 23
Source: PacWest analysis, company presentations (in some cases, exact well counts are estimates)
Client Confidential
The company has also pursued vertical integration in the Barnett and Raton, its other two core unconventional resource plays
Pioneer Barnett & Raton Development
Barnett Supply Discussion
The company has 2 rigs currently under contract with 3rd parties - Plans to increase to 4 rigs by year-end Deployed 1 company-owned frac fleet in 2011 Q2
Pioneer claims that its vertical integration model will generate a 45% IRR on a third-party savings basis, excluding managerial burdens
Pioneer Vertical Integration Savings
Pioneer has spent $440 million on vertical integration over 2011: - $300 million for equipment delivered in 2011 - $140 million for equipment to be delivered in the middle of 2012 (3 frac fleets and other) - Likely spent additional capital in 2009 to reserve orders Pioneer claims that the $440 million investment will generate a 45% IRR before taxes, though that is strictly on a cash savings basis and does not include incremental managerial burdens of these businesses; does not consider cost of capital Service Area/Savings
Frac Fleets YE Fleets Fracs/Fleet/Year Savings/Frac Annual Savings Rigs & Other Services Annual Savings Annualized Cash Savings
Client Confidential
Spraberry
5 ~115 $0.35MM $200MM $30MM $230MM
Eagle Ford
2 ~55 $1.70MM $185MM $185MM
Barnett
1 ~60 $0.75MM $45MM $45MM
Total
8 ~93 $0.58MM $430MM $30MM $460MM
Contents
1. PacWest Snapshot 2. Operator Vertical Integration Drivers Integrated Operators Integrated Services
Client Confidential
Southwestern forecasts that it will spend $2 billion in capital over 2011, with nearly 2/3rd of that spend in the Fayetteville
2011 Capital Spend ($billion) US Land Capex
EOG CHK MRO APC
Southwestern Capex
6.4
Fayetteville Appalachia New Ventures
Midstream
Corp
Other Areas
3%2%
10%
9%
OXY
DVN PXD SWN HES APA MRO NBL MUR 0.0
Client Confidential
2.0
1.7 1.7 1.6 0.9 0.3
2.0 Average = 2.6 4.0 6.0 8.0
PacWest 2011 | All rights reserved | 27
15%
61%
Note: Data is estimated for some peers are not all peers provide sufficient granularity in capital spending guidance Source: PacWest analysis, company presentations, company 10-Ks
Since 2007 Q1, Southwesterns new producing wells per quarter has increased 25% YoY, while its rig count has decreased 11% YoY
Fayetteville Development, wells put on production (2007 Q1 2011 Q2)
2010: 553
170 160 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 -
286
159 149 137
143 145
2007: 255
97 74 77
75
83
58
46
2007 2007 2007 2007 2008 2008 2008 2008 2009 2009 2009 2009 2010 2010 2010 2010 2011 2011 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
Rigs
Client Confidential
19
18
16
14
12
Southwestern has succeeded in reducing drilling days per well by 17% YoY for an average 53% reduction since 2007
Fayetteville Development
Days to Drill
20 17 14 12 10 11 8 $2.00 $3.00 $2.90 $3.00 $2.90 $2.80 $2.80 $4.00
Well Cost
$1.00
$-
2007
2008
2009
2010 2011 H1
2007
2008
2009
2010 2011 H1
Source: PacWest analysis, company presentations (in some cases, exact well counts are estimates)
Client Confidential PacWest 2011 | All rights reserved | 29
Southwestern has chosen to pursue a vertical integration strategy only in its core Fayetteville asset
Southwestern Assets
SWN Asset
Proved Reserves (Bcf) 4,345
Details
Focus of the companys E&P operations; the company owns nearly 1 million net acres in the play; as of EOY 2010, company had spud 2,445 wells in play since commencement in 2004 Traditional area of operations located in western Arkansas; have recently expanded activity to the south and east of the traditional fairway area, but has significantly reduced capital spend Owns nearly 175,000 net acres in play in NE Pennsylvania and have participated in a total of 25 wells since drilling commenced in 2009 Active in region since 2000 in Cotton Valley and has expanded activities to target Haynesville/Bossier
Vertical Integration
Fayetteville
Conventional Arkoma
226
38 321
Southwesterns vertical integration strategy extends to drilling rigs, sand, water sourcing, water hauling, in-field logistics, and civil works
Fayetteville Vertical Integration Strategy
Drilling Rigs
Set up a drilling subsidiary in 2005, DeSoto Drilling Inc. (DDI), which owns 11 rigs DDI owns/operates 11 rigs, all but one of the horizontal rigs in play; remaining rig is on month-to-month contract
Frac Sand
Spent $30 million in 2008 to acquire reserves in Arkansas and set up plant Quarry went live in 2009 Q2 and supplies roughly 70% of company sand demand, saving estimated $150,000 per frac job
Water Sourcing
Sources all water internally, though this is quite common among operators Experimenting with fracs to reduce water consumption 10% (~$60,000/job)
Water Hauling
Owns a network of water hauling trucks to handle the majority of its water hauling needs internally
In-field Logistics
Owns a network of trucks to handle the majority of in-field hauling needs internally
The company claims to save an estimated $0.3 million per well as a result its vertical integration efforts
Client Confidential PacWest 2011 | All rights reserved | 31
Southwestern employs Schlumberger, Calfrac, and Cudd for its pressure pumping services in the Fayetteville
Fayetteville Pressure Pumping Strategy
2011 Frac Jobs
Schlumberger 48% 32% 20%
Discussion
Southwestern employs three different pressure pumpers in the Fayetteville - Schlumberger, Calfrac, and Cudd Each pumper is on a 1-year contract that started in the February-March timeframe; each operates under a slightly different contract - Contracts are bid year-to-year The companys pressure pumping demands are some of the most basic in the industry - Frac depths range from 2,000 to 5,000 feet with ~5,000 feet laterals - Currently running 100% slickwater fracs Company has seen pressure pumping price increases in the 4-5% range over 2011, significantly less than most other operators in the area
PacWest 2011 | All rights reserved | 32
Pumper Share:
Calfrac Cudd
60 50 40 30 20
29 10 14 9 13
11 11
16 16
10
18 9 15 7 13 4 11
10 0
20
21
25
29 14 15 17
Jul Aug
Client Confidential
Note: Data from Jun, Jul, and Aug does not yet include all fracs completed during those months Source: PacWest analysis, PacWest FracDB, company presentations (in some cases, exact well counts are estimates)
Contents
1. PacWest Snapshot 2. Operator Vertical Integration Drivers Integrated Operators Integrated Services
Client Confidential
If timed properly, vertical integration can yield significant near-term benefits to operators, but the model also entails significant risks
Vertical Integration Strategic Considerations
Benefits
Ensures equipment availability and avoids delays during a tight supply market Potentially lowers per well costs if service business is operated efficiently
Risks
Bear risk of idle equipment/staff if price environment necessitates activity reduction Added enterprise complexity can potentially serve as distraction for management/staff Potentially increases per well costs if service business is not operated efficiently
Implications
Model can yield significant benefits during times of tight supply but those benefits become marginal as supply market loosens and turn negative as the market collapses Operators need to be strategic about the exit opportunity requires market foresight to know when the market is going to loosen and when to you should get out of the business North American supply market is just beginning to loosen from its peak in mid-2011 and things appear to be likely to equalize by late-2012 or early-2013 Market opportunity for vertical integration may be over for operators
Client Confidential PacWest 2011 | All rights reserved | 34
Greater operator vertical integration represents a potential strategic threat to service companies
Strategic Threat?
Larger independents increasing looking at peers well cost advantages with a keen eye - Baker Hughes leadership should be aware of these cost advantages for pricing decisions However, several factors reduce the vertical integration opportunity: - Backlogs for frac fleets and other key equipment currently exceed 9-12 months in many cases - Market tightness in key equipment and services appears to be loosening and moving towards a more stable balance the ideal time to seize the opportunity was likely 12-18 months ago, when a handful of prescient operators placed orders Given this, PacWest does not believe vertical integration is a new, long-term operator sourcing trend - It is an interesting short- to medium-term trend to note and monitor, but it does not represent a meaningful strategic threat to service companies
Client Confidential
Contents
1. PacWest Snapshot 2. Operator Vertical Integration 3. PacWest Market Intelligence Offerings
Client Confidential
PacWest currently offers multiple unconventional market intelligence product offerings to support subscriber decision-making
Market Intelligence Offerings
Breakdown of pressure pumping fleets/capacity by basin and supplier with strategic analysis of latest regional supply market trends Interactive database of 100+ critical unconventional suppliers Cost escalation forecast for major D&C categories
Detailed breakdown of frac activity by basin, operator, pumper Database of fracs including basin, operator, pumper, chemicals, chemical suppliers
Client Confidential PacWest 2011 | All rights reserved | 37
PumpingIQ provides the only granular breakdown of regional fleets/capacity by pressure pumper and analysis of market trends
Focus Markets
Bakken Eagle Ford
Permian
DJ Basin Anadarko Marcellus
Uinta/Piceance/Green River
Haynesville Fayetteville Barnett
SupplierIQ is an interactive database of 100+ suppliers that are critical players in shale supply markets
Supplier Analysis
Interactive database of 100+ companies that supply critical D&C products/services for shale production Database is updated quarterly with new suppliers; updates made to existing suppliers bi-annually
Profile Contents
PacWest Supplier Classification
Customers
Organizational Footprint Detailed discussion of Service Offerings: 15 product/services that are critical for shale production
CostIQ provides a forecast of cost increases for key drilling and completion cost drivers
Forecast Analysis
3-year forecast of D&C cost escalation, segmented into major categories
Includes strategic discussion of trends driving increases and/or decreases Updated bi-annually (every 6 months) PacWest utilizes three quantitative methods to forecast prices changes for each market segment: - Multi-variable regression
Cost Segments
Drilling
- Land rigs - OCTG - Drilling fluids
- Cementing services
Completion - Pressure pumping services - Proppant - Frac chemicals - Completion hardware - Completion rigs
- Demand/supply models
- Macroeconomic models
FracIQ is the source of frac activity data by operator and pressure pumper, with data broken down US-wide and regionally
Product Overview
The definitive subscription publication on frac activity across the US
Summary of fracs by region, operator, pressure pumper Market share by pumper and operator across multiple metrics Strategic analysis of frac trends and market dynamics, including implications for operators, pressure pumpers, and other stakeholders Updated quarterly
Contents
Aggregate US fracs:
- By operator - By pressure pumper Regional breakdown of fracs:
- By operator
- By pressure pumper - By frac type Operator and pumper relationships Frac practices, including chemicals usage
Your Land Rig Newsletter for the frac market available late 2011
Client Confidential PacWest 2011 | All rights reserved | 41
FracDB is the definitive database of fracs and frac chemicals that can be used to conduct sophisticated market analyses
Product Overview
Database of US fracs and frac chemicals, built into a rich structured data set
- The data set already contains nearly 7,000 fracs conducted in 2011 A sophisticated tool that can be used to run a variety of analyses: - Pressure pumping/frac market share - Completion chemicals market share - Regional frac design practices
Data Elements
Frac date
Well number, API number Operator TVD
Water volume
Pressure Pumper Play Chemical type Chemical ingredient Chemical supplier Contact us for more detail
FracDB is a powerful tool for the sophisticated market analyst available late 2011
Client Confidential PacWest 2011 | All rights reserved | 42
The ShaleIQ bundled product provides access to 3 useful products at a reduced price point
Bundle Includes
Breakdown of pressure pumping fleets/capacity by basin and supplier with strategic analysis of latest regional supply market trends
The ShaleIQ bundle is a valuable resource to add to your decision making toolkit
Client Confidential PacWest 2011 | All rights reserved | 43
PacWest delivers actionable intelligence that is designed to provide strategic recommendations to key decision-makers
Actionable Intelligence
Transforms volumes of disparate market data, insider industry activity and expert input into strategic and actionable recommendations for decision-makers Aggregates, organizes and distills a wide range of data and intelligence to provide information to our clients that is comprehensive, focused and strategic Analyzes this information to assess its strategic implications and provide a clear path of action for each stakeholder
Decision-Makers
Client Confidential
PacWest employs a comprehensive methodology that relies on primary intelligence and rigorous research and analysis
Methodology
PacWest uses a multi-pronged approach to develop its market intelligence offerings; the team:
1) Gathers and reviews all information available publicly and via proprietary databases
2) Engages its diverse network of industry contacts to gather real-time intelligence 3) Processes and synthesizes raw information into actionable intelligence
Secondary Research
These sources are regularly consulted: Market research and reports Company annual reports, 10-Ks, 10-Qs