RIGHT PEOPLE RIGHT RIGS RIGHT PARTNERS RIGHT ATTITUDE 2013 ANNUAL REPORT

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1 RIGHT PEOPLE RIGHT RIGS RIGHT PARTNERS RIGHT ATTITUDE 2013 ANNUAL REPORT

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3 Table of CONTENTS VISION & MISSION $1 billion energy service company within 5 years by 05 REPORT TO SHAREHOLDERS 12 MANAGEMENT S DISCUSSION & ANALYSIS 37 MANAGEMENT S REPORT being measurably more efficient Right People, Right Rigs, Right Partners, Right Attitude 38 INDEPENDENT AUDITOR S REPORT 39 FINANCIAL STATEMENTS 43 NOTES TO THE FINANCIAL STATEMENTS 81 CORPORATE INFORMATION Forward-Looking Information: This Annual Report contains forward-looking information in the Corporation s vision and mission statement and Report to Shareholders section including statements regarding: our vision and mission to become a $1 billion energy service company within 5 years by being measurably more efficient and our plan to deliver even stronger results in 2014, including stronger shareholder returns and performance. This forward-looking information involves material assumptions and known and unknown risks and uncertainties, certain of which are beyond the Corporation s control. Those assumptions include: changes to the regulatory environment in areas targeted for expansion; access to quality people for growth; and availability of suppliers to support our ongoing rig construction program. Further, there are risk factors and uncertainties that could cause the Corporation s actual results, performance or achievements to differ materially from the forward-looking information, including the risks set out in the Risks and Uncertainties section within the MD&A, contained in this Annual Report. The Corporation s actual results, performance or achievements could differ materially from those expressed in, or implied by, this forward-looking information and, accordingly, no assurances can be given that any of the events anticipated by the forward-looking information will transpire or occur, or if any of them do so, what benefits the Corporation will derive therefrom. The forward-looking information is made as at the date of this Annual Report and the Corporation does not undertake any obligation to update publicly or to revise any of the included forward-looking information, whether as a result of new information, future events or otherwise, except as may be required by applicable securities laws ANNUAL REPORT

4 Providing Drilling SOLUTIONS CORE VALUES Health, Safety & Environment Relationships Teamwork Communication Performance The CanElson Way THE PRIMARY BUSINESS OF CANELSON (TSX: CDI) is operating land -based contract drilling rigs in Canada, the United States and Mexico. This business is conducted through our Drilling Services Division. We also operate a compressed natural gas ( CNG ) transportation and related services business through our wholly owned subsidiary, CanGas Solutions Inc. ( CanGas ). Our goal is to combine management s EXTENSIVE exploration and production EXPERIENCE with its oilfield services knowledge to provide our customers with lower well costs while still delivering TOP DECILE financial results for our shareholders. We will achieve this goal by maintaining capital discipline and by offering a fleet of purpose-built efficient drilling rigs to provide full cycle financial RETURNS. Not just a rig rental company ANNUAL REPORT

5 Financial SNAPSHOT Revenue and Adjusted EBITDA Earnings and Dividends Credit Facilities New Capital Enterprise Value Number of Rigs ANNUAL REPORT

6 Measuring PERFORMANCE 2013 RESULTS: 2013 s results included an industry leading adjusted EBITDA percentage and top tier return on equity while preserving balance sheet strength. Our goal is to BE NUMBER ONE. We believe our shareholders have a right to measure our performance in the context of our peers. PERFORMANCE MEASUREMENT: 2013 (Rank out of 8) 2012 (Rank out of 10) 2011 (Rank out of 8) ADJUSTED EBITDA % 33.4% (1ST) 38.1% (1ST) 35.3% (3RD) Adjusted EBITDA (1) divided by annual gross revenue GROSS MARGIN % 41.1% (1ST) 45.1% (1ST) 41.5% (3RD) Annual gross margin (1) divided by annual gross revenue PROFIT MARGIN 16.4% (1ST) 21.7% (1ST) 18.1% (2ND) Annual net income divided by annual gross revenue RETURN ON EQUITY 11.0% (2ND) 16.4% (1ST) 13.9% (2ND) Annual net income divided by trailing four quarter average equity FUNDS FLOW TO PP&E 20.2% (2ND) 27.0% (2ND) 24.8% (2ND) Annual funds flow (1) divided by period end property and equipment G&A as a % of REVENUE 7.7% (3RD) 7.0% (6TH) 6.2% (2ND) Annual administration expense divided by annual gross revenue (1) Adjusted EBITDA, gross margin and funds flow are not measures that have prescribed meaning by International Financial Reporting Standards and are therefore referred to as non- GAAP measures. The non-gaap measures used by CanElson may not be comparable to other companies. For further information and explanation, see the Financial Summary in the Management s Discussion & Analysis. ANNUAL REPORT

7 Report to SHAREHOLDERS: I n 2013, CanElson Drilling generated financial and operating results which remain among the best in its peer group, thanks in large part to our people. Their hard work is the single most important factor in the overall performance of our company. Specifically in 2013, we were able to continue our outperformance as reflected by the following: In Canada, CanElson achieved capacity utilization rates that were 1.5 times better than industry average. In the US, CanElson generated a 37% increase in operating days for the year, compared with a year earlier. CanElson achieved a top tier Return on Equity of 11% and our year end net debt was equal only to 0.4 times our 2013 EBITDA. Our CanGas subsidiary is experiencing increased demand for bifuel application and enquiries about flare gas conservation. The above achievements are particularly impressive given that these performance results have been achieved in 5 years of our first rig deployment. In this letter we will outline some of the contributing factors which we expect will help us achieve our goal to become a $1 billion energy services company within 5 years by being measurably more efficient - Right People, Right Rigs, Right Partners, Right Attitude. RIGHT PEOPLE The most critical part of our business is attracting, training, motivating, and retaining our people, as their daily contributions to this company are a vital component of being measurably more efficient than our peers. An important aspect of attracting and training good people is having leadership that has a background in drilling. All of our senior operational leadership team have drilling rig experience and collectively have more than 500 years of drilling expertise. In addition, we have ongoing initiatives to further expand our engineering team ANNUAL REPORT

8 Having an experienced operational leadership team has allowed us to add 10 drilling rigs and over 200 people in 2013, with our employee count now exceeding We believe that a strong, growing business will provide career advancement opportunities for our employees. In turn, the deep experience and continued hard work of our employees will result in better results for our customers. RIGHT RIGS To provide efficiencies to our customers, our people need the right tools. We design mechanical or AC tele-doubles and AC triple rigs to our customer requirements. These rigs provide our people with the tools to deliver drilling efficiencies. Our drilling rigs have the flexibility to drill in the majority of the resource basins in North America. Compared with the average industry rig, we design and assemble our rigs to be easier, faster and less costly to build, set up, move and repair. As a result, our rigs are the top performers in every basin where we operate. We continue to generate top tier return on equity metrics, thereby confirming the efficacy of our business strategy and capital allocation plan. In the fourth quarter of 2013, we acquired Highkelly Drilling Ltd., which provided us with two new state-of-the-art AC triple drilling rigs, highly capable and experienced personnel and an immediate foothold with an active LNG customer in one of the most prolific liquids rich natural gas drilling regions in North America, allowing us to participate in the growing market for deeper wells. With this acquisition, and combined with our strong balance sheet, we are better positioned for further growth opportunities with other LNG players and in plays requiring deeper rigs, as our fleet of triple drilling rigs expands to four from two previously, with a fifth triple drilling rig currently under construction and a sixth triple drilling rig expected for deployment in Q RIGHT PARTNERS We consider all of our customers to be partners. We know that if we reduce well costs today for our customers they will give us more work in the future. We continue to listen to our customers and tailor our services to their needs. As such, we offer a choice of day rate, meterage/footage, a combination of both, or a turnkey project, each of which provides opportunities to share in the benefits of our efficiency. Our focus on efficiencies has resulted in clear customer interest in new-build drilling rigs. A large majority of these new rig contract opportunities are being driven by our historical performance combined with our ability to identify cost saving opportunities in the drilling process. As a result, we continue to invest in customer relationships, and our people, which allow us to assist in the drilling optimization process. In 2013, we entered into two formal partnerships with First Nations groups, one in Manitoba and one in Saskatchewan. Additionally, our Mexican Partnership purchased and refurbished two drilling rigs. We believe our performance in Mexico and our alignment with an experienced and strong local partner (Grupo Diavaz, with 40 years of experience serving PEMEX) provides an excellent opportunity for our joint venture DCM to expand its range of services, including potentially expanding its drilling rig fleet. ANNUAL REPORT

9 RIGHT ATTITUDE The primary challenge facing our customers within the horizontal well market is controlling well costs. With that in mind, we continue to focus on efficiency in the drilling process and cost saving programs. It is our experience that drilling contractors get the most profitable opportunities if they provide effective solutions rather than merely renting rigs. We are seeing incremental demand being driven from those operators looking for assistance in reducing drilling and related well costs. Additionally, we continue to cultivate a culture featuring an unrelenting commitment to the health and safety of our employees. How this translates into FINANCIAL PERFORMANCE FOR OUR SHAREHOLDERS Efficiencies are only valuable to our shareholders if we can translate them into financial returns. While we recognize that the oilfield services industry is cyclical, we believe that our shareholders deserve top decile returns throughout the full cycle. In 2013 our Return on Equity ( ROE ) based on our average shareholders equity was 11.0%. We accomplished top tier levels of shareholder returns while adding over $87 million of equity capital on our balance sheet during the year which has positioned us with very low levels of debt leverage for future growth. ACKNOWLEDGEMENTS For more insight into our 2013 results and outlook for 2014, I invite you to review our MD&A and audited financial statements. Our efficiency and performance are directly attributable to the hard work of our employees, management team, and the Board of Directors. They have earned our thanks and gratitude once again. I would also like to thank our customers and you, our shareholders, for your continuing support. RANDY HAWKINGS President and CEO ANNUAL REPORT

10 Translating GROWTH to Shareholder Returns INCREASING MARKET SHARE Growth in 5 Years During 2013, we continued to scale our business with dramatic growth in market capitalization. Our solutionsbased approach, featuring enhanced operating efficiencies and modern drilling rigs, has resulted in significant demand for new rigs even though 2013 saw a decline in North American rig count. CanElson Shareholder Returns Relative to the S&P/TSX Composite Index ANNUAL REPORT

11 Strategic OBJECTIVES Review of 2013 Strategic Objectives and Looking Ahead STRATEGIC OBJECTIVE ACTUAL RESULTS COMMENTS Expand our tele-double fleet Expand our service offering in Mexico Grow through acquisitions Develop and deploy a proprietary triple Assembled, contracted and deployed 4 tele-doubles Purchased, retrofitted, contracted 2 tele-doubles in Mexico Capitalized on two acquisitions: (1) $15 million at a discount to replacement cost; and (2) $43 million as a strategic move into the LNG and triple market Ongoing deployment expected in Q Achieved Achieved Achieved Development achieved We enter 2014 with expanded capabilities that enable our active participation in the growing demand for drilling pad wells, with a larger fleet of heavy duty teledouble and, with new AC triple drilling rigs to facilitate our increasing share of the deep well drilling market, and with significant demand for new build drilling rigs, while sustaining modest financial leverage to provide flexibility in pursuing new opportunities. Looking to 2014 CanElson s primary objective is to maintain and strengthen its top tier results by consistently providing operational excellence and drilling efficiencies to its customers PRIMARY OBJECTIVES We intend to carry out the following activities to further enhance our competitive positioning: Provide customers with lower overall well costs Expand our standard tele-double fleet, including AC rigs Expansion in the AC triple market Expansion of our offering in Mexico Continue to form new strategic long - term business relationships Continued growth through strategic acquisitions ANNUAL REPORT

12 Safety is our PRIORITY Our PHILOSOPHY Our management team has extensive experience on the rig floor. They know that the biggest impact of an unsafe workplace is borne by the injured worker, and because of that experience they know it is management s responsibility to ensure the rig crews are well trained, the equipment is well maintained, and safety is a priority in every phase of the operation. Management also knows that they cannot fix what they do not know about and, for that reason, we are very proud of our track record of reporting and acting on all incidents, including near misses. Our COMMITMENT We believe we are one of a very small number of publicly traded drilling contractors that have an independent Health, Safety, and Environment ( HSE ) Committee of the Board Directors. Every near miss incident is reported to the HSE Committee, and is subject to review by both the HSE Committee and the full Board of Directors. Measuring Our RESULTS We realize that the common industry statistical benchmark of Total Recordable Incident Frequency (TRIF, or its USA equivalent Recordable Incident Rate) has data gaps since it is reported quite inconsistently across the industry, which compromises safety performance analysis at an industry level. A more inclusive measure of safety performance, which combines the frequency and severity of accidents, is the medical care financial costs paid out to third party institutions for the accidents. Based on medical cost data for CanElson and for the industry provided by government and private insurers for workplace accidents, CanElson Drilling has a significantly lower cost of injuries relative to the industry, in all jurisdictions where we operate in Canada and the US. Our Dividends from Safety At CanElson, we believe a safe operation reflects better training, better equipment, better efficiency, and results in higher profits. A generation ago, the people who comprise CanElson's management team were coached in getting home safely from the rigs. It is now their responsibility to do everything possible to ensure that our people get home safely, and this responsibility is taken very seriously. ANNUAL REPORT

13 Rig FLEET As of December 31, 2013 TOTAL 50 RIGS 2013 Rig Deployment DRILLING RIGS DRILLING RIGS DRILLING RIGS DRILLING RIGS DRILLING RIGS DRILLING RIGS Purchased 2 new AC electric triple drilling rigs Constructed 4 ultra heavy telescopic double rigs Purchased an AC electric teledouble pad drilling rig and 2 single rigs 3 tele-doubles, 1 triple to be deployed in 2014 and a second in Q SERVICE RIGS ANNUAL REPORT

14 Management s DISCUSSION & ANALYSIS At February 27, 2014 This Management s Discussion and Analysis ( MD&A ) for CanElson Drilling Inc. and all of its subsidiaries and its unconsolidated joint venture company (collectively "CanElson or the Corporation or we or us or our ) should be read in conjunction with: (1) the audited December 31, 2013 consolidated financial statements prepared in accordance with International Financial Reporting Standards ( IFRSs ); (2) the audited December 31, 2012 consolidated financial statements prepared in accordance with previous IFRSs ("Previous IFRSs"); (3) the December 31, 2012 MD&A and (4) the Annual Information Form for the year ended December 31, Additional information regarding CanElson is available on SEDAR at All amounts are denominated in Canadian dollars (CDN$) unless otherwise identified. All amounts are stated in thousands, except for: per share amounts, number of drilling rigs, operating days, metres, and unless otherwise identified. FINANCIAL INFORMATION This is the Corporation s first fiscal year adopting IFRS 11 accounting for Joint Arrangements. In accordance with IFRS 11 the transition date was January 1, 2013 with retroactive application to January 1, 2012 and, accordingly, the comparative information for 2012 has been restated to conform with the requirements of IFRS 11. The application of IFRS 11 has changed the classification and subsequent accounting of the Corporation s investment in Diavaz CanElson de Mexico S.A. de C.V. (DCM), which was classified as a jointly controlled entity and previously accounted for using the proportionate consolidation method. Applying IFRS 11 requires that the Corporation apply equity accounting for its 50% interest in DCM. Additional information about the adoption of this standard and the Corporation s IFRSs accounting policies is discussed in the Accounting Policies and Critical Estimates section of the MD&A as well as in the notes to the December 31, 2013 and 2012 audited consolidated financial statements. The 2011 financial information contained within this MD&A has been prepared following Previous IFRSs requirements, as allowed under IFRS 1, and has not been restated. Information regarding IFRSs accounting policies can be found in the Accounting Policies and Critical Estimates section of this MD&A as well as in the notes to the December 31, 2013 audited consolidated financial statements KEY DEVELOPMENTS Key developments in 2013 include the following: Q1 - DCM acquired and retrofitted two tele-double drilling rigs for deployment in Mexico in Q2 and Q3. Q2 - completed a financing with the issuance of 6 million common shares at $4.85 per common share for gross proceeds of $29 million. Q3 - purchased AC tele-double pad drilling rig, two single rigs, spare equipment as well as land and buildings for $15 million. Q4 - completed a financing with the issuance of 5.6 million common shares at $6.20 per common share for gross proceeds of $34.9 million. Q4 - purchased Highkelly Drilling Ltd. ("Highkelly"), a private Canadian drilling company, for $44.1 million, resulting in ownership of two new AC triple drilling rigs operating in the Montney (LNG) liquids rich natural gas resource play of northeast British Columbia, as well as a third identical drilling rig that is under construction. Through 2013, built and deployed four additional tele-double drilling rigs, establishing a footprint in the LNG market of north east B.C. and expanding our presence in the Permian Basin (west Texas). ANNUAL REPORT

15 FOURTH QUARTER 2013 SUMMARY (Compared with a year earlier) Acquisition of Highkelly for $44.1 million including assumption of debt. Services revenue $81.1 million, up 24% from $65.4 million. Adjusted EBITDA $26.2 million, up 8% from $24.3 million (excludes Adjusted EBITDA from our equity investment joint venture DCM of $1.5 million (2012: $0.2 million)). Income attributable to shareholders of the Corporation $10.6 million, down 24% from $13.9 million. EPS (diluted) $0.12, down 33% from $0.18. Weighted average diluted shares outstanding 90.4 million, up 17% from 77.0 million. Declared fourth quarter dividend of $0.06 per share, up from $0.05. THE YEAR ENDED 2013 SUMMARY (Compared with a year earlier) Services revenue $257.0 million, up 18% from $218.4 million. Adjusted EBITDA $85.8 million, up 3% from $83.1 million (excluding Adjusted EBITDA from our equity investment joint venture DCM of $3.7 million (2012: $1.8 million)). Income attributed to shareholders of the Corporation $35.6 million, down 18% from $43.6 million. EPS (diluted) $0.43, down 26% from $0.58. Weighted average diluted shares outstanding 82.5 million, up 9% from 75.5 million. CanElson s Canadian utilization rate (spud to rig release days) in the fourth quarter of 2013 was 66%, or 1.5 times the industry average (2012: 1.6). CanElson s US utilization for the fourth quarter was 86% (2012: 84%). Total corporate utilization was 74% during the fourth quarter of 2013 (2012: 71%). For 2013 as a whole, CanElson s Canadian utilization rate was 53%, or 1.2 times the industry average (2012: 1.3). CanElson s US utilization for the year was 83% (2012: 80%). Total corporate utilization was 65% during 2013 (2012: 64%). Although the Corporation was able to maintain fourth quarter and 2013 full year utilization rates relative to the comparative periods and increase revenue and Adjusted EBIDTA as a result of our increased drilling rig fleet, income attributable to shareholders and earnings per share decreased for the fourth quarter and year compared to the same periods in 2012 due to subdued North American land drilling markets, resulting in lower industry land drilling activity, which put pressure on our drilling rig revenue rates. The rate of decline in earnings per share was greater than the rate of decline in income attributable to shareholders due to the timing of the equity issues in advance of the two acquisitions and financial contribution therefrom. These financing activities were undertaken to fund both current and future investment activities. CORPORATE OVERVIEW The primary business of CanElson (TSX: CDI) is operating land-based contract drilling rigs in Canada and the US for oil and natural gas exploration and development companies. The Corporation also has a 50% ownership interest in an unconsolidated joint venture, DCM, whose primary business is operating land-based contract drilling and service rigs in Mexico. We also provide compressed natural gas (CNG) and raw gas transportation (RGT) services through our wholly owned subsidiary, CanGas Solutions Inc. (CanGas). Our objective is to provide our customers with lower overall well costs while still delivering industry leading financial results for our shareholders on a full cycle basis by leveraging our extensive exploration and production experience, oilfield services knowledge, capital discipline and fleet of modern purpose-built, high efficiency drilling rigs. Drilling Services The Drilling Services Division operates drilling rigs and sells interests in drilling rigs to selected business relationships involving the Corporation. The business of drilling services also includes assembling new drilling rigs at a facility in Nisku, Alberta ANNUAL REPORT

16 The drilling rigs in our drilling services division are wholly-owned except as follows: 1. In Canada, CanElson has three partnerships with First Nations organizations, which each own and operate one drilling rig - 50% owned, CanElson Drilling Limited Partnership #1(LP #1), 54.4% owned, CanElson Drilling Limited Partnership #2 (LP #2) and 50% owned CanElson Drilling Limited Partnership #3 (LP #3). 2. In the US, 50% owned Midland C Ranch Holdings, LLC ("Midland") owns and operates three drilling rigs in Texas with an oil and gas operator. 3. In Mexico, CanElson has a 50% ownership interest in an unconsolidated joint venture Diavaz CanElson de Mexico, S.A. de C.V. (DCM). CanElson fully consolidates its subsidiaries LP #1, LP #2, LP #3 and Midland, and recognizes the non-controlling interest in our financial statements. Under IFRS 11, DCM is accounted for using the equity method effective January 1, 2013 with retroactive application of comparative financial results for the year ended December 31, Fleet deployment (by rigs) Canada Texas North Dakota Mexico Drilling Mexico Service Total December 31, 2013 December 31, (net 27.5) 23 (net 22.5) 12 (net 10.5) 10 (net 8.5) (net 1) (i) 1 (net 0.5) (i) 2 (net 1) 2 (net 1) 50 (net 45) 40 (net 36.5) Change % 26% 20% 25% 100% 25% (i) Includes 1 (net: 0.5) sub-contracted drilling rig. Gross fleet deployment (by %) Canada Texas North Dakota Mexico Drilling Mexico Service Total December 31, % 24% 10% 4% 4% 100% December 31, % 25% 10% 3% 5% 100% 2013 rig deployment activity by quarter During the first quarter of 2013, CanElson deployed two newly constructed wholly owned rigs to our Texas operation, bringing this fleet to 12 (net 10.5). In addition, we sold a 45.6% ownership interest in an existing CanElson drilling rig through LP #2 to a First Nations organization in Canada During the second quarter of 2013, we redeployed one rig from southeastern Saskatchewan to North Dakota and we entered into a 50% partnership with a First Nations organization on an existing CanElson drilling rig through the formation of LP #3. During the third quarter of 2013, we acquired three fully crewed drilling rigs, including an AC tele-double pad drilling rig and two single rigs from Calmena Energy Services ("Calmena"), and constructed and deployed new build Rig #37 to north east British Columbia. During the fourth quarter of 2013, we deployed new build Rig #38 to Alberta. CanElson acquired two AC triple drilling rigs (Rigs #101 and #102) operating in north east British Columbia, through a business combination with Highkelly. Rig fleet specifications Of CanElson s rig fleet, 40 (net 37) drilling rigs are telescopic double rigs rated from 3,500 to 4,400 metres true vertical depth (greater than 5,000 metres measured depth), 3 (net: 2) doubles rated between 2,500 and 2,800 meters, 4 triples rated up to 6,300 meters true vertical depth, and 2 singles rated up to 1,700 meters. The Corporation's rig fleet has an average age of 5 years, average vertical depth rating of greater than 4,000 metres and is suitable for drilling horizontal wells. ANNUAL REPORT

17 Rig fleet contract status Currently, our fleet is primarily focused on drilling oil and liquids resource wells in North America s most active basins. At the date of this MD&A, 100% (2012: 100%) of the drilling rig fleet was committed to customers. This commitment is based on current customer requests combined with 38% (2012: 37%) of the rigs that have long-term commitments with an average term greater than one year. We offer drilling rig contracts based on day rates, performance, or a combination of both. Performance contracts (typically involving a charge for depth drilled or for a complete turnkey project) assume more responsibility but in light of our significant experience in drilling risk management and high efficiency, these arrangements typically provide higher margins than day rate contracts. At December 31, 2013 approximately 16% (2012: 18%) of our drilling rig fleet was operating under performance contracts. CanGas Solutions Inc. We acquired CanGas on May 14, 2012 to build an innovative solutions-focused business to allow clients, including CanElson, to displace high cost diesel fuels with more economical and environmentally friendly compressed natural gas (CNG). In addition to expanding the use of lower-cost CNG on our own drilling rig fleet, third party interest in CanGas services has grown, resulting in a 300% year-over-year improvement in revenue. Our assessment of CanGas future growth prospects and rationale for investment is based on increasing demand for its services, environmental trends to reduce greenhouse gas emissions and waste, as well as the cost savings available from the substitution of diesel for less expensive natural gas. Financial highlights for the year ending December 31, (2012 results are for the period May 15 to December 31, 2012) Services revenue $ 7,410 $ 1,813 Gross margin 2, Adjusted EBITDA Financial highlights for the three months ended December 31, Services revenue $ 3,177 $ 633 Gross margin Adjusted EBITDA Revenue and gross margin continued to accelerate in the fourth quarter significantly exceeding the prior year fourth quarter and full year 2012 results. Also during the fourth quarter, CanGas continued to strengthen its CNG safety leadership. As a result of operational developments CanGas lead a process and equipment review with several bifuel conversion kit suppliers that resulted in equipment innovation. During the review CNG deliveries were paused with operations re-commencing in February 2014 as upgraded equipment implementation occurred. As a result of these operational developments, previous plans to seek external capital have been deferred. As the CanGas results are not yet material to the overall Corporation s results and are included in the drilling services division, no further financial analysis is presented within this MD&A ANNUAL REPORT

18 OUTLOOK Drilling Services For the fiscal year 2013 CanElson was able to maintain consolidated activity levels comparable to 2012 even though Canadian and US drilling services markets were subdued due to weather delays and overall market softness. We believe that our strategy has uniquely positioned CanElson to sustain relatively strong profitability during the full drilling industry cycle. The strategic drivers for our relative industry strength are: 1. Strategically diversified operations in oil-weighted regions within two balanced geographical segments, which provide diversity of earnings and less seasonality while maintaining focus and operational efficiency. 2. Standardized heavy duty, modern tele-double drilling rigs (average age of approximately 5 years and average vertical rating of greater than 4,000 metres) complemented by our new AC triples rigs, allowing us to outperform peers in terms of the total cost of safely drilling wells. 3. A solutions oriented culture as evidenced by providing performance-based drilling contracts and innovative cost saving opportunities. 4. A history of developing mutually-beneficial partnerships and strong client relationships with First Nations organizations, oil and gas operators and leading regional energy service providers such as Diavaz in Mexico. 5. Prudent financial management to limit debt leverage, thereby enabling the Company to be opportunistic at any point in the economic cycle. 6. Operational excellence underpinned through commitment to industry leading safety as evidenced by our superior drilling industry safety performance relative to benchmarks from third party sources such as provincial and state workers compensation boards and private insurance providers. Efficiency and Opportunity The North American land drilling rig market in 2013 was characterized by slightly lower year-over-year drilling rig counts due to customer caution with capital programs and extended weather delays. The primary challenge facing our customers within the horizontal well market is controlling well costs. Accordingly, market divergence is being driven by demonstrated efficiency in the drilling process and cost saving programs, leading to a modernization of the land drilling rig fleet. It is our experience that drilling contractors providing effective solutions rather than rig rentals have the most profitable opportunities. Therefore, while we continue to offer our customers high quality rigs for conventional day work contracts; we are seeing incremental demand being driven from those operators looking for assistance in reducing drilling and related well costs. This reduction in drilling costs does not necessarily correspond to a lower revenue rate for the drilling contractor, but instead focuses on the contractor s ability to minimize non-productive time, to maximize performance while drilling, and to flexibly integrate related equipment, services and contract types into the drilling solution. We currently have clear customer interest in new build drilling rigs. A large majority of these new rig contract opportunities are being driven by our historical performance combined with our ability to identify cost saving opportunities in the drilling process. As a result, we continue to invest in personnel and customer relationships that allow us to assist in the drilling optimization process. Canada 2013 for our customers was a year of cautious capital spending. Going into 2014, many customers appear to be increasingly optimistic, which is expected to result in increased spending levels. Additionally, with potentially large field developments as a result of proposed west coast LNG terminals, there may be significant incremental investment into the WCSB in 2014 and beyond. Through the first quarter of 2014, we expect to see stabilizing revenue rates with small increases primarily resulting from customer requests for additional equipment options. We have recently deployed two new build drilling rigs to add to the two recently acquired AC triple drilling rigs (acquired with the purchase of Highkelly) in response to expanding development of the liquids-rich region (LNG) of northeast British Columbia. ANNUAL REPORT

19 United States - Texas CanElson has 24% of its rig fleet focused on oil directed drilling in the Permian Basin in Texas. During 2013 CanElson continued to expand its fully contracted fleet in this basin even though the industry-wide rig count in this area declined primarily due to commodity price volatility and high-grading of the local rig fleet. Our success in the area has largely been the result of our drilling and operating efficiencies, coupled with performance-based contract options that deliver reduced customer well costs. We anticipate that the current revenue rates for CanElson s Texas rigs will continue into the first quarter of 2014, and we expect to achieve utilization levels in 2014 that will be consistent with United States - North Dakota Our customers in North Dakota continue to look for cost efficiencies as total well costs have been increasing due to cost inflations corresponding to well completions and related services. We expect that a similar number of wells will be drilled in 2014 compared to 2013, with fewer rigs being required due to more efficient drilling practices. We do not anticipate our utilization levels to be significantly impacted. Mexico We have demonstrated our ability to successfully do business in Mexico. We believe our performance in the region and our alignment with an experienced and strong local partner (Grupo Diavaz, with 40 years of experience serving PEMEX) provides an excellent opportunity for our joint venture DCM to expand its range of services, including potentially expanding its drilling rig fleet beyond the two recently refurbished drilling rigs. Rig Assembly Based on existing customer contracts and those being finalized, CanElson s 2014 investment and deployment of new build rigs is expected to be as follows: Rig #44 (tele-double): Delivered in January 2014 under a long-term contract. Rig #45 (tele-double): Expected to be delivered in Q under a long-term contract. Rig #103 (AC triple): Expected to be delivered in Q with contract pending. Rig #49 (AC tele-double): Expected to be delivered in Q under a long-term contract. Rig #104 (AC triple): Expected to be delivered in Q with contract pending. CanGas Solutions Inc. For 2014 we expect to continue investment in our fleet of truck-hauled CNG delivery trailers and compressors and to continue conversion of diesel engines on our drilling rigs to bi-fuel capacity based on increasing customer demand. A majority of customer requests for new drilling rigs identify a preference for rig bi-fuel capability. For more information about our investment plan see the Capital Availability and Capital Program below. Capital Availability and Capital Program CanElson is well capitalized with approximately $90 million of available capacity on existing credit facilities to take advantage of strategic opportunities. Funds flow continues to be strong and fully supports our current quarterly dividend rate of $0.06 per share as well as a majority of the expected 2014 capital investment program, with the remaining amount being funded through existing credit facilities ANNUAL REPORT

20 A review of CanElson's total 2013 and current anticipated 2014 capital investment programs is as follows: Drilling Services Spare equipment Capital Expenditures facility & overhead Upgrades & maintenance Expansion CanGas Total Current anticipated 2014 expenditures $ 5.6 $ 24.2 $ 63.4 $ 2.3 $ 95.5 Previously anticipated 2014 project expenditures (i) Increase from previously reported 2014 capital expenditures $ 0.9 $ 2.7 $ 37.2 $ 2.3 $ 43.1 Total capital expenditures incurred in 2013 $ 3.5 $ 15.7 $ $ 9.6 $ Previously anticipated 2013 project expenditures (ii) Variance from previously reported 2013 capital expenditures $ (2.9) $ (1.3) $ 34.2 $ (2.4) $ 27.6 (i) See our Press Release dated December 6, 2013 (ii) See our MD&A dated November 6, Capital Program Our modern standardized fleet allows us to minimize capital expenditures on maintenance and spare equipment. Expansion capital is for three new tele-doubles for our Canada and US operations, one new innovative and proprietary AC triple and the completion of one AC triple. The total expected capital expenditures for 2014 has now been expanded from the previously announced $52.4 million to $95.5 million primarily as a result of adding new build drilling rigs and bringing forward $20.1 million capital expenditures budgeted for 2013 into The 2014 capital program includes: 1. $51.6 million for the completion of the construction of two rigs (Rig #44 and Rig #103), construction of two additional tele-double rigs (Rigs #45 and #49). 2. $15.5 million for the construction of Rig #104, which is designed as an innovative and proprietary AC triple capable of moving quickly and being rigged up completely without cranes. 3. Approximately $26.1 million for equipment upgrades, spares, maintenance capital and shop upgrades. 4. Approximately $2.3 million for various CNG related projects for CanGas Capital Program The 2013 total capital investment program of $129.8 million is an increase of $27.6 million compared with the capital program as previously reported. The increase primarily relates to the business acquisition of Highkelly in the fourth quarter offset by favourable capital program variances and 2013 capital expenditures brought forward into The 2013 capital program included the following: Drilling Services $120.2 million capital investment allocated as follows: 1. $38 million primarily related to the purchase of two fully crewed drilling rigs from Highkelly. 2. $15 million for the purchase of three fully crewed drilling rigs from Calmena. 3. $48 million in expenditures required for the completion and deployment of Rig #35, Rig #36, Rig #37, and Rig #38 as well as purchase of long lead items for Rig #44 and Rig # $19.2 million for spares, shop/office upgrades and maintenance capital. $17.8 million will be brought forward into the 2014 capital program to complete the 2013 capital projects. ANNUAL REPORT

21 CanGas $9.6 million capital investment allocated primarily to the expansion of our fleet of truck-hauled natural gas delivery trailers, compressors and conditioning equipment to meet both current and anticipated demand. $2.3 million will be brought forward into the 2014 capital program to complete the 2013 capital projects. Primary Corporate Objectives Looking to 2014, CanElson s primary objective is to maintain and strengthen its industry leading utilization by consistently providing operational excellence and drilling efficiencies to its customers. With this focus, our aim is to be well positioned to secure customer commitments and capitalize on new opportunities. Subject to securing suitable customer commitments, we intend to carry out the following activities to further enhance our competitive positioning: Provide customers with lower overall well costs. Continue to expand our standard tele-double fleet, including additional AC doubles. Expand further into the AC triple drilling rig market. Expand our service offering in Mexico. Continue to form innovative long-term business relationships. Continue growth through strategic acquisitions. FINANCIAL SUMMARY For the three months ended December 31, For the year ended December 31, % change % change 2011 Services revenue $ 81,073 65, % $ 257,004 $ 218, % $ 184,758 Adjusted EBITDA (i) 26,200 24,322 8 % 85,751 83,137 3 % 66,067 Share of profit of unconsolidated joint venture % 1,776 1, % Net income attributed to shareholders 10,586 13,926 (24)% 35,558 43,582 (18)% 31,329 Net income per share Basic (33)% (24)% 0.45 Diluted (33)% (26)% 0.45 Cash dividends per share % % Funds flow (i) 25,844 23,980 8 % 85,381 83,197 3 % 60,357 Gross Margin (services) (i) 31,429 28, % 105,631 98,470 7 % 76,654 Weighted average diluted shares outstanding 90,376 76, % 82,526 75,514 9 % 69,536 As at December 31, % Change 2011 Current assets $ 79,170 $ 54, % $ 57,572 Total assets 546, , % 324,272 Trade payables, accrued liabilities and current taxes payable 26,720 20, % 24,649 Current deferred revenue 1, % 1,364 Current portion of loans and borrowings 17,163 11, % 5,481 Non-current deferred revenue 1,450 1,883 (23)% 2,373 Non-current portion of loans and borrowings 24,608 24,400 1 % 9,051 Total non-current liabilities % Equity attributable to shareholders of the Corporation 395, , % 245,741 nm calculation is not meaningful (i) NON-GAAP MEASURES This MD&A contains references to Adjusted EBITDA, funds flow and gross margin. These financial measures are not measures that have any standardized meaning prescribed by IFRSs and are therefore referred to as non-gaap measures. The non-gaap measures used by CanElson may not be comparable to similar measures used by other companies ANNUAL REPORT

22 Adjusted EBITDA is defined as income (loss) before interest, taxes, business acquisition transaction costs, depreciation and amortization, stock based compensation expense, gains on disposal of property and equipment, foreign exchange and share of unconsolidated joint venture profits. Adjusted EBITDA includes 100% of revenue and expenses from controlled entities where the Corporation holds less than 100% of the outstanding shares. Management believes that, in addition to net and total comprehensive income (loss), Adjusted EBITDA is a useful supplemental measure as it provides an indication of the results generated by CanElson s principal business activities prior to consideration of how these activities are financed, how the results are taxed in various jurisdictions, or how the results are effected by the accounting standards associated with CanElson s stock based compensation plan. For the three months ended December 31, For the year ended December 31, % Change % Change Income before interest and taxes $ 18,528 $ 19,008 (3) % $ 61,544 $ 66,936 (8 ) % Share of unconsolidated joint venture profits (676) (141) 379 % (1,776) (1,135) 56 % Depreciation expense 7,351 4, % 23,044 15, % Business acquisition transaction costs 383 nm % Stock based compensation expense % 2,018 2,275 (11 ) % Foreign exchange (gain)/loss (65) 128 (151) % 346 (499) (169 ) % Adjusted EBITDA $ 26,200 $ 24,322 8 % $ 85,751 $ 83,137 3 % Funds flow from operations is defined as cash provided by operating activities before changes in non-cash working capital. Funds flow from operations is a measure that provides shareholders and potential investors with additional information regarding CanElson s liquidity and its ability to generate funds to finance its operations, fund investing activities and support dividend payments. Management utilizes this measurement to assess CanElson s ability to finance operating activities and capital expenditures. For the three months ended December 31, For the year ended December 31, % Change % Change Operating cash flow $ 14,409 $ 9, % $ 73,586 $ 64, % Income taxes paid 3,073 nm 9,254 8,697 6 % Changes in working capital 8,362 14,388 (42) % 2,541 10,147 (75 ) % Funds flow $ 25,844 $ 23,980 8 % $ 85,381 $ 83,197 3 % Gross margin is defined as gross profit from services revenue before stock based compensation and depreciation. Gross margin is a measure that provides shareholders and potential investors additional information regarding CanElson s cash generating operating performance. Management utilizes this measurement to assess CanElson s operating performance. For the three months ended December 31, For the year ended December 31, % Change % Change Gross profit $ 23,892 $ 23,286 3 % $ 81,974 $ 82,356 % Depreciation expense 7,351 4, % 23,044 15, % Stock based compensation expense % (12) % Gross margin $ 31,429 $ 28, % $ 105,631 $ 98,470 7 % Three months ended and year ended December 31, 2013 compared with 2012 The average net rig fleet size for the three months and year ended December 31, 2013 increased by 6% and 25%, respectively, although certain financial and operating results did not increase proportionately, primarily due to a reduction in overall industry activity in the Western Canadian Sedimentary Basin (WCSB). Total revenue grew primarily based on the expanded rig fleet and therefore an overall higher number of drilling days. Although the number of drilling days was higher for the three month and year ended periods of 2013 relative to 2012, CanElson's 2013 Adjusted EBIDTA levels were only slightly higher than This was primarily a result of lower average operating gross margins and increased administration expenses to support the growing asset base. As a result, earnings per share decreased from the comparative periods in Financial and operating results for 2013 and 2012 vary significantly from 2011 due to the significant increase in the Corporation's drilling rig fleet (2011 average number of available drilling rigs: 25.9 rigs). The following table shows the expansion of the rig fleet expressed in terms of average rigs available for operation: For the three months ended December 31, For the year ended December 31, % Change % Change Average number of available drilling rigs (gross) % % Average number of available drilling rigs (net) % % ANNUAL REPORT

23 Unconsolidated Joint Venture Balance at Year ended December 31, January 1, 2012 Cash & cash equivalents $ 5,716 $ 880 $ 2,648 Non-cash current assets 21,106 12,094 7,672 Current liabilities 12,776 5,858 4,938 14,046 7,116 5,382 Non-current assets 18,016 3,662 3,918 Non-current liabilities 17, , ,000 2,683 Net assets $ 14,124 $ 10,116 $ 8,065 Corporation's share of unconsolidated joint venture net assets $ 7,062 $ 5,058 $ 4,033 Total revenue $ 31,010 $ 21,806 Total profit for the year 3,552 2,270 Total depreciation for the year 1, Total foreign exchange loss (gain) 232 (264) Total interest expense Total income tax expense 1, Unconsolidated Joint Venture Adjusted EBITDA 7,422 3,596 Corporation's share of the Unconsolidated Joint Venture Adjusted EBITDA(i) 3,711 1,798 Corporation's share of profits of unconsolidated joint venture 1,776 1,135 Corporation's share of other comprehensive income 228 (110) Corporation's share of total comprehensive income 2,004 1,025 Owned drilling rigs 2 Owned service rigs (i) The Corporation's share of the Unconsolidated Joint Ventures Adjusted EBITDA is 50% The Corporation conducts its operations in Mexico through 50% owned DCM, a Mexican joint venture company that is jointly controlled. DCM is jointly controlled due to the fact that the joint venture partners have joint control over the relevant activities. As of January 1, 2013 DCM is accounted for using the equity method with retroactive restatement of the prior year 2012 results. DCM has signed a 5-year contract with its customer for drilling and service rigs in the Ebano block near Tampico, Mexico. The customer is a Grupo Diavaz (Diavaz) joint venture that recently signed a 30-year production service agreement (CIEP) with PEMEX which contains a cost recovery for its drilling and completion expenditures, and a fee per barrel of oil produced. This is the same area where DCM has been drilling continuously for the same customer since late The number of drilling and service rigs required will be determined annually when the customer and PEMEX establish the annual work program for the following year. At the date of this MD&A, DCM has two drilling rigs and one service rig operating in the Ebano block, including one of the recently refurbished drilling rigs and an existing subcontracted drilling rig. One of the recently refurbished drilling rigs was damaged during operations in the third quarter, but has since been fitted with a new mast and returned to operations. During the third quarter of 2013, DCM signed a LOI that was subsequently converted to a contract for its second refurbished drilling rig for operations in the Panuco block near Tampico, Mexico, which is adjacent to the Ebano block. The term of the contract is for a fixed number of wells or 2 years, whichever comes first. The wells are similar to the horizontal wells that DCM has been drilling with some possible longer lateral sections. The rig mobilized to its first well on July 22, ANNUAL REPORT