KELSO TECHNOLOGIES INC.

Consolidated Financial Statements
For the years ended December 31, 2015 and December 31, 2014
(Expressed in US Dollars)

INDEPENDENT AUDITORS’ REPORT

TO THE SHAREHOLDERS OF KELSO TECHNOLOGIES INC.

We have audited the accompanying consolidated financial statements of Kelso Technologies Inc., which comprise the consolidated statements of financial position as at December 31, 2015 and 2014 and the consolidated statements of operations and comprehensive income (loss), changes in shareholders’ equity and cash flows for the years ended December 31, 2015, 2014 and 2013, and a summary of significant accounting policies and other explanatory information.

Management's Responsibility for the Consolidated Financial Statements
Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, as issued by the International Accounting Standards Board, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ Responsibility
Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards and the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.

Opinion
In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Kelso Technologies Inc. as at December 31, 2015 and 2014, and its financial performance and its cash flows for the years ended December 31, 2015, 2014 and 2013, in accordance with International Financial Reporting Standards, as issued by the International Accounting Standards Board.

See notes to consolidated financial statements

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See notes to consolidated financial statements

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See notes to consolidated financial statements

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Supplemental Cash Flow Information (Note 13)
See notes to consolidated financial statements

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KELSO TECHNOLOGIES INC.

MANAGEMENT DISCUSSION & ANALYSIS

YEAR ENDED

D ECEMBER 31, 2015

(Expressed in US Dollars unless otherwise indicated)

MANAGEMENT DISCUSSION AND ANALYSIS

GENERAL

The following management discussion and analysis (“MD&A”) of the operations and financial condition of Kelso Technologies Inc. (the “Company” or “Kelso”) provides an overview of significant developments that have affected the Company’s performance during the year ended December 31, 2015. It should be read in conjunction with the audited consolidated financial statements of the Company together with the related notes thereto for the year ended December 31, 2015.

The audited consolidated financial statements for the year ended December 31, 2015 referred to in this MD&A have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). The following MD&A and the Company’s audited consolidated financial statements were approved by the Audit Committee and the Board of Directors on March 28, 2016.

All amounts herein are expressed in United States dollars (the Company’s functional currency) unless otherwise indicated.

References to EBITDA in this MD&A refer to net earnings from continuing operations before interest, taxes, amortization, deferred income tax recovery, unrealized foreign exchange losses, non-cash share-based expenses (Black-Scholes option pricing model) and write-off of intangible assets. EBITDA is not an earnings measure recognized by IFRS and does not have a standardized meaning prescribed by IFRS. Management believes that EBITDA is an alternative measure in evaluating the Company's business performance. Readers are cautioned that EBITDA should not be construed as an alternative to net income as determined under IFRS; nor as an indicator of financial performance as determined by IFRS; nor a calculation of cash flow from operating activities as determined under IFRS; nor as a measure of liquidity and cash flow under IFRS. The Company's method of calculating EBITDA may differ from methods used by other issuers and, accordingly, the Company's EBITDA may not be comparable to similar measures used by any other issuer.

LEGAL NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This MD&A contains “forward-looking statements” within the meaning of applicable Canadian securities legislation that reflect the Company’s current expectations, forecasts and assumptions. Generally, forward looking statements can be identified by the use of forward-looking terminology such as “plans”, “expects” or “does not expect”, “is expected”, “budget”, “scheduled”, “estimates”, “forecasts”, “intends”, “anticipates” or “does not anticipate”, or “believes”, or variations of such words or phrases or state that certain actions, events or results “may”, “could”, “would”, “might” or “will be taken”, “occur” or “be achieved”.

Such forward looking statements involve a number of known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results expressed or implied by such forward looking statements These include but are not limited to the economic condition of the railroad industry, which is affected by numerous factors beyond the Company’s control including slow sales cycles, the existence of present and possible government regulation and competition.

In general terms the Company's products involve detailed proprietary and engineering knowledge and specific customer adoption criteria, hence factors that could cause actual results to be materially different include that product development may face unexpected delays; orders that are placed may be cancelled; anticipated customer order shipments may be rescheduled to future periods; product may not perform as well as expected; markets for various products may not develop as quickly as anticipated or at all; and operations may run into permit, labor or other problems.

Other factors include the uncertainty that profitable revenue levels can be achieved and sustained, general market circumstances could become unfavorable and there could be a need to continue to access additional development capital from internal or external sources to continue financially healthy business development operations.

Although the Company has attempted to identify important risk factors that could cause actual results to differ materially from those contained in forward-looking statements, there may be other factors that could cause results not to be as anticipated, estimated or intended. There can be no assurance that such statements will prove to be accurate as actual results and future events could differ materially from those anticipated in such statements.

Accordingly, readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date the statements were made. Readers are advised to consider such forward-looking statements in light of the risks set forth in the Risks and Uncertainties section of this MD&A (Page 21). The Company does not undertake to update any forward-looking statements that are incorporated by reference herein, except in accordance with applicable securities laws.

Additional information about the Company and its business activities is available on the Company’s website at www.kelsotech.com and public documents posted on www.sedar.com and on EDGAR at www.sec.gov in the United States.

DATE OF REPORT

March 28, 2016

SUMMARY OF THE YEAR ENDED DECEMBER 31, 2015

• Reported net loss (IFRS) year ended December 31, 2015 was $2,510,826 ($0.05 per share) compared to reported net income of $4,025,781 ($0.09 per share) for the year ended December 31, 2014.

• Revenues for the year ended December 31, 2015 were $18,910,122 compared to $23,816,809 for the year ended December 31, 2014.

• Gross profit was $5,100,129 (26.9% of revenues) for the year ended December 31, 2015 compared to $10,924,325 (45.8% of revenues) for the year ended December 31, 2014. This reflects a severe drop in sales of high value oil related equipment that was fueled by recent market inactivity due to low oil prices. This has shifted new tank car build schedules to future periods.

• Gross profit margins further diminished with start up manway sales that included the write offs of our research and development costs as well as heavier than expected start up expenses for low volume manway production.

• EBITDA for the year ended December 31, 2015 was $385,642 compared to EBITDA of $6,843,707 for the year ended December 31, 2014.

• Management compensation for the year ended December 31, 2015 fell to $727,217 compared to $1,243,763 for the year ended December 31, 2014.

• Reported net loss of $2,510,826 included items not involving cash for amortization of assets including our new production facility in Bonham, Texas in the amount of $237,201, unrealized foreign exchange expense of $584,162, share-based expense for incentive stock options (Black-Scholes) in the amount of $672,533 ,and a write off of intangible product development costs of $298,484.

• The Company has tax payable and recorded an income tax expense of $1,104,088 for the year ended December 31, 2015 compared to an income tax expense of $1,849,316 for the year ended December 31, 2014.The tax payable is a result of a tax review conducted by the Company to take into account the effects of tax in the United States. This is the most conservative approach that the Company can take at this time.

• The Canadian dollar has diminished in value against the US dollar resulting in a provision for an unrealized foreign exchange loss for our Canadian assets in the amount of $417,644 for the year ended December 31, 2015 compared to $389,801 for the year ended December 31, 2014.

• Product liability insurance has been included in cost of goods sold.

• Cash on deposit at December 31, 2015 was $3,175,292.

• Working capital at December 31, 2015 was $10,099,390 compared to $12,868,325 at December 31, 2014.

• To prepare for anticipated product orders created by new PHMSA regulations originally scheduled for January 2015 the Company invested heavily in inventories that were higher than ideal. Inventories were at $5,981,919 at December 31, 2015 compared to $4,161,506 at December 31, 2014.

• Company remains free of interest-bearing long-term debt commitments.

• Net assets were $13,606,719 at December 31, 2015 compared to $16,598,926 at December 31, 2014. This represents a book value of $0.30 per share at December 31, 2015 and $0.37 per share at December 31, 2014.

• Financial performance for the year-to-date has been heavily impacted by the delay in PHMSA regulations, global economic problems, poor crude oil commodity prices and various competitive factors.

CORPORATE OVERVIEW

Kelso is a railway equipment supplier that produces and sells proprietary tank car service equipment used for the safe loading, unloading and containment of hazardous materials (HAZMAT) during transport. Products are precision engineered and technologically advanced to provide economic and operational advantages while reducing the potential effects of human error, environmental harm and regulatory discipline during the transport of HAZMAT.

The Company’s common shares are publicly traded on the Toronto Stock Exchange under the trading symbol KLS and the NYSE Markets Exchange under the trading symbol KIQ. The Company listed on the Toronto Stock Exchange on May 22, 2014 and on the NYSE Markets Exchange on October 14, 2014.

The Company operates in combination with its wholly owned subsidiaries Kelso Technologies (USA) Inc and Kelso Innovative Solutions Inc.

In 1998, in response to growing environmental and safety concerns regarding the transport of HAZMAT, Kelso identified a worthy product development opportunity to pursue. The Company began engineering and testing a new design concept for a unique externally mounted constant force spring pressure relief valve (EPRV) for pressure management of HAZMAT being shipped via railroad.

While this EPRV design was recognized as a major innovation the Company faced many barriers to the advancement of its EPRV ambitions. These barriers included the lack of qualified railroad partners; inadequate financial capital; inability to meet minimum railroad vendor status; no production infrastructure; the inability to secure adequate product liability insurance; and achieving regulatory compliance all of which are required by the railroad industry.

Despite the challenges and with much perseverance the Company did eventually complete industry testing of its EPRV designs with the assistance of some more adventurous hazardous material stakeholders. The EPRV design was successfully patented and subsequently approved for use in the United States and Canadian railroad industry.

Unfortunately management had severely underestimated its limitations. The barriers it faced for market penetration included the need for considerable capital resources, management expertise and production infrastructure. Eventually Kelso’s business prospects stalled due to its poor financial health; lack of development capital and minimal sales results. Kelso found itself financially insolvent and looking for a new direction in early 2010.

The Company recruited and appointed a new executive management team in April 2010 at which time a new commercial business plan was established. In accordance with this strategic plan, new management consolidated the Company’s share capital on the basis of one new Common Share for seven old Common Shares; accessed new equity development capital; recruited railroad expertise; established a new production infrastructure whereby the Company believes it has a strong supply chain which provides parts to produce our products in amounts necessary to satisfy customer purchase orders and fluctuating demand; secured required regulatory approvals; secured product liability insurance; and implemented educational marketing initiatives.

Management has successfully implemented its initial business plans and established multi-million dollar sales of its products to North American rail tank car manufacturers (OEM) and retrofit/repair businesses. In accordance with the established business development goals revenues over the last five audited year end periods were as follows: $18,910,122 for the year ended December 31, 2015; $23,816,809 for the year ended December 31, 2014; $13,131,387 for the year ended December 31, 2013; $2,830,778 for the four month year ended December 31, 2012; $2,233,807 for the year ended August 31, 2012; and $1,326,024 for the year ended August 31, 2011.

The Company’s net earnings performance over the last five year end periods were as follows; a net loss of $2,510,826 for the year ended December 31, 2015; net income of $4,025,781 for the year ended December 31, 2014; net income of $2,456,636 for the year ended December 31, 2013; net income of $10,988 for the four month year ended December 31, 2012; a net loss of $1,276,827 for the year ended August 31, 2012; and a net loss of $1,463,869 for the year ended August 31, 2011. Currently the Company offers approximately 40 commercial products. These products include a series of 36 types of EPRV for pressure management; a revolutionary new one-bolt manway product trademarked the “Kelso Klincher™” (“KKM”); and an eduction tube system (ETS) that address the technical requirements of load and unload operations and the containment of hazardous commodities during transport.

In addition to current product offerings, our product development group, Kelso Innovative Solutions Inc (KIS) is incorporating railroad industry feedback into new product development decisions. Our engineers have been working on patent pending new products that include a high pressure EPRV, dual rating EPRV, vacuum relief valve and a bottom outlet valve which will be added to the Company’s catalogue when qualified. All product developments are expected to contribute substantially to the future financial growth of the Company. Other new products are in development which will allow Kelso to offer more complete packages for pressure and general service tank cars in the coming years.

The direction of the Company is being further influenced by the fallout of recent derailments of trains carrying hazardous materials that have raised government concerns and action plans over railroad safety. These concerns include the quality and effectiveness of service equipment used for containment of hazmat during rail operations and has led US and Canadian regulators to issue new tank car performance standards. Regulatory bodies have finalized design criteria for safety enhancements for new tank cars and retrofit of existing railroad tank cars carrying flammable liquids such as crude oil and ethanol. Tank car owners and users, especially those in the shale oil segment are assessing the impact of these new regulations which is delaying decisions related to individual fleet content and temporarily slowing down new tank car build schedules and tank car retrofit plans.

Although the final PHMSA and Transport Canada regulations are in place, the industry continues to fine-tune the details of products needed for compliance. Kelso is participating in the definition of these details and is adjusting product specifications accordingly. This is the focus of our business development plans.

The Company continues to develop new technology solutions for the railroad industry which has historically been slow to develop or adopt new technologies. Most rail tank car OEMs must deal with the challenges of strict regulatory compliance requirements that are time consuming, risky and contrary to their profit goals. Therefore many technology designs have not changed in decades even though environmental sensitivities, human safety issues and regulatory engineering problems continue to challenge the railroad industry. This provides Kelso with its ongoing opportunities to use its engineering creativity to provide unique technology services to the railroad industry and grow a successful multi-million business.

Kelso is growing its commercial product catalogue substantially to get ready for the next up-cycle in rail tank car production that is expected to commence later this year triggered by required compliance with new hazardous material regulations and laws. The railway industry has been bogged down with regulatory and economic challenges over the past year and there is a severe slowdown in rail tank car production. Kelso has managed its balance sheet well and has the necessary capital resources to maintain operations throughout 2016.

NEW DEPARTMENT OF TRANSPORTATION REGULATIONS FOR RAIL TANK CARS

On May 1, 2015 Transport Canada (TC) and the Department of Transportation (DOT) of the United States put forth their new requirements for rail tank cars used in the transportation of flammable liquids by rail. The final rules were developed by the U.S. Pipeline and Hazardous Material Safety Administration (PHMSA) and the Federal Railroad Administration (FRA). The rules establish minimum construction and performance standards for rail cars transporting dangerous goods, including petroleum crude oil and ethanol in North America. It covers High Hazard Flammable Trains (HHFT) defined as trains with more than 20 tank cars carrying Packing Group I or II commodities and High Hazard Flammable Unit Trains (“HHFUT”).

New tank cars constructed after October 1, 2015, are required to meet the new DOT Specification 117design or performance criteria. The prescribed car has a 9/16” tank shell, 11-gauge jacket, ½ inch full height head shield, thermal protection and appropriately sized pressure relief valves (PRV) and improved bottom outlet valves (BOV).

Existing tank cars must be retrofitted with the same key components based on a prescriptive, risk based retrofit schedule. As a result of the aggressive, risk-based approach, the final rule requires replacing or upgrading the entire fleet of DOT-111 tank cars for Packing Group 1, which covers all crude oil shipped by rail, within three years and all non-jacketed CPC-1232 tank cars, in the same service, within approximately five years.

Existing tank cars will have to be retrofitted to meet the new standard under the following time guidelines:

Relevant to Kelso is that the tank car must be equipped with appropriately sized pressure relief valves and improved bottom outlet valves. Kelso is a leader in the design and supply of these technologies.

BUSINESS MODEL

The business model of the Company is focused on the industrial design and engineering development of a new generation of qualified railroad equipment based on our patents, proprietary rights and specific adoption criteria established by our clientele. The resulting commercial products are to be marketed, produced and distributed to our OEM, repair and retrofit customers in the railroad industry.

Our primary goal is to build large profitable revenue streams from these products. Although there is no guarantee that the Company will be successful in achieving these revenue streams should they occur management plans to reinvest positive cash flows from operations into the expansion of our business capabilities to grow earnings to levels that will maintain financial health without further external funding.

Our overall focus is the growth of earnings, dividends and corporate value on behalf of Kelso’s shareholders.

The Company believes that the railroad industry has not meaningfully re-engineered load/unload and containment systems for hazardous materials in over 70 years. The Company also believes that the social liabilities, environmental sensitivities and worker safety issues have increased government pressure and spurred the new PHMSA regulations in both Canada and the United States. This should prompt the transportation industry to adopt new technologies at a much quicker pace which would provide Kelso a solid foundation on which to continue to grow a sustainable, profitable business.

Management believes the key features of our business model include:

• Experienced executive management including the directors and officers of the Company.
• Focused strategic plans that are achievable and sustainable on low capital investment.
• Railroad and regulatory alliances and influence.
• Strong working capital position.

• Reputable public company governance.
• Access to development capital (if required).
• Solid reputation as a reliable supplier of high-quality railroad equipment.
• Innovative products with a proven exceptional service record.
• Solution based engineering capability addressing customers’ specific criteria.
• Creation of a “new generation” of service equipment for tank cars through in-house product development.
• Acquisition of new or established products that can grow new markets under our management.
• Marketing initiatives that promote awareness of our products being “best available technology”.
• Reliable order base from customers to fuel profitable business growth.
• Production infrastructure and capacity that can supply overall demand.

Although still a small enterprise, Kelso believes that it is at the forefront of technology development for the railroad industry because it has successfully developed products using new technologies which are designed to address current industry and customer demand and replace products that are based on technology developed in some cases 80 years ago. Kelso’s business model is focused on becoming a leader in the design and supply of new technologies aimed at worker safety; and the safe handling and containment of hazardous materials in transportation systems while providing economic advantages to users.

QUALIFIED COMMERCIAL PRODUCTS

The Company currently offers approximately 40 commercial products. The key products include 36 types of EPRV for pressure management applications; the KKM manway securement system and ETS products that address the technical requirements of load/unload operations and the containment of hazardous commodities during transport. Products are designed for use on railroad tank cars but can be modified for use in other markets such as trucking. The Company has patent protection for EPRV and KKM. In addition to current product offerings, Kelso is working on new products to add to the commercial product catalogue by incorporating customer feedback into product development decisions.

External Constant Force Spring Pressure Relief Valves (“EPRV”)

Over the past decade Kelso has been involved in the development, regulatory approvals, marketing and manufacture of EPRV that are designed for railroad tank cars that carry hazardous and non-hazardous commodities. The Company currently offers 36 versions of the EPRV in its product line, including a number of high-performance EPRV products. As required all EPRV products have received AAR approval based on service trials and physical testing. The Company believes that its series of EPRV products are “best available technology” products; proprietary to Kelso; and have a number of significant competitive advantages that include:

• High “barrier to entry” for competitors due to our patent rights and the years of testing required by the AAR to gain regulatory approvals.
• The only high flow valve in market that is totally external which limits exposure to chemicals or other corrosive commodities transported in the tank car.
• Technological improvement over older valve systems as it eliminates the helical coil spring, the internal valve stems and spring guide tube.
• Multiple springs that prevent disruptions that occur when single spring designs become inoperable due to spring failure.
• Increased valve reliability due to little or no contact with HAZMAT.
• Uses flat gasket seal; more tolerant to contamination.

• Low profile provides for better roll over safety.
• External design allows complete inspection during loading.

“Kelso Klincher®” Manway (“KKM”)

The Company holds the patent rights for a new one-bolt manway technology trademarked as the “Kelso Klincher®”. The Tank Car Committee (TCC) of the Association of American Railroads (AAR) has cleared the KKM for unrestricted commercial use ending the required Field Service Trial (FST) requirements for the KKM. The TCC encourages innovation and the development of new designs of service equipment that improve tank car safety and reduce the risks of non-accidental releases of hazardous materials. The TCC has favorably recognized the performance of the KKM during the FST and want to see it in service on a broader scale. The TCC will advise all interested parties including shippers, owners and OEMs of rail tank cars that they are able to install as many KKM units as they wish to specify with no restrictions on use.

The Company believes that the KKM is an important technology change for the railroad industry where the return on investment and arguments for customers’ adoption of the KKM are compelling. They include:

• One bolt-and-strap design eliminates eye-bolt problems and possible leaks due to crushed gaskets.
• Eliminates lid deformation and nozzle distortion due to the over-torque of eye-bolts.
• Eliminates relaxation of gaskets under eye-bolt location.
• Eliminates eye-bolt nuts loosening in transit due to vibration and improper cross-bolting technique – a violation subject to regulatory fines in excess of $5,000 per eye bolt.
• Standard AAR-approved gasket retention method with currently used hard and soft gaskets.
• ACME Thread on T-Bolt virtually eliminates loosening due to vibration.
• Rigid collar at top of nozzle reduces risk of nozzle or lid distortion.
• Much faster opening and closing operation with one bolt management system which will take the current industry open/close standard cycle time of 25-35 minutes to 5 minutes with the KKM.
• Uniform load on the gasket prolongs service life as evidenced in field service trial.
• Reduces possible release of hazardous commodity in a roll-over accident by moving threaded closing mechanism below the plane of the lid.
• Ease of operation with lightweight hinged lid.
• No eye-bolts to kick at tank car inspection.

Eduction Tube Technology (“ETS”)

Our ETS is a long-hose device used in the loading and unloading of highly corrosive chemicals from rail and road tank cars. It is constructed of specialty materials and has been specifically designed for the rigors of acid handling and transport.

KKM Adapter Plate

Kelso has successfully developed and tested a fully functional loading arm adaptor that fits both the KKM and older hinged 6 and 8 eye-bolt manways currently in service on bank cars in North America. The adaptor attaches permanently to the existing loading arm apparatus and connects the loading arm to any existing manway in service today. The adaptors are a minimal expense when measured against the substantial capacity gains they will produce hence addressing the concerns of additional capital expenditures required to convert loading terminals that top-load HAZMAT.

PRODUCTION

Kelso currently operates two facilities totaling 50,000 square feet in Bonham, Texas. The Company is fully qualified and certified to produce products for the railroad industry. It has been granted the required certifications including holding an AAR M1002 Class D Registration and AAR M1003 Quality Assurance System Certification for its production facilities from the Association of American Railroads.

Location to supply chains and customers is a critical factor in our production strategy in order to reduce distribution costs of inbound components and shipping costs associated with outgoing finished products. Bonham, Texas is within approximately 250 miles of the Company’s main customers. Kelso controls engineering drawing/specifications, assembly, testing, certification and shipping processes for its products. Production output can be scaled upwards when required with minimal capital investment.

Our policy is that all parts and workforce must be sourced in the United States or Canada when possible. The Company utilizes assembly production techniques to produce finished products. Cast and fabricated components of our products are being sourced from expert certified suppliers as AAR regulations require the Company’s principle suppliers to be certified by the Company as meeting AAR requirements through site visits and operational audits. One of the audit requirements of the AAR is that the suppliers must utilize modern equipment and their employees must have proper training certifications including certifications for welding. The Company believes that this production model minimizes expensive capital layouts for manufacturing equipment and certified human resource expertise which in turn reduces our overall financial risks due to fabrication and casting errors.

Cost control and minimization is paramount to the Company’s production strategy as is the plant location relative to customers to reduce distribution costs. The Company has engaged suppliers and individuals with extensive production expertise with the overall goal of attaining economic, effective and efficient assembly operations. The Company requires that individuals and suppliers performing critical operations for component parts must have demonstrated a five year minimum experience with similar production procedures.

In June 2014 the Company completed its new 44,000 square foot facility at a cost of approximately $2.7 million in Bonham, Texas. Based on customer inputs and demand for products the new facility is custom designed to produce high volumes of our EPRV, KKM, BOV, VRV and several new products that are being developed.

SALES AND MARKETING

Kelso’s marketing objective is to build sales volume and increase market share for our current and future products. This involves building long-term relationships with all stakeholders in the railroad industry. The foundation of our business is the trust and confidence that stakeholders have in our ability to service their needs.

Our products are designed to provide reliable pressure management and containment of all commodities being shipped by rail tank car and are AAR (Association of American Railroads) approved. These commodities range from non-hazardous to the more dangerous and challenging hazardous materials. In general hazardous materials are ones that present serious risks to health or the environment. They may be explosive, gaseous, flammable, toxic, radioactive, corrosive, combustive or leachable. There are hundreds of different hazardous materials being produced and shipped all over North America including crude oil, ethanol, sulfur and acids.

The Company’s experienced marketing and sales professionals work directly with a wide range of customers who produce or retrofit tank cars or use railroad tank cars to transport hazardous and non-hazardous commodities as part of their business operations. We provide orientation services to these customers regarding our technologically advanced products and demonstrate the economic and operational advantages including minimizing the potential negative effects of human error, environmental harm and regulatory discipline for violations. Our sales objective is to have the customer specify our equipment on future orders for new tank cars to be produced or for tank cars that are destined for retrofit or repair.

Kelso’s products are not sold directly to the customer purchasing the tank cars as our products are installed on the finished tank car during their production. Once finalized by our customers their specifications go to the rail tank car manufacturers (“OEMs”) that produce new tank cars or railroad retrofit and repair businesses. These businesses order the customers specified equipment from Kelso to be installed during their production operations.

There are five major OEM customers in North America that purchase Kelso service equipment products on behalf of customers who ship non-hazardous and hazardous materials. They include Trinity Industries, American Railcar Industries, Union Tank Car, National Steel Car and Greenbrier. Although we communicate directly with many companies regarding their needs over 90% of our revenues are expected to be generated from the OEM segment of the railroad market at this time. Several new tank car OEMs are entering the market and Kelso has a business relationship with each of them.

In addition management has also established strategic advisory relationships with the Federal Railroad Administration of the United States (FRA) and Transport Canada (TC) both of which have requested that the Company participate in and present at FRA and TC training seminars throughout North America. Certain Kelso management personnel serve on AAR Task Force Committees that formulate tank car standards.

Management is a member of the AAR and has established key strategic relationships and memberships in other influential members of the railroad community including the Rail Supply Institute (RSI) and the Chlorine Institute. The Company is well connected with the Safety and HAZMAT sections of the Class 1 railroads, such as BNSF Railway, CSX, Union Pacific Railroad, Canadian National Railway and Canadian Pacific Railway.

The Company has also implemented educational marketing initiatives whereby the Company sends representatives and speakers to industry seminars and trade shows and to customer sponsored training seminars specific to customer locations.

Revenue Projections

The railroads; oil companies; tank car owners and manufacturers; provincial, state and municipal governments; along with federal and industry regulators are currently addressing the new DOT-117 specifications. The DOT-117 transition is complex, costly and time consuming to implement and has slowed Kelso’s anticipated business growth in 2015 from what the Company considered a reasonable projection in prior management discussions. Fiscal 2015 sales revenue fell short of previous estimated forecasts as a result of several risk factors identified by the Company in its disclosures. These factors caused a significant slowdown in demand for our products in 2015 and this trend is likely to extend into early 2016.

Kelso does not provide forward looking sales projections to the public. Management is unable to measure or predict the financial impact or the timing of business flows under the new regulations or the deteriorating economic conditions surrounding the crude oil industry, all of which are well beyond the control of Kelso. The new regulations came into effect as of May 1, 2015 and commencing on October 1, 2015 all new and retrofit rail tank cars must meet the new DOT-117 specifications.

All Kelso products meet these specifications. The Company is continuing the expansion of its product catalogue. Potential revenue per tank car is expected to increase sales volume in future periods as each tank car may include more types of our products.

The Company advises the public about its business progress by way of quarterly and annual financial statements as well as management discussions and analysis for those periods. The Company will issue press releases announcing material events that affect the business health of the Company in accordance with the policies and guidelines of the Toronto Stock Exchange and the NYSE Markets Exchange.

PRODUCT DEVELOPMENT AND PATENTS

Kelso’s ability to establish and sustain business growth lies in our ability to create new commercial products. Our research, development and engineering initiatives are conducted through our wholly owned subsidiary Kelso Innovative Solutions Inc (KIS).

KIS is dedicated to the creation of new patented products that better serve the modern challenges of the domestic and international markets for the transport of HAZMAT via rail and road. KIS works closely with HAZMAT stakeholders designing products that involve detailed proprietary and engineering knowledge and specific industry adoption criteria.

Many of these new products have significant industrial market prospects. Although all our products in development are expected to be successfully qualified, introduced and adopted commercially over the upcoming years there is no guarantee that such products will have significant market prospects or that they will be successfully developed, introduced and adopted commercially.

The Company’s pressure relief valve for high-pressure tank cars (JS330) designed to carry liquefied compressed gas is currently in testing. The Company’s BOV and vacuum relief valve (VRV) are currently in the service trial stage.

Vacuum Relief Valve (VRV)

The VRV is a low pressure device specifically designed to protect rail tank cars from the effect of an excessive vacuum and prevents the implosion of the tank car. The development of our patent pending VRV has been driven by customers’ demand for a better performing VRV due to high failure rates of current products in use in the market today.

Our new innovative VRV design features our patented constant force pressure springs and meets the new DOT-117 tank car specifications to be implemented on October 1, 2015. The Association of American Railroads (AAR) has approved Kelso’s new vacuum relief valve (VRV) design for commercial service trials that will take up to two years to complete.

Bottom Outlet Valve (BOV)

Bottom outlet valves are utilized on rail tank cars for the primary purpose of unloading the contents of the tank. The BOV must be a low-profile design as it is positioned at the lowest point of the tank so that a full discharge of the tank can be achieved. They are widely used in the transport of hazardous commodities such as crude oil, ethanol, chemicals, petrochemicals and minerals such as molten sulfur as well as many non-hazardous commodity applications.

The development of our patent pending BOV has been driven by customers’ demand for a better performing BOV due to chronic performance problems with current products in use in the market today. Our new innovative BOV design prevents valve operating stem leaks and features the use of non-corrosive ceramic materials and a seal protecting wiper. Our BOV meets the new DOT-117 tank car specifications to be implemented on October 1, 2015 and the new M1002 Tank Car Standards requiring a removable handle.

The Association of American Railroads (AAR) has approved Kelso’s new bottom outlet valve (BOV) design for commercial field trial testing that will take up to two years to complete.

High Pressure Relief Valve (HPRV)

The Company holds United States Patent Number: 9,163,738 for its unique design of a new high pressure constant-force spring pressure relief valve (HPRV) for specialized use in the “Pressure Tank Cars” category of the rail tank car market.

Our HPRV is a derivative of our existing PRV patent and meets the performance specifications and regulatory requirements for pressure tank cars. It is designed for demanding applications in the transport of pressurized commodities such as propane and anhydrous ammonia. The new HPRV will be offered in 225PSI, 247PSI, 280PSI and 330PSI ratings. It is suitable for applications in both the new tank car and retrofit/repair markets. We anticipate that we can service up to an additional 10% of the rail tank car market annually.

Kelso has received an AAR application number for its HPRV. The HPRV has been pressure and flow tested and confirmed by an independent, AAR-approved engineering test facility in Nunn, Colorado as required by the railroad industry. We anticipate that the service trial will commence in 2016 and be completed within two years. Final approvals from the American Association of Railroads (AAR) usually take up to one year for non-hazardous applications and two years for hazardous applications to obtain.

The development of our HPRV has been driven by customers’ concerns and demand for a better performing HPRV. Our HPRV design meets the DOT-112 tank car specifications.

Second Dual Preset Pressure Relief Valve (DPRV)

The Company was granted a United States Patent (#9,234,601 B1) for its Second Dual Preset Pressure Relief Valve on January 12, 2016.

Our new DPRV design is based on specialized mechanical engineering innovations that provide safety benefits in both accident and non-accident environments. In general terms in an accident involving fire the DPRV will significantly lower its operating pressure rating to a level that will keep the valve open in order to evacuate the tank car in less than 100 minutes as required by AAR recommendations. This capability in a fire allows the contents in the tank car to escape before it over pressurizes causing a breach or failure or before the contents self-combust. Both these dangerous situations can cause a catastrophic explosion of the tank car.

Our DPRV offers new safety advantages that are a dramatic improvement to current technology requirements. We are pursuing regulatory approvals from the American Association of Railroads for the commercial distribution of the DPRV.

RESULTS OF OPERATIONS

The financial results for the year ended December 31, 2015 are indicative of a developing railway equipment company that continues to transition into an industrial business enterprise from its product development roots. Kelso sells and distributes its patented AAR approved commercial products from a production infrastructure that can reliably supply railroad service equipment to a heavily regulated railroad industry.

In 2015 we have had to manage business development strategies in the worst rail tank car market since 2008. Political climate, regulatory uncertainty, low commodity prices and diminishing economic activity have slowed the rail tank car business significantly.

The Company as well as the rest of the railway industry has encountered operating slowdowns due in part to the confusion created by the new regulations that were announced at the end of April 2015. The industry and regulators have made some headway in clearing up the contentious issues but the economic benefits will not be realized until 2016 and beyond.

The bulk of our revenue is generated from sales of our EPRV equipment. Our KKM system is now producing revenue that is included in our financial results however our gross profit margins have suffered due to the inefficiencies and high start up costs for the KKM previously not affecting profitability. As time progresses we expect to streamline our manway production costs and move back to higher overall margin levels.

Revenues, corresponding expenses and financial performance during the year ended December 31, 2015 reflects Kelso’s progress in the execution of its business plans despite a challenged railroad and crude oil industry. Financial results reflect the revenue and related operational costs of marketing, producing and distributing its EPRV line as well as strategic costs to market and produce KKM and investments in new product development associated with future business growth.

Our strategic plan requires Kelso to make considerable ongoing investments in the expansion of production capacity (including equipment, lease costs, training and qualifying human resources); railroad regulatory filings; liability insurance; expanded marketing initiatives; independent lab testing and outside specialized industrial engineering services; new patent applications; enhanced Tier 1 regulatory disclosure in Canada and the United States; more efficient accounting systems and controls; pre-sales production planning and tooling for our KKM and BOV. These costs are written off or capitalized in the period when they occur and reflect in the reported profitability of the Company in the period in which they were incurred.

Year End - December 31, 2015

For the year ended December 31, 2015, the Company reported a net loss of $2,510,826 ($0.05 per share) against revenue of $18,910,122 compared to net income of $4,025,781 ($0.09 per share) against revenue of $23,816,809 for the year ended December 31, 2014.

Revenues diminished from 2014 levels as customers rescheduled their equipment needs to future periods due to deteriorating economic conditions, poor commodity prices and regulatory uncertainty. Gross profit margins declined to $5,100,129 (26.9% of revenues) for the year ended December 31, 2015 compared to $10,924,325 (45.9% of revenues) for the year ended December 31, 2014. This reflects a severe drop in sales of oil related products that coincide with market inactivity due to low oil prices. Gross profit also includes the effects of increased competition, the expensive start up costs of low volume manway production and the sale of old manway inventories. Diminishments in gross profit results were expected in 2015 and remain within the revised business development budgets established by management. The Company is working on new production methods and economies of scale to improve costs of goods sold in the future.

EBITDA for the year ended December 31, 2015 and December 31, 2014 has been calculated as follows:

Factors in the reported income for the year ended December 31, 2015 include expenses related to ongoing marketing initiatives in the amount of $730,389 (2014 - $571,990) and related travel costs of $445,555 (2014 - $290,400). These expenses are directly related to the generation of revenue during the year. These ongoing marketing initiatives are necessary to build our brand and fuel our future business growth.

A key component of our future business growth is the research, design, testing and qualification of new products. During the year ended December 31, 2015 our industrial product design and development costs rose to $783,680 (2014 - $440,600). This includes expenses related to design and continuing testing of our new VRV, DPRV, BOV and HPRV all of which form a significant opportunity for Kelso to grow its future revenues.

The growth of our business and preparing for the impact of the new PHMSA regulations reflect in our ongoing investments in human resources, marketing, sales and production operations for the year ended December 31, 2015. The Company recorded office and administrative costs of $1,547,182 (2014 - $1,097,092), Management compensation for the year ended December 31, 2015 fell to $727,217 representing compensation for four managing executives compared to $1,243,763 for the year ended December 31, 2014 representing three executives. Management compensation includes an accrual for management performance bonuses of $Nil. Consulting fees including investor relations were $505,869 (2014 - $409,271) for the year ended December 31, 2015.

Accounting, audit and legal fees are cost components of our corporate development strategies and the administration functions of a publicly listed industrial company. Costs for these professional services were $239,581 for the year ended December 31, 2015 (2014 - $225,481). The Company accrues its audit costs on a quarterly basis. Legal costs are related to public company administration including the preparation and filing of press releases, documentation and reviewing possible acquisition targets and new business arrangements regulatory documentation including (Annual Information Form) and Securities Exchange Commission documentation (20-F).

The Company’s functional currency is US dollars but Kelso holds various assets in Canadian dollars. The Canadian dollar has recently diminished in value against the US dollar therefore we have recorded an unrealized foreign exchange loss of $417,644 for the year ended December 31, 2015.

During 2015 the Company conducted a review of it’s tax exposure in the United States. As a result of that review the Company has recorded a net payable of $1,104,088. This represents the amount the Company possibly owes net of recoveries from taxes previously paid in Canada. This is the most conservative approach that the Company could take at this time and it will be exploring other tax avenues in the near future which could possibly mitigate this payable and possibly result in a significant recovery.

Revenues and profitability have diminished considerably from the previous year during the year ended December 31, 2015. Management cautions that the economics and overall infrastructure of the railway industry including the effects of new regulations and low commodity prices pose many challenges to our future business development and adoption of our products. Slow business activity stemming from economic and regulatory uncertainty could have a material effect on our current and future business abilities including financial condition and results of operations (see Risks and Uncertainties on Page 21).

Fourth Quarter - Three months ended December 31, 2015

For the three months ended December 31, 2015, the Company reports a net loss of $2,283,515 ($0.05 per share) against revenue of $3,071,130 compared to net income of $762,321 ($0.02 per share) against revenue of $6,751,794 for the three months ended December 31, 2014. The quarterly loss was largely due to tax entries as a result of the year end tax review.

Quarterly revenues continued to decline due to a dramatic slowing in railway activity being fueled by a poor economic climate, low commodity prices and regulatory uncertainty. The Company has experienced cost increases for raw materials, lower prices for competitive products and write offs of one-time manway development costs resulting in a gross profit $21,036 for the three months ended, December 31, 2015 compared to $2,933,583 (43.4%) for the three months ended December 31, 2014. The diminishment in gross profit results were due to the startup inefficiencies of our KKM manway development activity and an inefficient startup production system.

In accordance with IFRS the reported loss for the three months ended December 31, 2015 includes items not involving cash. These non cash items include amortization of equipment and patents, unrealized foreign exchange loss, tax expense and share-based expense.

Factors in the reported income for the three months ended December 31, 2015 include expenses related to ongoing marketing initiatives in the amount of $153,568 (2014 - $167,244) and related travel costs of $121,123 (2014 - $105,199). These expenses are directly related to the generation of revenues. These ongoing marketing initiatives continue to fuel our future business prospects.

A key component of our future growth is the research, design, testing and qualification of new products. During the three months ended December 31, 2015 our industrial product design and development costs were $156,641 (2014 - $168,225). This includes expenses related to design and continuing testing of our new VRV, DPRV, BOV and HPRV both of which form a significant opportunity for Kelso to grow its future revenues.

The growth of our business and impact of the new PHMSA regulations reflect in our ongoing investments in human resources, marketing, sales and production operations for the three months ended December 31, 2015. The Company recorded office and administrative costs of $481,055 (2014 - $380,913), executive management fees of $51,150 (2014 - $322,438) and consulting fees including investor relations of $38,053 (2014 - $108,840) for the three months ended December 31, 2015.

Accounting, audit and legal fees are cost components in our corporate finance strategies and the administration functions of a publicly listed industrial company. Costs for these professional services were $23,828 for the three months ended December 31, 2015 (2014 - $28,911). The Company accrues its audit costs on a quarterly basis. Legal costs are related to public company administration including the preparation and filing of press releases, documentation and reviewing possible acquisition targets and new business arrangements and regulatory documentation including (Annual Information Form) and Securities Exchange Commission documentation (20-F).

The Company’s functional currency is US dollars but Kelso holds various assets in Canadian dollars. The Canadian dollar has recently diminished in value against the US dollar therefore we have recorded an unrealized foreign exchange loss of $291,237 for the three months ended December 31, 2015.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 2015 the Company had cash on deposit in the amount of $3,175,292, accounts receivable of $1,706,488, prepaid expenses of $1,103,498 and inventory of $5,981,919 compared to cash on deposit in the amount of $9,895,463, accounts receivable of $2,850,180, prepaid expenses of $58,432 and inventory of $4,161,506 at December 31, 2014. The Company’s current ratio at December 31, 2015 was a healthy 5:1 compared to 4.1 to 1 December 31, 2014.

The working capital position of the Company at December 31 2015 was $10,099,390 which includes $2,795 due to related parties compared to a working capital position of $12,868,325 which includes $709,954 due to related parties at December 31, 2014.

Net assets were $13,606,719 at December 31, 2015 compared to $16,598,926 at December 31, 2014. At December 31, 2015 the Company had no interest bearing long-term liabilities or debt.

Kelso’s primary source of revenue is from new rail tank car builders and retrofit/repair customers. In 2015 we experienced the worst rail tank car market since 2008. Political climate, regulatory uncertainty, low commodity prices and diminishing economic activity have slowed the rail tank car business significantly.

Despite the poor economy Kelso is confident that the demand for its current products and new product offerings will improve in future periods. Indicators in the rail industry suggest that the demand for new tank car builds and mandatory retrofit activity will grow steadily during through 2018 based on new PHMSA regulations and should provide Kelso with growth in sales revenue.

The Company can currently generate the necessary capital resources required to finance operations by way of the sales of its products; the exercise of incentive stock options; and the issuance of equity securities through private placements if funding is necessary. The Company received new equity capital from the exercise of options in the amount of $373,723 during the year ended December 31, 2015.

The Company declared its second annual dividend on April 1, 2015 in the amount of $0.03 per share resulting in a total cash outlay of $1,377,654. The dividend was paid in cash on April 30, 2015.

Management takes all necessary precautions to minimize risks however additional risks could affect the future performance of the Company. Business risks are detailed in the Risks and Uncertainties section of this MD&A (Page 21).

At December 31, 2015, and at the date of this report, there are no proposed transactions to disclose.