UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.20549





FORM
10 - K





(Mark
One)


x
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15   (d) OF THE SECURITIES
      EXCHANGE ACT OF 1934


For the
fiscal year ended December 31, 2008





OR





o
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For the
transition period from – to –





Commission
File Number: 000 - 51076





WESTERN
GOLDFIELDS INC.


(Name of
Registrant in its Charter)





Ontario, Canada
            98 - 0544546(State or Other Jurisdiction of
            (I.R.S. Employer Identification No.)Incorporation or Organization)Royal Bank Plaza, South Tower, 200 Bay Street, Suite 3120, P.O. Box 167Toronto, Canada
            M5J 2J4(Address of Principal Executive Office)
            (Postal Code)





Registrant’s
telephone number, including area code: (416) 324 - 6000





Securities
registered under Section 12(b) of the Exchange Act:  None





Securities
Registered pursuant to Section 12 (g) of the Act:  Common Stock


(Title of
Class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the securities act. Yes oNo x





Indicate
by check mark if the issuer if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Securities Exchange Act of Act of
1934. Yes oNo x





Indicate
by check mark whether the registrant has (1) filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past ninety 90 days. Yes xNo o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes xNo o





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a small reporting company (check
one):  Large Accelerated Filer o Accelerated
Filer x
Non-Accelerated Filer o   Smaller
reporting company o





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes  ̈No x





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the issuer as of December 31, 2008 was $152,628,342.
For purposes of this computation, all executive officers, directors and 10%
shareholders were deemed affiliates. Such a determination should not be
construed as an admission that such 10% shareholders are
affiliates.





As of
March 5, 2009 there were 135,531,286 shares of common stock of the issuer issued
and outstanding.





DOCUMENTS
INCORPORATED BY REFERENCE: None











TABLE
OF CONTENTS





PART
      IItem
      1.
                            Business
                            
                            5Item
      1A.
                            Risk
      Factors
                            
                            17Item
      1B.
                            Unresolved
      Staff Comments
                            
                            25Item
      2.
                            Properties
                            
                            25Item
      3.
                            Legal
      Proceedings
                            
                            25Item
      4.
                            Submission
      of Matters to a Vote of Security Holders
                            
                            25PART
      IIItem
      5.
                            Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                            
                            26Item
      6.
                            Selected
      Financial Data
                            
                            28Item
      7.
                            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                            
                            28Item
      7A.
                            Quantitative
      and Qualitative Disclosures about Market Risk
                            
                            44Item
      8.
                            Financial
      Statements and Supplementary Data
                            
                            45Item
      9.
                            Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                            
                            70Item
      9A.
                            Controls
      and Procedures
                            
                            70Item
      9B.
                            Other
      Information
                            
                            70PART
      IIIItem
      10.
                            Directors,
      Executive Officers, Promoters and Control Persons; Compliance with Section
      16(a) of the Exchange Act
                            
                            71Item
      11.
                            Executive
      Compensation
                            
                            74Item
      12.
                            Security
      Ownership of Certain Beneficial Owners and Management
                            
                            81Item
      13.
                            Certain
      Relationships and Related Transactions
                            
                            82Item
      14.
                            Principal
      Accountant Fees and Services
                            
                            83PART
      IVItem
      15.
                            Exhibits
      and Financial Statements
                            
                            85


2





CAUTIONARY
NOTE REGARDING FORWARD LOOKING STATEMENTS





We have
included and from time to time may make in our public filings (including this
Form 10-K), press releases or other public statements, forward-looking
statements, including, without limitation, in our “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” in Part II, Item 7.
In some cases these statements are identifiable through the use of words such as
“anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,”
“target,” “can,” “could,” “may,” “should,” “will,” “would” and similar
expressions. You are cautioned not to place undue reliance on these
forward-looking statements. In addition, our management may make forward-looking
statements to analysts, investors, representatives of the media and others.
These forward-looking statements are not historical facts and represent only our
beliefs regarding future events and, by their nature, are inherently uncertain
and beyond our control.





These
forward-looking statements are based on the best estimates of management at the
time such statements are made.  Expected production, results and cost
of sales (including without limitation, statements made with respect to future
production and costs contemplated in our new mine plan) are based in part on
current and historical production and cost data factoring certain assumptions
with respect to future metal prices, costs, availability of supplies and labor
and other parameters.





The
nature of our business makes predicting the future trends of our revenues,
costs, production, expenses and net income difficult. The risks and
uncertainties involved in our businesses could affect the matters referred to in
such statements and it is possible that our actual results may differ materially
from the anticipated results indicated in these forward looking-statements.
Important factors that could cause actual results to differ from those in the
forward-looking statements include, without limitation:





·
            the
      effect of political, economic and market conditions and geopolitical
      events;·
            the
      actions and initiatives of current and potential
    competitors;·
            our
      reputation;·
            investor
      sentiment; and·
            other
      risks and uncertainties detailed elsewhere throughout this
      report.





Accordingly,
you are cautioned not to place undue reliance on forward-looking statements,
which speak only as of the date on which they are made. We undertake no
obligation to update publicly or revise any forward-looking statements to
reflect the impact of circumstances or events that arise after the dates they
are made, whether as a result of new information, future events or otherwise
except as required by applicable law. You should, however, consult further
disclosures we may make in future filings of our Annual Reports on Form 10-K,
Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, any amendments
thereto, available on the Securities and Exchange Commission website at www.sec.gov , and in
the corresponding documents filed in Canada.





CAUTIONARY
NOTE TO U.S. INVESTORS CONCERNING ESTIMATES OF MEASURED,


INDICATED
AND INFERRED RESOURCES





This 10-K
uses the terms "measured", "indicated" and/or "inferred" mineral resources.
United States investors are advised that while such terms are recognized by
Canadian regulations, the United States Securities and Exchange Commission does
not recognize them. United States investors are cautioned not to assume that all
or any part of mineral resources will ever be converted into mineral reserves.
Inferred mineral resources have a great amount of uncertainty as to their
existence, and as to their economic and legal feasibility. It cannot be assumed
that all or any part of an inferred mineral resource will ever be upgraded to a
higher category. Under Canadian rules, estimates of inferred mineral resources
may not form the basis of feasibility or other economic studies. United States
investors are cautioned not to assume that all or any part of an inferred
mineral resource exists, or is economically or legally
mineable.


3


Subsequent
Event and Proposed Business Combination
 
 The
Company, Western Goldfields Inc. and New Gold Inc. (“New Gold”) have entered
into a definitive business combination agreement dated as of March 3, 2009 for
the purpose of combining the ownership of their respective
businesses.  Under the terms of the agreement, New Gold will acquire
by way of a plan of arrangement all of the outstanding common shares of Western
Goldfields in exchange for one New Gold common share and CDN$0.0001 in cash for
each common share of Western Goldfields (the "Transaction").  Upon
completion of the Transaction, New Gold will have approximately 348 million
shares outstanding (436 million fully-diluted).
 
 The
Transaction is subject to regulatory approvals, court approval and obtaining a
minimum two-thirds approval of those shares voted at a special meeting of the
shareholders of Western Goldfields and majority approval at a special meeting of
the shareholders of New Gold.  The Transaction has been structured as
a plan of arrangement under the Business Corporations Act
(Ontario).  The parties expect to complete and mail the joint
information circular in April 2009 and plan to hold the special meetings in May
2009.  The Transaction is expected to close at the end of May
2009.
 
 The
definitive business combination agreement entered into in connection with the
Transaction includes a commitment by each of New Gold and Western Goldfields not
to solicit alternative transactions to the proposed Transaction. In certain
circumstances, if a party terminates the definitive agreement to enter into an
agreement to effect an acquisition proposal that is different from the
Transaction, then such party is obligated to pay to the other party as a
termination payment an aggregate amount equal to CDN$8.8 million. Each party has
also been provided with certain other rights, representations and warranties and
covenants customary for a transaction of this nature, and each party has the
right to match competing offers made to the other party.
 
 See “Item
1A. Risk Factors – Risks Related to the Business Combination with New Gold and
Operations of the Combined New Gold and Western Goldfields” for a discussion of
some of the risks associated with the transaction.
  4


PART
I




ITEM
1.    BUSINESS





(a)
Business Development





We were
formed pursuant to a reorganization completed in June 2007 whereby our
predecessor, Western Goldfields, Inc., an Idaho corporation (“WGI Idaho”),
became our wholly-owned subsidiary as a result of a merger with a newly created
subsidiary company, Western Goldfields (USA) Inc., a Nevada Corporation. WGI
Idaho was incorporated as Bismarck Mining Inc. in the State of Idaho in 1924 and
changed its name to Western Goldfields, Inc. in July 2002. We are an independent
gold producer focused on increasing production and maximizing cash flow
generation from our Mesquite Mine (“Mesquite” or the “Mine”) in Imperial County,
California.





Mesquite
is our most important asset, and during 2008 provided us with gold production
from material that was placed on the heap leach pad from two of our three open
pits: Rainbow and Big Chief. No mining was conducted from the Vista pit area. In
January 2008 we commenced operations for the production of gold from ore placed
on the leach pad in the second half of 2007. The gold produced provided us with
positive operating cash flow beginning in the third fiscal quarter of
2008.





In 2007
we completed the financing required for the development of the Mesquite Mine to
bring it back into full production based on the feasibility report completed in
August 2006. See “Our Feasibility Study” below and “Cautionary Notice Regarding
Forward-Looking Statements.”




New
Management and Private Placement Financing





On
February 13, 2006, we announced the restructuring of our Board of Directors and
the appointment of a new senior management team, including Mr. Randall Oliphant
as Chairman of the Board, Mr. Raymond Threlkeld as President and Chief Executive
Officer, and Mr. Brian Penny as Chief Financial Officer. On February 20, 2006,
we announced the completion of a $6.0 million private placement of our common
stock. The proceeds from this private placement were used:





·
            to
      repay in full our outstanding debt facility of $1.5 million plus accrued
      interest;





·
            to
      pay $2.0 to Romarco Minerals Inc. in full satisfaction of amounts owing
      upon termination of a merger agreement with that
  company;





·
            to
      pay costs of approximately $0.8 million for the completion of the Mesquite
      feasibility study; and





·
            the
      balance for general corporate
purposes.





Feasibility
Study and Subsequent Developments





On August
9, 2006, we announced the completion of a positive feasibility study to expand
the operation of our Mesquite mine property. We also announced proven and
probable reserves of 2.36 million ounces of gold. Accordingly, we began to
capitalize costs incurred in the development of the Mesquite Mine.





After
completion of the feasibility study, our primary focus was on obtaining
financing for and completing the expansion of the Mine.





On
November 30, 2006, we announced the signing of a mandate letter with Investec
Bank (UK) Limited to arrange and underwrite up to $105 million of project debt
and that we had received an indicative term sheet.





On
December 13, 2006, we announced positive initial results from the exploration
drilling program underway at the Mesquite Mine.





On
January 25, 2007, we sold 31,115,000 shares of common stock at Cdn. $2.25 per
share pursuant to a prospectus supplement to our shelf prospectus, which we
filed in October 2006 for gross proceeds of approximately $59.4 million and net
proceeds of approximately $55.2 million. On February 1, 2007, we sold a further
2,215,000 shares of common stock at Cdn. $2.25 per share pursuant to a
prospectus supplement to our shelf prospectus, for gross proceeds of
approximately $4.2 million and net proceeds of approximately $4.0 million. These
shares of common stock were issued upon the exercise of the underwriter’s over
allotment option. We have been using the proceeds from this offering to finance
our on-going activities at Mesquite, including the acquisition of the majority
of the mining equipment fleet, as well as for general corporate purposes. On
March 30, 2007, the Company, through its wholly-owned subsidiary, Western
Mesquite Mines, Inc., entered into a new term loan facility with Investec Bank
(UK) Limited under which the Company will be able to borrow up to $105.0 million
in connection with the development of the Mesquite Mine. Interest on advances
will be at U.S. LIBOR plus 2.2% until completion (as defined in the credit
agreement) and 1.75% after completion. Completion is expected to occur during
the first half of 2009. The agreement, in conjunction with the earlier equity
financing, completed the financing requirements for Mesquite. The Company had
drawn $86.3 million at September 30, 2008 to complete the Mesquite development
plan and subsequently, during the fourth fiscal quarter of 2008, repaid $17.7
million leaving $68.6 million outstanding under the credit facility at December
31, 2008.




5





On March
26, 2007 we announced proven and probable reserves of 2.77 million ounces due to
the successful 2006 drilling program.





On
October 12, 2007 we completed an offering of an aggregate of 11,316,000 common
shares of the Company, at Cdn. $3.05 per share pursuant to a short form
prospectus filed in Canada. The offering was not registered in the United
States. The gross proceeds received from this offering were $35.0 million and
the net proceeds were approximately $33.4 million. The proceeds from this
offering have been and will continue to be used to finance regional exploration
activities, carrying out testing on the non-oxide resources, corporate
development activities and for general working capital purposes.





On
October 6, 2008 we announced the implementation of an Improved Mine Plan (“the
Plan”) which would lead to sequential mining of the three open pits, beginning
in the Rainbow pit, and result in higher production of gold in the four year
period 2009 through 2012. As a result of the Plan, certain conditions of the
credit agreement were revised including the repayment terms and timing of the
completion testing. The repayment schedule was accelerated as a result of the
increased production profile with an amortization schedule requiring full
repayment by the end of fiscal 2012 versus the end of fiscal 2014 previously.
The timing for completion testing was extended with completion required by the
end of the second fiscal quarter of 2009.





On
November 4, 2008 we announced a share repurchase by way of a normal course
issuer bid to purchase certain of our outstanding common shares through the
Toronto Stock Exchange and NYSE Alternext. We initiated the repurchase program
as we felt the market price of the common shares was not reflective of the
underlying value. From the period November 7, 2008 through December 31, 2008,
the Company repurchased 2.3 million shares at an average price of Cdn. $1.36 per
share spending a total of Cdn. $3.1 million on the repurchases including
commission related expenses. No additional repurchases have taken place to-date
in fiscal 2009.





The
expansion of the Mine commenced in 2006 and was substantially completed by the
end of 2008 at a total cost of $111 million. On August 28, 2006, our common
shares commenced trading on the Toronto Stock Exchange under the symbol WGI, and
on November 8, 2007, our common shares commenced trading on the American Stock
Exchange, now the NYSE Alternext, under the symbol WGW.





Hedging
Activities





Our
preferred approach is to avoid the hedging of gold and provide our shareholders
with leverage to changes in the price of gold by selling in the spot market.
Under the terms of the term loan facility which we negotiated in early 2007, we
were required to enter into a gold hedging program acceptable to the banking
syndicate. In June 2007 we entered into a series of forward sales contracts for
429,000 ounces of gold at a price of $801 per ounce. These hedging contracts
represent a commitment of 5,500 ounces per month for 78 months commencing July
2008 with the last commitment deliverable in December 2014. During the second
half of fiscal 2008, we delivered 33,000 ounces into the hedge leaving 396,000
ounces hedged at December 31, 2008. We also delivered 5,500 ounces in each of
January and February 2009 as required under the terms of the
agreement.





The
Company has not designated these contracts as cash flow hedges. Accordingly the
hedge accounting rules of SFAS No.133 are not being applied and the period-end
mark-to-market adjustments of these contracts is immediately reflected in the
Company’s statement of operations and the cumulative effect is reflected as an
asset or liability on the balance sheet. At December 31, 2008, the spot price
for gold was $870 per ounce compared with our forward sale price of $801, which
resulted in our recording an unrealized loss of $45.2 million of which $5.6
million is current.





On
December 18, 2008 we announced our entry into a fuel hedge program with the
hedge of 1.5 million gallons of diesel in each of 2009 and 2010; the 1.5 million
gallons represents approximately 25% of the expected diesel consumption in each
year. The diesel was hedged at forward prices of $1.82 and $2.00 per gallon for
2009 and 2010, respectively. In addition to these hedged prices, the Company
expects to incur approximately $0.15 per gallon related to tax and delivery
charges. As approximately 20% of Mesquite’s operating costs are attributable to
diesel consumption, the Company felt it prudent to fix this portion of the
overall diesel costs. Subsequent to the year end, on January 13, 2009, we
announced additional fuel hedges of 1.4 and 1.5 million gallons of diesel in
2009 and 2010, respectively. This second round of hedged diesel was at forward
prices of $1.68 and $1.87 per gallon for 2009 and 2010, respectively. Overall,
the Company now has approximately 50% of its expected diesel consumption hedged
for each of 2009 and 2010 at weighted average prices of $1.75 and $1.94 per
gallon (excluding the estimated $0.15 per gallon for tax and delivery
charges).





Reorganization





On June
19, 2007 the shareholders of our predecessor company, WGI Idaho, approved an
agreement and plan of merger which became effective June 29, 2007 whereby our
place of incorporation was changed from Idaho, USA to Ontario, Canada, and our
name was changed from Western Goldfields, Inc. to Western Goldfields Inc. (or
“WGI Ontario”). We believe that the reorganization allows us to take advantage
of financial and other business opportunities that would not be available under
our previous corporate structure, including: being able to complete transactions
requiring shareholder approval more quickly; having a higher profile in the
Canadian markets; and being a more attractive investment to a wider range of
Canadian investors, while still being able to access U.S. capital
markets.




6





On
completion of the reorganization, the shares of common stock in Western
Goldfields, Inc. (the predecessor Idaho corporation) automatically became an
equal number of common shares of no par value in Western Goldfields Inc. (the
successor Ontario corporation) and the economic ownership of shareholders in the
new company remained unchanged.




Proposed Business Combination




Western
Goldfields Inc. and New Gold Inc. (“New Gold”) have entered into a definitive
business combination agreement dated March 3, 2009 for the purpose of combining
the ownership of their respective businesses.  Under the terms of the
agreement, New Gold will acquire by way of a plan of arrangement all of the
outstanding common shares of Western Goldfields on the basis of one New Gold
common share and CDN$0.0001 in cash for each common share of Western Goldfields
(the "Transaction").  Upon completion of the Transaction, New Gold
will have approximately 348 million shares outstanding (436 million
fully-diluted).





The
Transaction is subject to regulatory approvals, court approval and obtaining a
minimum two-thirds approval of those shares voted at a special meeting of the
shareholders of Western Goldfields and majority approval at a special meeting of
the shareholders of New Gold.  The Transaction has been structured as
a plan of arrangement under the Business Corporations Act
(Ontario).  The parties expect to complete and mail the joint
information circular in April 2009 and plan to hold the special meetings of
shareholders in May 2009.  The Transaction is expected to close at the
end of May 2009.





The
definitive business combination agreement entered into in connection with the
Transaction includes a commitment by each of New Gold and Western Goldfields not
to solicit alternative transactions to the proposed Transaction. In certain
circumstances, if a party terminates the definitive agreement to enter into an
agreement to effect an acquisition proposal that is different from the
Transaction, then such party is obligated to pay to the other party as a
termination payment an aggregate amount equal to Cdn. $8.8 million if New Gold
is the terminating party and Cdn. $8.8 million if Western Goldfields is the
terminating party. Each party has also been provided with certain other rights,
representations and warranties and covenants customary for a transaction of this
nature, and each party has the right to match competing offers made to the other
party.





Corporate
Structure:











The
Company’s four wholly owned subsidiaries are: Western Goldfields (USA) Inc. (a
holding company), Western Goldfields (Canada) Inc. (a management company),
Western Mesquite Mines, Inc. (an operating company), and Calumet Mining Company
(a dormant exploration company).





(b) Business of the
Issuer





We are a
gold production and exploration company with a focus on precious metal mining
opportunities in North America. Currently the Mesquite Mine is our sole mineral
property. Mesquite is a low-grade, open-pit operation employing heap leach pad
technology which we acquired in November 2003 from Newmont Mining
Corporation (“Newmont”). The mine is permitted and financed.





From late
2003 until late 2007, the Mine provided us with residual gold production from
material that had been placed on the heap leach pad by Newmont and previous
owners of the property. This production provided us with some operating cash
flow to help sustain our operations pending the reactivation of the Mine. In mid
2007, we commenced pre-production mining activities and in January 2008 we
commenced operations for the production of gold from ore placed on the leach pad
in the second half of 2007. In October 2008 we announced the Improved Mine Plan
which should result in higher production of gold in the years 2009 through
2012.




7





In
February 2006, the management team was changed and interim financing was
arranged. In August 2006, we completed a feasibility study for expansion and
operation of Mesquite based on proven and probable reserves of 2.36 million
ounces of gold. The feasibility study provided grounds to resume mining
operations and to expand existing, inactive open pit mines on the
property.





After
completion of the feasibility study, our priority had been to finance the
development of the Mesquite Mine and bring it back into full production. We
achieved both these objectives by December 31, 2007 and in fiscal 2008 the focus
shifted to increasing production and maximizing cash flow generation from the
Mine through planned improvements to the property. The Mine is fully funded and
we anticipate production to average approximately 150,000 ounces per year over
the twelve year life of the mine, with annual variances in production both above
and below this average.




In late
2006 we embarked on an expansion capital expenditure program budgeted at $108.6
million to acquire the mobile mining fleet and carry out several major
infrastructure projects necessary to bring Mesquite back into full production.
The fleet includes 14 haul trucks, 2 shovels, 1 front end loader and several
ancillary items. Commencing in the Spring of 2007 we started to take delivery of
the mining units and by year-end 2007 all the units had been placed into
service. The major items in the construction program were the leach pad
expansion, retrofit of the process plant, and construction of a truck repair
shop, warehouse and mine operations administrative office. The expansion program
was substantially completed by December 31, 2008 at a total cost of $111
million.





On March
26, 2007 we announced that we had increased proven and probable reserves at
Mesquite from 2.36 million ounces of gold to 2.77 million ounces. Approximately
50% of the increase is attributable to results from a drilling program of 27
holes at the Brownie Hill area of the mine which converted inferred oxide
resources to proven and probable reserves, and the remaining 50% is attributable
to an increase in the reserve gold price assumption from $450 to $500 per
ounce.





At
December 31, 2008, proven and probable reserves were estimated to be 2.57
million ounces, a reduction of 0.20 million ounces, reflecting production
depletion from mining activity in 2008.  There was no change in the
reserve gold price assumption of $500 per ounce.





Our
current operations involve circulating cyanide solution through the heap leach
pad. The gold and silver in solution is then extracted by processing the
“pregnant” solution through activated carbon which is then periodically treated
to recover the gold and silver into dore. The dore is then transported to
Johnson Matthey Inc. for further refining to 99.99% pure bullion.





We sell
our gold production to bullion dealers and refiners. In 2008, our sales of $95.4
million were apportioned between the spot gold market and delivery into the gold
hedge per the terms of our credit facility. $69.0 million of sales were
generated at the spot gold price with $26.4 million of sales attributable to the
sale of 33,000 ounces of gold at fixed forward prices of $801 per
ounce.  The loss of any of our customers would not have a material
adverse effect on the Company as there is an available market for our gold
bullion from other purchasers.





Description
of the Mesquite Mine





The Mine
property is located primarily in Sections 3-10 and 15-19, Township 13 South,
Range 19 East, SBB&M, south of the Chocolate Mountains in Imperial County,
California, approximately 35 miles east of Brawley, California, and 45 miles
northwest of Yuma, Arizona, just north of the Mexican border at an elevation of
between 600 and 1,000 feet above sea level. The property consists of 309
unpatented mining and millsite claims located on federal land administered by
the Bureau of Land Management (“BLM”), approximately 170 patented tracts that
are privately owned, and one piece of school trust lands leased from the
California State Lands Commission (“State”). Part of the property is operated by
Western Mesquite Mines, Inc. (“WMMI”) for mining purposes and part is operated
by County Sanitation District No. 2 of Los Angeles (“LACSD”) for a regional
landfill facility. The rights and obligations of WMMI and the LACSD are
contained in a Mineral Lease and Landfill Facilities Lease Agreement dated June
25, 1993 (“the Landfill Agreement”). The term of the Landfill Agreement is 31
years commencing June 25, 1993, and so long thereafter as WMMI continues to mine
or process ore on the property, but not to exceed 85 years in total. LACSD began
transporting refuse to their landfill site during the latter portion of
2008.





With
regard to that part of the property used for mining purposes, portions are
privately owned by WMMI, portions consist of unpatented mining and millsite
claims on BLM land that are owned (264 claims) or leased (45 claims) by WMMI,
and portions are owned by the State and leased by WMMI. The subject leases are
as follows:





§
              WMMI
      leases a group of 40 unpatented mining and millsite claims from the
      Sanitation District under the terms of the Landfill Agreement. As noted
      above, the term of that lease is 31 years commencing June 25, 1993, and so
      long thereafter as WMMI continues to mine or process ore on the property,
      but not to exceed 85 years in
total.





§
              WMMI
      leases a group of five unpatented mining claims from Bonnie Kovac, James
      Harbison and Stephen Galambos, Jr. pursuant to a Mineral Lease and
      Purchase Option dated October 20, 1982. The term of that lease is
      initially for 21 years and for a period so long thereafter as WMMI
      continues to exercise certain rights and continues to make minimum advance
      royalty payments under the
lease.




8




§
              WMMI
      leases 657.87 acres of land from the State pursuant to a Mineral
      Extraction Lease (No. PRC 8039.2) issued October 1, 2002. The term of that
      lease is ten years with a preferential right to renew for two successive
      periods not to exceed ten years each upon such reasonable terms and
      conditions as may be prescribed by the
State.





The
overall area covered by the Conditional Use Permit, issued by Imperial County,
and the Record of Decision, issued by the BLM, is approximately 5,200 acres.
Mining operations are supported by existing infrastructure, a reliable water
supply, grid electric power and State Highway 78, which passes close to the
Mine. The nearest rail siding is 15 miles away, but the rail line will be
extended to the Mine as part of the LACSD landfill project; this rail line
extension is currently in progress. The property is in a desert region with
average annual rainfall of approximately three inches and sparse desert
vegetation.











Since mining operations commenced in
1986, three major pits have been developed: Big Chief to the northwest of the
property, Rainbow to the northeast of the property, and Vista in between them.
The Mine infrastructure is located in the center of the property, feeding two
distinct areas of leach pad located to the south on the pediment. The carbon
plant is located to the southwest of the leach pad.





Expansion
plan





Newmont
developed a Mesquite Mine expansion plan to mine additional mineralized material
remaining in-situ and adjacent to the open pits. A Record of Decision (“ROD”)
was issued by the BLM in 2002, allowing for the expansion of the existing
operations. The ROD defines and authorizes future new disturbance that allows
for expansion of the Big Chief, Rainbow and Vista open pits. Our feasibility
study of August 2006 is the basis for the redevelopment of the mining
operations.





Under the
terms of our permits, we will process run-of-mine ore by expanding the
easternmost, Phase 6 leach pad. The feasibility study report set out the mining
fleet requirements for pre-production and commercial production. Our fleet
acquisition program in 2007 was based on these requirements. Additional
investment in the processing facilities, in the amount of $26.5 million, which
includes $19.5 million for the heap leach pad expansion and $7 million for new
processing facilities and modernization of existing facilities was also included
in the expansion. The retrofit of the process plant was completed during the
first fiscal quarter of 2008; new carbon columns for the processing circuit were
also installed during the quarter and were brought on line April 25, 2008. In
May 2007, an additional $2.6 million surety bond was posted in respect of future
reclamation costs, bringing the total amount subject to such bonds in respect of
reclamation costs to $11.3 million. Permit conditions defined by the ROD also
include, among other things, the implementation and maintenance of tortoise
education programs for employees, the construction of approved tortoise fencing
and the provision of 1,394 acres of tortoise habitat within the Chuckawalla
Bench Area, an area to the north of Mesquite Mine, to mitigate future
disturbance of tortoise habitat. During the fourth quarter of 2006 we provided
funds to the appropriate regulatory agencies for the purchase and management of
the compensation lands.





Hanson
Natural Resources Company (“HNRC”), a previous owner of the Mine, permitted a
permanent landfill facility on a portion of the lands occupying the southwest
sector of the property. In June 1993, Newmont entered into a mineral lease and
landfill facilities lease agreement with HNRC to conduct mining operations
concurrently with the proposed landfill operation. HNRC subsequently sold the
landfill site to LACSD which began landfill operations in late 2008. We believe
that there are opportunities for synergies between our mining operations and
this future landfill operation. This agreement is more fully described in Future
Landfill Development, below.




9





Geology,
Mineralization and Prior Mining Operations





The
Mesquite Mining District lies beneath alluvial pediment deposits at the base of
the Chocolate Mountains. Small bedrock outcrops were left uncovered by this
pediment to form the pre-mine surface exposure of the deposit. Several regional
blocks, comprised of distinct rock units, form boundaries to the
district.





Lithologies
exposed in the southern Chocolate Mountains include Proterozoic granitic and
metamorphic rocks, Mesozoic metamorphic and plutonic units, early to
mid-Tertiary volcanic and plutonic rocks, and Tertiary to Recent sedimentary
units. Proterozoic to Mesozoic units are represented by the Chuckwalla Complex,
while the Mesozoic terraine is a structurally complicated package of gneisses,
schist, phylitte, and plutons (Manske, 1991). These include the Orocopia Schist,
and probable Jurassic Winterhaven Formation, overlain by the Tertiary Quechan
Volcanic rocks and Quaternary alluvial deposits. There are three main structural
components which appear to have provided conduits for mineralization and offsets
to mineralization found at the Mesquite Mine.




The
Mesquite mine area is hosted in a Jurassic aged gneiss and pluton terrane. The
stratigraphic sequence is, from bottom to top: mafic, hornblende biotite, and
biotite gneiss overlain by Bay Horse Quartzite and Muscovite Schist. These units
have been crosscut by a number of quartz, feldspar, biotite and muscovite rich
granite sills, plutons and dikes. The gneiss units are present in a shallowly
dipping stratigraphic sequence, offset by numerous high and low angle faults.
This package is overlain by up to 400 feet of Tertiary lithified silts, sands,
and gravels and unconsolidated Quaternary gravels.





Northwest
trending structures appear to have the greatest control on gold distribution,
while the younger northeast trending faults have offset mineralization in a
stair step fashion. East west striking near vertical and northwest striking low
angle structures are also seen on the property. The system is bounded by
structures sub-parallel to the San Andreas Fault system. Deposition of gold was
within an epithermal environment along fractures, and the deposit was
subsequently oxidized down to around 500 feet below current surface topography.
Visible gold has been identified throughout the Mesquite area. Small flakes of
free “flour” gold have been found within the fault zones. Gold occurs at
Mesquite as both submicron disseminated and coarse gold. All documented gold
occurrences are native gold, and classification has been based on silver content
and grain size.





The ores
of Mesquite have proven to be readily amenable to heap leach processing over the
past twenty years of operations.





Goldfields
Mining Corporation (“Goldfields”), began acquiring leases and started an
exploratory drill program and ultimately the Mine was developed in 1985 with the
construction of an open pit mine with heap leach gold recovery that commenced
commercial operations in March 1986. In 1989, HNRC acquired Goldfields and
subsequently exchanged its wholly owned gold operations for assets held by Santa
Fe Pacific Minerals Corporation (“Santa Fe”) in 1993. In 1997, Newmont acquired
Santa Fe and continued mining operations until May 2001. Newmont continued
depositing ore on the heap leach pad until August 2001. Residual gold was drawn
from the leach pad from 2001 until late 2007.





Total
gold production from mine inception in 1986 through December 31, 2007 consisted
of approximately 4,000,000 ounces of gold being placed on the leach pad
resulting in approximately 3,000,000 ounces of gold being produced and
sold.





Holding
costs and royalty agreements





We pay
annual holding costs for our Mesquite properties of approximately $180,000.
These include payments to the BLM, maintenance fees to Imperial County,
California, state lease fees, a lease payment to LACSD and other lease fees and
property taxes.





Previously
mined material and any newly mined material at Mesquite will be subject to
production royalties ranging from 2.0% to 6.8% depending on the
location.





Newmont
retained a 50% interest in the net operating cash flow on the ore they had mined
and that was on the pad undergoing residual leaching. No royalty was paid under
the contractual agreement in 2006 or 2007. This cash flow royalty was terminated
in 2007.





In
addition, Newmont retained a production royalty ranging from 0.5% to 2.0% net
smelter return (“NSR”) on any newly mined ore. We started to pay this royalty in
respect of our new production in late 2007. This interest was assigned by
Newmont to Franco-Nevada U.S. Corporation under an agreement dated December 20,
2007. A total of $2.1 million was paid during 2008 as a result of the NSR
royalty.





10





The
Mesquite properties are subject to the following royalties:





Property
                
                Original Owner
                
                
                Franco-NevadaCalifornia
      State Lands Lease
                
                
                4.0 – 6.0
                %
                
                
                0.5
                %Wade/Kelly
      Patents
                
                
                6.3
                %
                
                
                0.5
                %McCrae/Hoover
      Patents
                
                
                6.0
                %
                
                
                0.5
                %Glamis
      & Associates Claims
                
                
                2.0
                %
                
                
                1.0
                %Hospah
      Claims (Newmont)
                
                
                —
                
                
                
                2.0
                %





The life-of-mine average expected
royalty is approximately 2.4%.





Mining
permits





In May
2001, Newmont ceased mining at Mesquite. Permits for a proposed expansion were
obtained by Newmont in early 2002 and include a Conditional Use Permit from
Imperial County, California, dated March 27, 2002 and a Record of Decision from
the Bureau of Land Management dated July 16, 2002. These permits were covered by
our Asset Purchase Agreement of November 7, 2003 with Newmont and were fully
transferred to us in April 2004. In addition, in February 2002, Newmont prepared
a reclamation and closure plan for Mesquite that was approved by the relevant
governmental agencies.





Reclamation
and remediation activities





With no
new ore having been placed on the leach pad since 2001, the productive capacity
of the leach pad progressively deteriorated through 2007. Although we
implemented various strategies to maintain output levels and monitor solution
grades being produced by the leach pad, during the third quarter of 2006 we
concluded that it was no longer economic to continue leaching the Vista pad and
we commenced closure operations. Rinsing of the pad was completed in late
January 2007 and a 16 hole drilling program was conducted to provide information
as to residual cyanide levels. Formal approval of this closure was received from
the California Regional Water Quality Board in May 2007. Costs of $0.3 million
relating to the Vista Pad reclamation and closure program were fully recoverable
from the reimbursement account maintained with American
International Group, Inc. (“AIG”).





We carry
out regular reviews of our plans and provisions for closure operations. The
feasibility study completed in August 2006 increased the mineral reserves for
the Mesquite Mine. As a result, we completed a review of the reclamation plan
and the reclamation and remediation liability as at September 1, 2006. The net
present value of these obligations was revised to $4.9 million. In May 2007, we
announced a further increase in the mineral reserves and the net effect was
reflected in an increase of $0.1 million in our provision for reclamation and
remediation as at December 31, 2007.  In 2008, our asset retirement
obligations related to the Mesquite Mine were independently assessed by a
third-party engineering firm.  The impact of the assessment was a
reduction of $0.2 million relating to changes in timing of future reclamation
activities and substantive changes in the mine closure plan.  More
specifically, the substantive changes included:


·
            Revision
      due to pre-2008 over-estimation of total area to be
      reclaimed.  Mesquite's original planned closure costs were based
      on Newmont’s assessment; Newmont had not claimed credit for major
      earthwork performed over a large part of the mine (waste rock facilities),
      and had retained acreages which do not exist as a
    liability.


·
            Downward
      revision in rinsing volume required for the heap leach based on recent
      experience.  Mesquite closed the Vista heap with one-third pour
      volume of water pumped up and through the heap, versus one-pour volume
      assumed in previous cost estimates.  We have now revised costs to
      about three-quarter pour volume, as a reasonable balance between
      conservatism and actual experience.





Until
late 2007, virtually all our gold production at Mesquite came from residual
leaching operations. During this period we were operating under an Interim
Management Plan (IMP) prepared and approved by the U.S. Bureau of Land
Management. The plan outlined the measures to be undertaken by us, as operator
of the Mesquite site, to maintain the site during the period of non-mining
activity. Under the IMP, priority was given to protecting public health and
safety, while maintaining the site in a condition suitable for reopening when
economic conditions were favorable.





Our
feasibility study





In March
2006 we initiated a feasibility study with a view to establishing mineable
reserves at Mesquite. Specifically, the study was designed to determine whether
mineralized material, that is accessible under the approved expansion permits,
can be economically exploited. The study used drilling results conducted by
previous holders of the property and mineral rights. The total cost of the
feasibility study was approximately $0.8 million. In August 2006, Micon
International Limited (“Micon”), an independent consultant of Toronto, Canada,
completed the feasibility study and reported positive results. The mineral
reserve estimate for the Mesquite Mine Feasibility Study was prepared by M.
Hester FAusIMM, Vice President, Independent Mining Consultants, Inc. (“IMC”),
Tucson AZ. IMC updated the resource block model for the Mesquite Mine in May
2006.




11




IMC later
completed a life of mine production schedule to tabulate ore tons, gold grade,
total material tons, and waste material tons on an annual basis. The
distribution of ore and waste contained in each of the mining phases was used to
develop the schedule, assuring that criteria such as continuous ore exposure,
mining accessibility, and consistent material movements were met.





It was
the opinion of IMC that the mine production schedule defined a mineral reserve
for a mining project. Measured and indicated mineral resources in the design
pits were converted to proven and probable mineral reserves respectively. Oxide
reserves are reported above a cut-off grade of 0.006 oz per ton, non-oxide
reserves are reported above a 0.012 oz per ton cut-off grade.





Based on
these estimated mineable reserves, we developed a mine plan and processing
design to mine and treat approximately 16 million tons per year of
ore.  Based on the total of 131 million tons contained in the mineable
reserves, a project life of approximately 13 years was proposed, including 19
months of engineering, procurement, construction and development followed by 91⁄2
years of mine production and 2 additional years of re-leaching.





A full
version of the feasibility study can be found on SEDAR at www.sedar.com and on
EDGAR at www.sec.gov.





Capital
and Operating Costs – Updated Projections





While we
believe that the Feasibility Study provided an excellent basis for the long term
planning for resumption and continuation of mining operations at Mesquite, we
recognize that the cost structure and assumptions that underpin it are dynamic.
We continue to experience a period of significant volatility in the demand for
mineral resources which has had a significant impact on commodity prices and on
the price and availability of many of our major cost inputs. We are continually
updating our projections and assumptions based on changing
circumstances.





A $108.6
million expansion capital spending plan for Mesquite, including $76.5 million
for acquisition of the mining fleet, was approved by our Board of Directors in
late 2006. The major reason for the increase over the Feasibility Study estimate
of $97.9 million was our decision to source haul trucks that would meet
California’s stringent environmental standards. The spending on the program to
date was approximately $111 million at December 31, 2008.





The cost
of sales per ounce(1) of
$508 for 2008 was higher than previously anticipated as a result of higher fuel
costs through the majority of the year, unexpected maintenance expenses related
to the truck and shovel fleet and the production of fewer gold ounces. Fewer
ounces were produced due to lower than expected truck and shovel availability,
increased stripping in late 2008 resulting from the Improved Mine Plan and lower
than expected benefit from secondary and tertiary leaching as the second lift
was placed on the pad later than expected. In late 2008 and early 2009, the
Company has worked to control costs going forward. We have hedged approximately
50% of our estimated diesel fuel requirements in each of 2009 and 2010. In
addition, we have procured and will continue to procure radial tires for the
truck fleet; the radial tires are less expensive and better performing than the
bias ply tires that were available in the market during 2008. The radial tires
also provide the ability for the trucks to travel faster with increased payloads
creating the potential to reduce operating costs. Production for 2009 is
forecast between 140,000 – 150,000 ounces of gold at a cost of sales of $530 -
$540 (1) per
ounce. Included in this cost estimate are approximately $11 million, or $75 per
ounce, in costs related to high cost inventory on the leach pad at December 31,
2008 being replaced by lower cost inventory at December 31, 2009. These costs
were incurred in fiscal 2008 and therefore do not impact 2009 cash flow.
Production for 2010 is expected to be approximately 175,000 ounces at cost of
sales of approximately $400(1) per
ounce.




(1)
              Cost of sales per ounce is a
      non-GAAP measure and is defined as cost of sales per theCompany’s financialstatements (mine operating costs
      plus royalties) divided by thenumber ofounces
    sold.




Mineral
Resources and Reserves




In August
2006, we announced the results of our Feasibility Study estimating a proven and
probable reserve of 2.36 million ounces based on a gold price of US $450 per
ounce. Measured and indicated mineral resources (inclusive of mineral reserves),
were estimated to be 3.6 million ounces based on a US $500 per ounce gold
price.





In March
2007, we announced that we had increased proven and probable reserves at
Mesquite to 2.77 million ounces. Estimated measured and indicated resources
(inclusive of reserves) also increased to 3.9 million ounces.





Approximately
50% of the reserve increase was attributable to assay results from a drilling
program of 27 holes at the Brownie Hill area of the mine which converted
inferred oxide resources to proven and probable reserves, and the remaining 50%
was attributable to increased gold price assumptions: from US $450 to US $500
per ounce for reserves and US $ 500 to US $600 for resources.





As at
December 31, 2007, proven and probable reserves were estimated to be 2.76
million ounces, reflecting minor production depletion of the March 2007 reserve
base. Estimated measured and indicated mineral resources (exclusive of mineral
reserves) increased to 4.3 million ounces.




12


The
December 31, 2007 resource and reserve estimate included all results from 125
exploration drill holes completed on the project since 2006.  The gold
price assumption for mineral reserves remained unchanged relative to the March
estimate at US $500 per ounce. The gold price assumption for mineral resources
was increased to US $650 per ounce. Measured and indicated mineral resources
increased by approximately 400,000 ounces, equally attributable to the
additional drilling results and the increase in gold price.





As at
December 31, 2008, proven and probable reserves were estimated to be 2.57
million ounces, a decrease of 0.20 million ounces, reflecting production
depletion through the end of December 2008.  The gold price assumption
for mineral reserves remained unchanged relative to the December 2007 estimate
at US $500 per ounce.




Estimated
measured and indicated resources (inclusive of mineral reserves) for the project
as at December 31, 2008 were estimated to be 4.1 million ounces with the
decrease reflecting production depletion from the December 31, 2007
estimate.
  The
majority of the data used to estimate the December 31, 2008 resources and
reserves was previously reviewed and verified by IMC as part of the 2006
Feasibility Study and a description of the procedures used is included in the
Mesquite Gold Project Technical Report dated May 26, 2006. Data collected since
filing of said Technical Report has been reviewed and verified by W. Hanson,
P.Geo., Vice President of Mine Development, a “qualified person” under Canada
National Instrument 43-101.




Mesquite
Mineral Reserves and Resources (1) (4) (6)


December
31, 2008





Mineral
Reserves


GradeClass
                                
                                Type
                                
                                
                                Tons
                                    (x 1,000) (2)
                                
                                
                                (Au ozs
                                  /ton)
                                
                                
                                Ounces
                                
                                
                                Metallurgical
                                    Recovery(3)Proven
                                
                                Oxide
                                
                                
                                91,982
                                
                                
                                
                                0.015
                                
                                
                                
                                1,413,000
                                
                                
                                
                                75-80
                                %Non
      oxide
                                
                                
                                16,429
                                
                                
                                
                                0.023
                                
                                
                                
                                386,000
                                
                                
                                
                                35-40
                                %Subtotal
                                
                                
                                108,411
                                
                                
                                
                                0.017
                                
                                
                                
                                1,799,000Probable
                                
                                Oxide
                                
                                
                                35,287
                                
                                
                                
                                0.017
                                
                                
                                
                                599,000
                                
                                
                                
                                75-80
                                %Non
      oxide
                                
                                
                                7,914
                                
                                
                                
                                0.022
                                
                                
                                
                                176,000
                                
                                
                                
                                35-40
                                %Subtotal
                                
                                
                                43,201
                                
                                
                                
                                0.018
                                
                                
                                
                                775,000Proven
      & Probable
                                
                                Total
                                
                                
                                151,612
                                
                                
                                
                                0.017
                                
                                
                                
                                2,574,000





Mineral
Resources (4) (5) (6)


(Exclusive
of Reserves)





Tons
                                                
                                                
                                                GradeClass
                                                
                                                Type
                                                
                                                
                                                (x 1,000) (2)
                                                
                                                
                                                (Au ozs/ton)Measured
                                                
                                                Oxide
                                                
                                                
                                                —
                                                
                                                
                                                
                                                —Non
      oxide
                                                
                                                
                                                4,707
                                                
                                                
                                                
                                                0.025Subtotal
                                                
                                                
                                                4,707
                                                
                                                
                                                
                                                0.025Indicated
                                                
                                                Oxide
                                                
                                                
                                                63,626
                                                
                                                
                                                
                                                0.011Non
      oxide
                                                
                                                
                                                32,344
                                                
                                                
                                                
                                                0.021Subtotal
                                                
                                                
                                                95,970
                                                
                                                
                                                
                                                0.015Measured
      & Indicated
                                                
                                                Total
                                                
                                                
                                                100,676
                                                
                                                
                                                
                                                0.015Inferred
                                                
                                                Oxide
                                                
                                                
                                                4,958
                                                
                                                
                                                
                                                0.013Non
      oxide
                                                
                                                
                                                4,798
                                                
                                                
                                                
                                                0.022Inferred
                                                
                                                Total
                                                
                                                
                                                9,756
                                                
                                                
                                                
                                                0.018





13





(1)
                The
      term “reserve” means that part of a mineral deposit that can be
      economically and legally extracted or produced at the time of the reserve
      determination.





(2)
                Tonnages
      include allowances for losses resulting from mining methods. Tonnages are
      rounded to the nearest
1,000.





(3)
                Ounces
      are estimates of metal contained in ore tonnages and do not include
      allowances for processing losses. Metallurgical recovery rates represent
      the estimated amount of metal to be recovered through metallurgical
      extraction processes. Ounces are rounded to the nearest
    1,000.





(4)
                Mineral
      resources and mineral reserves are classified in accordance with the
      Canadian Institute of Mining, Metallurgy and Petroleum’s (CIM) “Standards
      on Mineral Resources and Reserves, Definitions and Guidelines”. The
      mineral reserves disclosed above also meet the definition of reserves as
      defined under the United States Securities Commission Industry Guide
      7.





(5)
                CAUTIONARY NOTE TO U.S.
      INVESTORS CONCERNING MEASURED, INDICATED AND INFERRED MINERAL
      RESOURCES: These terms are required by the CIM’s “Standards on
      Mineral Resources and Reserves, Definitions and Guidelines”. U.S. INVESTORS ARE CAUTIONED
      NOT TO ASSUME THAT ALL OR ANY PART OF THE STATED MINERAL RESOURCES WILL BE
      CONVERTED INTO
RESERVES.





(6)
                The
      mineral resource and reserve estimates set out above were prepared under
      the supervision of Mr. W. Hanson, P.Geo., Vice-President of Mine
      Development, Western Goldfields Inc., who is a “qualified person” under
      Canadian National Instrument
43-101.





The term
“economically,” as used in the definition of reserve, means that profitable
extraction or production has been established or analytically demonstrated in a
full feasibility study to be viable and justifiable under reasonable investment
and market assumptions.





The term
“legally,” as used in the definition of reserve, does not imply that all permits
needed for mining and processing have been obtained or that other legal issues
have been completely resolved. However, for a reserve to exist, we must have a
justifiable expectation, based on applicable laws and regulations, that issuance
of permits or resolution of legal issues necessary for mining and processing at
the Mesquite Mine will be accomplished in the ordinary course and in a timeframe
consistent with our current mine plan.




The
Company’s disclosure includes the terms
mineral resources and mineral reserves, as defined by the Canadian Institute of
Mining, Metallurgy and Petroleum’s Standards on Mineral Resources and
Reserves. The company’s disclosure also meets the definition of reserves, proven
reserves, and probable reserves as defined by the United States Securities and
Exchange Commission’s Industry Guide 7.




14





Exploration
and environmental matters





Our
exploration, production and processing operations are extensively regulated
under various U.S. federal, state and local laws and regulations relating to the
protection of air and water quality, hazardous waste management and mine
reclamation. These laws and regulations are subject to change and could
substantially increase our liability or the costs of compliance. This could have
a material adverse effect on our operations or financial position. In addition,
whenever a previously unrecognized remediation claim becomes known or a
previously estimated cost is increased, the additional costs could have a
material adverse effect on our operations or financial position.





We
believe that we operate Mesquite in compliance with all local, state and federal
regulations. Stipulations in permits and approvals issued in respect of the Mine
further define the site requirements. Based on our mode of operations,
compliance with local, state and federal regulations relating to the protection
of the environment is expected to require expenditures of approximately $0.3
million in 2009.


On
November 7, 2003, we secured a bonding and insurance plan through American
International Specialty Lines Insurance Company (“AIG Insurance”) in respect of
the operations and certain closure liabilities at Mesquite. We paid the
insurance company initial premiums of $7.7 million, comprising $6.0
million in respect of the net present value of expected reclamation costs
and $1.7 million for an excess liability policy covering pollution and
reclamation obligations up to $14.0 million. The insurance company has provided
a series of environmental insurance programs designed to cap our liability for
reclamation and closure costs, including cost overruns as a result of unexpected
contamination, increased costs and legislative changes. The plan provided $8.7
million in bonds in favor of government agencies. As a result of increases in
proven and probable reserves in August 2006 and March 2007, which increased the
life of the mine by a total of two years, we agreed with AIG Insurance and the
regulatory agencies to revisions in our reclamation cost estimates. As a result,
in May 2007 the bonding program was increased by $2.6 million to $11.3 million,
and we were required to place an additional $2.1 million in the reimbursement
account. There were no additional changes to the program in 2008.
  The
insurance program covers closure and reclamation risk in excess of the amount
covered by the reimbursement account with AIG Insurance, to an aggregate limit
of $17.5 million (2007 - $8.7 million), and expires November 7, 2020. During
2007, the program limit and term were increased from $14.0 million and November
7, 2014 respectively.





The
insurance program also covers pollution and remediation risk up to $10.0
million. Coverages pertaining to existing conditions and new conditions expire
on November 7, 2013 and November 7, 2009 respectively. During 2007, the program
limit was increased from $5.0 million.





Once
closure of the heap leach pad covered by the bonds has started, we submit claims
to the insurer to release funds from the reimbursement account to pay for the
reclamation and closure expenditures as they are incurred. Any revenue from the
sale of material is to our account and any gains from cost savings in the actual
program versus the bonded amount will be released to us when the project bonding
is released.





Competition





While a
market for our product is always assured, we nevertheless face competitive
pressures in all aspects of our activities, including: the sourcing of
investment capital, the acquisition of economically attractive exploration
properties and existing mineral resources, attracting and retaining a skilled
and experienced workforce, and acquiring raw materials, capital equipment and
technical resources on an economic and timely basis.





Our
competitors include large international mining companies, independent producers
and numerous small companies and individuals, many of whom may have greater
financial, technical and other resources at their disposal. In general,
companies producing from properties with a higher grade of recoverable mineral
or which are more readily mineable are at a competitive advantage in that the
cost of production of the final mineral product is lower.





Mines
have limited lives and as a result, in the future we may identify and try to
acquire new exploration properties. There is a limited supply of desirable
mineral lands available in the United States where we would consider conducting
exploration activities. As a result of competitive pressures from other mining
companies, we may be unable to acquire attractive new mining properties on terms
that we consider acceptable.





Employees





As of
March 5, 2009, we had 235 employees, including our five executive officers. None
of our employees are represented by a labor union. We consider our relationships
with our employees to be good.





15





Insurance





We have
the following insurance coverages which are effective until November 7,
2009:





Policy Type
                      
                      LimitUmbrella
      Liability
                      
                      $
                      25,000,000Commercial
      General Liability
                      
                      
                      2,000,000Directors
      and Officers Liability
                      
                      
                      15,000,000Business
      Automotive
                      
                      
                      1,000,000Workers
      Compensation
                      
                      $
                      2,000,000




In
addition we have the following insurance coverages which are effective until the
dates noted:





ExpiryPolicy Type
                          
                          Date
                          
                          LimitCommercial
      Property / Builders’ Risk (1)
                          
                          Jun.
      1, 2009
                          
                          $
                          100,000,000Fiduciary
      Liability
                          
                          Nov.
      7, 2009
                          
                          
                          1,000,000Commercial
      Crime
                          
                          Jan.12,
      2010
                          
                          
                          3,000,000Pollution
      Legal Liability (2)
                          
                          Nov.
      7, 2013
                          
                          
                          10,000,000Reclamation
      Costs Policy
                          
                          Nov.
      7, 2020
                          
                          $
                          17,500,000





(1)
              Includes
      $10,000,000 Business Interruption.(2)
              Includes
      $5,000,000 excess coverage for new conditions and pre-existing conditions
      expiring Nov.7, 2009 and Nov.7, 2013,
  respectively.





We
believe that we maintain insurance at levels that are consistent with industry
standards and sufficient for companies of our size and scope.





Future
landfill development





When
Mesquite was owned by Hanson Natural Resource Company (“HNRC”), a permanent
landfill facility was permitted on a portion of the lands occupying the
south-west sector of the property. The lands on which portions of the landfill
were to be constructed were originally administered by the BLM and were
subsequently acquired by HNRC by way of a land “swap”. In 1993, a Mineral Lease
and Landfill Facilities Agreement (“the Landfill Agreement”) was signed between
HNRC on the one hand and Hospah Coal Company (“Hospah”), a subsidiary of
Newmont, and Santa Fe on the other. The LACSD is now the successor to HNRC and
we assumed the rights and obligations of Hospah / Santa Fe / Newmont when we
acquired the entire Mesquite operations on November 9, 2003.





The
Landfill Agreement sets out the parties’ respective rights and obligations with
respect to real property, overburden, and ore material. The general objective of
the Landfill Agreement is to enable us to freely and profitably develop and
operate the Mine, and for LACSD to freely and profitably operate the landfill.
This will be accomplished by:


·
            cooperation
      and coordination between the
parties;





·
            avoidance
      and minimization of conflicts arising through the respective
      operations;





·
            ensuring
      that one party’s operations do not result in greater costs for the other
      party;





·
            joint
      utilization of certain properties, facilities and
    resources;





·
            mutual
      benefit through efficient and thorough use of resources, including
      recycling of overburden and spent ore, and optimization of efficiency,
      capabilities and profitability of the parties’ respective
      operations.





Under the
Agreement we have the right to explore for, mine, extract, process, market and
sell ore, and otherwise conduct mining and processing activities, anywhere on
the property for an initial period through 2024 with automatic extensions until
2078. LACSD began active landfill operations in late 2008 transporting refuse
from Los Angeles County to the landfill site at Mesquite.





16





Title
and liabilities - real property





Under the
1993 Agreement, LACSD has retained all reclamation and environmental
responsibilities as of the closing date which were legally required to be
completed and performed with respect to the Hospah owned property (as
distinguished from overburden and ore material) and the Santa Fe leased property
prior to that date.





Title
and liabilities - overburden





Title to
existing overburden and overburden stockpiles at Mesquite as at the date of the
1993 Agreement with LACSD was transferred to LACSD. Ownership of overburden
material placed on the leased property after that date transfers to LACSD on its
placement. We have assumed all reclamation and environmental responsibilities
with respect to overburden existing as of the closing date of the 1993 Agreement
and incurred after that date. The agreement makes provision for us to use
material in connection with our mining operations and for reimbursement to us of
any incremental costs incurred in moving material to accommodate LACSD
operations.





Title
and liabilities - ore, spent ore and associated materials (“Ore
Material”)





We
acquired the ore material that was on the leach pad on the lease property at the
date of the 1993 Agreement, but LACSD has retained reclamation and environmental
responsibilities up to that date. Ownership of the underlying pad and real
property remains with LACSD, subject to the mining lease. Ownership of ore
material placed on the pad after the 1993 Agreement belongs to us and we retain
reclamation and environmental responsibilities. The 1993 Agreement provides that
we are to locate any new leach pad and stockpiled ore on the leased property and
also on the LACSD owned property if necessary for efficient treatment of
ore.





We are
obligated to rinse and neutralize spent ore in accordance with the approved
reclamation plan and certify this fact to our regulators. On acceptance of this
certification by LACSD, the leach pad and real property involved will then be
eliminated from our lease and the title to the spent ore will be conveyed to
LACSD.





If LACSD
requires rinsing and neutralization beyond applicable licenses and laws, it will
reimburse us for our incremental costs, with any additional gold recovery being
used as an offset. If we are operationally unable to perform supplementary
rinsing and neutralizing, LACSD can do this at its expense and retain any
additional gold recovery.





LACSD may
at its cost remove rinsed and certified spent ore, which has been conveyed to
it, from the pad for purposes of the landfill. It will then assume reclamation
and environmental responsibilities for this material and reimburse us for any
incremental cost as a result of such removal. LACSD will assume reclamation and
environmental responsibilities for the leach pad and associated real property
only to the extent actually occupied by LACSD and incorporated by construction
into the landfill project.





LACSD has
the right to terminate the lease in respect of any leach pad and the associated
real property on giving reasonable advance notice (1) after ore on the pad has
reached design load capacity and further leaching is not economic; or (2) more
than five years following cessation of regular leaching; in which event LACSD
will pay us any damages in connection with the loss of prospective profits from
recoverable gold left on the pad, according to calculations contained in the
1993 Agreement.





ITEM
1A.    RISK FACTORS





Factors
that could cause our actual results to differ materially from those described in
the forward-looking statements contained in this Form 10-K and other documents
we file with the Securities and Exchange Commission include the risks described
below. You should also refer to the other information in this Annual Report on
Form 10-K, including the financial statements and accompanying notes
thereto.





Risks
Related To Our Operations





If we should
experience significant net operating
losses, we may need additional financing to fund our operations, which may not
be available to us.





We
emerged from dormancy in 1999 to pursue mineral exploration and development
opportunities, and we have a limited operating history in our current form.
Since we reorganized our business in 2003, we have incurred operating costs in
each quarter but only began to generate any revenue in January 2004. With the
resumption of mining operations in mid 2007 and gold production from new ore
beginning in January 2008 we expect to generate positive cash flow in 2009 and
beyond, however, we have a cumulative deficit in shareholders’ equity of
approximately $61.6 million as at December 31, 2008.





To date
we have been largely dependent on equity and debt financing to carry out our
expansion plans at Mesquite. If our operations do not generate positive cash
flow in future, additional financing may not be available when needed or on
acceptable terms, if at all.   If we are unable to raise
additional financing when necessary, we may have to delay our exploration,
development and production efforts or any property acquisitions or be forced to
cease operations.




17





Exploration
and production may not prove successful, will involve risks and have no
guaranteed outcome.





Although
the resumption of mining operations at Mesquite was based on a positive
feasibility study incorporating substantial volumes of drilling data, our
business operations are subject to risks and hazards inherent in the mining
industry. The reactivation of the Mine and the exploration for additional
reserves involve significant risks that even a combination of careful
evaluation, experience and knowledge may not eliminate.





Our
exploration and production may be hampered by mining, heritage and environmental
legislation, industrial accidents, industrial disputes, cost overruns, land
claims and compensation and other unforeseen contingencies. Our success also
depends on the delineation of economically recoverable reserves, the
availability and cost of required development capital, movement in the price of
commodities, as well as obtaining all necessary consents and approvals for the
conduct of our production and exploration activities.





Exploration
and production at the Mesquite Mine may prove unsuccessful. Mineable reserves
may become depleted resulting in a reduction of the value of those tenements and
a diminution in our cash flow and cash reserves as well as possible
relinquishment of the exploration and mining tenements.





Risks
involved in mining operations include unusual and unexpected geologic
formations, seismic activity, rock bursts, cave-ins, flooding and other
conditions involved in the drilling and removal of any material, any of which
could result in damage to life or property, environmental damage and possible
legal liability.





Whether
income will result from the Mesquite Mine depends on the successful
establishment of mining operations. Factors including costs, actual
mineralization, consistency and reliability of ore grades and commodity prices
affect successful project development. The reactivation and efficient operation
of processing facilities, the existence of competent operational management and
prudent financial administration, as well as the availability and reliability of
appropriately skilled and experienced consultants also can affect successful
project development.





We have
235 full-time
employees including our executive officers, and we are dependent on our
directors, officers and third-party contractors.





We have
five executive officers and 230 other individuals who are full time employees.
Our management team at Mesquite is comprised of six people. We also engage
consultants from time to time. Although we believe that we have a talented team
in place, competition for skilled personnel, notably geologists and engineers,
is intense and there is no assurance that we will be able to hire and retain
such personnel in the future. We are also dependent upon the efforts and
abilities of our officers and directors. While much of our operations are
handled by our employees, our directors and officers direct our policies and
manage our operations. The loss of any one of these individuals could adversely
affect our business.





Our
business is dependent on good labor and employment relations.





Production
at the Mesquite Mine is dependent upon the efforts of our employees. Relations
between us and our employees may be impacted by changes in labor relations which
may be introduced by, among others, employee groups, unions, and the relevant
governmental authorities in whose jurisdictions we carry on business. Adverse
changes in such legislation or in the relationship between us and our employees
may have a material adverse effect on our business, results of operations, and
financial condition.





If we do
not continually place
new ore in sufficient quantities and of adequate grade on the leach pad, we will
be unable to achieve or maintain targeted production levels.





We must
continually place fresh gold-bearing ore on the leach pad to replace current
production. Depleted deposits must be replaced by expanding operations on our
existing property or by locating new deposits in order for us to maintain our
production levels over the long term. Although our Feasibility Study and mine
plan indicate that, based on certain major assumptions as to the selling price
of gold and cost inputs, economic deposits will be available for the life of the
Mine, there can be no assurance that this will in fact be the case. Success in
exploration for gold is uncertain. There is no assurance that we will continue
to find additional commercially viable mineral deposits on our property. As a
result, our metals inventory may decline as minerals are produced without
adequate replacement.


Estimates
of proven and probable deposits are uncertain, and any inaccuracies could result
in the estimates being overstated.





Estimates
of proven and probable deposits and costs of goods sold are subject to
considerable uncertainty. Such estimates are, to a large extent, based on
interpretations of geologic data obtained from drill holes and other sampling
techniques. Gold producers use feasibility studies to derive estimates of costs
of goods sold based upon anticipated tonnage and grades of minerals to be mined
and processed, the predicted configuration of the deposits, expected recovery
rates, comparable facility, equipment and operating costs, and other factors.
Actual costs of goods sold and economic returns on projects may differ
significantly from original estimates. It could take several years from initial
drilling of an area at Mesquite until it is brought into production and, during
that time, the economic feasibility of exploiting the area may change. Any
significant inaccuracies in the interpretations or assumptions used or changes
in conditions could cause the quantities and net present value of the Mesquite
deposit to be overstated. The data included and referred to in this annual
report represent only estimates. You should not assume that the present value
referred to in this annual report represents the current market value of our
estimated deposits.




18





A shortage of equipment and supplies
could adversely affect our ability to operate our business.





We are
dependent on the availability of key supplies and equipment to carry out our
mining operations. This risk has been heightened by the increased level of
activity in the mining industry worldwide in recent years. The shortage of such
supplies, equipment and parts could have a material adverse effect on our
ability to carry out our operations and therefore limit or increase the cost of
production.





Increased
costs could affect our financial condition.





Costs at
the Mesquite Mine are subject to variation due to factors, such as changing ore
grade, metallurgy and revisions to mine plans in response to the physical shape
and location of the ore body. Operating costs can be significantly affected by
volatility in the price of various commodities, notably fuel and electricity.
Such commodities are at times subject to volatile price movements, including
increases that could make production at certain operations less profitable.
Increases in the price of these major cost drivers could have a significant
effect on our profitability.





Unforeseen
title defects may result in a loss of entitlement to production and
reserves.





In common
with many mineral properties, our ownership of Mesquite could be subject to
prior undetected claims or interests. Although we performed a title review of
the Mine in 2007 as a pre-condition to establishing our term loan facility, this
does not guarantee or certify that an unforeseen defect in title will not arise
to defeat a claim by us. If any such defect were to arise, our entitlement to
the reserves associated with the Mesquite Mine could be jeopardized, and could
have a material adverse effect on our financial condition, results of operations
and our ability to timely execute our business plan.





Our
business activities are subject to extensive laws and regulations that expose us
to significant compliance costs and the risk of lawsuits.





Our
operations and exploration and development activities are subject to extensive
United States and Canadian federal, state, provincial and local laws and
regulations governing various matters, including:





·
              taxation;





·
              mining
      royalties;





·
              environmental
      protection; and





·
              labor
      standards and occupational health and safety, including mine
      safety.





The costs
associated with compliance with these laws and regulations are substantial and
possible future laws and regulations, changes to existing laws and regulations
or more stringent enforcement of current laws and regulations by governmental
authorities, could cause additional expense, capital expenditures, restrictions
on or suspensions of our operations and delays in the development of the
Mesquite Mine. Moreover, these laws and regulations may allow governmental
authorities and private parties to bring lawsuits based upon damages to property
and injury to persons resulting from the health and safety impacts of our past
and current operations, and could lead to the imposition of substantial fines,
penalties or other civil or criminal sanctions.




Our
operations are subject to numerous governmental permits which are difficult to
obtain and we may not be able to obtain or renew all of the permits we
require.





In the
ordinary course of business, we are required to obtain and renew governmental
permits for the operation, re-commissioning and expansion of the Mesquite Mine.
Obtaining or renewing the necessary governmental permits is a complex and
time-consuming process involving costly undertakings on our part. The duration
and success of our efforts to obtain and renew permits are contingent upon many
variables not within our control including the interpretation of applicable
requirements implemented by the permitting authority. We may not be able to
obtain or renew permits that are necessary to our operations, or the cost to
obtain or renew permits may exceed our estimates. Failure to comply with
applicable environmental and health and safety laws and regulations may result
in injunctions, fines, suspension or revocation of permits and other penalties.
There can be no assurance that we have been or will at all times be in full
compliance with all such laws and regulations and with our environmental and
health and safety permits or that we possess all required permits. The costs and
delays associated with compliance with these laws, regulations and permits and
with the permitting process could prevent us from continuing with the operation
or development of Mesquite or could increase the costs of development or
production and materially adversely affect our business, results of operations
or financial condition.




19





We
are subject to substantial costs for compliance with environmental laws and
regulation and may be subject to substantial costs for liability related to
environmental claims.





Our
exploration, production and processing operations are extensively regulated
under various U.S. federal, state and local laws relating to the protection of
air and water quality, hazardous waste management, endangered species, and mine
reclamation. We may be subject to future liability for environmental costs,
including capital costs to comply with environmental laws, costs associated with
the remediation of soil or groundwater contamination at our current and formerly
owned or operated properties, and reclamation and closure costs upon cessation
of our operations at the Mesquite Mine. In addition, we may be subject to
reclamation costs for our claims, even if we have not conducted the activity on
those properties. Further, the regulatory environment for our operations could
change in ways that would substantially increase our liability or the costs of
compliance and that could have a material adverse effect on our operations or
financial position.





Various
laws and permits require that financial assurances be in place for certain
environmental and reclamation obligations and other potential liabilities.
Without adequate insurance we may be unable to undertake further trenching,
drilling or development or continue operations at Mesquite until we obtain
financial assurances to cover potential liabilities. We have an existing
insurance policy for our reclamation costs at the Mesquite Mine. During 2007 we
negotiated amendments to the policy resulting in increased limits and extension
of the term of coverage to reflect increases in reclamation costs due to
expansion at Mesquite. Such insurance coverage will be subject to review from
time to time and there can be no guarantee that it will be available on
acceptable terms in the future.





We
are treated as a U.S. corporation for U.S. federal income tax
purposes.




Even
though we are organized as a Canadian corporation, we are treated as a U.S.
corporation for all U.S. federal income tax purposes.  Our status as a
U.S. corporation generally will have implications for both non-U.S. and U.S.
shareholders.  If we pay dividends, any dividends paid to non-U.S.
shareholders will be subject to U.S. federal tax withholding at a rate of 30% of
the gross amount of the dividends, unless the rate is reduced under an
applicable income tax treaty.  Any dividends paid to non-Canadian
shareholders, including U.S. shareholders, generally will be subject to Canadian
withholding tax.  Such dividends will not constitute foreign source
income for U.S. shareholders, and U.S. shareholders may not be able to claim a
U.S. foreign tax credit for any Canadian withholding tax unless such U.S.
shareholders have sufficient other foreign source income.  The gross
amount of dividends will also be included in a U.S. shareholder’s gross income,
which may result in double taxation to U.S. shareholders.  Such
dividends will not constitute foreign source income for Canadian shareholders
for Canadian tax purposes, and Canadian shareholders would not be able to claim
a Canadian foreign tax credit for any U.S. withholding tax.  The
dividends will also be subject to the standard Canadian tax rules applicable to
taxable dividends received by a Canadian shareholder from a Canadian corporation
and which would result in double taxation.




We
may be a “U.S. real property holding corporation,” which may result in
significant U.S. federal income tax consequences for non-U.S.
shareholders.




We may be
a “U.S. real property holding corporation” for U.S. federal income tax
purposes.  If we have been a U.S. real property holding corporation at
any time during the shorter of the five-year period ending on the date a
non-U.S. shareholder disposes of our shares or the period during which the
non-U.S. shareholder has held our shares, the non-U.S. shareholder will be
subject to U.S. federal income tax on any gain realized on the
disposition.  Such gain will be taxed at the rates applicable to U.S.
persons, and the non-U.S. shareholder generally will need to file a U.S. federal
income tax return.  As long as our shares are considered to be
“regularly traded” on an established securities market, including the Toronto
Stock Exchange and NYSE Alternext, the U.S. tax on gain will only apply to
non-U.S. shareholders who have directly or indirectly held 5% or more of our
stock at any time during the shorter of the five-year period ending on the date
a non-U.S. shareholder disposes of our shares or the period during which the
non-U.S. shareholder has held our shares.  If our stock ceases to be
regularly traded on an established securities market, all non-U.S. shareholders
would be taxed on any gain realized on disposition of our shares.  We
encourage our non-U.S. shareholders to consult with their personal tax advisors
regarding the U.S. federal income tax consequences to them if we are a U.S. real
property holding corporation.  Any capital gain resulting from the
sale will not constitute foreign source income for Canadian shareholders for
Canadian tax purposes, and Canadian shareholders would not be able to claim a
Canadian foreign tax credit or deduction in computing income in respect of such
U.S. tax.




Risks
Related To Our Industry





If
the world-wide financial crisis continues, the volatility and disruptions in the
capital and credit markets could adversely affect our business, including
affecting the cost of new capital, our ability to refinance our scheduled debt
maturities and meet our other obligations as they come due.





The
capital and credit markets have been experiencing extreme volatility and
disruption. In the fourth quarter of 2008, the volatility and disruption reached
unprecedented levels. The markets have exerted extreme downward pressure on
stock prices and upward pressure on the cost of new debt capital and have
severely restricted credit availability for most issuers.




20





The
disruptions in the capital and credit markets have also resulted in higher
interest rates on public issuances of debt securities and increased costs under
credit facilities. Continuation of these disruptions could increase our interest
expense, adversely affecting our results of operations and financial
position.





Our
access to funds under our credit facility is dependent on the ability of the
financial institutions that are parties to the facility to meet their funding
commitments. Those financial institutions may not be able to meet their funding
commitments if they experience shortages of capital and liquidity or if they
experience excessive volumes of borrowing requests within a short period of
time. Moreover, the obligations of the financial institutions under our credit
facility are several and not joint and, as a result, a funding default by one or
more institutions does not need to be made up by the
others.


Longer
term volatility and continued disruptions in the capital and credit markets as a
result of uncertainty, changing or increased regulation of financial
institutions, reduced alternatives or failures of significant financial
institutions could adversely affect our access to the liquidity needed for our
businesses in the longer term. Such disruptions could require us to take
measures to conserve cash until the markets stabilize or until alternative
credit arrangements or other funding for our business needs can be
arranged.





We
are dependent on the price of gold, which is subject to numerous factors beyond
our control. A substantial or extended decline in gold prices would have a
material adverse effect on our revenues, profits and cash flows.





Our
business is extremely dependent on the price of gold, which is affected by
numerous factors beyond our control. Factors tending to put downward pressure on
the price of gold include:





·
              sales
      or leasing of gold by governments and central
  banks;





·
              a
      low rate of inflation and a strong U.S.
dollar;





·
              global
      and regional recession or reduced economic
  activity;





·
              speculative
      trading;





·
              the
      demand for gold for industrial uses, use in jewelry, and
      investment;





·
              high
      supply of gold from production, disinvestment, scrap and
      hedging;





·
              interest
      rates;





·
              sales
      by gold producers in forward transactions and other
    hedging;





·
              the
      production and cost levels for gold in major gold-producing nations;
      and





·
              the
      cost level (in local currencies) for gold in major consuming
      nations.





Any drop
in the price of gold would adversely impact our future revenues, profits and
cash flows. In addition, sustained low gold prices can:





·
              reduce
      revenues further by production cutbacks due to cessation of the mining of
      deposits or portions of deposits that have become uneconomic at the
      then-prevailing gold price;





·
              halt
      or delay the development of new projects;
and





·
              reduce
      funds available for exploration, with the result that depleted minerals
      are not replaced.





During
the last five years, the average annual market price of gold has fluctuated
between $406 per ounce and $872 per ounce, as shown in the table
below.





2004
                        
                        
                        2005
                        
                        
                        2006
                        
                        
                        2007
                        
                        
                        2008$
                        406
                        
                        
                        $
                        445
                        
                        
                        $
                        603
                        
                        
                        $
                        696
                        
                        
                        $
                        872




21




Our
operations may be adversely affected by risks and hazards associated with the
mining industry.





Our
business is subject to a number of risks and hazards including adverse
environmental effects, technical difficulties due to unusual or unexpected
geologic formations, and pit wall failures.





Such
risks could result in personal injury, environmental damage, damage to and
destruction of our production facility, delays in mining and liability. For some
of these risks, we maintain insurance to protect against these losses at levels
consistent with our historical experience and industry practice. However, we may
not be able to maintain current levels of insurance, particularly if there is a
significant increase in the cost of premiums. Insurance against environmental
risks is generally expensive and may not continue to be available for us and
other companies in our industry. Our current policies may not cover all losses.
Our existing policies may not be sufficient to cover all liabilities arising
under environmental law or relating to hazardous substances. Moreover, in the
event that we are unable to fully pay for the cost of remedying an environmental
problem, we might be required to suspend or significantly curtail operations or
enter into other interim compliance measures.





We
have numerous competitors in the mining industry, many of whom have greater
resources and technical capacity than we do and, as a result, we may be unable
to effectively compete.





Mineral
exploration and mining is competitive in all of its phases. We compete with
numerous other companies and individuals, including some with greater financial,
technical and other resources than us, in the search for and the acquisition of
attractive mineral properties. Our ability to operate successfully in the future
will depend not only on our ability to develop the Mesquite Mine, but also on
our ability to select and acquire suitable producing properties or prospects for
mineral exploration. We may be unable to compete successfully with our
competitors in acquiring such properties or prospects on terms we consider
acceptable, if at all, which could have a material adverse effect on our future
operations.





Gold
producers must continually obtain additional reserves.





Gold
producers must continually replace reserves depleted by production. Depleted
reserves must be replaced by expanding known ore bodies or by locating new
deposits in order for producers to maintain production levels over the long
term. Exploration is highly speculative in nature, involves many risks and
frequently is unproductive. No assurances can be given that any of our new or
ongoing exploration programs will result in new mineral producing operations.
Once mineralization is discovered, it may take many years from the initial
phases of drilling until production is possible, during which time the economic
feasibility of production may change.





Risks
Related To Our Common shares





We
will likely require additional capital in the future and no assurance can be
given that such capital will be available at all or available on terms
acceptable to us.





Although
we believe that the Mesquite expansion is fully funded, in order to finance the
future growth of our business, it is likely that we will need to raise further
capital. The success and the pricing of any such financing will be dependent
upon the prevailing market conditions at that time. If additional capital is
raised by an issue of securities, this may have the effect of diluting the
interests of our existing shareholders. Any debt financing, if available, may
involve financial covenants that limit our operations. If we cannot obtain such
additional financing, we may be required to reduce the scope of any activities
that could adversely affect our business, operating results and financial
condition.





Failure
to achieve and maintain effective internal control over our financial reporting
in accordance with the rules of the SEC could harm our business and operating
results and/or result in a loss of investor confidence in our financial reports,
which could have a material adverse effect on our business and stock
price.





As a
public company, we are required to fully comply with Section 404 of the
Sarbanes-Oxley Act, and, beginning in fiscal, 2008, to obtain an annual
attestation from our independent auditors regarding our internal control over
financial reporting in addition to our management’s assessment of internal
control over financial reporting. While management has designed or caused to be
designed internal controls over financial reporting procedures, and has found
those procedures to be effective as of December 31, 2008, upon completion of our
auditor’s evaluation, we identified control weaknesses of varying degrees of
severity under applicable SEC and Public Company Accounting Oversight Board
rules and regulations that remain unremediated.  At December 31, 2008
we do not have control deficiencies that constitute a “material weakness” or
changes in internal controls that materially affect, or are reasonably likely to
materially affect internal controls over financial reporting. A “material
weakness” is a significant deficiency or combination of significant deficiencies
that results in more than a remote likelihood that a material misstatement of
the annual or interim financial statements will not be prevented or
detected.  Failure to maintain an effective system of internal control
may result in inaccurate reporting of our financial results or failure to
prevent fraud.  Failure to maintain effective internal controls in
compliance with Section 404 or the report by us of a material weakness may cause
investors to lose confidence in our financial statements, and could have a
material adverse effect on our business and stock price.  If we fail
to remedy any future material weakness, our financial statements may be
inaccurate, we may face restricted access to the capital markets and our stock
price may be adversely affected. See “Item 9A - Controls and
Procedures”.





22





All
of our directors and officers may not be subject to legal process in the United
States.





Our
directors and officers reside in Canada and the United Kingdom. As a result, it
may be difficult or impossible to effect service of process within the United
States upon those individuals, to bring suit against any of those individuals in
the United States or to enforce in the United State courts any judgment obtained
there against any of those individuals predicated upon any civil liability
provisions of the United States federal securities laws. Investors should not
assume that Canadian or British courts will enforce judgments of United States
federal securities courts against any director or officer residing in Canada or
the United Kingdom, including judgments obtained in actions predicated upon the
civil liability provisions of the United States federal securities laws or the
securities or “blue sky” laws of any state within the United States, or will
enforce, in original actions, liabilities against such directors or officers
predicated upon the United States federal securities laws or any such state
securities or blue sky laws.





We
may experience volatility in our stock price.





The
market price of our common shares may fluctuate significantly in response to a
number of factors, some of which are beyond our control, including:





·
              quarterly
      variations in operating
results;





·
              changes
      in financial estimates by securities
analysts;





·
              changes
      in market valuations of other similar
companies;





·
              announcements
      by us or our competitors of new products or of significant technical
      innovations, contracts, acquisitions, strategic partnerships or joint
      ventures;





·
              additions
      or departures of key
personnel;





·
              any
      deviations in net sales or in losses from levels expected by securities
      analysts; and





·
              future
      sales of common shares.





As a
result of any of these factors, the market price of our shares of common shares
at any given point in time may not accurately reflect our long-term value.
Securities class action litigation often has been brought against companies
following periods of volatility in the market price of their securities. We may
in the future be the target of similar litigation. Securities litigation could
result in substantial costs and damages and divert management’s attention and
resources.





Any future
restatement of our financial statements may adversely affect the trading price
of our common
shares.





In August
2006 we completed the restatement of our consolidated financial statements for
the years ended December 31, 2005 and 2004, and we believe they are presented in
accordance with the requirements of United States generally accepted accounting
principles. However, such restatements do not prevent future changes or
adjustments, including additional restatements. If there were future
restatements of our consolidated financial statements, such restatements may
adversely affect the trading price of our common shares.





We
have not paid dividends in the past and do not anticipate doing so in the
future.





To date,
we have not paid any dividend on our shares of common shares. We believe that
our cash flow can best be deployed in growing our business and we do not intend
to declare or pay any cash dividends in the foreseeable future. Payment of any
future dividends will be at the discretion of our board of directors, after
taking into account many factors, including our operating results, financial
condition, and current and anticipated cash needs.





Risk
Related to the Business Combination with New Gold and Operations of the Combined
New Gold and Western Goldfields (the “Combined Company”)





There
can be no certainty that all conditions precedent to the Transaction will be
satisfied.  Failure to complete the Transaction could negatively
impact the share price of Western Goldfields or otherwise adversely affect our
business.





The
completion of the Transaction is subject to a number of conditions precedent,
certain of which are outside our control, including receipt of shareholder,
court and regulatory approvals.  There can be no certainty, nor can we
provide any assurance, that these conditions will be satisfied or, if satisfied,
when they will be satisfied.  If the Transaction is not completed, the
market price of our common shares may decline to the extent that the market
price reflects a market assumption that the Transaction will be completed. If
the Transaction is not approved and or if we decide to seek another merger or
business combination, there can be no assurance that we will be able to find a
party willing to pay an equivalent or more attractive price than the
consideration to be paid pursuant to the Transaction.




23





Certain
costs related to the Transaction, such as legal, accounting and certain
financial advisor fees, must be paid by Western Goldfields even if the
Transaction is not completed. If the Transaction is not completed, we may also
be required to pay a termination fee of Cdn. $8.8 million or Cdn. $0.75 million
as an expenses payment in the Transaction is not approved by our
shareholders.





Risks
associated with the fixed consideration.





Pursuant
to the provisions of the agreement with respect to the Transaction, each of our
common share will be exchanged for one New Gold common share and a nominal cash
consideration. This consideration is fixed and it will not increase or decrease
due to fluctuations in the market price either of the New Gold common shares or
the Western Goldfields common shares.  The implied value of the
consideration that our shareholders will receive pursuant to the Transaction
will depend on the market price of the New Gold common shares on the effective
date of the Transaction. If the market price of the New Gold common shares
increases or decreases, the value of the consideration that our shareholders
receive pursuant to the Transaction will correspondingly increase or
decrease.  There can be no assurance that the market price of the New
Gold common shares on the effective date of the Transaction will not be lower
than the market price of such shares on the date hereof.  In addition,
the number of New Gold common shares being issued in connection with the
Transaction will not change despite decreases or increases in the market price
of our common shares. Many of the factors that affect the market price of the
New Gold common shares and our common shares are beyond the control of New Gold
and Western Goldfields, respectively. These factors include fluctuations in
commodity prices (most importantly gold), fluctuations in currency exchange
rates, changes in the regulatory environment, adverse political developments,
prevailing conditions in the capital markets and interest rate
fluctuations.





Uncertainties
associated with the Transaction.





The
Transaction will involve the integration of companies that previously operated
independently. An important factor in the success of the Transaction will be the
ability of the management team of the Combined Company to integrate all or part
of the operations, systems, technologies and personnel of New Gold and Western
Goldfields following the completion of the transaction. The Transaction and/or
the integration of the two businesses may result in unanticipated operational
problems and interruptions, expenses and liabilities, the diversion of
management attention and the loss of key employees, customers or suppliers.
There can be no assurance that the Transaction and business integration will be
successful or that the combination will not adversely affect the business,
financial condition or operating results of the Combined Company. In addition,
Combined Company may incur costs related to the Transaction and related to
integrating the two companies. There can be no assurance that Combined Company
will not incur additional material costs in subsequent quarters to reflect
additional costs associated with the Transaction or that that the benefits
expected from the Transaction will be realized.
 
 The
Termination Fee provided under the Arrangement Agreement governing the terms of
the Transaction may discourage other parties from attempting to acquire
us.


Under the
business combination agreement with New Gold, we are required to pay a
termination fee of Cdn$8.8 million in the event the agreement is terminated in
certain circumstances.  This termination fee may discourage other
parties from attempting to acquire our company, even if those parties would
otherwise be willing to offer greater value to our shareholders than that
offered by New Gold under the Transaction.





Risk
Factors Regarding New Gold and its business.





The Combined Company will be subject to
most if not all of the risk factors currently affecting New Gold and its
business and operations. Readers should review the disclosure documents filed by
New Gold on www.sedar.com in order to become informed with respect to the
business, operations and risk factors of New Gold.


24


ITEM
1B.  UNRESOLVED STAFF COMMENTS





None.





ITEM
2.     PROPERTIES





As of
December 31, 2008, we owned or retained interests in properties comprising the
Mesquite Mine more fully described in Part 1, Item 1(b) “Description of Mesquite
Mine”.





Since
June 2006 our head office has been located in Toronto, Ontario, Canada, where we
share premises with Silver Bear Resources Inc. (“Silver Bear”), a related party
through certain senior executives and a director of Silver Bear also serve as a
senior executive and as a director of Western Goldfields. Under a cost sharing
agreement with Silver Bear, we were charged with 50% of the rental and operating
costs of the space occupied when the office was leased by Silver Bear. During
the year ended December 31, 2008 overhead costs of $0.2 million were charged by
Silver Bear to Western Goldfields under this agreement (2007 - $0.3
million).





We
relocated our Toronto head office in June of 2008 and we have entered into a
lease for the ten year period commencing June 1, 2008. Estimated rental and
operating costs over the first year of the lease is approximately $0.5 million
and over the ten year term is approximately $5.4 million. As a result of Western
Goldfields entering into the new lease we charged Silver Bear for their
proportional share under the cost sharing agreement.  During the year
ended December 31, 2008 overhead costs, including lease costs for the new
premises, of $0.5 million were charged by Western Goldfields to Silver
Bear.  At December 31, 2008 $23,000 (2007 - $31,000) was payable to
Silver Bear.





In
November 2008, a new cost sharing agreement was reached between Silver Bear and
Western Goldfields with an effective date of January 1, 2009.  The new
agreement amends cost sharing ratios between the two companies to one-third
recovery of shared costs from Silver Bear which reflects the current level of
activities and Western Goldfields would initially incur the costs.





ITEM
3.    LEGAL PROCEEDINGS





The
Company is involved in legal proceedings from time to time, arising in the
ordinary course of its business.  Typically, the amount of ultimate
liability with respect to these actions will not, in the opinion of management,
materially affect Western Goldfields’ financial position, results of operations
or cash flows.





In
assessing loss contingencies related to legal proceedings that are pending
against us or unasserted claims that may result in such proceedings, the Company
and its legal counsel evaluate the perceived merits of any legal proceedings or
unasserted claims as well as the perceived merits of the amount of relief sought
or expected to be sought.  If the assessment of a contingency suggests
that a loss is probable, and the amount can be reliably estimated, then a loss
is recorded.  When a contingent loss is not probable but is reasonably
possible, or is probable but the amount of loss cannot be reliably estimated,
then details of the contingent loss are disclosed.  Loss contingencies
considered remote are generally not disclosed unless they involve guarantees, in
which case we disclose the nature of the quantities.  Legal fees
incurred in connection with pending legal proceedings are expensed as
incurred.





There
were no loss contingencies accrued in the years ended December 31, 2008, 2007,
or 2006.





ITEM
4.    SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS





There
were no matters submitted to a vote of our security holders during the fourth
quarter ended December 31, 2008.


25





PART
II





ITEM
5.    MARKET FOR REGISTRANT’S COMMON
EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES





Until
November 7, 2007, our common shares were quoted under the symbol “WGDF.OB” on
the Over-the-Counter Bulletin Board. Since November 8, 2007, our common shares
have been quoted under the symbol “WGW” on the American Stock Exchange. On
October 1, 2008, NYSE Euronext successfully closed the acquisition of the
American Stock Exchange, and our common shares now trade on the NYSE Alternext
under the symbol “WGW”. In Addition, since August 28, 2006 our common shares
have been quoted under the symbol “WGI.TO” on The Toronto Stock Exchange. The
following tables set forth the high and low bid information for our common
shares for the periods indicated in the past two fiscal years, which reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual transactions:





NYSE
Alternext





Quarter Ended
                    
                    High Bid
                      Quotation
                    
                    
                    Low Bid
                      Quotation2008:Fourth
      quarter (October 1, 2008 to December 31, 2008)
                    
                    $
                    1.73
                    
                    
                    $
                    0.35





American
Stock Exchange





Quarter Ended
                    
                    High Bid
                      Quotation
                    
                    
                    Low Bid
                      Quotation2008:Fourth
      quarter (September 1, 2008 to September 30, 2008)
                    
                    $
                    1.73
                    
                    
                    $
                    0.35Third
      quarter
                    
                    $
                    2.60
                    
                    
                    $
                    1.09Second
      quarter
                    
                    $
                    3.31
                    
                    
                    $
                    2.07First
      quarter
                    
                    $
                    4.14
                    
                    
                    $
                    2.842007:Fourth
      quarter (November 8, 2007 to December 31, 2007)
                    
                    $
                    4.16
                    
                    
                    $
                    3.16





Over-the-Counter
Bulletin Board





Quarter Ended
                    
                    High Bid
                      Quotation
                    
                    
                    Low Bid
                      Quotation2007:Fourth
      quarter (September 1, 2007 to November 7, 2007)
                    
                    $
                    4.27
                    
                    
                    $
                    3.35Third
      quarter
                    
                    $
                    3.79
                    
                    
                    $
                    1.69Second
      quarter
                    
                    $
                    2.61
                    
                    
                    $
                    1.81First
      quarter
                    
                    $
                    2.44
                    
                    
                    $
                    1.60





The
Toronto Stock Exchange (in Canadian dollars)




Quarter Ended
                      
                      High Bid
                        Quotation
                      
                      
                      Low Bid
                        Quotation2008:Fourth
      quarter
                      
                      C$
                      2.06
                      
                      
                      C$
                      0.50Third
      quarter
                      
                      C$
                      2.60
                      
                      
                      C$
                      1.10Second
      quarter
                      
                      C$
                      3.38
                      
                      
                      C$
                      2.08First
      quarter
                      
                      C$
                      4.13
                      
                      
                      C$
                      2.822007:Fourth
      quarter
                      
                      C$
                      3.91
                      
                      
                      C$
                      3.15Third
      quarter
                      
                      C$
                      3.43
                      
                      
                      C$
                      1.73Second
      quarter
                      
                      C$
                      2.65
                      
                      
                      C$
                      2.03First
      quarter
                      
                      C$
                      2.85
                      
                      
                      C$
                      1.90




26




Holders





As of
March 5, 2009, we estimate that we have approximately 8,300 shareholders of
record of our common shares; however we believe that there are additional
beneficial owners of our common shares who own our stock in “street
name.”





Dividends





We have
never declared or paid dividends on our common shares. We currently intend to
retain future earnings, if any, for use in our business, and, therefore, we do
not anticipate declaring or paying any dividends in the foreseeable future.
Payments of future dividends, if any, will be at the discretion of our board of
directors after taking into account various factors, including our financial
condition, operating results, current and anticipated cash needs and plans for
expansion.





Unregistered
Sales of Securities and Use of Proceeds





None.


27


ITEM 6.   SELECTED FINANCIAL
DATA




For summarized financial data, refer to
tables and discussion presented inItem 7. -“Management’s
Discussion and Analysis of Financial Condition and Results of
Operations”.


ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS





The
following Management’s Discussion and Analysis (“MD&A”) provides information
that management believes is relevant to an assessment and understanding of the
consolidated financial condition and results of operations of Western Goldfields
Inc. and its subsidiaries and including its predecessor, Western Goldfields,
Inc. (collectively “Western Goldfields” or the “Company”).  This
MD&A should be read in conjunction with our audited consolidated financial
statements for the years ended December 31, 2008, 2007 and 2006 and the notes
thereto.  The information is presented as of March 5,
2009.  All amounts in this discussion are expressed in U.S. dollars,
unless otherwise specified.  Continuous disclosure materials are
available on our website at www.westerngoldfields.com, on SEDAR at www.sedar.com
and EDGAR at www.sec.gov.





The
following discussion contains forward-looking statements that involve numerous
risks and uncertainties.  Actual results of the Company could differ
materially from those discussed in such forward-looking statements as a result
of these risks and uncertainties, including those set forth in this MD&A
under “Risk Factors.”





Overview





We are a
gold producer with mining and exploration activities at our Mesquite Mine
(“Mesquite” or the “Mine”) located in Imperial County, California.  We
acquired Mesquite from Newmont Mining Corporation (“Newmont”) in November
2003.  Until late 2007 Mesquite provided us with residual gold
production from ore that was placed on the heap leach pad by Newmont and
previous owners of the property.  We completed a positive feasibility
study in August 2006 and subsequent equity and debt financings have enabled us
to resume mining operations at Mesquite.  We started to place new ore
on the heap leach pad during the second half of 2007 and this started to be
reflected in our gold production and inventories by late
2007.   We attained “steady state” production from the new leach
pad during the second quarter of 2008.  We have obtained all necessary
permits and will have substantially completed our capital expansion program
during 2008.





Overall
Performance





($ in thousands except ounces and per share amounts)
                    
                    Years ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Gold
      ounces produced
                    
                    
                    108,325
                    
                    
                    
                    8,000
                    
                    
                    
                    12,668Gold
      ounces sold
                    
                    
                    110,880
                    
                    
                    
                    6,889
                    
                    
                    
                    13,210Revenues
      from gold sales
                    
                    $
                    95,427
                    
                    
                    $
                    4,666
                    
                    
                    $
                    7,859Cost
      of sales (excludes amortization and accretion)
                    
                    $
                    56,304
                    
                    
                    $
                    19,292
                    
                    
                    $
                    9,568Cost
      of goods sold
                    
                    $
                    65,427
                    
                    
                    $
                    23,512
                    
                    
                    $
                    9,460Gross
      profit (loss)
                    
                    $
                    30,000
                    
                    
                    $
                    (18,846
                    )
                    
                    $
                    (1,601
                    )Operating
      income (loss)
                    
                    $
                    22,833
                    
                    
                    $
                    (28,011
                    )
                    
                    $
                    (10,840
                    )Net
      income (loss)
                    
                    $
                    14,616
                    
                    
                    $
                    (50,309
                    )
                    
                    $
                    (11,583
                    )Net
      income (loss) per common share - basic
                    
                    $
                    0.11
                    
                    
                    $
                    (0.43
                    )
                    
                    $
                    (0.18
                    )-
      diluted
                    
                    $
                    0.10
                    
                    
                    $
                    (0.43
                    )
                    
                    $
                    (0.18
                    )Average
      realized gold price ($/ounce)
                    
                    $
                    861
                    
                    
                    $
                    677
                    
                    
                    $
                    595Cost
      of sales per ounce1
      ($/ounce)
                    
                    $
                    508
                    
                    
                    $
                    2,800
                    
                    
                    $
                    724


(1)  Cost
of sales per ounce is a non-GAAP financial performance measure with no
standardized meaning under US GAAP.  It is defined as cost of sales
per Western Goldfields’ financial statements divided by the number of gold
ounces sold.





Our first
gold pour from new production occurred in December 2007.  During the
first half of 2008, we were focused on achieving “steady state” production from
the new ore being placed on the leach pad that was constructed in the previous
fiscal year.  By late May, solution flow to the leach pad had become
saturated; steady state pregnant solution flow had been achieved, and production
rates had stabilized.  During 2008 we produced and sold 108,325 ounces
and 110,880 ounces of gold, respectively.  Production for the year was
lower than expectation as a result of equipment availability problems and the
decision made during the third quarter to change the mine plan.  Of
the ounces sold, 33,000 were delivered into a hedge program as a condition of
the debt facility, at a fixed price of $801 per ounce.  Total revenues
were $95.4 million in 2008 compared to $4.7 million in 2007 when we were mainly
recovering gold from residual heap leaching.





During
2008, the Mine incurred escalating production costs, most notably for fuel and
haulage truck tires.  We have since entered into and begun executing
fuel hedge contracts to mitigate the effects of fuel price
volatility.  The selling price for gold in world markets continues to
be strong and offsets the full impact of input cost increases.  As
this was our first year of resuming mining operations with new ore being placed
on the heap leach pad, cost of goods sold in 2008 was $65.4 million compared
with $23.5 million in the previous year.




28





We earned
net income of $14.6 million in 2008 which benefited from the positive operating
income of $22.8 million and the net realized and unrealized gain on the
mark-to-market of gold forward sales contracts of $13.1 million.  In
2007, we incurred a net loss of $50.3 million which was largely affected by an
operating loss of $28.0 million and an unrealized loss on mark-to-market of gold
forward sales contracts of $58.9 million due largely to increasing gold prices
when our hedges were fixed at $801 per ounce.





Economic
Trends





Although there was significant
volatility in gold prices during 2008, on an overall basis this was a strong
year for gold.  The cumulative average gold price for the year was
$875 per ounce with the price ending in December at $870 per
ounce.  Key factors influencing the price of gold includes currency
rate fluctuations and the relative strength of the U.S. dollar, the supply of
and demand for gold, and macroeconomic factors such as the level of interest
rates and inflation expectations.  Gold prices have been subject to
volatile price movements over short periods of time, especially in 2008 with the
current market environment.  The price of gold is the largest single
factor affecting Western Goldfields’ profitability and operating cash
flows.  As such, the current and future financial performance of the
Company will be closely correlated to the price of gold.  During 2008,
we realized gold prices that were slightly lower than the average market price
as ounces necessary to satisfy gold hedge contracts at prices that were lower
than average market prices were delivered into, and recognized in
revenue.  Of the 110,880 ounces sold during the year, 33,000 ounces or
30% were hedged at $801 per ounce.





Our operating costs were negatively
affected by rising costs with respect to labor, energy and
consumables.  Mining is generally an energy intensive activity,
especially in an open-pit operation such as Mesquite, where energy prices had a
significant impact on operations.  Approximately 20% of Mesquite’s
operating costs are attributable to diesel consumption.  We consume
diesel fuel which is refined from crude oil and is therefore subject to the same
price volatility affecting crude oil prices.  With global demand
decreasing towards the end of 2008 on fears of a global economic slowdown, oil
prices have decreased from a record high of $147 per barrel in the third quarter
of 2008 to close at $45 per barrel at the end of the year.  Relatively
high fuel prices during the first three quarters of 2008 have translated into
higher costs for petroleum based expenditures including, diesel fuel,
lubricants, explosives, tires and transportation.  With the declining
fuel prices during late 2008, we took the opportunity to enter into fuel hedging
contracts for approximately 25% of the Mesquite Mine’s fuel requirements over
the next two years.  An additional set of contracts were entered into
in early 2009 thereby hedging a combined 50% of our Mine’s projected
requirements in 2009 and 2010.





The
deterioration of the global economy in 2008 created a challenging environment
for all companies to operate within.  For the more junior mining
companies, access to funds became a key determinant of future
viability.  Companies found that debt and equity markets were
effectively closed in many jurisdictions resulting in the postponement of
capital raisings.  Meanwhile, banks and other lenders were declining
terms or unable to refinance existing debt.  Western Goldfields was in
a position of having previously secured a $105.0 million term loan facility, of
which $86.3 million was drawn and the first repayment of $17.7 million was made
on December 31, 2008.  The Mesquite Mine’s capital project is
substantially complete and we do not anticipate drawing on the $17.7 million of
available credit.  Our expectation is to have fully paid off the
credit facility by December 31, 2012.





Given the
early warning signs of a volatile financial market, we implemented a
conservative investment strategy wherein funds in excess of operating
requirements were invested in short-term, highly liquid government of Canada or
U.S. treasury bills.  While the interest earned on these investments
were nominal, we believe strongly in the safety and security of our funds above
all else.  We held no other investments during 2008 and plan on
maintaining our current investment strategy into the foreseeable
future.  At December 31, 2008, our cash balances were held with CIBC
and Bank of America and we had no excess funds invested in short-term, highly
liquid government of Canada or U.S. treasury bills.  We continuously
monitor the performance of our banks and will actively seek alternative banking
solutions should the situation dictate.  Although we cannot completely
eliminate the risks associated with managing a company in a volatile and
uncertain economic climate, we are continuously monitoring and assessing the
impacts to our Company and using a prudent and conservative investment
strategy.





We are
also cognizant of market effects on our suppliers.  In the current
volatile environment, significant changes in an entity can occur very
quickly.  We continue to monitor the performance of our current
suppliers and thoroughly assess the viability of new suppliers.  We
have assessed business critical suppliers and ensured back-up measures and
alternatives are in place.  We also closely monitor companies with
which we have our bonding and insurance programs and counterparties where we
have contracted into gold sales and fuel hedging contracts.  At this
time, we are comfortable that our counterparties are able to honor their
commitments.





Revised
Mine Plan





On October 6, 2008 we announced the
implementation of an Improved Mine Plan (the “Plan”) which would consist of
sequential mining of the three open pits beginning in the Rainbow pit and result
in higher production of gold in the four-year period 2009 through
2012.  The new mine Plan for Mesquite anticipates increased
efficiencies while minimizing haul distances and thereby producing more ounces
of gold and increasing annual cash flow generation over the four-year
period.  The impact also included reduced gold production in the
fourth quarter of 2008 as we commenced sequential mining of the
pits.





29





Amended
Term Loan Facility





Our
wholly-owned subsidiary, Western Mesquite Mines, Inc., has a term loan facility
with a syndicate of banks for $105.0 million.  The facility comprises
multiple-draw loans originally maturing December 31, 2014, of which $87.3
million was available for the development of the Mesquite Mine, and the
remainder is available for up to 12 months after achieving completion for other
corporate purposes.  Achieving completion is defined as the
satisfaction of financial, production and technical criteria, and based on the
new mine Plan, is now expected to occur on or before June 30,
2009.  On December 18, 2008, the repayment schedule was accelerated as
a result of the increased production profile with an amortization schedule
requiring full repayment by December 31,
2012.


Repayment
of the facility is semi-annually with the first repayment of $17.7 million made
on December 31, 2008.  The loan facility also requires mandatory
prepayments being made from 50% of excess cash flow.  An estimate of
the timing and amount of prepayments cannot be objectively determined, as these
payments are based on the amount by which the Mesquite Mine’s cash balance after
scheduled repayments and interest payments, at the date of repayment, exceeds
$4.0 million.  We did not qualify for a mandatory repayment at
December 31, 2008.  Interest on each advance is charged at U.S. dollar
LIBOR plus 2.2% up to completion and at U.S. dollar LIBOR plus 1.75% after
completion.





As at
December 31, 2008 we have approximately $68.6 million of outstanding principal
on the loan facility.  Based on our current plans, we do not
anticipate making further draws.





Gold
Hedging





On June
7, 2007, we entered into forward sales contracts for 429,000 ounces of gold (the
“Hedging Contracts”) at a price of $801 per ounce.  These Hedging
Contracts were a requirement under the term loan facility.  The
Hedging Contracts represent a commitment of 5,500 ounces per month for 78 months
commencing July 2008, with the last commitment deliverable December
2014.  We expect to produce on average approximately 166,000 ounces
annually during the term of the Hedging Contracts, of which 66,000 ounces
annually will be covered by the Hedging Contracts, leaving approximately 100,000
ounces leveraged to the price of gold.  Since we have not designated
these forward sales contracts as cash flow hedges, they are being
marked-to-market at the end of each period for financial reporting
purposes.  We have recorded an unrealized pre-tax gain of $14.4
million for the year-ended December 31, 2008.  The cumulative
unrealized pre-tax loss of $45.2 million has been disclosed as a liability as at
December 31, 2008.  In comparison, $58.9 million was recognized as a
liability as at December 31, 2007.  We settled into the first hedges
during the second half of 2008.  As a result of gold prices being
higher than the settled amount of $801, we realized pre-tax losses of $1.3
million for the year-ended December 31, 2008.





Fuel
Hedging





On
December 15, 2008, we entered into a fuel hedge program with the hedging of 1.5
million gallons of diesel in each of 2009 and 2010; the 1.5 million gallons
represents approximately 25% of the expected diesel consumption in each year.
The diesel was hedged at forward prices of $1.82 and $2.00 per gallon for 2009
and 2010, respectively. In addition to these hedged prices, the Company expects
to incur approximately $0.15 per gallon related to tax and delivery
charges.  As approximately 20% of Mesquite’s operating costs are
attributable to diesel consumption, the Company felt it prudent to fix this
portion of the overall diesel costs.





The
Company has not designated these contracts as cash flow
hedges.  Accordingly, the period-end mark-to-market adjustment related
to these contracts is reflected on the statement of operations of the Company as
unrealized losses on fuel hedge contracts and the cumulative effect is reflected
as an asset or liability on the balance sheet.  On December 31, 2008,
as a result of declining fuel prices, an unrealized loss and corresponding
liability of $0.9 million was recognized.





Subsequent
to the year end, on January 12, 2009, we entered into additional fuel hedges
with the hedging of 1.4 and 1.5 million gallons of diesel in 2009 and 2010,
respectively.  This second commitment of diesel was hedged at forward
prices of $1.68 and $1.87 per gallon for 2009 and 2010,
respectively.  Overall, the Company now has approximately 50% of its
expected diesel consumption hedged for each of 2009 and 2010.





Normal
Course Issuer Bid





On
November 4, 2008 we announced a share repurchase by way of a normal course
issuer bid (“NCIB”) to purchase certain of our outstanding common shares through
the Toronto Stock Exchange and NYSE Alternext.  We initiated the
repurchase program as we felt the market price of our common shares was not
reflective of the underlying value.  The Company had approval to
repurchase up to a maximum of 12.8 million common shares, or approximately 10%
of the Company’s public float from the period November 7, 2008 to November 6,
2009.  From the period November 7, 2008 through December 31, 2008, the
Company repurchased 2.3 million shares at a cost of $2.5 million.  The
Company returned to treasury and cancelled the repurchased shares.  We
do not anticipate any further repurchases at this time.  A copy of the
Company’s Notice of Intention to make an NCIB may be obtained, without charge,
by contacting the Director of Governance and Regulatory Affairs of Western
Goldfields Inc. at (416) 324-6000.





30





Capital
Program





During
2008, the remaining aspects of our capital program, launched in late 2006, were
substantially completed.  In the first quarter of 2008, the expanded
leach pad became operational and the retrofit of the process plant was
completed.  During the remainder of the year, new carbon columns for
the processing circuit were brought on stream and construction of the new truck
repair shop, warehouse and mine administrative office was substantially
completed.  Our latest forecast for spending on the expansion capital
program is $111.3 million, of which $95.4 million was incurred in 2006 and
2007.  Spending on the expansion program in 2008 was $15.6
million.  Remaining planned expenditures of the capital program in
2009 are items relating to the general site and leach pad which are estimated to
be approximately $0.3 million.





Reserves
and Resources





On March
26, 2007 we announced that we had increased proven and probable reserves at
Mesquite from 2.36 million ounces of gold to 2.77 million
ounces.  Approximately 50% of the increase was attributable to assay
results from a drilling program of 27 holes at the Brownie Hill area of the mine
which converted inferred oxide resources to proven and probable reserves, and
the remaining 50% was attributable to an increase in the reserve gold price
assumption from $450 to $500 per ounce.  Since that estimate, assay
results have been received which are in line with and support the estimated
grades and thickness of the Brownie Hill resource estimate and suggest the
potential for further resource increases.





Proven
and probable mineral reserves as at December 31, 2008 are 151.61 million tons at
0.017 ounces Au/ton containing 2.57 million ounces.  Measured and
indicated mineral resources (exclusive of mineral reserves) as at December 31,
2008 are 100.68 million tons grading 0.015 ounces Au/t containing 1.53 million
ounces of gold.  These changes from the previous year reflect
production depletion.





Mineral
resources and reserves have been estimated in accordance with the CIM Definition
Standards for Mineral Resources and Reserves adopted by the CIM Council on
December 11, 2005 as required by National Instrument NI
43-101.  Mineral reserves have been estimated at a gold price of $500
per ounce.  Mineral resources are reported in addition to Mineral
reserves.  Wes Hanson P.Geo., Vice-President of Mine Development is
the qualified person responsible for the mineral resource and reserve
estimates.  He is a qualified person as defined by NI
43-101.





Review
of Annual Financial Results





Selected Financial Information
($ in thousands, except ounces
and per share amounts)





Years ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Gold
      ounces - sold
                    
                    
                    110,880
                    
                    
                    
                    6,889
                    
                    
                    
                    13,210Gold
      ounces - produced
                    
                    
                    108,325
                    
                    
                    
                    8,000
                    
                    
                    
                    12,668Average
      realized gold price ($/ounce)
                    
                    $
                    861
                    
                    
                    $
                    677
                    
                    
                    $
                    595Cost
      of sales per ounce1
      ($/ounce)
                    
                    $
                    508
                    
                    
                    $
                    2,800
                    
                    
                    $
                    724





Years ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Revenues
      from gold sales
                    
                    $
                    95,427
                    
                    
                    $
                    4,666
                    
                    
                    $
                    7,859Cost
      of sales (excludes amortization and accretion)
                    
                    $
                    56,304
                    
                    
                    $
                    19,292
                    
                    
                    $
                    9,568Cost
      of goods sold
                    
                    $
                    65,427
                    
                    
                    $
                    23,512
                    
                    
                    $
                    9,460Gross
      profit (loss)
                    
                    $
                    30,000
                    
                    
                    $
                    (18,846
                    )
                    
                    $
                    (1,601
                    )Operating
      income (loss)
                    
                    $
                    22,833
                    
                    
                    $
                    (28,011
                    )
                    
                    $
                    (10,840
                    )Net
      income (loss)
                    
                    $
                    14,616
                    
                    
                    $
                    (50,309
                    )
                    
                    $
                    (11,583
                    )Net
      income (loss) per share – basic
                    
                    $
                    0.11
                    
                    
                    $
                    (0.43
                    )
                    
                    $
                    (0.18
                    )–
      diluted
                    
                    $
                    0.10
                    
                    
                    $
                    (0.43
                    )
                    
                    $
                    (0.18
                    )Cash
                    
                    $
                    11,275
                    
                    
                    $
                    43,870
                    
                    
                    $
                    5,503Working
      Capital
                    
                    $
                    34,590
                    
                    
                    $
                    46,784
                    
                    
                    $
                    4,549Plant
      and equipment, net of accumulated amortization
                    
                    $
                    111,334
                    
                    
                    $
                    77,951
                    
                    
                    $
                    4,329Construction
      in process
                    
                    $
                    —
                    
                    
                    
                    21,864
                    
                    
                    
                    2,881





(1)  Cost
      of sales per ounce is a non-GAAP financial performance measure with no
      standardized meaning under US GAAP.  It is defined as cost of
      sales per Western Goldfields’ financial statements divided by the number
      of gold ounces sold.





31





2008
vs. 2007





The
Company’s net income to common shareholders for the year ended December 31, 2008
was $14.6 million, or $0.11 per basic share, compared with a net loss of $50.3
million, or $0.43 per share, for the year ended December 31, 2007.





Gold sold
in 2008 increased to 110,880 ounces compared to 6,889 ounces in
2007.  This is primarily the result of the ramping of production of
our Mesquite Mine during 2008.  This resulted in revenue increasing
from $4.7 million in 2007 from residual heap leaching to $95.4 million in
2008.  The continued strengthening in gold market prices resulted in
recognizing $184 higher per ounce revenues when compared to the previous fiscal
year.





The
increasing mining activity throughout 2008 also resulted in increased cost of
goods sold.  As inventory in the heap leach grew to 52,146 ounces at
December 31, 2008, we capitalized $31.8 million of related
costs.  Since June 30, 2008 new ore placed on leach pad was being
valued at average cost based on current mining costs, including amortization and
depletion, as this was lower than net realizable value.  Prior to this
date, the costs of placing ore on the heap leach was high due to the start-up
phase of operations and therefore ore on heap leach pad, metal in-process and
bullion required write-down to net realizable value.  Cost of goods
sold for the year ending December 31, 2008 was $65.4 million compared to $23.5
million in 2007.





We earned operating income of $22.8
million in 2008, compared with an operating loss of $28.0 million in
2007.  We earned significant revenues from gold sales and reach a
normalized state of operations, and had lower general and administrative costs
in 2008.  In 2007, we had a net loss of $50.3 million that was
significantly affected by an unrealized loss of $58.9 million on the
mark-to-market of gold hedge contracts which we entered into as a requirement of
our loan facility.  This loss was partially offset by an income tax
recovery of $37.1 million from meeting the more likely than not criteria that
Mesquite would be earning income and generating positive cash flows in the near
future.  In 2008, we begun earning taxable income and have recorded
$13.0 million in tax expenses.  Overall, we were able to achieve net
income of $14.6 million in 2008 compared to a net loss of $50.3 million in
2007.





Our cash balance, excluding restricted
cash, declined from $43.9 million at December 31, 2007 to $11.3 million at
December 31, 2008.  By the third quarter of 2008, we had drawn $86.3
million from our $105 million credit facility.  On December 31, 2008,
we made our first scheduled repayment of $17.7 million under the
facility.  In addition, we were owed $2.1 million from sales which
occurred before year-end but cash was not received until January 2, 2009 due to
a bank error.  At December 31, 2008 we had a working capital balance
of $34.6 million compared to $46.9 million in the previous year.





2007
vs. 2006





The
Company’s net loss to common shareholders for the year ended December 31, 2007
was $50.3 million, or $0.43 per share, compared with $11.6 million, or $0.18 per
share, for the year ended December 31, 2006.





Results
for 2007, as compared with 2006, were negatively impacted by the 48% reduction
in gold ounces sold, from 13,210 ounces to 6,889 ounces.  With no new
ore being placed on the leach pad for most of 2007, it was increasingly
difficult to extract the residual gold and maintain the solution grades coming
from the leach pad.  This lower production was partially offset by the
14% increase in the average selling price per ounce from $595 to $677,
reflecting the continuation of relatively strong pricing in world markets. Cost
of sales per ounce for 2007, based on mine cost of sales less non-cash
amortization and depletion, was $2,800, as compared with $724 per ounce in
2006.  During the first half of 2007, these costs reflected the high
fixed cost component in cost of goods sold, the increase in mine staffing as we
prepared to go back into production, and the expensing of stripping
costs.





Other
operating expenses for 2007 were $9.2 million, unchanged from 2006. General and
administrative expenses of $5.8 million were up $1.5 million from $4.3 million
in 2006 reflecting staff increases and incentive compensation
payments.  Non-cash stock based compensation for 2007 of $2.6 million
was significantly lower than the $3.2 million expense the previous
year.  The higher expense in 2006 primarily reflects grants of options
to our new management team in early 2006.  Other operating expenses in
2006 also included $0.5 million in respect of severance costs payable in common
shares.  Exploration expense in 2007 relates mainly to the drilling
program to identify new resources in a new area for drilling to the south of the
Brownie Hill.  In 2006, exploration expense relates mainly to the
feasibility study.





Other
expense for 2007 was $59.4 million compared with $0.7 million in 2006. The major
negative factor was the $58.9 million non-cash expense relating to the
mark-to-market of our gold forward sales contracts.  These hedging
contracts represent a commitment of 5,500 ounces for 78 months commencing July
2008, with the last commitment deliverable December 2014.  Other
income was favorably impacted by an increase in interest income from $0.4
million to $2.0 million.  Prior to 2007, we did not recognize the
recoverability of any part of our deferred tax assets including operating losses
carried forward. After consideration of several factors, including our plans for
operations based on the feasibility study of August 2006, the successful
resumption of full mining operations, confirmation that ore grades to date are
consistent with reserve estimates, and our updated projections, we have
determined that it is more likely than not that we will realize the benefit of a
substantial amount of the deferred tax asset that we have
accumulated.  In 2007 we recorded a tax recovery of $37.1
million.




32





At
December 31, 2007, our available cash balance was $43.9 million, our restricted
cash was $7.5 million, and our working capital was $46.8
million.  Although we had made expenditures on our mine expansion
program totaling $95.4 million, we had not fully utilized the $76.5 million
withdrawn on our credit facility nor the funds received from an earlier
financing.  This compares to our cash balance of $5.5 million and
working capital balance of $4.5 million at December 31, 2006 when we had not yet
secured full financing for our Mesquite Mine project.





Summary of Quarterly Results
($ in thousands, except ounces
and per share amounts)





Dec-08
                  
                  
                  Sept-08
                  
                  
                  Jun-08
                  
                  
                  Mar-08
                  
                  
                  Dec-07
                  
                  
                  Sept-07
                  
                  
                  Jun-07
                  
                  
                  Mar-07Total
      revenues
                  
                  
                  24,472
                  
                  
                  
                  41,352
                  
                  
                  
                  20,347
                  
                  
                  
                  9,256
                  
                  
                  
                  606
                  
                  
                  
                  1,281
                  
                  
                  
                  1,546
                  
                  
                  
                  1,233Unrealized
      gain (loss) on mark-to-market of gold hedging contracts
                  
                  
                  15,822
                  
                  
                  
                  31,415
                  
                  
                  
                  (8,708
                  )
                  
                  
                  (24,112
                  )
                  
                  
                  (30,570
                  )
                  
                  
                  (28,331
                  )
                  
                  
                  —
                  
                  
                  
                  —Income
      tax recovery (expense)
                  
                  
                  (7,706
                  )
                  
                  
                  (17,204
                  )
                  
                  
                  2,029
                  
                  
                  
                  9,832
                  
                  
                  
                  37,133
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Net
      income (loss)
                  
                  
                  7,781
                  
                  
                  
                  30,518
                  
                  
                  
                  (4,059
                  )
                  
                  
                  (19,624
                  )
                  
                  
                  (7,293
                  )
                  
                  
                  (36,375
                  )
                  
                  
                  (4,007
                  )
                  
                  
                  (2,634
                  )Diluted
      income (loss) per share - basic
                  
                  
                  0.06
                  
                  
                  
                  0.22
                  
                  
                  
                  (0.03
                  )
                  
                  
                  (0.14
                  )
                  
                  
                  (0.06
                  )
                  
                  
                  (0.31
                  )
                  
                  
                  (0.04
                  )
                  
                  
                  (0.03
                  )-
      diluted
                  
                  
                  0.05
                  
                  
                  
                  0.21
                  
                  
                  
                  (0.03
                  )
                  
                  
                  (0.14
                  )
                  
                  
                  (0.06
                  )
                  
                  
                  (0.31
                  )
                  
                  
                  (0.04
                  )
                  
                  
                  (0.03
                  )Cash
      and cash equivalents
                  
                  
                  11,275
                  
                  
                  
                  37,914
                  
                  
                  
                  26,549
                  
                  
                  
                  32,829
                  
                  
                  
                  43,870
                  
                  
                  
                  18,038
                  
                  
                  
                  18,750
                  
                  
                  
                  57,147Total
      assets
                  
                  
                  207,368
                  
                  
                  
                  234,506
                  
                  
                  
                  232,244
                  
                  
                  
                  226,363
                  
                  
                  
                  214,495
                  
                  
                  
                  126,252
                  
                  
                  
                  92,037
                  
                  
                  
                  79,894Total
      long-term financial liabilities
                  
                  
                  101,692
                  
                  
                  
                  131,186
                  
                  
                  
                  159,218
                  
                  
                  
                  158,592
                  
                  
                  
                  131,479
                  
                  
                  
                  83,590
                  
                  
                  
                  4,826
                  
                  
                  
                  4,741





Fourth
Quarter 2008 Review





In the
fourth quarter of 2008, we produced and sold 28,378 and 30,625 ounces,
respectively.  As a result of progression towards a new mine plan
during the fourth quarter, we did not produce as many ounces as
anticipated.  On October 6, 2008, we announced details of our new mine
plan at Mesquite which contemplates mining the pits sequentially with focus on
the Rainbow pit starting in 2009.  The preparation towards the new
mine plan resulted in increase stripping activity at the Rainbow pit in the
fourth quarter of 2008.  We also experienced equipment availability
issues, most notably being a decline in shovel availability, during the third
quarter which impacted ounces produced during the fourth quarter.  We
realized an average gold selling price of $799 per ounce during the quarter for
total revenues of $24.5 million.  Of the total ounces sold, 16,500
ounces or 54% were sold at hedged prices of $801 per ounce.





Cost of
goods sold during the fourth quarter of 2008 was relatively high at $18.1
million given the number of ounces produced.  Even though we did not
produce as many ounces compared to the previous quarter, the nature of mining
activities is that many of the input costs are relatively fixed regardless of
the number of ounces produced.  The higher cost of gold on the leach
pad at December 31, 2008 is expected to affect the future cost of gold sold
negatively.





We
recognized an unrealized gain of $15.8 million on the mark-to-market of our gold
forward sales contracts given the decline in the spot price of gold from $885
per ounce at September 30, 2008 to $870 per ounce at December 31,
2008.  We have remaining gold forward sales contracts totaling 396,000
ounces to be delivered in tranches of 5,500 ounces per month, until December 31,
2014.  On December 15, 2008, we entered into a fuel hedge program
where we hedged 1.5 million gallons of diesel in each of 2009 and
2010.  The diesel was hedged at forward prices of $1.82 and $2.00 per
gallon for 2009 and 2010, respectively.  As a result of the continuing
decline in fuel prices to the end of the year - at December 31, 2008 we
recognized an unrealized loss of $0.9 million on these fuel hedge
contracts.





During
the fourth quarter, we realized an income tax expense of $7.7 million as a
result of earning taxable income.  Overall, we had net income of $7.8
million in the quarter ended December 31, 2008.





Results
of Operations





Revenue




Years ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Gold
      sales revenue
                    
                    
                    95,427
                    
                    
                    
                    4,666
                    
                    
                    
                    7,859Average
      price realized per ounce
                    
                    
                    861
                    
                    
                    
                    677
                    
                    
                    
                    595Increase
      (decrease) in revenues
                    
                    
                    90,761
                    
                    
                    
                    (3,193
                    )
                    
                    
                    (1,939
                    )Change
      in revenues attributable to ounces sold
                    
                    
                    70,434
                    
                    
                    
                    (3,761
                    )
                    
                    
                    (4,364
                    )Change
      in revenues attributable to average selling price
                    
                    
                    20,327
                    
                    
                    
                    568
                    
                    
                    
                    2,425


33





2008
vs. 2007





Gold
production for 2008 was 108,325 ounces compared with 8,000 ounces for
2007.  During 2007, production at Mesquite was derived from residual
gold leaching of ore placed on the leach pad several years
previously.  Mining of new ore at Mesquite started in July 2007 and
the first pour of gold from new ore occurred in January 2008.  Ore
production has been building up steadily since that time but production since
the third quarter of 2008 fell below expectations as a result of production
difficulties which included most significantly the decline in mine equipment
availability.  Approximately 45.6 million tons of waste and 8.9
million tons of ore were mined in 2008 at an average grade of 0.022 ounces per
ton.  The nominal production in 2007 reflects the nearly complete
depletion of recoverable gold ounces from ore placed on the leach pad prior to
Western Goldfields acquisition of the Mesquite Mine.  Gold sales for
2008 were 110,880 ounces at an average selling price of $861 for revenues of
$95.4 million, compared with 6,889 ounces at an average selling price of $677
for revenues of $4.7 million for 2007.  The strength in world market
prices for gold positively influenced the revenue variance by $20.3
million.  The 2008 figures exclude $1.3 million in realized losses
from the settlement of the gold hedge contracts.





2007
vs. 2006





Poured
gold production for 2007 was 8,000 ounces compared with 12,668 ounces in
2006.  The lower production reflects the almost total depletion of the
ore placed on the leach pad prior to our acquisition of
Mesquite.  Continued leaching of the old ore was only justified by the
sustained high price of gold in the year.  Gold sales for 2007 were
6,889 ounces at an average selling price of $677 for revenues of $4.7 million
compared with 13,210 ounces at an average selling price of $595 for revenues of
$7.9 million in 2006.  The higher average selling price reflects the
increase in the world price for gold and our sale of all production in the spot
market.





Cost
of Goods Sold




Years ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Cost
      of goods sold
                    
                    
                    65,427
                    
                    
                    
                    23,512
                    
                    
                    
                    9,460Increase
      (decrease)
                    
                    
                    41,915
                    
                    
                    
                    14,052
                    
                    
                    
                    (1,152
                    )Gross
      profit (loss) %
                    
                    
                    31
                    %
                    
                    
                    (403
                    )
      %
                    
                    
                    (20
                    )%Increase
      (decrease)
                    
                    
                    434
                    %
                    
                    
                    (383
                    )%
                    
                    
                    (12
                    )
      %





2008
vs. 2007





Cost of
goods sold for year ended December 31, 2008 increased by $41.9 million compared
to 2007.  Prior to the second quarter of 2008, cost of goods sold
exceeded revenues.  Gross profit percentage for 2008 was 31%,
reflecting the ramp up of mining production, the attainment of steady state
ounce flow from the leach pad and progression towards normal costs reflecting
ongoing operations.  Gross loss percentage for the year ended December
31, 2007 was 403%, reflecting the higher costs of the previous quarters when the
new leach pad was in start-up mode and when a relatively high volume of waste
material was moved to access the ore body.  The higher costs in 2008
as compared with 2007 also reflect increases in several cost inputs, most
notably fuel, tires, blasting and mining fleet maintenance.  Mine site
administration costs have also increased as the Mesquite Mine now has a full
management and administration team in place.  Costs also reflect
substantially higher amortization charges for the new plant and equipment that
was placed in service throughout 2007 and 2008.





2007
vs. 2006





Cost of
goods sold for 2007 increased by $14.0 million or 149% compared to 2006. The
increase reflects the commencement of stripping activities as the mining fleet
came into service during the third quarter and the costs of resumed mining
operations which built-up steadily during the second half of the
year.  The higher costs also reflect increases in fuel, chemicals,
power and payroll costs.  Mine site administration costs have also
increased as we assembled the management team to handle the construction program
and resumed production.  Costs for 2007 were also impacted by
substantially higher amortization charges for the new plant and equipment that
was placed in service during the year.  Our evaluation of the
provision for mine reclamation costs at December 31, 2007 resulted in only a
minor adjustment whereas in 2006 a similar review resulted in a reduction in the
liability of $1.5 million which was reflected as a reclamation cost
recovery.  Since, for the first time since we acquired Mesquite in
November 2003, we had identifiable new gold ounces relating to the new ore
placed on the leach pad, we were able to include this value in
inventory.  There was no comparable inventory item in previous
years.





34





Major
Components of Cost of Goods Sold




Years ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006Mine
      operating costs
                  
                  
                  54,231
                  
                  
                  
                  19,100
                  
                  
                  
                  9,266Royalties
                  
                  
                  2,073
                  
                  
                  
                  192
                  
                  
                  
                  302Amortization
      and accretion
                  
                  
                  9,332
                  
                  
                  
                  4,242
                  
                  
                  
                  1,352Reclamation
      cost recovery
                  
                  
                  (209
                  )
                  
                  
                  (22
                  )
                  
                  
                  (1,460
                  )Cost
      of goods sold
                  
                  
                  65,427
                  
                  
                  
                  23,512
                  
                  
                  
                  9,460




2008
vs. 2007





Mine
operating costs, including inventory adjustments, were $54.2 million in 2008,
compared to $19.1 million in 2007.  2008 costs represented the first
year of full mining operations.  The most significant components of
mine operating costs included:  labor, contracted services, fuel and
tire costs.  Mine site administration costs for 2008 were $5.6 million
compared with $3.1 million in 2007, reflecting the increase in staff and
associated costs to support full mining operations.  Amortization and
accretion expense for 2008 was $9.3 million compared with $4.2 million in 2007,
reflecting mining fleet additions from May 2007 onwards, the new leach pad
addition in 2008 and increased ounces produced.





During
2008 we have increased our gold inventory in the leach pad and in-process to
52,146 ounces from 2,185 ounces, respectively.  Inventoried costs
associated with respect to the leach pad and metal-in-process build-up were
$31.8 million and $1.4 million, respectively, compared with $7.7 million and
$0.8 million in 2007, respectively.  In the first quarter of 2008, the
new leach pad was in start-up mode.  A steady state of solution flow
and planned gold production was not reached until late May 2008.  As a
result, unit production costs in the first half of the year were abnormally
skewed and not representative of anticipated future costs.   The
high costs resulted in gold inventories being initially carried at realizable
value.  It was not until the second quarter of 2008 that net
realizable value exceeded the cost of the inventory.  In the third
quarter of 2007, we had just resumed mining operations and began placing new ore
on the leach pad.  Reflecting the start-up phase of the operation,
production levels in the period ended December 31, 2007 were low relative to
mining costs incurred.  Accordingly, the estimated ounces contained in
ore on leach pad at December 31, 2007 were valued at net realizable
value.





Our asset
retirement obligations related to the Mesquite Mine were independently assessed
by a third-party engineering firm as part of our 2008 year-end
procedures.  The impact of the assessment was a reduction of $0.2
million relating to changes in timing of future reclamation activities and
substantive changes in the mine closure plan.  More specifically, the
substantive changes included:


·
            Revision
      due to pre-2008 over-estimation of total area to be
      reclaimed.  Mesquite's original planned closure costs were based
      on Newmont’s assessment; Newmont had not claimed credit for major
      earthwork performed over a large part of the mine (waste rock facilities),
      and had retained acreages which do not exist as a
    liability.


·
            Downward
      revision in rinsing volume required for the heap leach based on recent
      experience.  Mesquite closed the Vista heap with one-third pour
      volume of water pumped up and through the heap, versus one-pour volume
      assumed in previous cost estimates.  We have now revised costs to
      about three-quarter pour volume, as a reasonable balance between
      conservatism and actual experience.





The
foregoing factors resulted in a gross profit of $30.0 million for 2008 compared
with a gross loss of $18.8 million for 2007.





2007
vs. 2006





Mine
operating costs, including inventory adjustments, for 2007 were $19.1 million,
compared to $9.3 million for 2006.  During 2006 there was no active
mining at Mesquite. The increase reflects the commencement of stripping
activities as the mining fleet came into service during the second quarter of
2007 onwards and the costs of resumed mining operations which built up steadily
during the second half of 2007.  Approximately 18.9 million tons of
waste and 1.0 million tons of ore were mined in 2007.  Costs in 2007
also reflect increases in fuel, chemicals, power and payroll
costs.  Mine site administration costs for 2007 were $3.1 million
compared with $1.6 million in 2006, reflecting the increase in staff and
associated costs to support the capital program and resumed mining operations as
the year progressed.  This program was only getting underway in
2006.  Amortization and accretion expense for 2007 was $4.2 million
compared with $1.4 million in 2006, reflecting the placing into service of the
mining fleet from May 2007 onwards and higher accretion expense associated with
revisions to the reclamation plan at Mesquite in 2006.





Costs
associated with the change in leach pad and metal-in-process inventories in 2007
were $9.3 million compared with $0.4 million in 2006. The Company resumed mining
operations and started placing new ore on the leach pad in July 2007. Because we
were in start up mode, unit production costs were unusually high and not
representative of anticipated future costs.  Accordingly, the
estimated 12,080 recoverable gold ounces contained in ore on leach pad as of
December 31, 2007 were valued at estimated net realizable
value.  Previously no value had been attributed to gold ounces in the
leach pad.  Metal-in-process inventory represents metal in solution or
in subsequent stages of the refining process. Reflecting the start-up phase of
the operation, unit production costs for this aspect of inventory were also
high. Accordingly, the estimated 1,086 ounces of metal-in-process inventory as
of December 31, 2007 were also valued at net realizable value.




35





In the
third quarter of 2006 we recorded a cost recovery of $1.5 million resulting from
a reduction in the estimate of the net present value of expected reclamation
costs at Mesquite.  A re-evaluation of the liability was made on
completion of the feasibility study in August 2006.  We performed a
similar evaluation at December 31, 2007 which gave rise to a negligible change
in the liability.





The
foregoing factors resulted in a gross loss of $18.8 million for 2007 compared
with a gross loss of $1.6 million in 2006.





Other
Operating Expenses





Years ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006General
      and administrative
                    
                    
                    6,061
                    
                    
                    
                    8,370
                    
                    
                    
                    7,471Severance
      costs payable in common shares
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    547Exploration
      and business development
                    
                    
                    1,106
                    
                    
                    
                    795
                    
                    
                    
                    1,221





2008
vs. 2007





Other
operating expenses for 2008 were $7.2 million compared with $9.2 million in
2007.  General and administrative expense of $6.1 million, including
stock based compensation, in 2008 decreased from the 2007 expense of $8.4
million.  Listing expenses and legal fees were substantially higher in
2007 as a result of corporate financing and reorganization
activities.  In 2008, we incurred higher audit and taxation services
fees, reflecting the engagement of a major accounting firm.  This was
also the first year that our U.S. Sarbanes-Oxley program requires auditor
attestation resulting in incremental consulting fees.  We have also
incurred $0.2 million in recruitment fees to fill senior management
positions.





Stock
based compensation, included within general and administrative expenses,
represents the non-cash costs of options, as calculated under the Black-Scholes
option pricing model, and was granted to directors, officers, employees and
consultants.  The lower cost of $1.3 million in 2008, compared to $2.6
million in 2007, reflects the fact that options granted to the new management
team in 2006 were fully expensed.  There were 1.8 million options
granted in 2008 compared to 1.4 million options granted in 2007.  Of
the total options granted in 2008, 1.3 million were granted during the fourth
quarter of 2008 with the amortization affecting future periods.





Exploration
activities at Mesquite during 2008 totaled $0.7 million and related primarily to
a drilling program to explore for oxide resources south of the Brownie Hill area
at the mine site.  Costs of $0.8 million in 2007 related to a similar
drilling program.  The 2007 program resulted in an increase in proven
and probable reserves resources of 0.4 million ounces and an increase in the
mine life of approximately two years.  During 2008, we also incurred
costs of $0.4 million in assessing complementary business
opportunities.





2007
vs. 2006





Other
operating expenses for 2007 were $9.2 million, unchanged from
2006.  General and administrative expenses in 2007, excluding stock
based compensation were higher than 2006 by approximately $1.5 million,
primarily reflecting increased incentive compensation payments and legal
expenses in connection with the Company’s reorganization. Stock based
compensation in 2007 was approximately $0.5 million lower than 2006 primarily
because of high initial amortization expense, reflecting the vesting schedule of
awards to the new management team in 2006. 2006 also included $0.5 million in
respect of severance costs for former management, settled by way of issuance of
common shares.  There was no comparable expense in 2007.





Other
Income (Expense)





Years ended December 31,2008
                    
                    
                    2007
                    
                    
                    2006Interest
      income
                    
                    $
                    1,093
                    
                    
                    $
                    1,976
                    
                    
                    $
                    392Interest
      expense and commitment fees
                    
                    
                    (4,127
                    )
                    
                    
                    (1,863
                    )
                    
                    
                    (20
                    )Amortization
      of deferred debt issuance costs
                    
                    
                    (461
                    )
                    
                    
                    (342
                    )
                    
                    
                    —Realized
      and unrealized gain (loss) on mark-to-marketof
      gold forward sales contracts
                    
                    
                    13,078
                    
                    
                    
                    (58,901
                    )
                    
                    
                    —Unrealized
      gain (loss) on mark-to-marketof
      fuel forward contracts
                    
                    
                    (931
                    )
                    
                    
                    —
                    
                    
                    
                    —Gain
      on extinguishment of debt
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    143Loss
      on foreign currency exchange
                    
                    
                    (3,820
                    )
                    
                    
                    (343
                    )
                    
                    
                    (14
                    )Gain
      (loss) on sale of assets
                    
                    
                    —
                    
                    
                    
                    42
                    
                    
                    
                    (19
                    )Merger
      termination expense
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (1,225
                    )





36





2008
vs. 2007





Other
income for 2008 was $4.8 million compared to expenses totaling $59.4 million in
2007.  The decrease in expenses primarily reflects the 2007 charge of
$58.9 million in respect of the unrealized mark-to-market loss on gold forward
sales contracts as a result of the increasing spot price of gold during the
period and the downward movement in gold forward lease rates.  In
2008, a mark-to-market unrealized gain of $14.4 million was
recognized.  This was combined with a realized loss of $1.3 million on
the settlement of the first six hedge contracts totaling 33,000
ounces.





During
2008, we also entered into fuel hedge contracts.  We hedged 1.5
million gallons of diesel per year at forward prices of $1.82 and $2.00 per
gallon in 2009 and 2010, respectively.  At December 31, 2008, these
hedge contracts were priced higher than the prevailing market prices, as such,
an unrealized loss of $0.9 million was recognized.





Interest
income for 2008 was $1.1 million compared with $2.0 million in the previous year
as a result of cash balances being relatively high during 2007 after the equity
issue in January of that year and declining interest rates throughout
2008.  Interest expense and commitment fees of $4.1 million in 2008
reflect the term loan advances in the range of $76.5 - $86.3 million during the
year.  The effect of a higher principal balance outstanding during the
year was partially offset by declining interest rates, most notably during the
last quarter of 2008.  At December 31, 2007, only $76.5 million had
been withdrawn under the loan facility.  In 2008, a foreign exchange
loss of $3.8 million was recognized due to holding Canadian dollar bank deposits
at a time when that currency was weakening in relation to the U.S.
dollar.





At
year-end 2007, we determined that it was more likely than not that we would
realize the benefit of a substantial amount of the accumulated deferred tax
asset.  Accordingly, at December 31, 2007 a tax recovery of $37.1
million was recognized, principally arising from net operating loss carry
forwards for income tax purposes and timing differences arising from the
recording of the accounting loss in respect of the mark-to-market of gold
forward sales contracts.  At December 31, 2008, the deferred tax asset
was $24.4 million, which incorporates the effects of a reconciliation of the
previously filed corporate tax returns.





The
factors discussed above resulted in net income to common stockholders for 2008
of $14.6 million or $0.11 per basic share, compared with a net loss of $50.3
million or $0.43 per share in 2007.





In November 2008, we received approval
for a normal course issuer bid program for the repurchase of our outstanding
common shares.  We had approval to repurchase up to a maximum of 12.8
million common shares, or approximately 10% of Western Goldfields’ public float
from the period November 7, 2008 to November 6, 2009.  During the year
ended December 31, 2008, we repurchased 2.3 million common shares as a cost of
$2.5 million.  We returned to treasury and subsequently cancelled
these shares.  The excess of the purchase price over the carrying
amount of the shares purchased was recorded as a $0.3 million reduction of
retained accumulated deficit.





2007
vs. 2006





Other
expense for 2007 was $59.4 million compared to $0.7 million in
2006.  We earned $2.0 million on our surplus cash in 2007 which arose
from the equity issues in January and October 2007. Advances under the term
credit facility commenced in July 2007 and gave rise to interest expense of $1.1
million.  There was no comparable expense in 2006.  The term
credit facility that became effective March 30, 2007 also gave rise to agency
and commitment fees of $0.8 million that were expensed in 2007 and deferred debt
issuance costs of $3.7 million, of which $0.3 million was amortized in
2007.  In addition, at December 31, 2007, we recorded a cumulative
loss of $58.9 million relating to the mark-to-market of our gold forward sales
contracts, and recorded an exchange loss of $0.3 million through holding U.S.
dollar cash balances at a time when that currency was weakening in relation to
the Canadian dollar. The most significant item of cost in 2006 was our payment
of a termination fee of $1.0 million and expense reimbursement costs of $0.2
million on termination of a proposed merger agreement.





Prior to
2007 we did not record any credit to earnings in respect of the value of tax
losses available for set-off against future profits.  Since we now
believe, on the basis of our mine plan and the successful resumption of
production at Mesquite, that it is more likely than not that we will be able to
use these tax losses, we have recorded a recovery of $37.1 million in
2007.





The above
were the major factors in reporting a net loss to common shareholders for 2007
of $50.3 million or $0.43 per share, compared with a net loss of $11.6 million
or $0.18 per share in 2006.





Liquidity
and Capital Resources





Operating
Activities





In 2008,
operating activities used cash of $1.5 million compared to using $28.6 million
in 2007.  The net income for 2008 was $14.6 million, including the
non-cash impact of $12.8 million in net mark-to-market gains and losses on gold
forward sales and fuel hedge contracts, and deferred income taxes of $12.7
million.  Other non-cash expense items included amortization of
deferred debt issuance costs of $0.5 million and stock-based compensation of
$1.3 million.  Amortization and accretion expense increased from $3.9
million in 2007 to $9.2 million in 2008 as a result of the capital additions
that were part of the Mesquite mine expansion project and increased ounces of
gold produced.  Changes in the composition of non-cash working capital
items during 2008 used $26.8 million.  The largest single item was the
increase in inventories of $23.9 million, reflecting an increase of
approximately 32,802 ounces in recoverable gold on the leach pad during the
period.  Prior to fiscal year-end 2008, we sold a shipment of gold
valued at $2.1 million but did not receive payment until January 2, 2009 due to
a bank error.  As such, this amount has been recorded as an accounts
receivable at December 31, 2008.




37





Investing
Activities





Cash
required for investing activities in 2008 was $22.0 million compared with $104.1
million in 2007.  Spending in 2008 was on several process related
projects forming part of the Mesquite Mine expansion project, most notably being
the new leach pad, new carbon columns, retrofit of the process plant, and a
truck repair facility.  The project is now substantially complete and
future related capital expenditures will be nominal.  Capital
expenditures in 2007 totaled $94.6 million which consisted of shovels, haul
trucks, leach pad expansion costs.  We also deposited an additional
$2.1 million to our reclamation and remediation account in 2007.





In 2007,
we transferred $7.5 million of cash to a cost overrun account as a requirement
of our credit facility.  We have reclassified the cash used by
restricted cash of $7.5 million as an investing activity.  In previous
filings, the comparative 2007 figure had been presented as an operating
activity.





Financing
Activities





During 2008 we were advanced a further
$9.9 million under the term loan facility.  As a result of the new
mine plan presented to the lenders, the term loan facility was amended on
December 18, 2008.  In addition to extending the defined completion
date of the project from December 31, 2008 to June 30, 2009, a revised debt
amortization schedule was agreed upon.  On December 31, 2008 we made
the first scheduled repayment in the amount of $17.7 million.  In
2007, we had drawn $76.5 on the term loan facility to advance our Mesquite mine
expansion project.  We were also successful in closing two financing
transactions in 2007 which raised a total of $92.6 million.  In 2008,
we received $1.3 million on the combined exercises of stock options and warrants
compared with $5.5 million in 2007.





As part of our approved normal course
issuer bid program for the repurchase of our outstanding common shares, we
repurchased 2.3 million common shares for $2.5 million in the period November 7,
2008 to December 31, 2008.  We returned to treasury and cancelled
these shares.  The excess of the purchase price over the carrying
amount of the shares purchased was recorded as a $0.3 million reduction of
retained accumulated deficit.





Balance
Sheet





At December 31, 2008, we had available
cash balances of $11.3 million, restricted cash of $7.5 million, and working
capital of $34.6 million.  In addition, we currently have unutilized
credit facilities of $17.7 million.  At present it is not anticipated
there will be further draws under the credit facility.  We expect to
spend an additional $0.3 million in completing expansion related projects during
2009.





The
draw-downs on the loan facility in 2007 and into 2008 enabled us to fund the
completion of the expansion program at Mesquite and the inventory buildup
associated with the ramp-up of production until the generation of operating cash
flow was achieved during the second quarter of 2008.  By December 31,
2008, we are substantially complete with the Mesquite expansion project and
therefore have transferred all remaining balances from construction in process
to plant and equipment.  The transferred balances will create
incremental amortization expense in future periods.





We
are well financed and earning free cash flows which we believe to be sufficient
to:  fund ongoing operations, including discharging our current
obligations in the normal course of operations, repay our loan facility, and
realize potential business opportunities.  Our most liquid investments
were held from time to time in the form of cash and short-term government
treasury bills which management believes have minimal exposure to the prevailing
uncertain and volatile market conditions.  At December 31, 2008 we
held our cash balances in CIBC and Bank of America accounts.





Related
Party Transactions





Since
June 2006 our head office has been located in Toronto, Ontario, Canada, where we
share premises with Silver Bear Resources Inc. (“Silver Bear”), a related party
through certain senior executives and a director of Silver Bear also serve as a
senior executive and as a director of Western Goldfields. Under a cost sharing
agreement with Silver Bear, we were charged with 50% of the rental and operating
costs of the space occupied when the office was leased by Silver Bear. During
the year ended December 31, 2008 overhead costs of $0.2 million were charged by
Silver Bear to Western Goldfields under this agreement (2007 - $0.3
million).





We
relocated our Toronto head office in June of 2008 and we have entered into a
lease for the ten year period commencing June 1, 2008. Estimated rental and
operating costs over the first year of the lease is approximately $0.5 million
and over the ten year term is approximately $5.4 million. As a result of Western
Goldfields entering into the new lease we charged Silver Bear for their
proportional share under the cost sharing agreement.  During the year
ended December 31, 2008 overhead costs, including lease costs for the new
premises, of $0.5 million were charged by Western Goldfields to Silver
Bear.  At December 31, 2008 $23,000 (2007 - $31,000) was payable to
Silver Bear.




38





In
November 2008, a new cost sharing agreement was reached between Silver Bear and
Western Goldfields with an effective date of January 1, 2009.  The new
agreement amends cost sharing ratios between the two companies to one-third
recovery of shared costs from Silver Bear which reflects the current level of
activities and Western Goldfields would initially incur the costs.





Contractual
Obligations





The
following table presents the contractual obligations outstanding as at December
31, 2008:





Total
                      
                      
                      Less than
                        1 Year
                      
                      
                      2- 3
                        Years
                      
                      
                      4- 5
                        Years
                      
                      
                      More than
                        5 YearsLoan
      payable1
                      
                      $
                      68,640
                      
                      
                      $
                      11,656
                      
                      
                      $
                      31,082
                      
                      
                      $
                      25,902
                      
                      
                      $
                      —Mesquite
      expansion project
                      
                      
                      300
                      
                      
                      
                      300
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Reclamation
      and remediation obligations2
                      
                      
                      10,097
                      
                      
                      
                      362
                      
                      
                      
                      1,356
                      
                      
                      
                      1,123
                      
                      
                      
                      7,256Share
      of office lease
                      
                      
                      3,812
                      
                      
                      
                      387
                      
                      
                      
                      774
                      
                      
                      
                      946
                      
                      
                      
                      1,705Total
                      
                      $
                      82,849
                      
                      
                      $
                      12,705
                      
                      
                      $
                      33,212
                      
                      
                      $
                      27,971
                      
                      
                      $
                      8,961




(1)
            In
      addition to the scheduled repayments, mandatory prepayments are required
      semi-annually based on excess cash flow from the Mesquite
      Mine.  An estimate of the timing and amount of prepayments has
      not been included in the chart above, as these payments are based on the
      amount by which the Mesquite Mine’s cash balance, at date of repayment,
      exceeds $4.0 million.


(2)
            In
      current dollars (undiscounted).


(3)
            This
      chart does not include obligations that can be settled by physical
      delivery of gold.





Off
Balance Sheet Arrangements





We had no
off-balance sheet arrangements at December 31, 2008 and December 31, 2007 or at
the date of this report.





Outlook





On October 6, 2008, we announced
details of our new mine plan for the Mesquite Mine.  We will focus on
mining ore from the Rainbow pit starting in 2009.  This compares to
the previous plan in which mining was split between the Rainbow and Big Chief
pits.  We expect to achieve increased efficiency by consolidating
equipment into one location, including reduced mining costs due to short haulage
distances, no wasted time moving between pits, as well as improved operator
efficiency.  The estimated mine life remains unchanged at 14 years and
we plan to mine our three pits sequentially through the duration of the mine
life to continue to maximize these efficiencies.





In 2009,
we expect to incur $68.0 to $72.0 million in operating costs to place
approximately 155,000 recoverable ounces of gold on the leach pad.  At
the end of 2008, Western Goldfields had approximately 52,146 recoverable ounces
of inventory on the leach pad which is estimated to increase to approximately
65,000 ounces at the end of 2009.  Due to the timing of leach pad
recoveries and the impact of inventory adjustments, the Company forecasts
production and sales to be between 140,000 and 150,000 ounces at cost of sales
per ounce1 of $530
to $540. As higher cost leach pad gold inventory at December 31, 2008 is planned
to be replaced by lower cost inventory at December 31, 2009, the planned cost of
sales2 for 2009
includes approximately $11 million from the expected reduction in the value of
leach pad gold inventory. These costs were included in work in process inventory
at December 31, 2008 and therefore do not affect 2009 operating cash
flow.  Operating cash flow is expected to be $40 - $45 million for
2009 assuming a gold price of $850 per ounce. Western Goldfields expects
production and sales to grow again in 2010 to approximately 175,000 ounces with
total operating costs remaining similar to 2009 at $68 to $72 million, thus
reducing the cost of sales per ounce1 in 2010
to approximately $400.





While
total operating costs are expected to remain consistent on a quarterly basis
from $16.5 to $18.5 million, higher stripping ratios and lower grades result in
lower ounces placed and lower production in the first three quarters of
2009.  Approximately 50% of the recoverable ounces placed in 2009 are
forecast to be placed in the fourth quarter.  Production in each of
the first three quarters is expected to be 33,000 to 38,000 ounces before
increasing to 38,000 to 43,000 ounces in the fourth quarter.  The cost
of sales per ounce2 in the
first three quarters of the year are forecast to be $595 to $605 and include
approximately $4 million per quarter of costs from the expected reduction in the
value of leach pad gold inventory quarter to quarter.  The fourth
quarter cost of sales per ounce1 is
expected decline to $365 to $375 and include approximately a $1.0 million
reduction to cost of sales2 from the
expected increase in the value of leach pad gold inventory during the fourth
quarter.  The inventory related costs do not impact the Company's cash
flow in the respective quarters.





Western
Goldfields repaid $17.7 million of its outstanding debt at the end of 2008
leaving $68.6 outstanding under the credit facility.  At the end of
2008, the Company had cash of $11.3 million, excluding $7.5 million of
restricted cash.  As Mesquite's expansion program is substantially
completed, we expect nominal sustaining capital requirements going
forward.  We are forecasting approximately $1.5 million in capital
spending in 2009 and only $0.5 million annually thereafter.





We intend
to continue using Mesquite's cash flow to de-lever the balance sheet and pursue
disciplined growth opportunities.




39





The 2009
cost of sales2 forecast
assumes a diesel price of $1.75 per gallon for the 50% of Mesquite's 2009 diesel
requirement that is currently unhedged; $1.75 per gallon corresponds to the
January 2009 price paid for diesel at Mesquite.  Diesel represents
approximately 20% of Mesquite's annual operating cost.  Cost of sales
per ounce1 is
impacted by changes in diesel price as approximately 50% of Mesquite's annual
diesel consumption remains unhedged.


(1)
            Cost
      of sales per ounce is a non-GAAP financial performance measure with no
      standardized meaning under US GAAP.  It is defined as cost of
      sales per Western Goldfields’ financial statements divided by the number
      of gold ounces sold.(2)
            Cost
      of sales is defined as mine operating costs, including changes in leach
      pad inventory, plus royalties.  Cost of sales does not include
      non-cash amortization and accretion
expense.





Critical
Accounting Policies and Estimates





Listed
below are the accounting policies that we believe are critical to our financial
statements due to the degree of uncertainty regarding the estimates or
assumptions involved and the magnitude of the asset, liability, revenue or
expense being reported.  For additional information on the market risk
that we face see Item 7A – “Quantitative and Qualitative Disclosure about Market
Risk”.




Derivative
Instruments





The
Company accounts for its gold forward sales and fuel hedges in conformity with
the following statements issued by the Financial Accounting Standards Board
(“FASB”): Statement of Financial Accounting Standards (“SFAS”) No. 133,
“Accounting for Derivative Instruments and Hedging Activities,” as amended by
SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB No. 133,” SFAS No. 138, “Accounting for
Certain Derivative Instruments and Certain Hedging Activities,” and SFAS No.
149, “Amendment of Statement 133 on Derivative Instruments and Hedging
Activities”.  These standards establish accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities.  They require
that an entity recognize all derivatives as either assets or liabilities in the
balance sheet and measure those instruments at fair value.





A
derivative may be specifically designated as a hedge of financial risk exposures
of anticipated transactions if, both at the inception of the hedge and
throughout the hedge period, the changes in fair value of the contract
substantially offset the effect of commodity price changes on the anticipated
transactions and if it is probable that the transactions will
occur.  Pursuant to such a designation, the income effect of the
change in derivative values would be accounted for in other comprehensive income
based upon the Company's valuation of the associated financial gain or
loss.  Any change arising from the determination of the derivative's
effectiveness would be accounted for as a charge to current
operations.





At
December 31, 2008, the Company’s gold forward sales and fuel hedge contracts did
not meet the criterion in SFAS No.133, and therefore were not designated as cash
flow hedges.  These derivative contracts have been entered into in
order to effectively establish prices for future production of metals and to
establish prices for future purchases of energy.  Since the hedge
accounting rules of SFAS No.133 are not being applied, the period-end
mark-to-market of these contracts are immediately reflected on the statement of
operations of the Company and the cumulative effect is reflected as an asset or
liability on the balance sheet.  Realized and unrealized gains or
losses associated with these derivative contracts are included in earnings in
the period in which the underlying hedged transaction is
recognized.




Amortization





Expenditures
for new facilities or equipment and expenditures that extend the useful lives of
existing facilities or equipment are capitalized and amortized using the
straight line method at rates sufficient to depreciate such costs over the
estimated useful lives of such facilities or equipment.





We have
expensed all mine development costs prior to our establishing proven and
probable reserves upon completion of the feasibility study in August 2006.
Subsequent costs incurred to access reserves, drilling and related costs
incurred that meet the definition of an asset were capitalized and amortized on
a units-of-production basis.





The costs
incurred in the construction of our leach pad expansion were capitalized and
being amortized on a units-of-production basis.





The
expected useful lives used in amortization calculations are based on applicable
facts and circumstances, as described above. Significant judgment is involved in
the determination of useful lives, and no assurance can be given that actual
useful lives will not differ significantly from the useful lives assumed for
purposes of amortization.





Carrying Value of Long-Lived
Assets





We review
and evaluate the carrying value of our long-lived assets for impairment when
events or changes in circumstances indicate the carrying values may not be
recoverable. Our long-lived assets comprise the fair values allocated to the
plant and equipment acquired upon completion of the Mesquite acquisition and
subsequent additions. Annually, we review the present value of future cash flows
to determine if the amounts carried under plant and equipment are
recoverable.




40




Material
changes to any of these factors or assumptions discussed above could result in
future impairment charges.





Inventories





Ore on Heap Leach
Pad




Prior to
July 2007, the Company placed no value on the mineralized material that had been
placed on the leach pad at the Mesquite Mine prior to the acquisition of the
property by the Company on November 7, 2003.  The reserve estimates
reported by the Company in August 2006 and March 2007 support the recoverability
of inventoried production costs.  Accordingly, since resumption of
mining operations in July 2007, new ore placed on the leach pad has been valued
at the lower of average cost or net realizable value.  Any adjustment
to net realizable value is reflected in the statement of operations as a
component of mine operating costs.  Costs are added to ore on leach
pad based on current mining costs, including applicable amortization and
depletion relating to mining operations.  Costs are removed from ore
on leach pad as ounces are recovered based on the average cost per estimated
recoverable ounce of gold on the leach pad.  The estimates of
recoverable gold on the leach pad are calculated from the quantities of ore
placed on the leach pad (based on measured tonnage), the grade of ore placed on
the leach pad (based on assay results), and a recovery percentage (based on ore
type).




Metal-in-Process
Inventories




Under the
heap leaching process, ore on leach pad is treated with a chemical solution
which dissolves the gold contained in the ore.  The solution is
further processed in a plant where the gold is
recovered.  Metal-in-process inventories represent metal in solution
or in subsequent stages of the refining process.  In-process
inventories are measured based on assays of the solution and projected
recoveries from the refining circuit and are valued at average production cost
or net realizable value.  Average production cost is based on the
average cost of material fed into the process from the leach pad plus the
in-process conversion costs, including applicable amortization relating to the
process facilities.  Metal-in-process inventories are valued at the
lower of average cost or net realizable value and any adjustment to net
realizable value is reflected in the statement of operations as a component of
mine operating costs.





Although
the amount of recoverable gold ounces placed on the leach pad, based on tonnage
and grade of ore, is reconciled to the gold ounces actually recovered, the
nature of the leaching process inherently limits the ability to precisely
monitor inventory levels.  As a result, the metallurgical balancing
process is constantly monitored and estimates are refined based on actual
results over time.  The determination of both the ultimate recovery
percentage and the quantity of metal expected over time requires the use of
estimates, which are subject to revision since they are based upon metallurgical
test work.  The Company expects to continue to process and recover
metal from the leach pad until no longer considered economically
feasible.





Bullion




Bullion
(metal refined to industry purity standards) inventory, which includes metal
held on our behalf by third parties, is valued at the lower of average
production cost or net realizable value.





Deferred
Taxes





The
Company accounts for income taxes using the liability method, recognizing
certain temporary differences between the financial reporting basis of the
Company’s assets and liabilities and the related income tax basis for such
assets and liabilities.  This method generates either a net deferred
income tax asset or liability for the Company, as measured by the statutory tax
rates in effect.  The Company derives its deferred income tax benefit
or charge by recording the change in either the net deferred income tax asset or
liability balance in the year.





The
Company’s deferred income tax assets include certain future income tax
benefits.  A valuation allowance is recorded against deferred income
tax assets if management does not believe the Company has met the “more likely
than not” standard required by SFAS No. 109 to allow recognition of such an
asset.





Reclamation and Remediation
Liabilities





Our
mining and exploration activities are subject to various laws and regulations
governing the protection of the environment. In August 2001, the Financial
Accounting Standards Board (“FASB”) issued Statement of Financial Accounting
Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations” which
established a uniform methodology for accounting for estimated reclamation and
remediation costs. The statement was adopted in July 2003 upon the acquisition
of Mesquite when we recorded the estimated present value of the reclamation and
remediation liabilities. Our estimates of reclamation and remediation
liabilities are reviewed and adjusted from time to time to reflect changes in
the estimated present value resulting from the passage of time and revisions to
the estimates of either timing or amount of reclamation and abandonment
costs.


41





Accounting
for reclamation and remediation liabilities requires management to make
estimates at the end of each period of the undiscounted costs expected to be
incurred. Such cost estimates include ongoing care, maintenance and monitoring
costs. Changes in estimates are reflected in earnings in the period an estimate
is revised.




Accounting
for reclamation and remediation liabilities requires management to make
estimates of the future costs we will incur to complete the reclamation and
remediation work required to comply with existing laws and regulations. Actual
costs incurred in future periods could differ from amounts estimated.
Additionally, future changes to environmental laws and regulations could
increase the amount of reclamation and remediation work required. Any such
increases in future costs could materially impact the amounts charged to
earnings for reclamation and remediation.





Stock Options and Warrants
Granted to Employees and Non-employees





The
Company accounts for grants of stock options and warrants in terms of SFAS No.
123 (R), “Share Based Payment”, which revises SFAS No.123, “Accounting for
Stock-Based Compensation”. Accordingly, the Company measures all employee
stock-based compensation awards and awards to non-employees in exchange for
goods and services, using a fair value method and records such expense in its
financial statements over the service period. In its application of the
Black-Scholes model for valuation of stock options and warrants, management is
required to make estimates based on several assumptions, including: risk-free
interest rate, volatility rate, and the expected life of the options and
warrants. Actual results could differ from these estimates.





Recent
Accounting Pronouncements





In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, “Fair Value Measurements”.  The Statement defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value
measurements.  The Statement does not require any new fair value
measurements.  The provisions of the Statement are effective for
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years.  In February 2008, FASB
staff issued FSP No. FAS 157-2 which delays the effective date of SFAS No. 157
for nonfinancial assets or liabilities that are not required or permitted to be
measured at fair value on a recurring basis to fiscal years beginning after
November 15, 2008, and interim periods within those years.  Effective
January 1, 2008, the Company adopted SFAS No. 157 as it relates to financial
assets and liabilities.  The new disclosures are included in Note
19.





In
February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities - Including an amendment of FASB Statement No.
115”.  The Statement permits entities to choose to measure many
financial instruments and certain other items at fair value.  The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reporting earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions.  The Company adopted SFAS No. 159 effective
January 1, 2008 but this has had no impact on the Company’s financial position,
financial performance and cash flows.





In
December 2007, FASB issued FAS 141(R), “Business Combinations”, which will
replace FAS 141 prospectively for business combinations consummated after the
effective date of December 15, 2008.  Under FAS 141(R), business
combinations will be accounted for under the “acquisition method”, compared to
the “purchase method” mandated by FAS 141.  Significant changes will
result from applying the acquisition method, including: more acquisitions will
be accounted for as business combinations rather than as asset acquisitions;
acquisition related costs of the acquirer will be expensed as incurred, whereas
under FAS 141 these costs are capitalized as part of the business combination;
and the assets acquired and liabilities assumed are recorded at 100% of fair
value even if less than 100% is obtained, whereas under FAS 141 only the
controlling interest’s portion is recorded at fair value.  In the
event of the Company being involved in a future business combination, the
Company will evaluate the application of FAS 141(R).





In
December 2007, FASB issued FAS 160, “Non-Controlling Interests in Consolidated
Financial Statements” which is effective for fiscal years beginning after
December 15, 2008.  Under FAS 160, non-controlling interests will be
measured at 100% of the fair value of assets acquired and liabilities
assumed.  Under current standards, the non-controlling interest is
measured at book value.  For presentation and disclosure purposes,
non-controlling interests will be classified as a separate component of
shareholders’ equity.  In addition, FAS 160 will change the manner in
which increases and decreases in ownership percentages are accounted
for.  The provisions of FAS 160 are to be applied prospectively with
the exception of the presentation and disclosure provisions, which are to be
applied for all prior periods presented in the financial
statements.  In the event of the Company being required in the future
to prepare consolidated financial statements including a non-controlling
interest in another entity, the Company will evaluate the application of FAS
160.





In March
2008, FASB issued FAS No. 161, “Disclosures about Derivative Instruments and
Hedging Activities – an amendment of FASB Statement No. 133”, which is effective
for financial statements issued for fiscal years and interim periods beginning
after November 15, 2008, with early application encouraged.  The
statement requires enhanced disclosures about an entity’s derivative and hedging
activities and thereby improves the transparency of financial
reporting.  The statement changes the disclosure requirements for
derivative instruments and hedging activities.  Entities are required
to provide enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedging items are
accounted for under Statement 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance and cash flows.  The Company is
compliant with these enhanced disclosure requirements in respect of its gold
forward sales and fuel hedge contracts.


42





In June
2008, FASB issued FSP EITF 03-6-1, "Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities" which is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those years.  The statement
addresses whether instruments granted in share-based payment transactions are
participating securities prior to vesting and, therefore, need to be included in
the earnings allocation in computing earnings per share under the two-class
method described in paragraphs 60 and 61 of FASB Statement No. 128, Earnings per
Share.The
Company has evaluated the impact of FSP EITF 03-6-1 and concluded there is no
impact on the Company's consolidated financial statements.





In June
2008, the FASB issued EITF No. 07-5, Determining Whether an Instrument (or an
Embedded Feature) is Indexed to an Entity's Own Stock ("EITF07-5").
 EITF07-5 provides that an entity should use a two step approach to
evaluate whether an equity-linked financial instrument (or embedded feature) is
indexed to its own stock, including evaluating the instrument's contingent
exercise and settlement provisions. It also clarifies on the impact of foreign
currency denominated strike prices and market-based employee stock option
valuation instruments on the evaluation. EITF07-5 is effective for fiscal years
beginning after December 15, 2008.  The Company is currently assessing the
impact, if any, on its consolidated financial position and results of
operations.





In
December 2008, FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interest in
Variable Interest Entities”, for the purpose of improving the transparency of
transfers of financial assets and an enterprise’s involvement with variable
interest entities (VIEs), including qualifying special-purpose entities (QSPEs).
 The VIE disclosure requirements focus on an enterprise’s involvement with
VIE’s and it’s judgments about the accounting for them. The FSP also requires
disclosure of the details of any financial or other support provided to a VIE
that the enterprise was not previously contractually required to provide, and
the primary reasons for providing the support.  The primary beneficiary of
a VIE is also required to disclose the terms of any arrangements, that could
require the enterprise to provide future support to the VIE.  In addition,
FSP FAS 140-4 and FIN 46(R)-8 requires disclosure of the carrying amount and
classification of the variable interest entity’s assets and liabilities in the
Balance Sheet and a reconciliation of those amounts to the enterprise’s maximum
exposure to loss.  There was no impact of this pronouncement on our
financial statements.





Conclusion
Regarding the Effectiveness of Disclosure Control and Procedures





Under the
supervision and with the participation of the Company’s management, including
the Chief Executive Officer and Chief Financial Officer, an evaluation of the
disclosure controls and procedures was conducted, as such is defined under Rules
13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934,
as amended (the Exchange Act). Based on this evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that the Company’s disclosure
controls and procedures were effective as at the end of the fiscal year covered
by this Form 10-K to provide reasonable assurance that the information required
to be disclosed by the Company in the reports it files, and the transactions
that are recorded, processed, summarized and reported, within the appropriate
time periods and forms.


Management’s
Report on Internal Control Over Financial Reporting


Management
is responsible for establishing and maintaining adequate internal control over
financial reporting. As such term is defined in Exchange Act Rule 13a-15(f),
internal control over financial reporting is a process designed by, or under the
supervision of, the principal executive and principal financial officers, or
persons performing similar functions, and effected by the board of directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States. Internal control over financial reporting
includes those policies and procedures that:
 
 (1)
              pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of assets of the
      Company;
 
 (2)
              provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of the financial statements in accordance with accounting
      principles generally accepted in the United States, and that receipts and
      expenditures of the Company are being made only in accordance with
      authorizations of management and the directors of the Company;
      and
 
 (3)
              provide
      reasonable assurance regarding prevention of unauthorized acquisition,
      use, or disposition of the Company’s assets that could have a material
      effect on the financial statements.
 
 Management
conducted an evaluation of the effectiveness of the Company’s internal control
over financial reporting based on the criteria in Internal Control—Integrated
Frameworkissued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this evaluation under the criteria in Internal Control—Integrated
Framework, management concluded that internal control over financial
reporting was effective as of December 31, 2008.
  The
effectiveness of internal control over financial reporting as at December 31,
2008, was audited by PricewaterhouseCoopers LLP, our independent auditors, as
stated in their report which is included with the audited financial
statements.
  Changes
in Internal Control Over Financial Reporting





There has
not been any change in the Company’s internal control over financial reporting
that occurred during the Company’s fourth fiscal quarter of 2008 that has
materially affected, or is reasonably likely to materially affect, the Company’s
internal control over financial reporting.





Limitations
of Controls and Procedures





The
Company’s management, including the Chief Executive Officer and Chief Financial
Officer, believe that any disclosure controls and procedures or internal
controls over financial reporting, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the
control system are being met.  Further, the design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs.  Because of the
inherent limitations in all control systems, they cannot provide absolute
assurance that all control issues and instances of fraud, if any, within the
Company have been prevented or detected.  These inherent limitations
include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or
mistake.  Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by unauthorized
override of the control.  The design of systems of controls also is
based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions.  Accordingly,
because of the inherent limitations in a cost effective control system,
misstatements due to error or fraud may occur and not be
detected.


43




ITEM 7A.    QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK





Risks





In the
normal course of business, we are exposed to market risk, including changes in
interest rates and prices of certain commodities, notably gold and
fuel.  A change in the market price of these commodities significantly
affects our profitability and cash flow.





Gold
prices can fluctuate widely due to numerous factors, such as: demand, forward
selling by producers, central bank activities, the strength of the U.S. dollar
and global mine production levels.  We use gold forward sales
contracts to manage a portion of our exposure to risk arising through changes in
the price of gold.  While we are exposed to credit risk in the event
of non-performance by counterparties to these agreements, in all cases the
counterparties are highly rated financial institutions and we do not anticipate
non-performance.  We do not hold or issue derivative financial
instruments for trading purposes.





At
December 31, 2008, our gold forward sales contracts consisted of a series of
contracts to sell 5,500 ounces per month at a price of $801 per ounce over a
remaining 72-month period to December 2014.  The fair value of the
liability on the remaining contracts as at December 31, 2008 was $45.2 million
(2007 - $58.9 million).  We monitor our hedge positions and perform
sensitivity analyses on our forward contracts to determine the mark-to-market
gain/loss at current gold prices.  We estimate that a 10% change in
the spot price of gold from the level of $870 per ounce at December 31, 2008
translates into a mark-to-market fluctuation of approximately $34.4
million.





Gold
sales covered by the forward sales contracts represent approximately 44% of our
forecast annual shipments for 2009.  The balance of our shipments will
be sold in the spot market.  We estimate that a 10% change in the
price of gold from the level of $870 per ounce at December 31, 2008 translates
into a $7.2 million increase/decrease in revenues from un-hedged production in
2009.





At
December 31, 2008, our fuel hedge contracts consisted of a series of contracts
hedging 126,000 gallons per month at prices of $1.82 and $1.90 per gallon for
2009 and 2010, respectively.  The fair value of the liability on the
contracts as at December 31, 2008 was $0.9 million.  We monitor our
hedge positions and perform sensitivity analyses on our forward contracts to
determine the mark-to-market gain/loss at current fuel prices.  We
estimate that a 10 cent change in the spot price of fuel from the level of $1.45
per gallon at December 31, 2008 translates into a mark-to-market fluctuation of
approximately $0.3 million.





Fuel
costs are a significant cost element at Mesquite.  Approximately 20%
of Mesquite’s operating costs are attributable to diesel
consumption.  The market price of diesel and gasoline is unpredictable
and can fluctuate significantly.  During the first nine months of
2008, world oil prices were at very high levels and were being reflected in the
price paid for fuel.  We estimate that a 10 cent change in the price
of diesel fuel from an average of approximately $2.90 per gallon experienced
during the year translates into a $0.7 million increase/decrease in mining
costs.





At
December 31, 2008 we had $68.6 million of bank debt outstanding of which $11.7
million is current.  This debt currently bears interest based on
short-term U.S. dollar LIBOR rates, generally for one-month periods, plus
2.2%.  A 1% fluctuation in U.S. dollar LIBOR rates at current levels
of indebtedness would translate into a $0.7 million change in reported pre-tax
income.





We have a
bonding and insurance program, primarily with American International Specialty
Lines Insurance Company (“AIG Insurance”) in respect of the operations and
closure liabilities of the Mesquite Mine.  At December 31, 2008, we
had $8.9 million in the account.  On September 16, 2008, AIG
Insurance’s parent company, American International Group, Inc. (“AIG”), suffered
a liquidity crisis following the downgrade of its credit rating.  The
United States Federal Reserve has since loaned money to AIG in order for the
company to meet its obligations to post additional collateral to trading
partners.  As a result of Federal and State laws governing the
operation of AIG Insurance, it is not believed that our funds are at
risk.


44




ITEM 8.    FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA





TABLE
      OF CONTENTS




PageReport
      of Independent Registered Public Accounting Firm - PricewaterhouseCoopers
      LLP
                  
                  46Report
      of Independent Registered Public Accounting Firm – HJ &
      Associates, LLC
                  
                  47Consolidated
      Balance Sheets as of December 31, 2008 and 2007
                  
                  48Consolidated
      Statements of Operations and Other Comprehensive Loss for the years ended
      December 31, 2008, 2007 and 2006
                  
                  49Consolidated
      Statements of Changes in Stockholders’ Equity (Deficit) for the years
      ended December 31, 2008 and 2007
                  
                  50Consolidated
      Statements of Cash Flows for the years ended December 31, 2008, 2007 and
      2006
                  
                  51Notes
      to Consolidated Financial Statements
                  
                  52


45


INDEPENDENT AUDITORS’
REPORT





To the
Stockholders of Western Goldfields Inc.





We have
completed an integrated audit of Western Goldfields Inc.’s (the Company’s) 2008
consolidated financial statements and of its internal control over financial
reporting as at December 31, 2008 and an audit of its 2007 consolidated
financial statements. Our opinions, based on our audits, are presented
below.





Consolidated
financial statements





We have
audited the accompanying consolidated balance sheets of Western Goldfields Inc.
as at December 31, 2008 and December 31, 2007, and the related consolidated
statements of operations and comprehensive income (loss), consolidated
statement of stockholders’ equity and consolidated statement of cash flows for
each of the years then ended. These financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on
these financial statements based on our audits.





We
conducted our audits of the Company’s financial statements 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 plan and perform an audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit of financial
statements includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. A financial statement audit also
includes assessing the accounting principles used and significant estimates made
by management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Company as at December
31, 2008 and December 31, 2007 and the results of its operations and its cash
flows for each of the years then ended in accordance with accounting principles
generally accepted in the United States of America.





The
consolidated financial statements of the Company as of December 31, 2006 and for
the year then ended were audited by other auditors whose report dated
February 24, 2007 expressed an unqualified opinion on those
statements.





Internal
control over financial reporting





We have
also audited Western Goldfields Inc’s internal control over financial reporting
as at December 31, 2008, based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company’s management is responsible for
maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management’s Report on Internal Controls over
Financial Reporting. Our responsibility is to express an opinion on the
Company’s internal control over financial reporting based on our
audit.





We
conducted our audit of internal control over financial reporting in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. An audit of internal control
over financial reporting includes obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists,
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk, and performing such other procedures as we
consider necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the
financial statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





In our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as at December 31, 2008 based on criteria
established in Internal Control — Integrated Framework issued by the
COSO.




/s/
PricewaterhouseCoopers LLP
 Chartered
Accountants, Licensed Public Accountants


Toronto,
Ontario


Canada


March 5,
2009


46




REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM





To the
Stockholders of


Western
Goldfields Inc.


Toronto,
Ontario, Canada





We have
audited the accompanying consolidated statements of operations and other
comprehensive loss, stockholders’ equity (deficit) and cash flows of Western
Goldfields Inc. for the year ended December 31, 2006. These consolidated
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated results of operations and cash flows
of Western Goldfields Inc. for the year ended December 31, 2006 in conformity
with United States generally accepted accounting principles.




/s/ HJ
& Associates, LLC


Salt Lake
City, Utah


February
24, 2007


47







PART I – FINANCIAL
INFORMATION


Item 1.   Financial
Statements


WESTERN
      GOLDFIELDS INC.CONSOLIDATED
      BALANCE SHEETS(In
      thousands U.S. dollars)





December 31,
                                                    
                                                    
                                                    December 31,2008
                                                    
                                                    
                                                    2007ASSETSCURRENT
      ASSETSCash
      and cash equivalents
                                                    
                                                    $
                                                    11,275
                                                    
                                                    
                                                    $
                                                    43,870Restricted
      cash (Note 4)
                                                    
                                                    
                                                    7,500
                                                    
                                                    
                                                    
                                                    7,500Receivables
                                                    
                                                    
                                                    2,550
                                                    
                                                    
                                                    
                                                    298Inventories
      (Note 5)
                                                    
                                                    
                                                    35,098
                                                    
                                                    
                                                    
                                                    11,201Prepaid
      expenses
                                                    
                                                    
                                                    1,747
                                                    
                                                    
                                                    
                                                    887Current
      portion of deferred income tax asset (Note 11)
                                                    
                                                    
                                                    2,045
                                                    
                                                    
                                                    
                                                    755TOTAL
      CURRENT ASSETS
                                                    
                                                    
                                                    60,215
                                                    
                                                    
                                                    
                                                    64,511Plant
      and equipment, net of accumulated amortization (Note 6)
                                                    
                                                    
                                                    111,334
                                                    
                                                    
                                                    
                                                    77,951Construction
      in process (Note 7)
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    21,864Investments
      - reclamation and remediation (Note 8)
                                                    
                                                    
                                                    8,934
                                                    
                                                    
                                                    
                                                    8,661Long-term
      deposits
                                                    
                                                    
                                                    367
                                                    
                                                    
                                                    
                                                    348Long-term
      prepaid expenses (Note 9)
                                                    
                                                    
                                                    1,384
                                                    
                                                    
                                                    
                                                    1,555Deferred
      debt issuance costs, net of accumulated amortization (Note
    10)
                                                    
                                                    
                                                    2,766
                                                    
                                                    
                                                    
                                                    3,227Deferred
      income tax asset (Note 11)
                                                    
                                                    
                                                    22,368
                                                    
                                                    
                                                    
                                                    36,378TOTAL
      OTHER ASSETS
                                                    
                                                    
                                                    147,153
                                                    
                                                    
                                                    
                                                    149,984TOTAL
      ASSETS
                                                    
                                                    $
                                                    207,368
                                                    
                                                    
                                                    $
                                                    214,495LIABILITIES
      & STOCKHOLDERS' EQUITYCURRENT
      LIABILITIESAccounts
      payable and accrued liabilities
                                                    
                                                    $
                                                    7,484
                                                    
                                                    
                                                    $
                                                    8,781Current
      portion of mark-to-market loss on gold hedging contracts (Notes
      12)
                                                    
                                                    
                                                    5,606
                                                    
                                                    
                                                    
                                                    1,935Current
      portion of mark-to-market loss on fuel hedging contracts (Note
      13)
                                                    
                                                    
                                                    540
                                                    
                                                    
                                                    
                                                    —Current
      portion of loan payable (Note 14)
                                                    
                                                    
                                                    11,656
                                                    
                                                    
                                                    
                                                    6,882Current
      portion of reclamation and remediation liabilities (Note
    15)
                                                    
                                                    
                                                    339
                                                    
                                                    
                                                    
                                                    129TOTAL
      CURRENT LIABILITIES
                                                    
                                                    
                                                    25,625
                                                    
                                                    
                                                    
                                                    17,727LONG-TERM
      LIABILITIESMark-to-market
      loss on gold hedging contracts (Note 12)
                                                    
                                                    
                                                    39,580
                                                    
                                                    
                                                    
                                                    56,966Mark-to-market
      loss on fuel hedging contracts (Note 13)
                                                    
                                                    
                                                    391
                                                    
                                                    
                                                    
                                                    —Loan
      payable (Note 14)
                                                    
                                                    
                                                    56,984
                                                    
                                                    
                                                    
                                                    69,581Reclamation
      and remediation liabilities (Note 15)
                                                    
                                                    
                                                    4,737
                                                    
                                                    
                                                    
                                                    4,932TOTAL
      LIABILITIES
                                                    
                                                    
                                                    127,317
                                                    
                                                    
                                                    
                                                    149,206COMMITMENTS
      AND CONTINGENCIES (Note 21)
                                                    
                                                    
                                                    —
                                                    
                                                    
                                                    
                                                    —STOCKHOLDERS'
      EQUITYCommon
      stock, of no par value, unlimited shares authorized; 134,801,286 and
      135,049,685 shares issued and outstanding, respectively (Note
      17)
                                                    
                                                    
                                                    133,383
                                                    
                                                    
                                                    
                                                    133,725Stock
      options and warrants (Note 18)
                                                    
                                                    
                                                    8,291
                                                    
                                                    
                                                    
                                                    7,551Accumulated
      deficit
                                                    
                                                    
                                                    (61,623
                                                    )
                                                    
                                                    
                                                    (75,987
                                                    )TOTAL
      STOCKHOLDERS' EQUITY
                                                    
                                                    
                                                    80,051
                                                    
                                                    
                                                    
                                                    65,289TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                                                    
                                                    $
                                                    207,368
                                                    
                                                    
                                                    $
                                                    214,495




The
accompanying notes are an integral part of these consolidated financial
statements.


48




WESTERN
GOLDFIELDS INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


AND
COMPREHENSIVE INCOME / LOSS


(In
thousands U.S. dollars)


Year Ended December 31,2008
                                                            
                                                            
                                                            2007
                                                            
                                                            
                                                            2006REVENUESRevenues
      from gold sales
                                                            
                                                            $
                                                            95,427
                                                            
                                                            
                                                            $
                                                            4,666
                                                            
                                                            
                                                            $
                                                            7,859COST
      OF GOODS SOLDMine
      operating costs
                                                            
                                                            
                                                            54,231
                                                            
                                                            
                                                            
                                                            19,100
                                                            
                                                            
                                                            
                                                            9,266Royalties
                                                            
                                                            
                                                            2,073
                                                            
                                                            
                                                            
                                                            192
                                                            
                                                            
                                                            
                                                            302Cost
      of sales (excludes amortization and accretion)
                                                            
                                                            
                                                            56,304
                                                            
                                                            
                                                            
                                                            19,292
                                                            
                                                            
                                                            
                                                            9,568Amortization
      and accretion
                                                            
                                                            
                                                            9,332
                                                            
                                                            
                                                            
                                                            4,242
                                                            
                                                            
                                                            
                                                            1,352Reclamation
      cost recovery
                                                            
                                                            
                                                            (209
                                                            )
                                                            
                                                            
                                                            (22
                                                            )
                                                            
                                                            
                                                            (1,460
                                                            )65,427
                                                            
                                                            
                                                            
                                                            23,512
                                                            
                                                            
                                                            
                                                            9,460GROSS
      PROFIT (LOSS)
                                                            
                                                            
                                                            30,000
                                                            
                                                            
                                                            
                                                            (18,846
                                                            )
                                                            
                                                            
                                                            (1,601
                                                            )EXPENSESGeneral
      and administrative
                                                            
                                                            
                                                            6,061
                                                            
                                                            
                                                            
                                                            8,370
                                                            
                                                            
                                                            
                                                            7,471Severance
      costs payable in common shares
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            547Exploration
      and business development
                                                            
                                                            
                                                            1,106
                                                            
                                                            
                                                            
                                                            795
                                                            
                                                            
                                                            
                                                            1,2217,167
                                                            
                                                            
                                                            
                                                            9,165
                                                            
                                                            
                                                            
                                                            9,239OPERATING
      INCOME (LOSS)
                                                            
                                                            
                                                            22,833
                                                            
                                                            
                                                            
                                                            (28,011
                                                            )
                                                            
                                                            
                                                            (10,840
                                                            )OTHER
      INCOME (EXPENSE)Interest
      income
                                                            
                                                            
                                                            1,093
                                                            
                                                            
                                                            
                                                            1,976
                                                            
                                                            
                                                            
                                                            392Interest
      expense and commitment fees
                                                            
                                                            
                                                            (4,127
                                                            )
                                                            
                                                            
                                                            (1,863
                                                            )
                                                            
                                                            
                                                            (20
                                                            )Amortization
      of deferred debt issuance costs
                                                            
                                                            
                                                            (461
                                                            )
                                                            
                                                            
                                                            (342
                                                            )
                                                            
                                                            
                                                            —Realized
      and unrealized gain (loss) on mark-to-market of gold forwardsales
      contracts (Note 12)
                                                            
                                                            
                                                            13,078
                                                            
                                                            
                                                            
                                                            (58,901
                                                            )
                                                            
                                                            
                                                            —Unrealized
      loss on mark-to-market of fuel forward contracts (Note 13)
                                                            
                                                            
                                                            (931
                                                            )
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —Gain
      on extinguishment of debt
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            143Loss
      on foreign currency exchange
                                                            
                                                            
                                                            (3,820
                                                            )
                                                            
                                                            
                                                            (343
                                                            )
                                                            
                                                            
                                                            (14
                                                            )Gain
      (loss) on sale of assets
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            42
                                                            
                                                            
                                                            
                                                            (19
                                                            )Merger
      termination expense
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            (1,225
                                                            )4,832
                                                            
                                                            
                                                            
                                                            (59,431
                                                            )
                                                            
                                                            
                                                            (743
                                                            )INCOME
      (LOSS) BEFORE INCOME TAXES
                                                            
                                                            
                                                            27,665
                                                            
                                                            
                                                            
                                                            (87,442
                                                            )
                                                            
                                                            
                                                            (11,583
                                                            )INCOME
      TAX RECOVERY (EXPENSE)
                                                            
                                                            
                                                            (13,049
                                                            )
                                                            
                                                            
                                                            37,133
                                                            
                                                            
                                                            
                                                            —NET
      INCOME (LOSS)
                                                            
                                                            
                                                            14,616
                                                            
                                                            
                                                            
                                                            (50,309
                                                            )
                                                            
                                                            
                                                            (11,583
                                                            )PREFERRED
      STOCK DIVIDENDS
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            (17
                                                            )NET
      INCOME (LOSS) TO COMMON STOCKHOLDERS
                                                            
                                                            
                                                            14,616
                                                            
                                                            
                                                            
                                                            (50,309
                                                            )
                                                            
                                                            
                                                            (11,600
                                                            )OTHER
      COMPREHENSIVE INCOMEForeign
      currency translation adjustment
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            —
                                                            
                                                            
                                                            
                                                            (2
                                                            )NET
      COMPREHENSIVE INCOME (LOSS)
                                                            
                                                            $
                                                            14,616
                                                            
                                                            
                                                            $
                                                            (50,309
                                                            )
                                                            
                                                            $
                                                            (11,585
                                                            )NET
      INCOME (LOSS) PER SHARE - BASIC
                                                            
                                                            $
                                                            0.11
                                                            
                                                            
                                                            $
                                                            (0.43
                                                            )
                                                            
                                                            $
                                                            (0.18
                                                            )-
      DILUTED
                                                            
                                                            $
                                                            0.10
                                                            
                                                            
                                                            $
                                                            (0.43
                                                            )
                                                            
                                                            $
                                                            (0.18
                                                            )WEIGHTED
      AVERAGE NUMBER OF COMMON SHARESOUTSTANDING
      - BASIC
                                                            
                                                            
                                                            136,169,809
                                                            
                                                            
                                                            
                                                            116,903,752
                                                            
                                                            
                                                            
                                                            63,664,614-
      DILUTED
                                                            
                                                            
                                                            148,171,716
                                                            
                                                            
                                                            
                                                            116,903,752
                                                            
                                                            
                                                            
                                                            63,664,614




The
accompanying notes are an integral part of these consolidated financial
statements.


49




WESTERN GOLDFIELDS
INC.


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY


(In
thousands U.S. dollars)


(Years
ended December 31, 2008, 2007 and 2006)


Preferred Stock
                                                  
                                                  
                                                  Common Stock
                                                  
                                                  
                                                  Stock Options
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  Accumulated OtherNumber
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  Number
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  and
                                                  
                                                  
                                                  Accumulated
                                                  
                                                  
                                                  Comprehensiveof Shares
                                                  
                                                  
                                                  Amount
                                                  
                                                  
                                                  of Shares
                                                  
                                                  
                                                  Amount
                                                  
                                                  
                                                  Warrants
                                                  
                                                  
                                                  Deficit
                                                  
                                                  
                                                  Income (Loss)
                                                  
                                                  
                                                  TotalBalance,
      December 31, 2005
                                                  
                                                  
                                                  1,000,000
                                                  
                                                  
                                                  $
                                                  10
                                                  
                                                  
                                                  
                                                  39,468,051
                                                  
                                                  
                                                  $
                                                  13,014
                                                  
                                                  
                                                  $
                                                  4,942
                                                  
                                                  
                                                  $
                                                  (14,078
                                                  )
                                                  
                                                  $
                                                  —
                                                  
                                                  
                                                  $
                                                  3,888Common
      stock and warrants issued by way of private placement
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  20,000,000
                                                  
                                                  
                                                  
                                                  4,012
                                                  
                                                  
                                                  
                                                  1,988
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  6,000Common
      stock issued on conversion of series A preferred stock
      (Note16)
                                                  
                                                  
                                                  (1,000,000
                                                  )
                                                  
                                                  
                                                  (10
                                                  )
                                                  
                                                  
                                                  3,125,000
                                                  
                                                  
                                                  
                                                  25
                                                  
                                                  
                                                  
                                                  (15
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —Common
      stock issued on conversion of series A preferred stock
      warrants
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  1,562,500
                                                  
                                                  
                                                  
                                                  300
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  300Common
      stock issued on exercise of common stock warrants
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  12,647,325
                                                  
                                                  
                                                  
                                                  11,534
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  11,534Common
      stock issued on exercise of common stock options
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  1,135,000
                                                  
                                                  
                                                  
                                                  633
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  633Common
      shares issued for exploration assets and services and severance
      agreements
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  515,000
                                                  
                                                  
                                                  
                                                  684
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  684Stock
      options issued
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  3,209
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  3,209Warrants
      issued for consultants' services
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  233
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  233Exercise
      and expiration of warrants and options
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  2,683
                                                  
                                                  
                                                  
                                                  (2,683
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —Net
      loss for the year ended December 31, 2006
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (11,583
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (11,583
                                                  )Dividend
      on preferred stock (Note 16)
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (17
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (17
                                                  )Other
      comprehensive income
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (2
                                                  )
                                                  
                                                  
                                                  (2
                                                  )Balance,
      December 31, 2006
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  78,452,876
                                                  
                                                  
                                                  
                                                  32,885
                                                  
                                                  
                                                  
                                                  7,674
                                                  
                                                  
                                                  
                                                  (25,678
                                                  )
                                                  
                                                  
                                                  (2
                                                  )
                                                  
                                                  
                                                  14,879Common
      stock and warrants issued under prospectus supplement
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  44,646,000
                                                  
                                                  
                                                  
                                                  92,608
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  92,608Common
      stock issued on exercise of common stock warrants
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  10,248,052
                                                  
                                                  
                                                  
                                                  4,508
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  4,508Common
      stock issued on exercise of common stock options
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  1,702,757
                                                  
                                                  
                                                  
                                                  1,040
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  1,040Stock
      options issued
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  2,561
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  2,561Exercise
      and expiration of warrants and options
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  2,684
                                                  
                                                  
                                                  
                                                  (2,684
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —Net
      loss for the year ended December 31, 2007
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (50,309
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (50,309
                                                  )Other
      comprehensive income
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  2
                                                  
                                                  
                                                  
                                                  2Balance,
      December 31, 2007
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  135,049,685
                                                  
                                                  
                                                  
                                                  133,725
                                                  
                                                  
                                                  
                                                  7,551
                                                  
                                                  
                                                  
                                                  (75,987
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  65,289Common
      stock issued on exercise of common stock warrants
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  750,000
                                                  
                                                  
                                                  
                                                  338
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  338Common
      stock issued on exercise of common stock options
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  1,281,234
                                                  
                                                  
                                                  
                                                  980
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  980Stock
      options issued
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  1,335
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  1,335Exercise
      and expiration of warrants and options
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  595
                                                  
                                                  
                                                  
                                                  (595
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —Shares
      acquired under normal course issuer bid (Note 17)
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (2,279,633
                                                  )
                                                  
                                                  
                                                  (2,255
                                                  )
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  (252
                                                  )
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  (2,507
                                                  )Net
      income for the year ended December 31, 2008
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  14,616
                                                  
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  
                                                  14,616Balance,
      December 31, 2008
                                                  
                                                  
                                                  —
                                                  
                                                  
                                                  $
                                                  —
                                                  
                                                  
                                                  
                                                  134,801,286
                                                  
                                                  
                                                  $
                                                  133,383
                                                  
                                                  
                                                  $
                                                  8,291
                                                  
                                                  
                                                  $
                                                  (61,623
                                                  )
                                                  
                                                  $
                                                  —
                                                  
                                                  
                                                  $
                                                  80,051





The
accompanying notes are an integral part of these consolidated financial
statements.


50




WESTERN
GOLDFIELDS INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(In
thousands U.S. dollars)


Year Ended December 31,2008
                                            
                                            
                                            2007
                                            
                                            
                                            2006CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income (loss)
                                            
                                            $
                                            14,616
                                            
                                            
                                            $
                                            (50,309
                                            )
                                            
                                            $
                                            (11,583
                                            )Adjustments
      to reconcile net income (loss) to net cash provided (used) by operating
      activities:Items
      not affecting cash:Amortization
      of plant and equipment
                                            
                                            
                                            9,196
                                            
                                            
                                            
                                            3,925
                                            
                                            
                                            
                                            1,088Amortization
      of deferred debt issuance costs
                                            
                                            
                                            461
                                            
                                            
                                            
                                            342
                                            
                                            
                                            
                                            —Accretion
      expense (Note 15)
                                            
                                            
                                            224
                                            
                                            
                                            
                                            337
                                            
                                            
                                            
                                            270Deferred
      income taxes
                                            
                                            
                                            12,720
                                            
                                            
                                            
                                            (37,133
                                            )
                                            
                                            
                                            —Reclamation
      cost recovery
                                            
                                            
                                            (209
                                            )
                                            
                                            
                                            (22
                                            )
                                            
                                            
                                            (1,460
                                            )Reclamation
      costs incurred
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (148
                                            )
                                            
                                            
                                            (201
                                            )Loss
      (gain) on sale of assets and investments
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (42
                                            )
                                            
                                            
                                            19Interest
      net of reimbursed costs - reclamation and remediation
                                            
                                            
                                            (273
                                            )
                                            
                                            
                                            (234
                                            )
                                            
                                            
                                            (89
                                            )Common
      stock issued in respect of severance agreements
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            547Stock
      based compensation
                                            
                                            
                                            1,335
                                            
                                            
                                            
                                            2,561
                                            
                                            
                                            
                                            3,579Mark-to-market
      (gain) loss on gold hedging contracts
                                            
                                            
                                            (13,715
                                            )
                                            
                                            
                                            58,901
                                            
                                            
                                            
                                            —Mark-to-market
      loss on fuel hedging contracts
                                            
                                            
                                            931
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —Changes
      in assets and liabilities:Decrease
      (increase) in:Accounts
      receivable
                                            
                                            
                                            (2,025
                                            )
                                            
                                            
                                            (74
                                            )
                                            
                                            
                                            (214
                                            )Inventories
                                            
                                            
                                            (23,897
                                            )
                                            
                                            
                                            (10,689
                                            )
                                            
                                            
                                            394Prepaid
      expenses and deposits
                                            
                                            
                                            (708
                                            )
                                            
                                            
                                            (610
                                            )
                                            
                                            
                                            (392
                                            )Increase
      (decrease) in:Accounts
      payable
                                            
                                            
                                            (1,759
                                            )
                                            
                                            
                                            2,156
                                            
                                            
                                            
                                            885Payroll
      and related taxes payable
                                            
                                            
                                            (1,561
                                            )
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —Accrued
      expenses
                                            
                                            
                                            3,447
                                            
                                            
                                            
                                            2,101
                                            
                                            
                                            
                                            (110
                                            )Accrued
      interest expense
                                            
                                            
                                            (316
                                            )
                                            
                                            
                                            360
                                            
                                            
                                            
                                            (49
                                            )Net
      cash used by operating activities
                                            
                                            
                                            (1,533
                                            )
                                            
                                            
                                            (28,578
                                            )
                                            
                                            
                                            (7,316
                                            )CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of plant and equipment, including construction in process
                                            
                                            
                                            (22,050
                                            )
                                            
                                            
                                            (94,611
                                            )
                                            
                                            
                                            (3,444
                                            )Increase
      in reclamation and remediation investment
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (2,090
                                            )
                                            
                                            
                                            —Proceeds
      from sale of assets
                                            
                                            
                                            —
                                            
                                            
                                            
                                            98
                                            
                                            
                                            
                                            —Restricted
      cash (Note 22)
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (7,500
                                            )
                                            
                                            
                                            —Net
      cash used by investing activities
                                            
                                            
                                            (22,050
                                            )
                                            
                                            
                                            (104,103
                                            )
                                            
                                            
                                            (3,444
                                            )CASH
      FLOWS FROM FINANCING ACTIVITIESShares
      acquired under normal course issuer bid (Note 17)
                                            
                                            
                                            (2,507
                                            )
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —Advances
      under loan facilities
                                            
                                            
                                            9,877
                                            
                                            
                                            
                                            76,462
                                            
                                            
                                            
                                            —Repayments
      under loan facilities
                                            
                                            
                                            (17,700
                                            )
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (2,205
                                            )Deferred
      debt issuance costs
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (3,570
                                            )
                                            
                                            
                                            —Common
      stock issued for cash
                                            
                                            
                                            —
                                            
                                            
                                            
                                            92,608
                                            
                                            
                                            
                                            4,012Warrants
      issued for cash
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            1,988Exercise
      of options to purchase common stock
                                            
                                            
                                            980
                                            
                                            
                                            
                                            1,040
                                            
                                            
                                            
                                            633Exercise
      of warrants to purchase common stock
                                            
                                            
                                            338
                                            
                                            
                                            
                                            4,508
                                            
                                            
                                            
                                            11,834Preferred
      stock dividends
                                            
                                            
                                            —
                                            
                                            
                                            
                                            —
                                            
                                            
                                            
                                            (51
                                            )Net
      cash provided (used) by financing activities
                                            
                                            
                                            (9,012
                                            )
                                            
                                            
                                            171,048
                                            
                                            
                                            
                                            16,211Change
      in cash and cash equivalents
                                            
                                            
                                            (32,595
                                            )
                                            
                                            
                                            38,367
                                            
                                            
                                            
                                            5,451Cash
      and cash equivalents, beginning of period
                                            
                                            
                                            43,870
                                            
                                            
                                            
                                            5,503
                                            
                                            
                                            
                                            52Cash
      and cash equivalents, end of period
                                            
                                            $
                                            11,275
                                            
                                            
                                            $
                                            43,870
                                            
                                            
                                            $
                                            5,503SUPPLEMENTAL
      CASH FLOW DISCLOSURES:Interest
      paid
                                            
                                            $
                                            (4,358
                                            )
                                            
                                            $
                                            (2,374
                                            )
                                            
                                            $
                                            (20
                                            )Interest
      received
                                            
                                            $
                                            887
                                            
                                            
                                            $
                                            1,500
                                            
                                            
                                            $
                                            89Taxes
      paid
                                            
                                            $
                                            570
                                            
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            —NON-CASH
      FINANCING AND INVESTING ACTIVITIES:Stock,
      options and warrants issued for services
                                            
                                            $
                                            1,335
                                            
                                            
                                            $
                                            2,575
                                            
                                            
                                            $
                                            4,126Equipment
      purchases included in accounts payable
                                            
                                            $
                                            551
                                            
                                            
                                            $
                                            1,886
                                            
                                            
                                            $
                                            —Non-cash
      component of inventories
                                            
                                            $
                                            1,556
                                            
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            —Preferred
      stock dividends
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            —
                                            
                                            
                                            $
                                            17





The
accompanying notes are an integral part of these consolidated financial
statements.




51




WESTERN
GOLDFIELDS INC.


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS


(all
tabular data in US$ thousands unless otherwise stated)





1. ORGANIZATION AND DESCRIPTION
OF BUSINESS





Western
Goldfields Inc. (hereinafter “the Company” or “WGI Ontario”) and its wholly
owned subsidiaries are engaged in the exploration for, development and
extraction of precious metals, principally in North America.  The
Company’s four wholly owned subsidiaries are:  Western Goldfields USA
Inc. (a holding company), Western Goldfields (Canada) Inc. (a management
company), Western Mesquite Mines, Inc. (an operating company), and Calumet
Mining Company (an exploration company).





On June
19, 2007 the shareholders of the Company’s predecessor, Western Goldfields,
Inc., an Idaho corporation (“WGI Idaho”), approved an agreement and plan of
merger effective June 29, 2007 whereby the Company’s place of incorporation was
changed from Idaho, USA to Ontario, Canada, and its name was changed from
Western Goldfields, Inc. to Western Goldfields Inc. (the
“Reorganization”).  For accounting purposes, the Reorganization was
treated as a reorganization of entities under common control which has not
resulted in any changes in the consolidated carrying amounts of assets,
liabilities and stockholders’ equity.  As used herein, the term “the
Company” refers to WGI Ontario and its predecessor WGI Idaho.





The
Company was in the exploration stage until late 2003.  With the
acquisition of the Mesquite Mine in November 2003, the Company exited the
exploration stage and became an operating mining company.  Until June
2007, the Company’s operations were restricted to the production of gold from
material that was placed on heap leach pad by previous owners of the
mine.  In June 2007, the Company commenced active mining operations
and in December 2007 commenced leaching new ore.





The
Company, through its wholly-owned subsidiary, Western Mesquite Mines, Inc.
(“WMMI”), entered into a term loan facility with a syndicate of banks,
originally dated March 30, 2007 and subsequently amended and restated (Note 14),
under which facility WMMI can borrow up to $105 million in connection with the
development of the Mesquite Mine.  Of this amount, $87.3 million was
available until Completion of the project and $17.7 million is available until
12 months after Completion.  The agreement, in conjunction with the
equity financings in 2007 completed the financing requirements for
Mesquite.  On December 18, 2008 the term loan facility was further
amended which included an acceleration of the loan repayment
schedule.  At December 31, 2008, $86.3 million had been drawn on the
facility and the first repayment of $17.7 million was made.





The
Company’s year-end for reporting purposes is December 31.





2. BASIS OF PRESENTATION AND SIGNIFICANT
ACCOUNTING POLICIES





The
consolidated financial statements include the accounts of Western Goldfields
Inc. and its 100% owned subsidiaries: Western Goldfields USA Inc., Western
Goldfields (Canada) Inc., Western Mesquite Mines, Inc., and Calumet Mining
Company (collectively “Western Goldfields”).  The consolidated
financial statements include the assets and liabilities of Western Goldfields as
at December 31, 2007 and 2008 and its results of operations and its cash flows
for the years ended December 31, 2007 and 2008.  All inter-company
accounts and transactions have been eliminated on consolidation.





The
preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America (“U.S. GAAP”)
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period.  Significant areas
requiring the use of management estimates relate to the determination of mineral
reserves, reclamation and remediation obligations, impairment of assets, useful
lives for amortization, measurement of heap leach, metal-in-process and finished
goods inventories, value of options and warrants, and valuation allowances for
future tax assets.  Actual results could differ from these
estimates.





Accounts
Receivable





The
Company records its trade accounts receivable at cost less an allowance for
doubtful accounts. The Company evaluates its accounts receivable and establishes
an allowance for doubtful accounts, where necessary, based on a history of past
write-offs and collections and current credit conditions.





The
Company’s trade receivables are related to precious metals delivered against a
forward sales contract or a spot sale contract whose settlement has not
occurred.  Settlement usually occurs between two and fifteen business
days and is made through international metals refiners and
brokers.  At December 31, 2008 the Company had trade receivables
outstanding of $2.1 million (2007 - nil).





52





Basic and Diluted Net Income
(Loss) Per Share





Net
income (loss) per share calculations are based on the weighted average number of
common shares and common share equivalents issued and outstanding during the
year.  Diluted earnings per share is calculated using the treasury
stock method, which assumes that outstanding stock options and warrants with an
average exercise price below market price of the underlying shares, are
exercised and the assumed proceeds are used to repurchase common shares of the
Company at the average market price of the common shares for the
period.




Cash and Cash
Equivalents





The
Company considers all highly liquid investments with original maturities of
three months or less at the date of acquisition to be cash
equivalents.  These highly liquid investments only comprise short-term
Canadian and U.S. government treasury bills.





Deposits





Under the
terms of its agreement with the local electrical power utility, the Company is
required to collateralize certain portions of its obligations and has assigned a
$0.3 million certificate of deposit. The timing of the release of this
collateral is dependent on the credit worthiness of the Company and/or the
timing and closure of the Mesquite mine. Collateral could also be released to
the extent that the Company is able to secure alternative financial assurance
satisfactory to the respective agency. Management expects that the collateral
will remain in place beyond a twelve-month period and has therefore classified
these deposits as long-term.




Derivative
Instruments





The
Company accounts for its forward sales of gold and hedges of fuel in conformity
with the following statements issued by the Financial Accounting Standards Board
(“FASB”): Statement of Financial Accounting Standards (“SFAS”) No. 133,
“Accounting for Derivative Instruments and Hedging Activities,” as amended by
SFAS No. 137, “Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB No. 133,” SFAS No. 138, “Accounting for
Certain Derivative Instruments and Certain Hedging Activities,” and SFAS No.
149, “Amendment of Statement 133 on Derivative Instruments and Hedging
Activities”.  These standards establish accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities.  They require
that an entity recognize all derivatives as either assets or liabilities on the
balance sheet and measure those instruments at fair value.





A
derivative may be specifically designated as a hedge of financial risk exposures
of anticipated transactions if, both at the inception of the hedge and
throughout the hedge period, the changes in fair value of the contract
substantially offset the effect of commodity price changes on the anticipated
transactions and if it is probable that the transactions will
occur.  Pursuant to such a designation, the income effect of the
change in derivative values would be accounted for in other comprehensive income
based upon the Company's valuation of the associated financial gain or
loss.  Any change arising from the determination of the derivative's
effectiveness would be accounted for as a charge to current
operations.  The Company has not currently designated its forward
sales of gold and hedges of fuel as cash flow hedges.





The
Company’s gold forward sales and fuel hedge contracts are economic
hedges.  These derivative contracts have been entered into in order to
effectively establish prices for future production of metals and to establish
prices for future purchases of energy.  Since the hedge accounting
rules of SFAS No.133 are not being applied, the period-end mark-to-market
adjustment of these contracts are immediately reflected on the statement of
operations of the Company and the cumulative effect is reflected as an asset or
liability on the balance sheet.  Realized and unrealized gains or
losses on these contracts are included in earnings in the period in which the
underlying hedged transaction is recognized.





Exploration and Development
Costs





In
accordance with U.S GAAP, the Company expenses exploration costs as
incurred.  The Company capitalizes costs in respect of projects that
meet the definition of an asset after mineralization is classified as proven and
probable reserves.  Upon the completion of the feasibility study in
respect of the Mesquite Mine in August 2006 and the determination of proven and
probable reserves, the Company now capitalizes development costs for that
mineral property.





Fair Value of Financial
Instruments





The
Company's financial instruments as defined by SFAS No. 107, “Disclosures about
Fair Value of Financial Instruments,” include cash and cash equivalents,
restricted cash, accounts and loans receivable, prepaid expenses, accounts
payable, accrued expenses and short-term borrowings.  All instruments
are accounted for on a historical cost basis, which, due to the short maturity
of these financial instruments, approximates fair value at December 31, 2008 and
2007.





53





Inventories





Ore on Heap Leach
Pad




Prior to
July 2007, the Company placed no value on the mineralized material that had been
placed on the leach pad at the Mesquite Mine prior to the acquisition of the
property by the Company on November 7, 2003.  The reserve estimates
reported by the Company in August 2006 and March 2007 support the recoverability
of inventoried production costs.  Accordingly, since resumption of
mining operations in July 2007, new ore placed on the leach pad has been valued
at the lower of average cost or net realizable value.  Any adjustment
to net realizable value is reflected in the statement of operations as a
component of mine operating costs.  Costs are added to ore on leach
pad based on current mining costs, including applicable amortization and
depletion relating to mining operations.  Costs are removed from ore
on leach pad as ounces are recovered based on the average cost per estimated
recoverable ounce of gold on the leach pad.  The estimates of
recoverable gold on the leach pad are calculated from the quantities of ore
placed on the leach pad (based on measured tonnage), the grade of ore placed on
the leach pad (based on assay results), and a recovery percentage (based on ore
type).




Metal-in-Process
Inventories




Under the
heap leaching process, ore on leach pad is treated with a chemical solution
which dissolves the gold contained in the ore.  The solution is
further processed in a plant where the gold is
recovered.  Metal-in-process inventories represent metal in solution
or in subsequent stages of the refining process.  In-process
inventories are measured based on assays of the solution and projected
recoveries from the refining circuit and are valued at average production cost
or net realizable value.  Average production cost is based on the
average cost of material fed into the process from the leach pad plus the
in-process conversion costs, including applicable amortization relating to the
process facilities.  Metal-in-process inventories are valued at the
lower of average cost or net realizable value and any adjustment to net
realizable value is reflected in the statement of operations as a component of
mine operating costs.





Although
the amount of recoverable gold ounces placed on the leach pad, based on tonnage
and grade of ore, is reconciled to the gold ounces actually recovered, the
nature of the leaching process inherently limits the ability to precisely
monitor inventory levels.  As a result, the metallurgical balancing
process is constantly monitored and estimates are refined based on actual
results over time.  The determination of both the ultimate recovery
percentage and the quantity of metal expected over time requires the use of
estimates, which are subject to revision since they are based upon metallurgical
test work.  The Company expects to continue to process and recover
metal from the leach pad until no longer considered economically
feasible.





Bullion




Bullion
(metal refined to industry purity standards) inventory, which includes metal
held on our behalf by third parties, is valued at the lower of average
production cost or net realizable value.





Materials and
Supplies




Materials
and supplies inventory is stated at the lower of average cost or net realizable
value.





Other Comprehensive
Loss





The
Company reports other comprehensive loss according to SFAS No. 130, “Reporting
Comprehensive Income”.  SFAS No. 130 requires unrealized gains and
losses on the Company's available-for-sale securities, to be included as a
separate component of stockholders’ equity as other comprehensive
income.  In addition, gains and losses arising from the conversion to
U.S. dollars of subsidiary company financial statements denominated in foreign
currency, and gains and losses arising from the mark-to-market of forward sales
derivative contracts which are accounted for as hedges, are required under SFAS
No.130 to be reported as other comprehensive income as a separate component of
stockholders’ equity.  No such amounts have been recorded during 2008
and 2007.





Plant and
Equipment





The
Company evaluates the recoverability of plant and equipment when events and
circumstances indicate that such assets might be impaired.  We compare
the sum of the undiscounted cash flows expected to be generated from the mine
site to its carrying amount – and if the sum of undiscounted cash flows is less
than the carrying amount, an impairment loss is recognized if the carrying
amount of the individual long-lived assets within the group exceeds their fair
values.  Maintenance and repairs are expensed as
incurred.  Replacements and betterments are
capitalized.  The cost and related reserves of assets sold or retired
are removed from the accounts, and any resulting gain or loss is reflected in
results of operations.




Plant and
equipment is stated at cost less accumulated
amortization.  Amortization of mobile mining equipment and other
equipment is calculated using the straight-line method over the estimated useful
lives of the assets, which range from three to twelve
years.  Development costs relating to the relocation of fauna, which
bear no relation to mineral production, are being depreciated on a straight-line
basis over the expected life of the mineral property.  All other
development costs, processing plan, mine structures and infrastructure is being
depreciated on a units of production basis over the estimated life of the ore
body based on estimated proven and probable reserves.





54




Deferred
Taxes





The
Company accounts for income taxes using the liability method, recognizing
certain temporary differences between the financial reporting basis of the
Company’s assets and liabilities and the related income tax basis for such
assets and liabilities.  This method generates either a net deferred
income tax asset or liability for the Company, as measured by the statutory tax
rates in effect.  The Company derives its deferred income tax benefit
or charge by recording the change in either the net deferred income tax asset or
liability balance in the year.





The
Company’s deferred income tax assets include certain future income tax
benefits.  A valuation allowance is recorded against deferred income
tax assets if management does not believe the Company has met the “more likely
than not” standard required by SFAS No. 109 to allow recognition of such an
asset.





Reclamation and Remediation
Costs and Liabilities





The
Company records a liability and corresponding asset for estimated costs for
future site reclamation and closure.  The estimated present value of
the asset retirement obligation is reassessed on an annual basis or when new
material information becomes available.  Increases or decreases to the
obligation usually arise due to changes in legal or regulatory requirements, the
extent of environmental remediation required or methods of reclamation or cost
estimates.  The present value of the estimated costs of these changes
are recorded in the period in which the change is identified and quantified.
Changes to asset retirement obligations related to operating mines are recorded
with an offsetting change to the related asset.  For properties where
mining activities have ceased or are in reclamation, changes are charged
directly to earnings.  The present value is determined using the
Company’s credit adjusted risk free interest rate.





Revenue
Recognition





Revenue
is recognized when the following conditions are met:  persuasive
evidence of an arrangement exists; delivery and transfer of title (gold revenue
only) have occurred under the terms of the arrangement; the price is fixed or
determinable; and collectability is reasonably assured.  Third party
smelting and refining costs are recorded as a cost of sales and silver
by-product credits reduce cost of sales as generated.





In 2007,
the Company entered into gold forward sales contracts for the sale of 429,000
ounces of gold at $801 per ounce commencing July 2008 with the last commitment
deliverable on December 2014.  As at December 31, 2008, the Company
had settled, financially or physically at the Company’s discretion, contracts
totaling 33,000 ounces.





Gross
revenues from gold sales for the years ended December 31, 2008, 2007 and 2006
were to the following major customers:




December 31,
                          2008
                        
                        
                        December 31,
                          2007
                        
                        
                        December 31,
                            2006Customer
      A
                        
                        $
                        69,370
                        
                        
                        $
                        —
                        
                        
                        $
                        —Customer
      B
                        
                        
                        9,127
                        
                        
                        
                        —
                        
                        
                        
                        —Customer
      C
                        
                        
                        7,316
                        
                        
                        
                        4,666
                        
                        
                        
                        6,946Customer
      D
                        
                        
                        6,543
                        
                        
                        
                        —
                        
                        
                        
                        —Customer
      E
                        
                        
                        2,824
                        
                        
                        
                        —
                        
                        
                        
                        —Customer
      F
                        
                        
                        247
                        
                        
                        
                        —
                        
                        
                        
                        —Customer
      G
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        913$
                        95,427
                        
                        
                        $
                        4,666
                        
                        
                        $
                        7,859





Stock Options and Warrants
Granted to Employees and Non-employees





The
Company accounts for grants of stock options and warrants in terms of SFAS No.
123 (R), “Share Based Payment”, which revises SFAS No.123, “Accounting for
Stock-Based Compensation”.  Accordingly, the Company measures all
employee stock-based compensation awards and awards to non-employees in exchange
for goods and services, using a fair value method and records such expense in
its financial statements over the service period.





Stripping Costs Incurred
During Production





The
Company accounts for stripping costs during production in accordance with the
FASB Emerging Issues Task Force Issue No. 04-06 (“EITF 04-06”), “Accounting for
Stripping Costs Incurred during Production in the Mining
Industry”.  EITF 04-06 addresses the accounting for stripping costs
incurred during the production phase of a mine and refers to these costs as
variable production costs that should be included as a component of inventory to
be recognized in costs applicable to sales in the same period as the revenue
from the sale of inventory.  As a result, capitalization of
post-production stripping costs is appropriate only to the extent product
inventory exists at the end of a reporting period.  During the
development stage of a mine, pre-production stripping costs are capitalized and
typically are amortized over the productive life of the mine.  The
Company is following this guidance in its accounting for stripping costs
associated with the expansion of the existing mine workings at
Mesquite.




55





3.   RECENT ACCOUNTING
PRONOUNCEMENTS





In
September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 157, “Fair Value Measurements”.  The Statement defines fair value,
establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value
measurements.  The Statement does not require any new fair value
measurements.  The provisions of the Statement are effective for
statements issued for fiscal years beginning after November 15, 2007, and
interim periods within those fiscal years.  In February 2008, FASB
staff issued FSP No. FAS 157-2 which delays the effective date of SFAS No. 157
for nonfinancial assets or liabilities that are not required or permitted to be
measured at fair value on a recurring basis to fiscal years beginning after
November 15, 2008, and interim periods within those years.  Effective
January 1, 2008, the Company adopted SFAS No. 157 as it relates to financial
assets and liabilities.  The new disclosures are included in Note
19.





In
February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities - Including an amendment of FASB Statement No.
115”.  The Statement permits entities to choose to measure many
financial instruments and certain other items at fair value.  The
objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reporting earnings caused by measuring
related assets and liabilities differently without having to apply complex hedge
accounting provisions.  The Company adopted SFAS No. 159 effective
January 1, 2008 but this has had no impact on the Company’s financial position,
financial performance and cash flows.





In
December 2007, FASB issued FAS 141(R), “Business Combinations”, which will
replace FAS 141 prospectively for business combinations consummated after the
effective date of December 15, 2008.  Under FAS 141(R), business
combinations will be accounted for under the “acquisition method”, compared to
the “purchase method” mandated by FAS 141.  Significant changes will
result from applying the acquisition method, including: more acquisitions will
be accounted for as business combinations rather than as asset acquisitions;
acquisition related costs of the acquirer will be expensed as incurred, whereas
under FAS 141 these costs are capitalized as part of the business combination;
and the assets acquired and liabilities assumed are recorded at 100% of fair
value even if less than 100% is obtained, whereas under FAS 141 only the
controlling interest’s portion is recorded at fair value.  In the
event of the Company being involved in a future business combination, the
Company will evaluate the application of FAS 141(R).





The most
significant changes to Western Goldfields’ accounting for business combinations
that will result from applying the acquisition method
include:  (i) the definition of a business is broadened to
include development stage entities, and therefore more acquisitions will be
accounted for as business combinations rather than asset acquisitions;
(ii) the measurement date for equity interests issued by the acquirer is
the acquisition date instead of a few days before and after terms are agreed to
and announced, which may significantly change the amount recorded for the
acquired business if share prices differ from the agreement and announcement
date to the acquisition date; (iii) all future adjustments to income tax
estimates will be recorded to income tax expense, whereas under FAS 141 certain
changes in income tax estimates were recorded to goodwill;
(iv) acquisition-related costs of the acquirer, including investment
banking fees, legal fees, accounting fees, valuation fees, and other
professional or consulting fees will be expensed as incurred, whereas under FAS
141 these costs were capitalized as part of the business combination;
(v) the assets acquired and liabilities assumed are recorded at 100% of
fair value even if less than 100% is obtained, whereas under FAS 141 only the
controlling interest’s portion is recorded at fair value; and (vi) the
non-controlling interest will be recorded at its share of fair value of net
assets acquired, including its share of goodwill, whereas under FAS 141 the
non-controlling interest is recorded at its share of carrying value of net
assets acquired with no goodwill being allocated.





In
December 2007, FASB issued FAS 160, “Non-Controlling Interests in Consolidated
Financial Statements” which is effective for fiscal years beginning after
December 15, 2008.  Under FAS 160, non-controlling interests will be
measured at 100% of the fair value of assets acquired and liabilities
assumed.  Under current standards, the non-controlling interest is
measured at book value.  For presentation and disclosure purposes,
non-controlling interests will be classified as a separate component of
shareholders’ equity.  In addition, FAS 160 will change the manner in
which increases and decreases in ownership percentages are accounted
for.  The provisions of FAS 160 are to be applied prospectively with
the exception of the presentation and disclosure provisions, which are to be
applied for all prior periods presented in the financial
statements.  In the event of the Company being required in the future
to prepare consolidated financial statements including a non-controlling
interest in another entity, the Company will evaluate the application of FAS
160.





In March
2008, FASB issued FAS No. 161, “Disclosures about Derivative Instruments and
Hedging Activities – an amendment of FASB Statement No. 133”, which is effective
for financial statements issued for fiscal years and interim periods beginning
after November 15, 2008, with early application encouraged.  The
statement requires enhanced disclosures about an entity’s derivative and hedging
activities and thereby improves the transparency of financial
reporting.  The statement changes the disclosure requirements for
derivative instruments and hedging activities.  Entities are required
to provide enhanced disclosures about (a) how and why an entity uses derivative
instruments, (b) how derivative instruments and related hedging items are
accounted for under Statement 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance and cash flows.  The Company is
compliant with these enhanced disclosure requirements in respect of its gold
forward sales and fuel hedge contracts.




56




In June
2008, FASB issued FSP EITF 03-6-1, "Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities" which is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those years.  The statement
addresses whether instruments granted in share-based payment transactions are
participating securities prior to vesting and, therefore, need to be included in
the earnings allocation in computing earnings per share under the two-class
method described in paragraphs 60 and 61 of FASB Statement No. 128, Earnings per
Share.The
Company has evaluated the impact of FSP EITF 03-6-1 and concluded there is no
impact on the Company's consolidated financial statements.





In June 2008, the FASB issued EITF No.
07-5, Determining Whether an Instrument (or an Embedded Feature) is Indexed to
an Entity's Own Stock ("EITF07-5").  EITF07-5 provides that an entity
should use a two step approach to evaluate whether an equity-linked financial
instrument (or embedded feature) is indexed to its own stock, including
evaluating the instrument's contingent exercise and settlement provisions. It
also clarifies on the impact of foreign currency denominated strike prices and
market-based employee stock option valuation instruments on the evaluation.
EITF07-5 is effective for fiscal years beginning after December 15, 2008.
 The Company is currently assessing the impact, if any, on its consolidated
financial position and results of operations.





In
December 2008, FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public
Entities (Enterprises) about Transfers of Financial Assets and Interest in
Variable Interest Entities”, for the purpose of improving the transparency of
transfers of financial assets and an enterprise’s involvement with variable
interest entities (VIEs), including qualifying special-purpose entities (QSPEs).
 The VIE disclosure requirements focus on an enterprise’s involvement with
VIE’s and it’s judgments about the accounting for them. The FSP also requires
disclosure of the details of any financial or other support provided to a VIE
that the enterprise was not previously contractually required to provide, and
the primary reasons for providing the support.  The primary beneficiary of
a VIE is also required to disclose the terms of any arrangements, that could
require the enterprise to provide future support to the VIE.  In addition,
FSP FAS 140-4 and FIN 46(R)-8 requires disclosure of the carrying amount and
classification of the variable interest entity’s assets and liabilities in the
Balance Sheet and a reconciliation of those amounts to the enterprise’s maximum
exposure to loss.  There was no impact of this pronouncement on our
financial statements.





4.
RESTRICTED CASH





The
Company, through its wholly-owned subsidiary, Western Mesquite Mines, Inc.
(“WMMI”), entered into a term loan facility with a syndicate of banks,
originally dated March 30, 2007 and subsequently amended and restated (Note
14).  Under the terms of this facility the Company has set aside
$7,500,000 in a cost overrun account until Completion of the Mesquite Mine
development project, which occurs on satisfaction of physical and economic
completion tests as set out in the credit agreement.  At Completion,
unused funds will be applied to fund a debt service reserve account, established
to hold an amount equal to the debt service amounts payable on the next
repayment date as set out in the credit agreement, and thereafter any surplus
funds may be returned to the Company.  Interest earned on restricted
cash is for the account of the Company.  Completion of the Mesquite
Mine development project, as defined in the credit agreement, has not yet been
reached.




5. INVENTORIES





Inventories
consist of the following:





December 31,
                          2008
                        
                        
                        December 31,
                          2007Ore
      on leach pad
                        
                        $
                        31,847
                        
                        
                        $
                        7,724Metal-in-process
                        
                        
                        1,409
                        
                        
                        
                        847Bullion
                        
                        
                        6
                        
                        
                        
                        994Supplies
                        
                        
                        1,836
                        
                        
                        
                        1,636Total
      inventories
                        
                        $
                        35,098
                        
                        
                        $
                        11,201





Inventories
are valued at the lower of cost or net realizable value (“NRV”).





Since
June 30, 2008, new ore placed on leach pad has been valued at cost, based on
current mining costs, including amortization and depletion, since this is lower
than NRV.  At December 31, 2007, ore on leach pad was valued at
NRV.





Since
June 30, 2008, metal-in-process inventory has been valued at cost, based on the
average cost of gold-in-solution fed into the process from the leach pad plus
further processing costs, including amortization relating to processing
facilities, since this is lower than NRV.





Bullion
represents gold held for our account a refiner pending sale.  Since
June 30, 2008, bullion has been valued at cost, based on the average cost of the
in-process inventory plus refining costs, since this is lower than
NRV.  At December 31, 2007, bullion was valued at NRV.





57




6. PLANT AND
EQUIPMENT





The
following is a summary of plant and equipment, and accumulated amortization as
at December 31, 2008 and December 31, 2007:





December 31,
                            2008
                          
                          
                          December 31,
                            2007Buildings
                          
                          $
                          9,886
                          
                          
                          $
                          4,215Equipment
                          
                          
                          84,053
                          
                          
                          
                          74,633Leach
      pad expansion and other processing equipment
                          
                          
                          29,824
                          
                          
                          
                          2,684Mine
      development
                          
                          
                          3,864
                          
                          
                          
                          3,517127,627
                          
                          
                          
                          85,049Less
      accumulated amortization
                          
                          
                          (16,293
                          )
                          
                          
                          (7,098
                          )Net
      Plant and Equipment
                          
                          $
                          111,334
                          
                          
                          $
                          77,951





Capitalized
interest expense for the year ended December 31, 2008 was $0.2 million (2007 -
$0.5 million) based on the interest attributable to borrowings incurred to
finance the construction of assets intended for the Company’s own
use.  Capitalization of interest ceases when an asset is ready for its
intended use.





Mine
development as at December 31, 2008 includes $1.4 million (2007 - $1.4 million)
in respect of fauna relocation costs and $2.2 million (2007 - $1.9 million) in
respect of capitalized development drilling costs.





Amortization
expense for the year ended December 31, 2008 was $9.2 million (2007 - $3.9
million).  Amortization of mobile mining equipment and other equipment
is calculated using the straight-line method over the estimated useful lives of
the assets, which range from three to twelve years. The great majority of assets
acquired under the expansion program are depreciated over 12 years. Development
costs relating to the relocation of fauna, which bear no relation to mineral
production, are being depreciated on a straight-line basis over the expected
life of the mineral property.  Amortization of all other mine
development costs, processing plant, mine structures and infrastructure is
calculated using the units-of-production basis over the estimated life of the
ore body based on estimated proven and probable reserves.





The
Company reviews and tests the carrying amounts of assets when events or changes
in circumstances suggest that the carrying amount may not be
recoverable.  Assets are grouped at the lowest level for which
identifiable cash flows are largely independent of the cash flows of other
assets and liabilities.  All assets related to the Mesquite Mine are
included in one group.  If there are indications that an impairment
may have occurred we compare the sum of the undiscounted cash flows expected to
be generated from the Mesquite mine to its carrying amount.  If the
sum of undiscounted cash flows is less than the carrying amount, an impairment
charge is recognized if the carrying amount exceeds the fair
value.  Long-lived assets subject to potential impairment at the
Mesquite Mine include buildings, plant and equipment, and capitalized mineral
property acquisition and mine development costs.  For impairment
assessment purposes, the estimated fair value of buildings, plant and equipment
is based on a combination of current depreciated replacement cost and current
market value.





7. CONSTRUCTION IN
PROCESS





The
following is a summary of the major components of construction in process at
December 31, 2008 and December 31, 2007:





December 31,
                          2008
                        
                        
                        December 31,
                          2007Leach pad
      expansion
                        
                        $
                        —
                        
                        
                        $
                        12,837Building
      construction and site infrastructure
                        
                        
                        —
                        
                        
                        
                        9,027$
                        —
                        
                        
                        $
                        21,864





Construction
in process is accumulated and carried forward at cost until completion of
construction or until the equipment is substantially complete and ready for
productive use, at which time the cost is transferred to plant and equipment and
is amortized over the asset’s expected useful life.





Cumulative
spending on the leach pad expansion and building construction and site
infrastructure have been fully capitalized and amortization commenced during
2008.





58





8. INVESTMENTS - RECLAMATION AND
REMEDIATION





The
Company has a bonding and insurance program, primarily with American
International Specialty Lines Insurance Company (“AIG Insurance”), in respect of
the operations and closure liabilities of the Mesquite Mine.  Under
the program, the Company initially paid $6.0 million into a reimbursement
account with AIG, representing the net present value of expected reclamation
costs.  As a result of increases in proven and probable reserves in
August 2006 and March 2007, which increased the reserve life of the mine by two
years, the Company agreed with AIG and the regulatory agencies to revisions in
its reclamation cost estimates.  As a consequence, in May 2007 the
bonding program was increased from approximately $8.7 million to approximately
$11.3 million and the Company was required to place an additional $2.1 million
into the reimbursement account with AIG.  In addition, changes were
made to the insurance program as described in Note 9.


During
the second half of 2006 and first quarter of 2007, the Company carried out
closure procedures in respect of the Vista heap leach pad.  Related
costs of $0.3 million were reimbursed by AIG.





The
following is a summary of cumulative activity in the reimbursement account as at
December 31, 2008 and December 31, 2007:




December 31,
                            2008
                          
                          
                          December 31,
                            2007Original
      deposit to reimbursement account
                          
                          $
                          5,999
                          
                          
                          $
                          5,999Additional
      deposit to reimbursement account
                          
                          
                          2,091
                          
                          
                          
                          2,091Interest
      earned from inception
                          
                          
                          1,193
                          
                          
                          
                          9209,283
                          
                          
                          
                          9,010Reclamation
      costs reimbursed
                          
                          
                          (349
                          )
                          
                          
                          (349
                          )Closing
      balance
                          
                          $
                          8,934
                          
                          
                          $
                          8,661





The
following bonds have been issued by AIG and approved by regulatory agencies
under the bonding component of the insurance program:





Bond
                                                            Number
                                                          
                                                          Inception
                                                            Date
                                                          
                                                          Value
                                                          
                                                          Obligee(s)ESD 7315360
                                                          
                                                          11/7/2003
                                                          
                                                          $
                                                          1,218
                                                          
                                                          Imperial County, CaliforniaCalifornia Department of ConservationU.S. Bureau of Land ManagementESD 7315361
                                                          
                                                          11/7/2003
                                                          
                                                          $
                                                          1,468
                                                          
                                                          Imperial County, CaliforniaCalifornia Department of ConservationU.S. Bureau of Land ManagementESD 7315362
                                                          
                                                          11/7/2003
                                                          
                                                          $
                                                          62
                                                          
                                                          Imperial County, CaliforniaCalifornia Department of ConservationU.S. Bureau of Land ManagementESD 7315363
                                                          
                                                          11/7/2003
                                                          
                                                          $
                                                          550
                                                          
                                                          California Water Quality Control BoardESD 7315358
                                                          
                                                          11/7/2003
                                                          
                                                          $
                                                          6,978
                                                          
                                                          U.S. Bureau of Land ManagementESD 7315359
                                                          
                                                          11/7/2003
                                                          
                                                          $
                                                          50
                                                          
                                                          California State Lands CommissionESD 7315533
                                                          
                                                          5/30/2007
                                                          
                                                          $
                                                          977
                                                          
                                                          Imperial County, CaliforniaCalifornia Department of ConservationU.S. Bureau of Land ManagementCalifornia State lands Commission




9. LONG-TERM PREPAID EXPENSES




The
Company has paid advance premiums in respect of insurance policies to cover
environmental risks at the Mesquite Mine.  In 2007, the insurance
program was re-evaluated in light of the increase in reserves and forecast mine
life at Mesquite.





The
insurance program covers closure and reclamation risk in excess of the amount on
deposit in the Investment - Remediation and Reclamation account which was $8.9
million at December 31, 2008 (2007 - $8.7 million), to an aggregate limit of
$17.5 million (2007 - $17.5 million), and expires November 7,
2020.  On May 30, 2007, the program limit and term were increased from
$14.0 and November 7, 2014, respectively.





59




The
program also covers pollution and remediation risk up to $10.0 million and
includes coverage for pre-existing conditions and new conditions.  The
terms pre-existing conditions and new conditions expire on November 7, 2013 and
November 7, 2009, respectively.  On May 30, 2007, the program limit
was increased from $5,000,000.





The
premium cost is being amortized over the terms of the policies and is summarized
below.





December 31,
                            2008
                          
                          
                          December 31,
                            2007Original Policy
      Premiums
                          
                          $
                          1,643
                          
                          
                          $
                          1,643Additional
      Policy Premium
                          
                          
                          724
                          
                          
                          
                          724Amortization
      to date
                          
                          
                          (812
                          )
                          
                          
                          (641
                          )Unamortized
      Premium Cost
                          
                          
                          1,555
                          
                          
                          
                          1,726Current
      Portion
                          
                          
                          (171
                          )
                          
                          
                          (171
                          )Long-Term
      Prepaid Expenses
                          
                          $
                          1,384
                          
                          
                          $
                          1,555





10. DEFERRED DEBT ISSUANCE
COSTS





Debt
issuance costs, primarily bank fees and professional fees and expenses
associated with the term loan facility (Note 14) incurred to December 31, 2008
were $3.6 million (2007 - $3.6 million).  These costs are being
amortized on a straight-line basis over the term of the facility to December 31,
2012.  Amortization for the year ended December 31, 2008 was $0.5
million (2007 - $0.3 million).





December 31,
                        2008
                      
                      
                      December 31,
                        2007Debt
      issuance costs incurred
                      
                      $
                      3,570
                      
                      
                      $
                      3,570Cumulative
      amortization
                      
                      
                      (804
                      )
                      
                      
                      (343
                      )Closing
      balance
                      
                      $
                      2,766
                      
                      
                      $
                      3,227





11. DEFERRED INCOME TAX
ASSETS





Income
Taxes





December 31,
                          2008
                        
                        
                        December 31,
                          2007Current
                        
                        $
                        (329
                        )
                        
                        $
                        755Deferred
                        
                        
                        (12,720
                        )
                        
                        
                        36,378(Expense)
      recovery of income taxes
                        
                        $
                        (13,049
                        )
                        
                        $
                        37,133





The
Company’s effective income tax rate on earnings (loss) has been determined as
follows:





December 31,
                                2008
                              
                              
                              December 31,
                                2007United States
      federal statutory income tax rate
                              
                              
                              35.0
                              %
                              
                              
                              35.0
                              %Increase
      by the effects of:State
      tax
                              
                              
                              5.8
                              %
                              
                              
                              4.0
                              %Permanent
      tax adjustments
                              
                              
                              3.2
                              %
                              
                              
                              —Change
      in valuation allowance
                              
                              
                              0.1
                              %
                              
                              
                              2.3
                              %Other
      adjustments
                              
                              
                              3.1
                              %
                              
                              
                              —Effective
      tax rate
                              
                              
                              47.2
                              %
                              
                              
                              41.3
                              %Income
      (loss) before income taxes
                              
                              $
                              27,665
                              
                              
                              $
                              (87,442
                              )Income
      tax recovery (expense)
                              
                              $
                              (13,049
                              )
                              
                              $
                              37,133





60





Deferred
Taxes





The
significant components of the deferred tax asset at December 31, 2008 and 2007
are as follows:





December 31,
                                    2008
                                  
                                  
                                  December 31,
                                    2007Current
      deferred tax assets
                                  
                                  $
                                  2,045
                                  
                                  
                                  $
                                  755Long-term
      deferred tax assetsUnrealized
      loss on mark-to-market of
                                    gold
      forward sales contracts
                                  
                                  
                                  15,577
                                  
                                  
                                  
                                  22,217Net
      operating losses
                                  
                                  
                                  25,451
                                  
                                  
                                  
                                  19,131Mining
      property
                                  
                                  
                                  1,265
                                  
                                  
                                  
                                  1,265Reclamation
      cost
                                  
                                  
                                  1,979
                                  
                                  
                                  
                                  1,948Exploration
      cost
                                  
                                  
                                  35
                                  
                                  
                                  
                                  453Stock-based
      compensation
                                  
                                  
                                  1,675
                                  
                                  
                                  
                                  1,335Minimum
      tax
                                  
                                  
                                  327
                                  
                                  
                                  
                                  —Other
                                  
                                  
                                  637
                                  
                                  
                                  
                                  —Total
      long-term deferred tax assets
                                  
                                  
                                  46,946
                                  
                                  
                                  
                                  46,349Long-term
      deferred tax liabilitiesFixed
      assets
                                  
                                  
                                  (16,944
                                  )
                                  
                                  
                                  (2,370
                                  )Total
      long-term deferred tax liabilities
                                  
                                  
                                  (16,944
                                  )
                                  
                                  
                                  (2,370
                                  )Net
      long-term deferred tax asset
                                  
                                  
                                  32,047
                                  
                                  
                                  
                                  44,734Valuation
      allowance
                                  
                                  
                                  (7,634
                                  )
                                  
                                  
                                  (7,600
                                  )Net
      deferred tax assets
                                  
                                  $
                                  24,413
                                  
                                  
                                  $
                                  37,134





At
December 31, 2008, the Company had loss carryforwards (“NOLs”) for federal and
state income tax purposes of approximately $66.5 million and $51.0 million,
respectively (2007 - $49.9 million and $49.9 million).  These losses
expire from 2022 to 2028.  The ability to utilize these loss
carryforwards is dependent upon a number of factors, including the future
profitability of operations and other tax limitations.  Utilization of
the NOLs may be subject to a substantial annual limitation due to ownership
change limitations that may have occurred or that could occur in the future, as
required by Section 382 of the Internal Revenue Code of 1986, as amended (the
“Code”), as well as similar state and foreign limitations.  These
ownership changes may limit the amount of NOLs that can be utilized annually to
offset future taxable income and tax, respectively.  In general, an
“ownership change” as defined by Section 382 of the Code, results from a
transaction or series of transactions over a three-year period resulting in an
ownership change of more than 50 percentage points of the outstanding stock of a
company by certain stockholders or public groups.  Based on
management’s assessment, the Company has placed a valuation allowance against
its otherwise recognizable deferred tax assets mainly due to possible Code
Section 382 limitations against the utilization of certain of the Company’s
NOLs.  A tax benefit of $25.1 million less a valuation allowance of
$6.0 million resulting in a net tax benefit of $19.1 million has been recognized
in the consolidated financial statements with respect to income tax loss
carry-forwards.





As a
result of the adoption of SFAS No. 123R, the Company will recognize excess tax
benefits associated with the exercise of stock options directly to stockholders’
equity only when realized.  Accordingly, deferred tax assets are not
recognized for NOLs resulting from excess tax benefits.  As of
December 31, 2008, deferred tax assets do not include $0.7 million of these
excess tax benefits from employee stock option exercises that are a component of
the Company’s net operating loss carryforwards.  Additional paid in
capital will be increased up to an additional $0.7 million if and when such
excess tax benefits are realized.





The
Company adopted the FASB’s Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”), effective
January 1, 2007.  FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in financial statements and requires the impact of a tax
position to be recognized in the financial statements if that position does not
have a more-likely-than-not likelihood of being sustained by the taxing
authority.  The adoption of FIN 48 did not have a material
effect on the Company’s consolidated financial position or results of
operations.





As of
December 31, 2008 the Company does not have any accrued interest or penalties
related to uncertain tax positions.  The Company’s policy is to
recognize interest and penalties related to uncertain tax positions in income
tax expense.  We do not have any interest or penalties related to
uncertain tax positions in income tax expense during the years ended December
31, 2008, 2007 and 2006.  The tax years 2002-2007 remain open to
examination by the major taxing jurisdictions to which the Company is
subject.





61





12. MARK-TO-MARKET LOSS ON GOLD HEDGING
CONTRACTS





Under the
terms of the term loan facility originally dated March 30, 2007 and subsequently
amended and restated (Note 14), Western Mesquite Mines Inc. was required, as a
condition precedent to drawdown the loan, to enter into a gold hedging program
acceptable to the banking syndicate.  On June 14, 2007 the Company
announced that all requirements needed to make the facility available for
drawdown had been met and that it had executed gold forward sales contracts for
429,000 ounces of gold at a price of $801 per ounce.  The hedging
contracts represent a commitment of 5,500 ounces per month for 78 months
commencing July 2008 with the last commitment deliverable in December
2014.





At
December 31, 2008, the Company’s gold forward sales contracts did not meet the
criterion in SFAS No.133, and therefore were not designated as cash flow
hedges.  Accordingly, the period-end mark-to-market adjustment related
to these contracts is immediately reflected on the statement of operations of
the Company as unrealized gains or losses on gold forward sales contracts and
the cumulative effect is reflected as an asset or liability on the balance
sheet.





Starting
in July 2008, the Company began settling these contracts, at the Company’s
option, by physical delivery of gold or on a net financial settlement
basis.  Realized losses of $1.3 million were recognized for the year
ended December 31, 2008 (2007 - $nil).  The remaining contracts were
marked-to-market as at December 31, 2008 using a spot price of gold of $870 per
ounce (2007 - $836 per ounce).  The cumulative unrealized pre-tax loss
of $45.2 million has been disclosed as a liability as at December 30, 2008 (2007
- $58.9 million) and the Company has recorded an unrealized gain of $14.4
million for the year ended December 31, 2008 (2007 - $58.9 million unrealized
loss).





13. MARK-TO-MARKET LOSS ON FUEL
CONTRACTS





The
Company entered into fuel hedge contracts with financial institutions on
December 15, 2008.  The hedging contracts represent a total commitment
of 1.5 million gallons of diesel per year at prices of $1.82 and $2.00 per
gallon in 2009 and 2010, respectively.  The Company will be
financially settling 126,000 gallons of diesel per month.





At
December 31, 2008, the Company’s fuel hedge contracts did not meet the criterion
in SFAS No.133, and therefore were not designated as cash flow
hedges.  Accordingly, the period-end mark-to-market adjustment related
to these contracts is immediately reflected on the statement of operations of
the Company as unrealized gains or losses on fuel hedging contracts and the
cumulative effect is reflected as an asset or liability on the balance
sheet.





The
contracts were marked-to-market as at December 31, 2008.  The
cumulative unrealized loss of $0.9 million has been disclosed on the statement
of operations and as a liability on the balance sheet as at December 31, 2008
($0.5 million is shown as a current liability).





14. LOAN PAYABLE





Term
Loan Facility





The
Company, through its wholly owned subsidiary WMMI, entered into a term loan
facility with a syndicate of banks, dated March 30, 2007 as amended and restated
on May 31, 2007 and as further amended on June 29, 2007, July 16, 2007, August
14, 2007, and August 14, 2008, under which WMMI can borrow up to $105 million in
connection with the development of the Mesquite Mine.  The facility
was for a term of 7.75 years until December 31, 2014 and comprises a
multiple-draw term loan of which $87.3 million was available as required for the
development of the Mesquite Mine; the remainder will be available for up to 12
months after completion for corporate purposes.  The facility is secured by
all of the assets of WMMI and a pledge of the shares of WMMI owned by the
Company. In addition, until Completion, the facility is guaranteed by the
Company.  The facility was further amended on December 18, 2008 to
encompass the following:  alterations to the original development plan
contemplated by the Company; acceleration of the loan repayment period with the
final payment now due on December 31, 2012; and, extension of the date by which
completion must be reached to June 30, 2009.





Interest
on the term loan is charged at U.S. dollar LIBOR plus 2.2% prior to completion
and U.S. dollar LIBOR plus 1.75% after completion.  Completion occurs upon
the satisfaction of certain technical and financial criteria as defined in the
credit agreement.  As at December 31, 2008, WMMI had drawn $86.3 million
(2007 - $76.5 million), less repayments of $17.7 million (2007 - $nil), under
the facility and incurred interest at an average rate of approximately 5.0% for
the year (2007 – 7.3%).  Repayment of the project facility is on a
semi-annual basis, from December 31, 2008 through December 31, 2012 according to
an agreed schedule of percentages of the loan outstanding on the final day of
the availability period. On the basis of the loan outstanding at December 31,
2007, the initial repayment on December 31, 2008 was $17.7 million, or 20.5% of
the loan.  In addition to the scheduled repayments, mandatory prepayments
are required semi-annually based on excess cash flows from the Mesquite
Mine.  At December 31, 2008 there were no excess cash flows to trigger
a prepayment.





62





The
schedule of repayments is as follows:





December 31,
                          2008June
      30, 2009
                        
                        $
                        4,749December
      31, 2009
                        
                        
                        6,907June
      30, 2010
                        
                        
                        11,224December
      31, 2010
                        
                        
                        8,634June
      30, 2011
                        
                        
                        4,317December
      31, 2011
                        
                        
                        6,907June
      30, 2012
                        
                        
                        12,951December
      31, 2012
                        
                        
                        12,951$
                        68,640




This
schedule excludes any mandatory prepayments which can only be determined at date
of scheduled repayment.




15. RECLAMATION AND REMEDIATION
LIABILITIES





Federal,
state and local laws and regulations concerning environmental protection affect
the Company’s operations.  Under current regulations, the Company is
required to meet performance standards to minimize environmental impact from
operations and to perform site reclamation and remediation
activities.  The Company’s provision for reclamation and remediation
liabilities is based on known requirements.  It is not possible to
estimate the impact on operating results, if any, of future legislative or
regulatory developments.  The Company’s estimate of the net present
value of these obligations for the Mesquite Mine is based upon existing
reclamation standards at December 31, 2008 and is in conformity with SFAS No.
143.  The increase in the net present value of the liability is
recognized for accounting purposes as accretion expense during the period under
review.





In 2008,
our asset retirement obligations related to the Mesquite Mine were independently
assessed by a third-party engineering firm.  The impact of the
assessment was a reduction of $0.2 million relating to changes in timing of
future reclamation activities and substantive changes in the mine closure
plan.  More specifically, the substantive changes
included:


·
            Revision
      due to pre-2008 over-estimation of total area to be
      reclaimed.  Mesquite's original planned closure costs were based
      on Newmont’s assessment; Newmont had not claimed credit for major
      earthwork performed over a large part of the mine (waste rock facilities),
      and had retained acreages which do not exist as a
    liability.


·
            Downward
      revision in rinsing volume required for the heap leach based on recent
      experience.  Mesquite closed the Vista heap with one-third pour
      volume of water pumped up and through the heap, versus one-pour volume
      assumed in previous cost estimates.  We have now revised costs to
      about three-quarter pour volume, as a reasonable balance between
      conservatism and actual experience.





In May
2007, the Company announced an increase in its mineral reserves which is
reflected in an increase of $0.1 million in the provision for reclamation and
remediation as at December 31, 2007.  Subsequent production depletion
had no impact on the provision for reclamation and remediation.





The
following table sets out the activity for the Company’s reclamation and
remediation liabilities for the years ended December 31, 2008 and
2007:





December 31,
                    2008
                  
                  
                  December 31,
                    2007Opening
      Balance
                  
                  $
                  5,061
                  
                  
                  $
                  4,805Accretion
                  
                  
                  224
                  
                  
                  
                  337Reclamation
      costs incurred
                  
                  
                  —
                  
                  
                  
                  (148
                  )Increase
      (reduction) in the present value of obligations
                  
                  
                  (209
                  )
                  
                  
                  67Ending
      Balance
                  
                  
                  5,076
                  
                  
                  
                  5,061Less:
      current portion
                  
                  
                  339
                  
                  
                  
                  129$
                  4,737
                  
                  
                  $
                  4,932





16.   PREFERRED SHARES




Following
the Reorganization, the Company has no authorized class of preferred
shares.  Prior to the Reorganization, Western Goldfields, Inc. had
25,000,000 shares, $0.01 par value per share, of preferred stock authorized of
which nil were issued. As of December 31, 2006, there were nil preferred shares
issued and outstanding.





63




On
December 31, 2004, the Company entered into a subscription agreement with RAB
Special Situations, LLP (“RAB”), pursuant to which the Company issued and sold
to RAB 1,000,000 shares of its Series “A-1” convertible preferred stock (“Series
A Preferred”) and warrants to purchase up to 500,000 shares of its Series A
Preferred stock, for an aggregate purchase price of $500,000.





All of
the preferred shares were converted into common stock in 2006.





The
holders of Series A Preferred were entitled to receive dividends at a rate of
7.5% of the conversion price (as defined) per annum.  The Company paid
accrued dividends in the amount of $51,354 on conversion of the Series A
Preferred on May 31, 2006.





17. COMMON
SHARES





Reclassification
of Additional Paid In Capital





Following
the Reorganization, the Company’s authorized share capital, as an Ontario
corporation, comprises solely an unlimited number of common shares of no par
value.  Prior to the Reorganization, the Company’s authorized common
stock, as an Idaho corporation, was 500 million common shares of $0.01 par
value.  The impact of the conversion from shares of $0.01 stated value
to shares of no par value has been reflected in the financial statements on a
retroactive basis.  Accordingly, amounts recorded as credits in the
Additional Paid-In Capital component of Stockholders’ Equity as at June 29, 2007
and December 31, 2006 have been reclassified as Common Stock.





Public
Offerings of Common Shares





In
January 2007, the Company issued 33,330,000 common shares at a price of $1.91
per share (Cdn. $2.25 per share) under a prospectus supplement to the Company’s
shelf prospectus dated October 27, 2006.  Net proceeds to the Company,
after expenses of $4.5 million, were $59.2 million.





In
October 2007, the Company issued 11,316,000 common stock at a price of $3.13 per
share (Cdn. $3.05 per share) under a Short Form Prospectus dated October 2,
2007.  Net proceeds to the Company, after expenses of $2.0 million,
were $33.4 million.





Other
Issuances of Common Shares





During
the year ended December 31, 2008, 1,281,234 options were exercised for cash
consideration of $1.0 million.





During
the year ended December 31, 2008, 750,000 shares of common stock were issued for
cash consideration of $0.3 million upon the exercise of 750,000 warrants to
purchase common shares.





During
the year ended December 31, 2007, the Company issued 1,702,757 shares of common
stock for cash consideration of $1.0 million upon the exercise of options to
purchase common shares.  Of the shares issued, 103,125 were issued
under the cashless method under which option holders receive that number of
shares calculated by dividing the amount by which their options are “in the
money” by the share price at date of exercise.





During
the year ended December 31, 2007, the Company issued 10,248,052 shares of common
stock for cash consideration of $4,508,053 upon the exercise of 10,248,052
warrants to purchase common shares.





In
January, 2007, the Company announced that it was offering 1,950,000 common
shares to certain of its shareholders at the same price as the public offering
in that month.  This offering was made because certain shareholders of
the Company’s predecessor, WGI Idaho, who owned shares of common stock issued
prior to July 1, 1997 may have had pre-emptive rights to purchase shares to
maintain their proportional stock ownership in WG Idaho; however, the Company
believed there was uncertainty with respect to whether such rights
existed.  In light of this uncertainty and without admitting that such
rights exist, in connection with the market offering, WGI Idaho provided holders
of its common stock whose holdings could be traced back to common stock issued
prior to July 1, 1997, the opportunity to purchase shares on the same terms as
this offering.  No shareholders responded to the offering which
expired, unexercised, on February 14, 2007.  No pre-emptive rights
attach to the shares of WGI Ontario.





Normal
Course Issuer Bid





In
November 2008, the Company received approval from the Toronto Stock Exchange for
a normal course issuer bid (“NCIB”) program for the repurchase of its
outstanding common shares.  The Company had approval to repurchase up
to a maximum of 12,838,011 common shares, or approximately 10% of the Company’s
public float from the period November 7, 2008 to November 6,
2009.  During the year ended December 31, 2008, the Company
repurchased 2,279,633 common shares at a cost of $2.5 million.  The
Company returned to treasury and cancelled these shares.  The excess
of the purchase price over the carrying amount of the shares purchased was
recorded as a $0.3 million increase in retained accumulated deficit at
416-324--601S.





64




18. STOCK OPTIONS AND
WARRANTS





The
Company has a stock incentive plan which is intended to provide an incentive to
officers, employees, directors and consultants of the Company.  The
option price is determined by the Compensation Committee of the Board of
Directors at its sole discretion but shall not be less than the closing price of
the Company’s common stock on The Toronto Stock Exchange two trading days after
the date of the grant.  The term of each option granted shall be for a
period of not exceeding ten years from the date of the grant.  Except
as expressly provided for in the option holder’s employment, consulting or
termination contract, the option holder may exercise the option to the extent
exercisable on the date of such termination at any time within three months
after the date of termination.





The plan
is a non-qualifying stock option plan for U.S. income tax
purposes.  For awards made before and after the reorganization of the
Company effective June 29, 2007, the price of options granted is expressed in
terms of U.S. and Canadian dollars, respectively.  The aggregate
number of shares of the Company’s common stock for which option awards may be
granted under the plan shall not exceed 5,000,000.  At December 31,
2008, 976,667 (2007 – 2,625,000) option awards were available for issuance under
the plan.





Prior to
inception of the Western Goldfields’ stock option plan, of the awards issued,
9,855,118 option awards remain outstanding as at December, 31,
2008.





The
Company estimates the fair value of options and warrants using the Black-Scholes
option price calculation.  Some options and warrants may be exercised
by means of a “cashless exercise” to receive a number of shares of common stock
equal in market value to the difference between the market value of the shares
of common stock issuable under the option or warrant and the total cash exercise
price of the option or warrant being exercised.





During
the year ended December 31, 2008, 1,281,234 options were exercised for cash
proceeds of $1.0 million and 136,666 options were forfeited.





On August
8, 2008, the Company issued 400,000 options to employees and an officer, and
100,000 options to a consultant for services rendered, with an exercise price of
Cdn. $2.00 per share.  The options vest in three equal annual
installments beginning on August 8, 2008, and were fair valued at $0.5
million.





On
November 27, 2008, the Company issued 1,285,000 options to employees, officers,
and directors, with an exercise price of Cdn. $1.75 per share.  The
options vest in three equal annual installments beginning on November 26, 2009,
and were fair valued at $1.2 million.





During
the year ended December 31, 2007, 1,749,632 options were exercised for cash
proceeds of $1.0 million and 10,000 options expired.  Of the options
exercised, 150,000 were exercised in exchange for 103,125 common shares under
the cashless method under which option holders receive that number of shares
calculated by dividing the amount by which their options are “in the money” by
the share price at date of exercise.





During
the year ended December 31, 2007, the Company issued 1,400,000 options to
employees, officers and directors, with a weighted average exercise price of
$2.60.  These options vest in three equal annual installments
beginning on the grant date and were fair valued at $2.8 million.





The
value of each option award is estimated on the date of the grant using the
Black-Scholes option-pricing model.  The model requires the input of
subjective assumptions, including the weighted-average risk-free rate of return,
expected term of the option award and stock price volatility.  These
assumptions were adjusted to reflect prevailing interest rates, plan experience
and stock market performance of the Company’s shares,
respectively.  These estimates involve inherent uncertainties and the
application of management judgment.  In addition, we are required to
estimate the expected forfeiture rate and only recognize expense for options
expected to vest.  As a result, if other assumptions had been used,
our recorded stock-based compensation expense could have been different from
that reported.  The Black-Scholes option pricing model used the
following assumptions:





2008
                            
                            2007
                            
                            2006Weighted-average
      risk-free rate of return (%)
                            
                            
                            2.6%
                            
                            3.9% - 5.0%
                            
                            
                            4.6% - 5.0%Dividend yield
                            
                            
                            -%
                            
                            -%
                            
                            
                            -%Expected life in years
                            
                            
                            4 and 5
                            
                            4 and 7
                            
                            
                            7Volatility
                            
                            
                            75%
                            
                            91% - 98%
                            
                            
                            102% - 107%





65





The following is a
summary of stock option activity for the years ended December 31, 2008 and
2007:





Options
                                              
                                              
                                              Weighted
                                                Average
                                                Exercise
                                                Price
                                              
                                              
                                              Aggregate
                                                Intrinsic
                                                Value
                                              
                                              
                                              Weighted
                                                Average Fair
                                                ValueBalance January
      1, 2007
                                              
                                              
                                              13,661250
                                              
                                              $
                                              0.61Granted
                                              
                                              
                                              1,400,000
                                              
                                              
                                              2.60Exercised
                                              
                                              
                                              (1,749,632
                                              )
                                              
                                              0.65Forfeited
      / cancelled
                                              
                                              
                                              (10,000
                                              )
                                              
                                              0.65Outstanding
      at December 31, 2007
                                              
                                              
                                              13,301,618
                                              
                                              
                                              0.82
                                              
                                              $
                                              39,882,132Exercisable
      at December 31, 2007
                                              
                                              
                                              9,403,291
                                              
                                              $
                                              0.72
                                              
                                              $
                                              29,111,056Weighted
      average fair value of options as of December 31, 2007
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              $
                                              0.55Balance
      January 1, 2008
                                              
                                              
                                              13,301,618
                                              
                                              $
                                              0.82Granted
                                              
                                              
                                              1,785,000
                                              
                                              
                                              1.48Exercised
                                              
                                              
                                              (1,281,234
                                              )
                                              
                                              0.76Forfeited
      / cancelled
                                              
                                              
                                              (136,666
                                              )
                                              
                                              1.72Outstanding
      at December 31, 2008 (1)
                                              
                                              
                                              13,668,718
                                              
                                              
                                              0.86
                                              
                                              $
                                              10,990,223Exercisable
      at December 31, 2008
                                              
                                              
                                              11,687,054
                                              
                                              $
                                              0.73
                                              
                                              $
                                              10,770,835Weighted
      average fair value of options as of December 31, 2008
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              
                                              $
                                              0.56




(1)
            Includes
      options granted under predecessor
plan.





The total
intrinsic value of options exercised during the year ended December 31, 2008 was
$2.2 million (2007 - $2.1 million).





The
following table summarizes information about the stock options outstanding at
December 31, 2008:





Awards Outstanding by RangeExercise Price
                                                                            $
                                                                          
                                                                          Awards Outstanding
                                                                          
                                                                          Awards ExercisableLow
                                                                          
                                                                          High
                                                                          
                                                                          Quantity
                                                                          
                                                                          Weighted
                                                                            Average
                                                                            Outstanding
                                                                            Contractual
                                                                            Life
                                                                          
                                                                          Weighted
                                                                            Average
                                                                            ExercisePrice
                                                                            $
                                                                          
                                                                          Quantity
                                                                          
                                                                          Weighted
                                                                            Average
                                                                            Remaining
                                                                            Contractual
                                                                            Life
                                                                          
                                                                          Weighted
                                                                            Average
                                                                            Exercise Price$0.01
                                                                          
                                                                          
                                                                          0.50
                                                                          
                                                                          
                                                                          7,710,117
                                                                          
                                                                          
                                                                          4.00
                                                                          
                                                                          
                                                                          0.34
                                                                          
                                                                          
                                                                          7,710,117
                                                                          
                                                                          
                                                                          4.00
                                                                          
                                                                          
                                                                          0.340.51
                                                                          
                                                                          
                                                                          1.00
                                                                          
                                                                          
                                                                          2,145,000
                                                                          
                                                                          
                                                                          3.77
                                                                          
                                                                          
                                                                          0.86
                                                                          
                                                                          
                                                                          2,145,000
                                                                          
                                                                          
                                                                          3.77
                                                                          
                                                                          
                                                                          0.861.01
                                                                          
                                                                          
                                                                          1.50
                                                                          
                                                                          
                                                                          1,285,000
                                                                          
                                                                          
                                                                          4.90
                                                                          
                                                                          
                                                                          1.42
                                                                          
                                                                          
                                                                          —
                                                                          
                                                                          
                                                                          —
                                                                          
                                                                          
                                                                          —1.51
                                                                          
                                                                          
                                                                          2.00
                                                                          
                                                                          
                                                                          908,601
                                                                          
                                                                          
                                                                          5.85
                                                                          
                                                                          
                                                                          1.81
                                                                          
                                                                          
                                                                          460,269
                                                                          
                                                                          
                                                                          5.64
                                                                          
                                                                          
                                                                          1.862.01
                                                                          
                                                                          
                                                                          2.50
                                                                          
                                                                          
                                                                          1,320,000
                                                                          
                                                                          
                                                                          4.88
                                                                          
                                                                          
                                                                          2.21
                                                                          
                                                                          
                                                                          1,171,668
                                                                          
                                                                          
                                                                          4.80
                                                                          
                                                                          
                                                                          2.202.51
                                                                          
                                                                          
                                                                          3.00
                                                                          
                                                                          
                                                                          —
                                                                          
                                                                          
                                                                          —
                                                                          
                                                                          
                                                                          —
                                                                          
                                                                          
                                                                          —
                                                                          
                                                                          
                                                                          —
                                                                          
                                                                          
                                                                          —3.01
                                                                          
                                                                          
                                                                          3.04
                                                                          
                                                                          
                                                                          300,000
                                                                          
                                                                          
                                                                          5.94
                                                                          
                                                                          
                                                                          3.04
                                                                          
                                                                          
                                                                          200,000
                                                                          
                                                                          
                                                                          5.94
                                                                          
                                                                          
                                                                          3.0413,668,718
                                                                          
                                                                          
                                                                          4.30
                                                                          
                                                                          
                                                                          0.86
                                                                          
                                                                          
                                                                          11,687,054
                                                                          
                                                                          
                                                                          4.14
                                                                          
                                                                          
                                                                          0.73




As of
December 31, 2008, there was $1.7 million (2007 - $1.7 million) of total
unrecognized compensation cost related to nonvested stock-based compensation
arrangements granted under the plan.  The cost is expected to be
recognized over a weighted-average period of 1.6 years (2007 – 1.1
years).





66





Warrants





The
following is a summary of warrant activity for the years ended December 31, 2008
and 2007:





Year Ended
                                    December 31,
                                    2008
                                  
                                  Year ended
                                    December 31,
                                    2007Balance,
      start of year
                                  
                                  
                                  6,806,180
                                  
                                  17,054,232Issued
                                  
                                  
                                  —
                                  
                                  —Expired
                                  
                                  
                                  —
                                  
                                  —Exercised
                                  
                                  
                                  (750,000
                                  )
                                  (10,248,052
                                  )Balance,
      end of year
                                  
                                  
                                  6,056,180
                                  
                                  6,806,180





Warrants
outstanding to acquire common shares of the Company at December 31, 2008 are as
follows:





Warrants Outstanding
                            
                            Exercise   Price
                            
                            Expiry Date6,056,180
                            
                            
                            $ 
       0.76
                            
                            Note
      (1)





(1)
              Newmont Mining Corporation
      (“Newmont”) received warrants as part of the purchase price for Mesquite
      in November 2003. The warrants expire between June 9, 2011 and June 9,
      2012







19. FAIR VALUE OF FINANCIAL
INSTRUMENTS





As
discussed in Note 3, effective January 1, 2008, the Company adopted SFAS 157 as
it relates to financial assets and liabilities that are being measured at fair
value on a recurring basis.  Although the adoption of SFAS 157 did not
materially impact its financial condition, results of operations, or cash flows,
the Company is now required to provide additional disclosures as part of its
consolidated financial statements.  In accordance with FSP 157-2, the
Company deferred adoption of SFAS 157 as it relates to nonfinancial assets and
liabilities measured at fair value on a non-recurring basis.




SFAS 157
defines fair value, establishes a framework for measuring fair value in
accordance with U.S. GAAP, and expands disclosure about fair value
measurements.  The statement is intended to enable the reader of the
financial statements to assess the inputs used to develop those measurements by
establishing the hierarchy for ranking the quality and reliability of the
information used to determine fair values.  The statement requires
that assets and liabilities carried at fair value be classified and disclosed in
a three-tier fair value hierarchy.  These tiers include: Level 1,
defined as quoted market prices in active markets for identical assets and
liabilities; Level 2, defined as inputs other than Level 1 that are observable,
either directly or indirectly, such as quoted prices for similar assets or
liabilities; quoted prices in markets that are not active; model-based valuation
techniques for which all significant assumptions are observable in the market;
or inputs that are observable or can be corroborated by observable market data
for substantially the full term of the assets or liabilities; and Level 3,
defined as unobservable inputs that are not corroborated by market
data.




The
following table sets out the Company’s financial assets and liabilities at
December 31, 2008 at fair value by level within the fair value
hierarchy.  As required by FAS 157, liabilities are classified in
their entirety based on the lowest level of input that is significant to the
fair value measurement.





Fair Value at December 31, 2008Total
                  
                  
                  Level 1
                  
                  
                  Level 2AssetsCash and cash
      equivalents and restricted cash
                  
                  $
                  18,775
                  
                  
                  $
                  18,775
                  
                  
                  $
                  —Receivables
                  
                  $
                  2,550
                  
                  
                  $
                  —
                  
                  
                  $
                  2,550LiabilitiesBank
      debt
                  
                  $
                  68,640
                  
                  
                  $
                  68,640
                  
                  
                  $
                  —Derivative instruments – forward gold sales
      contracts
                  
                  $
                  45,186
                  
                  
                  $
                  —
                  
                  
                  $
                  45,186Derivative
      instruments – forward fuel hedge contracts
                  
                  $
                  931
                  
                  
                  $
                  —
                  
                  
                  $
                  931




The
Company’s cash and restricted cash are represented by account balances and
short-term deposits with major Canadian and U.S. banks.  Canadian
account balances and deposits are converted to U.S. dollars at the closing
exchange rate on December 31, 2008 and accordingly are classified within Level 1
of the fair value hierarchy.


67





The
Company’s bank debt represents the current and long-term portions of advances
under the Company’s term-loan facility.  As the loan was re-negotiated
at the end of 2008, the book value is representative of fair value from a market
participant’s perspective.  Accordingly it is classified within Level
1 of the fair value hierarchy.




The
Company’s gold forward sales and fuel hedge contracts are valued using pricing
models which require a variety of inputs, including contractual terms and yield
curves, and correlation of such inputs.  The Company utilizes the
market approach to measurement of fair value for these derivative
instruments.  This approach uses prices and other relevant information
generated by market transactions involving comparable
liabilities.  Such derivative contracts trade in liquid markets and,
as such, model inputs can generally be verified and do not involve significant
management judgment.  As the derivatives are in a net liability
position at year-end, the Company has determined that there is no counterparty
credit risk.  Such instruments are typically classified within Level 2
of the fair value hierarchy.





20.  RELATED PARTY
TRANSACTIONS





Since
June 2006 our head office has been located in Toronto, Ontario, Canada, where we
share premises with Silver Bear Resources Inc. (“Silver Bear”), a related party
through certain senior executives and a director of Silver Bear also serve as a
senior executive and as a director of Western Goldfields. Under a cost sharing
agreement with Silver Bear, we were charged with 50% of the rental and operating
costs of the space occupied when the office was leased by Silver Bear. During
the year ended December 31, 2008 overhead costs of $0.2 million were charged by
Silver Bear to Western Goldfields under this agreement (2007 - $0.3
million).





We
relocated our Toronto head office in June of 2008 and we have entered into a
lease for the ten year period commencing June 1, 2008. Estimated rental and
operating costs over the first year of the lease is approximately $0.5 million
and over the ten year term is approximately $5.4 million. As a result of Western
Goldfields entering into the new lease we charged Silver Bear for their
proportional share under the cost sharing agreement.  During the year
ended December 31, 2008 overhead costs, including lease costs for the new
premises, of $0.5 million were charged by Western Goldfields to Silver
Bear.  At December 31, 2008 $23,000 (2007 - $31,000) was payable to
Silver Bear.





In
November 2008, a new cost sharing agreement was reached between Silver Bear and
Western Goldfields with an effective date of January 1, 2009.  The new
agreement amends cost sharing ratios between the two companies to one-third
recovery of shared costs from Silver Bear which reflects the current level of
activities and Western Goldfields would initially incur the costs.





During
June 2007, prior to the reorganization and change of domicile of the Company
effective June 29, 2007, Canadian resident officers and directors exercised
warrants to purchase common shares of the Company’s stock at a price of $0.45
per share as follows:





·
            Rockcliff
      Group Limited, a corporation of which our Chairman of the Board, Randall
      Oliphant, is the sole shareholder, Chairman and Chief Executive
      Officer – 1,250,000 warrants




·
              TerraNova
      Partners L.P., a limited partnership of which our Director, Vahan
      Kololian, is the founder and managing partner – 416,667
      warrants





·
            Brian
      Penny, our Chief Financial Officer – 166,667
  warrants




·
              Sandra-Meddick-Ruth,
      the wife of our Director, Gerald Ruth – 250,000
  warrants




·
              Muriel A. Ruth, the mother of our
      Director, Gerald Ruth – 66,667
warrants





21.  COMMITMENTS AND
CONTINGENCIES





Mining
Industry




Although
the mineral exploration and mining industries are inherently speculative and
subject to complex environmental regulations, the Company is unaware of any
pending litigation or of any specific past or prospective matters which could
impair the value of its mining claims.





Contract
with the County Sanitation District of Los Angeles





During
its ownership of the Mesquite Mine, Hanson Natural Resource Company, a prior
operator of the mine, entered into an agreement with the County Sanitation
District of Los Angeles County, which then developed and permitted a plan to
create a 100-year landfill at the Mesquite Mine.





Under the
agreement with the County Sanitation District of Los Angeles County, the Company
has the right to explore, mine, extract, process, market and sell ore, and
otherwise conduct mining and processing activities, anywhere on the property for
an initial period through 2024 with automatic extensions until
2078.  Much of the infrastructure at the property is likely to be
retained by the landfill after mining operations are completed and the Company
has met certain reclamation standards.


68





Mesquite
Expansion





The
Company is in the final stages of completion of the mine expansion program at
Mesquite.  As at December 31, 2008, planned and committed capital
spending on the program is approximately $0.3 million.





Lease
Agreement





The
Company has entered into a lease for head office premises for the ten-year
period which commenced June 1, 2008.  Estimated rental and operating
costs over the next year is approximately $0.5 million and over the ten-year
term are approximately $5.4 million.  During 2008, Silver Bear shared
one-half of these costs.  In the new cost sharing agreement, effective
January 1, 2009, Silver Bear will share one-third of total occupancy costs (Note
20).





Litigation
and Claims





The
Company is involved in legal proceedings from time to time, arising in the
ordinary course of its business.  Typically, the amount of ultimate
liability with respect to these actions will not, in the opinion of management,
materially affect Western Goldfields’ financial position, results of operations
or cash flows.





In
assessing loss contingencies related to legal proceedings that are pending
against us or unasserted claims that may result in such proceedings, the Company
and its legal counsel evaluate the perceived merits of any legal proceedings or
unasserted claims as well as the perceived merits of the amount of relief sought
or expected to be sought.  If the assessment of a contingency suggests
that a loss is probable, and the amount can be reliably estimated, then a loss
is recorded.  When a contingent loss is not probable but is reasonably
possible, or is probable but the amount of loss cannot be reliably estimated,
then details of the contingent loss are disclosed.  Loss contingencies
considered remote are generally not disclosed unless they involve guarantees, in
which case we disclose the nature of the quantities.  Legal fees
incurred in connection with pending legal proceedings are expensed as
incurred.





There
were no loss contingencies accrued in the years ended December 31, 2008, 2007,
or 2006.





22.  COMPARATIVE
INFORMATION





The
Company has reclassified the cash used by restricted cash of $7.5 million from
the initial classification as an operating activity to investing activity in
these financial statements to conform to the year-end December 31, 2007
classification.





23.  SUBSEQUENT EVENTS





Additional
Fuel Hedging Contracts





During
January 2009, Western Goldfields entered into additional fuel hedge contracts
for each of the next two years.  The Company hedged 1,386,000 and
1,512,000 gallons of diesel at forward prices of $1.68 and $1.87 per gallon in
2009 and 2010, respectively.  In each month, 126,000 gallons of diesel
will be settled on a financial basis commencing February 2009.





Proposed
Business Combination





Western
Goldfields Inc. and New Gold Inc. (“New Gold”) have entered into a definitive
business combination agreement dated as of March 3, 2009 for the purpose of
combining the ownership of their respective businesses.  Under the
terms of the agreement, New Gold will acquire by way of a plan of arrangement
all of the outstanding common shares of Western Goldfields on the basis of one
New Gold common share and CDN$0.0001 in cash for each common share of Western
Goldfields (the "Transaction").  Upon completion of the Transaction,
New Gold will have approximately 348 million shares outstanding (436 million
fully-diluted).





The
Transaction is subject to regulatory approvals, court approval and obtaining a
minimum two-thirds approval of those shares voted at a special meeting of the
shareholders of Western Goldfields and majority approval at a special meeting of
the shareholders of New Gold.  The Transaction has been structured as
a plan of arrangement under the Business Corporations Act
(Ontario).  The parties expect to complete and mail the joint
information circular in April 2009 and plan to hold the special meetings of
shareholders in May 2009.  The Transaction is expected to close at the
end of May 2009.


The
definitive business combination agreement entered into in connection with the
Transaction includes a commitment by each of New Gold and Western Goldfields not
to solicit alternative transactions to the proposed Transaction. In certain
circumstances, if a party terminates the definitive agreement to enter into an
agreement to effect an acquisition proposal that is different from the
Transaction, then such party is obligated to pay to the other party as a
termination payment an aggregate amount equal to CDN$8.8 million if New Gold is
the terminating party and CDN$8.8 million. Each party has also been provided
with certain other rights, representations and warranties and covenants
customary for a transaction of this nature, and each party has the right to
match competing offers made to the other party.


69




ITEM
9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE





None.




ITEM 9A.   CONTROLS AND
PROCEDURES





(a)
Evaluation of Disclosure Controls and Procedures





Under the
supervision and with the participation of the Company’s management, including
the Chief Executive Officer and Chief Financial Officer, an evaluation of the
disclosure controls and procedures was conducted, as such is defined under
Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of
1934, as amended (the Exchange Act). Based on this evaluation, the Chief
Executive Officer and the Chief Financial Officer concluded that the Company’s
disclosure controls and procedures were effective, as at
the end of the fiscal year covered by this Form 10-K, to provide
reasonable assurance that the information required to be disclosed by the
Company in the reports it files, and the transactions that are recorded,
processed, summarized and reported, within the appropriate time periods and
forms.





(b)
Management’s Report on Internal Control over Financial Reporting




Management
is responsible for establishing and maintaining adequate internal control over
financial reporting. As such term is defined in Exchange Act Rule 13a-15(f),
internal control over financial reporting is a process designed by, or under the
supervision of, the principal executive and principal financial officers, or
persons performing similar functions, and effected by the board of directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States. Internal control over financial reporting
includes those policies and procedures that:





(1)
              pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of assets of the
      Company;





(2)
              provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of the financial statements in accordance with accounting
      principles generally accepted in the United States, and that receipts and
      expenditures of the Company are being made only in accordance with
      authorizations of management and the directors of the Company;
      and





(3)
              provide
      reasonable assurance regarding prevention of unauthorized acquisition,
      use, or disposition of the Company’s assets that could have a material
      effect on the financial
statements.





Management
conducted an evaluation of the effectiveness of the Company’s internal control
over financial reporting based on the criteria in Internal Control—Integrated
Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this evaluation under the
criteria in Internal
Control—Integrated Framework, management concluded that
internal control over financial reporting was effective as of December 31,
2008.








(c)
Changes in Internal Control Over Financial Reporting





There has
not been any change in the Company’s internal control over financial reporting
that occurred during the Company’s fourth fiscal quarter of 2008 that has
materially affected, or is reasonably likely to materially affect, the Company’s
internal control over financial reporting.




Limitations
of Controls and Procedures





The
Company’s management, including the Chief Executive Officer and Chief Financial
Officer, believe that any disclosure controls and procedures or internal
controls over financial reporting, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the
control system are being met.  Further, the design of a control system
must reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs.  Because of the
inherent limitations in all control systems, they cannot provide absolute
assurance that all control issues and instances of fraud, if any, within the
Company have been prevented or detected.  These inherent limitations
include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or
mistake.  Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by unauthorized
override of the control.  The design of systems of controls also is
based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions.  Accordingly,
because of the inherent limitations in a cost effective control system,
misstatements due to error or fraud may occur and not be detected.





ITEM 9B.   OTHER
INFORMATION





None.


70





PART
III




ITEM10.
              DIRECTORS, EXECUTIVE OFFICERS,
      PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE
      EXCHANGE ACT





The
following table sets forth the name, age and position of each of our executive
officers and directors as of March 5, 2009:




Name
                          
                          Age
                          
                          Position(s) with the Company
                          
                          Date of Appointment as DirectorRandall
      Oliphant
                          
                          49
                          
                          Executive
      Chairman
                          
                          February
      13, 2006Raymond
      Threlkeld
                          
                          62
                          
                          President and Chief Executive
      Officer
                          
                          June
      14, 2006Brian
      Penny
                          
                          46
                          
                          Chief
      Financial OfficerWesley
      Hanson
                          
                          48
                          
                          Vice President of Mine DevelopmentArthur
      Chen
                          
                          32
                          
                          Controller
      and SecretaryVahan
      Kololian  (1) (2)
                          
                          55
                          
                          Director
                          
                          March
      14, 2006Martyn
      Konig  (1) (2)
                          
                          51
                          
                          Director
                          
                          February
      13, 2006Gerald
      Ruth (1) (2)
                          
                          50
                          
                          Director
                          
                          May
      10,
2004




(1)
            Member of Audit
      Committee


(2)
            Member of Compensation,
      Governance and Environmental
Committee




Randall Oliphant, age 49, is
the Executive Chairman and a director of the Company.  He is also a
director and the President and Chief Executive Officer of Silver Bear Resources
Inc. He has been the Chairman and Chief Executive Officer of Rockcliff Group
Limited, a private corporation actively involved with its shareholdings,
primarily in the mining sector, including Western Goldfields Inc. since
September 2004. Mr. Oliphant is on the Advisory Board of Metalmark Capital LLC
(formerly Morgan Stanley Capital Partners), and serves on the boards of
WesternZagros Resources Ltd. and Franco-Nevada Corporation. Since 2003, Mr.
Oliphant has served on the boards of a number of public and private companies
and not-for-profit organizations. From 1999 to 2003, he was the President and
Chief Executive Officer of Barrick Gold Corporation. Mr. Oliphant is a Chartered
Accountant.





Raymond Threlkeld, age 62, has
over 30 years of mineral industry experience ranging from discovery, feasibility
study, development management, operations management, and corporate officer.
Since 2005, Mr. Threlkeld has been the Chief Operating Officer of Silver Bear
Resources Inc. From 1996 to 2005 Mr. Threlkeld held various senior management
positions in precious metal mine development with Barrick Gold Corporation and
Coeur d’Alene Mines Corporation including the development of the Pierina Mine in
Peru, the Bulyanhulu Mine in Tanzania and the Veladero Mine in Argentina. Mr.
Threlkeld has had exploration acquisition success in the Western United States
in addition to the management and project development experience cited
above.





Brian Penny, age 46, has
over 20 years of experience in mine finance and accounting.  He has been
the Chief Financial Officer of the Company since 2006.  Since
2005, Mr. Penny has also been the Chief Financial Officer of Silver Bear
Resources Inc. Since 2004, Mr. Penny has been a Director of, and chairs the
Audit Committee of Equinox Minerals Limited. While serving as Chief Financial
Officer with Kinross Gold Corporation from 1993 to 2004, Mr. Penny was
responsible for all finance, banking, hedging and financial reporting activities
including the financial due diligence surrounding a U.S. $1.3 billion merger
with TVX Gold Inc. and Echo Bay Mines Ltd. Mr. Penny is a Certified Management
Accountant.




Wesley Hanson, age 48, has
over 27 years of mining experience including exploration, mine geology, mine
engineering, mine operations, consulting geology and corporate management. Mr.
Hanson joined Western Goldfields in 2006 and he is also an officer of Silver
Bear Resources. From 2002 to 2006, Mr. Hanson held various supervisory positions
with Kinross Gold Corporation, the most recent being Vice President of Technical
Services where he supervised resource and reserve disclosure and managed the
company's technical staff supporting Kinross' mining operations and corporate
development activities. Mr. Hanson is a Professional Geologist.





Arthur Chen, age 32, served as
Controller for Central Sun Mining Inc. (formerly Glencairn Gold Corporation), a
publicly traded company with operating mines and exploration properties in
Central America, from 2006 to 2008.  Mr. Chen was responsible for managing
the daily financial operations of the company, including corporate reporting and
company-wide Sarbanes-Oxley compliance.  From 2005 to 2006, Mr. Chen was
Assistant Controller at Lucent Technologies Canada Inc., the Canadian subsidiary
of an U.S. based telecommunications solutions provider.  Prior to 2005, Mr.
Chen held various positions at Ernst & Young LLP, including Manager in the
firm’s Assurance and Technology and Security Risk Solutions groups.  Mr.
Chen is a Chartered Accountant.


.


Vahan Kololian, age 55, is the
founder and Managing Partner of TerraNova Partners LP, which invests in the
industrial, services and resource sectors. Since 2002 Mr. Kololian has been
Chairman of Precinda Corporation, a private manufacturing company. Mr. Kololian
started his career in investment banking in 1980 with Burns Fry Limited (now BMO
Nesbitt Burns). Since 1990 he has held leadership positions in private equity
partnerships. Mr. Kololian also serves on the boards of the following public
companies:  Clear Point Business Resources Inc., Consolidated Puma
Minerals Inc. and Manicouagan Minerals Inc. Mr. Kololian holds BA and LL.B.
degrees.


71





Martyn Konig, age 51, has 27
years experience in investment banking and the commodity markets. Since 2005 Mr.
Konig has served as Chief Executive Officer of Blackfish Capital, including
managing the Blackfish Capital Resources Fund, a hedge fund focused on small
/mid cap mining companies. He has extensive experience in the natural resource
sector, acting as CEO from 2004-2008 of AIM listed Latitude Resources
Limited, a mining investment company, prior to which he held senior management
roles  in resource finance and commodity trading operations at various
international investment banks. Mr. Konig was a main Board Director of NM
Rothschilds and Sons Ltd. for 15 years and held senior positions at Goldman
Sachs and UBS. Mr. Konig is a Barrister and Fellow of the Chartered Institute of
Bankers. He is also a Non-Executive Director of TSX/ AIM listed  European
Goldfields Limited.





Gerald Ruth , age 50, has
served as a Director since May 2004. Since 2003, Mr. Ruth has operated an
independent corporate finance consulting business. Mr. Ruth is currently a
Director and Chief Executive Officer of Yonge Street Capital Corp., a capital
pool company listed on the TSX Venture Exchange, and President and Chief
Executive Officer of Gersan Capital Corp., a limited market dealer involved in
corporate finance, capital markets activities and strategic advisory services.
From 1988 to 2003, Mr. Ruth held various positions at the Toronto Stock
Exchange, where he served as Head of Listings from 1997 to 2003. Mr. Ruth is a
Chartered Accountant.




To our
knowledge, none of our directors, officers or affiliates, and no owner of record
or beneficial owner of more than five percent (5%) of our securities, and no
associate of any such director, officer or security holder, is a party adverse
to us or has a material interest adverse to us in reference to pending
litigation.





Independence
of the Board




Three out
of the five members of the Board are independent within the meaning of the
governance guidelines issued by the Canadian securities regulatory authorities
National Policy 58-201and the
rules of the NYSE Alternext. Each of Messrs. Kololian, Konig and Ruth are
independent. Mr. Threlkeld is not independent as he is an officer of the
Company. Mr. Oliphant is also not independent as he acts as executive Chairman
of the Company.




The
independent directors meet at the end of each Board meeting without management
and non-independent directors being present, if deemed necessary.




Meetings
of the Board and Committees of the Board




The Board
meets a minimum of four times per year, usually every quarter and following the
annual meeting of the Company's shareholders. Each committee of the Board meets
at least once each year or more frequently as deemed necessary by the applicable
committee, and at least four times a year in the case of the Audit Committee.
The frequency of the meetings and the nature of the meeting agendas are
dependent upon the nature of the business and affairs which the Company faces
from time to time. During 2008, the Board met 8 times, the Audit Committee met 4
times and the Compensation, Governance and Environmental Committee met 3 times.
The following table provides details regarding director attendance at Board and
Committee meetings held during their tenure on their respective committees
during 2007.





Meetings
Attended out of Meetings Held




Director
                    
                    Board
                    
                    Audit Committee
                    
                    Compensation
                      Governance and
                      Environmental
                      CommitteeRandall
      Oliphant
                    
                    8
      out of 8
                    
                    —
                    
                    —Raymond
      Threlkeld
                    
                    8
      out of 8
                    
                    —
                    
                    —Vahan
      Kololian
                    
                    8
      out of 8
                    
                    4
      out of 4
                    
                    4
      out of 4Martyn
      Konig
                    
                    8
      out of 8
                    
                    4
      out of 4
                    
                    4
      out of 4Gerald
      Ruth
                    
                    8
      out of 8
                    
                    4
      out of 4
                    
                    4
      out of 4




Nomination
for Directors




The Board
has established the Compensation, Governance and Environmental Committee which
has assumed responsibility for the appointment and assessment of directors. The
Compensation, Governance and Environmental Committee is comprised of Messrs.
Kololian, Konig and Ruth, all of whom are independent of the
Company.





While
there are no specific criteria for Board membership, the Company attempts to
attract and retain directors with business knowledge and a particular knowledge
of mineral exploration, development and mining or other areas (such as finance)
which provide knowledge which would assist in guiding the officers of the
Company. As such, nominations would normally be the result of recruitment
efforts and discussions amongst the Compensation, Governance and Environmental
Committee, prior to the consideration of the Board as a whole.


72





Code
of Ethics





The Board
has adopted a Code of Business Conduct and Ethics (the “Code”) for its
directors, officers and employees. The Board, acting through Audit Committee has
responsibility for monitoring compliance with the Code by ensuring all
directors, officers and employees receive and become thoroughly familiar with
the Code and acknowledge their support and understanding of the Code. Any
non-compliance with the Code is to be reported to the appropriate person. A copy
of the Code may be accessed under the Company’s profile at
www.sedar.com.





The Board
takes steps to ensure that directors, officers and employees exercise
independent judgment in considering transactions and agreements in respect of
which a director, officer or employee of the Company has a material interest,
which include ensuring that directors, officers and employees are thoroughly
familiar with the Code and, in particular, the rules concerning reporting
conflicts of interest and obtaining direction regarding any potential conflicts
of interest.




The Board
encourages and promotes an overall culture of ethical business conduct by
promoting compliance with applicable laws, rules and regulations; providing
guidance to directors, officers and employees to help them recognize and deal
with ethical issues; promoting a culture of open communication, honesty and
accountability; and ensuring awareness of disciplinary action for violations of
ethical business conduct.





Our code of ethics is available on our website at www.westerngoldfields.com.




Compensation,
Governance and Environmental Committee





The
Company’s Compensation, Governance and Environmental Committee (“the CGE
Committee”) reviews and makes recommendations regarding the compensation of
executive officers of the Company. Mr. Kololian served as Chairman of the
Committee and Messrs. Konig and Ruth were members of the committee during the
year ended December 31, 2008. All members of the CGE Committee are independent
directors. The CGE Committee periodically reviews the compensation paid to
directors and management based on factors including time commitment, comparative
fees paid by similar companies in the industry, performance and level of
responsibility.




Audit
Committee





Our Audit
Committee is comprised of Messrs. Kololian, Konig and Ruth, all of whom are
independent and financially literate under Canadian governance requirements
and
the rules of the NYSE Alternext. Our board of directors has determined that Mr.
Ruth is an Audit Committee financial expert within the meaning of Item 407 of
Reg. S-K under the Securities Exchange Act of 1934. Our Audit Committee’s
principal responsibilities consist of: (i) recommending the selection of
independent auditors; (ii) reviewing the scope of the audit conducted by the
auditors, as well as the audit itself; (iii) reviewing matters concerning
financial reporting, accounting and audit procedures, and policies generally,
and (iv) monitoring the independence and performance of our independent
auditors.





The
primary function of the Audit Committee is to assist our Board of Directors in
fulfilling its oversight responsibilities by:





·
            reviewing
      our financial statements, financial reports and other financial
      information provided by us to any governmental body or the public and
      other relevant documents;




·
            recommending
      the appointment and reviewing and appraising the audit efforts of our
      independent registered accounting firm and providing an open avenue of
      communication among the independent auditor, financial and senior
      management and the Board of
Directors;




·
            serving
      as an independent and objective party to monitor our financial reporting
      process and internal controls, our processes to manage business and
      financial risk, and our compliance with legal, ethical and regulatory
      requirements; and




·
            Encouraging
      continuous improvement of, and fostering adherence to, our policies,
      procedures and practices at all
levels.




The Board
of Directors has adopted a written charter setting out responsibilities of the
Audit
Committee. A copy of the charter is included as an exhibit.





SECTION 16(a) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE





Section
16(a) of the Securities Exchange Act of 1934 requires certain defined persons to
file reports of and changes in beneficial ownership of a registered security
with the Securities and Exchange Commission and the National Association of
Securities Dealers in accordance with the rules and regulations promulgated by
the Commission to implement the provisions of Section 16. Under the regulatory
procedure, officers, directors, and persons who own more than ten percent of a
registered class of a company’s equity securities are also required to furnish
the Company with copies of all Section 16(a) forms they file.  To the best of our
knowledge, based solely on a review of the copies of Forms 3, 4 and 5 furnished
to us during the fiscal year ended December 31, 2008, our officers, directors
and greater than 10% beneficial owners complied with all Section 16(a) filing
requirements.


73





ITEM 11.   EXECUTIVE
COMPENSATION




Compensation
Discussion and Analysis




Introduction




This
Compensation Discussion and Analysis provides an overview of Western Goldfields
Inc.’s executive compensation program, including:




•
            the
      general compensation principles and objectives of our executive
      compensation program;




•
            the
      material elements of our executive compensation program and the process we
      use for making executive compensation decisions;
  and




•
            information
      about the 2008 compensation earned by the following officers (the “Named
      Executive Officers”):




•
            Randall
      Oliphant, our Executive Chairman;




•
            Raymond
      Threlkeld, our President and Chief Executive
  Officer;




•
            Brian
      Penny, our Chief Financial Officer;




•
            Paul
      Semple, our Vice President – Projects;
and




•
            Wesley
      Hanson, our Vice President – Mine
Development.




Compensation
Principles and Objectives




Our
executive compensation program is designed to achieve the following
objectives:




•
            support
      our business goals by fostering profitable growth and increasing
      shareholder value;




•
            align
      the interests of executive officers and shareholders;
  and




•
            attract,
      retain and motivate high-caliber executive
  officers.




The
program seeks to motivate our executives (including the Named Executive
Officers) to continually improve company financial performance and increase
shareholder value both over the short and long-term.




As
described below, our executive compensation program is also designed to provide
executives with a mix of cash and equity-based compensation opportunities and a
level of benefits intended to be competitive with those companies with which we
compete for executive talent, and to align executive pay with the objectives of
the program.  Our executive compensation program consists of the
following main elements of compensation:




•
            base
      salary;




•
            annual
      cash bonuses; and




•
            stock
      options.




Competitive
Benchmarking




Our
executive compensation program strives to provide a mix of base salary, annual
cash bonus awards and stock option awards (referred to as target total direct
compensation) for the Named Executive Officers that is aligned with the
program’s principles and competitive with compensation at approximately the
median level for a group of selected publicly-traded companies benchmarked in a
report prepared by PricewaterhouseCoopers LLP entitled “2008 Mining Industry
Salary Surveys.”  For 2008, the PricewaterhouseCoopers report surveyed
82 mining companies.   This group includes our direct competitors
and those companies with which we compete for executive talent. and is
considered the Company’s peer group (the “Peer Group”).


74




Determining
Compensation




Role
of the Compensation Committee




The
Committee is responsible for reviewing and approving the design and overseeing
the administration of our executive compensation program and for annually
reviewing and approving all compensation decisions relating to the Named
Executive Officers.  Generally, all decisions with respect to the
amount or form of compensation for our Named Executive Officers are made by the
Committee in accordance with the methodology described below.




In
addition to reviewing data from our Peer Group, the Committee also considers the
following factors in setting the target total direct compensation for each Named
Executive Officer: (i) the individual responsibilities, experience and
achievements of the Named Executive Officers and their potential contributions
toward our performance; (ii) except with respect to our Executive Chairman,
recommendations from senior management; and (iii) whether the components of
each Named Executive Officer’s compensation align with our executive
compensation program’s overall objectives.  In addition, our Executive
Chairman provides recommendations to the Committee in setting the target total
direct compensation for our President and CEO.  While the Committee
generally seeks to set target total direct compensation levels for the Named
Executive Officers at approximately the median of the Peer Group, our executive
compensation program is designed to provide the Committee with the flexibility
to set target total direct compensation at, above, or below the median of the
Peer Group in order to recognize factors such as experience, skill sets and
ongoing or potential contributions by our executives.  In addition,
actual compensation earned in any annual period may be at, above, or below the
median depending on individual and company performance for the
year.  In setting the compensation of our Executive Chairman, the
Committee generally applies the same principles it applies to other Named
Executive Officers.




Role
of Executive Officers




Our
Executive Chairman establishes the strategic direction of our executive
compensation program in consultation with the Committee, evaluates the
performance of the Named Executive Officers, including our President and CEO
(excluding his own performance) and makes recommendations to the Committee
regarding their compensation.  Our Executive Chairman also
participates in developing and recommending the appropriate performance measures
for the Committee to consider when making compensation determinations for the
Named Executive Officers.  Our Chief Financial Officer also supports
the Committee in its work and implements our executive compensation
program.




Elements
of Our Executive Compensation Program




The
following discusses in more detail the elements of, and rationale for, the
compensation awarded to the Named Executive Officers.  The Committee
reviews and, if appropriate, updates our executive compensation program at the
end of each fiscal year in preparation for the upcoming year.




Base
Salary




A portion
of annual cash compensation is paid in the form of a base salary to provide the
Named Executive Officers with a level of security and stability.  Base
salaries for the Named Executive Officers are reviewed by the Committee on an
annual basis and also in connection with any promotion or other change in
responsibilities of any Named Executive Officer.  The Committee
reviews and approves the annual base salaries for the Named Executive Officers
based on an evaluation of the individual’s experience, contributions, skill
level, scope of responsibilities, level of pay compared to comparable executives
in the Peer Group, and, for each Named Executive Officer other than the
Executive Chairman (but including the President and CEO), recommendations from
the Executive Chairman.  The Committee generally sets the base
salaries at approximately the median level for comparable executives in the Peer
Group.


The base
salary of each Named Executive Officer is set forth in the “Salary” column of
the Summary Compensation Table included with this document.  Base
salaries for 2008 were adjusted by the Committee to more closely reflect the
median level for comparable executives in the Peer Group. For 2008, our
Executive Chairman and President and Chief Executive Officer received increases
equal to 10% of their 2007 base salaries;  our Chief Financial Officer
did not receive an increase to his 2007 base salary; and our Vice President,
Projects and Vice President, Mine Development received reductions of 25% to
their 2007 base salaries.  These reductions in salary were for
our Vice President Projects and Vice President Mine Development, made to better
reflect the ratio of time spent between the Company and Silver Bear
Resources.




Annual
Cash Bonus Awards




The Committee provides Named Executive
Officers with the opportunity to earn annual cash bonus awards under our Bonus
Plan.  The purpose of the Bonus Plan is to provide the Named Executive
Officers with the opportunity to receive an annual cash bonus that is related to
the achievement of company and individual performance goals and contributions as
determined at the end of each fiscal year by the Committee in its sole
discretion.




Target
annual bonus amounts under the Bonus Plan for the Named Executive Officers are
established by the Committee based on an analysis of comparable executives in
the Peer Group.  The Committee generally sets target annual cash
incentive awards at approximately the median level for comparable executives in
the Peer Group.  The actual annual awards earned by the Named
Executive Officers for any year may be at above or below the target level based
on their contribution to the Company’s performance and their individual
performance with respect to the achievement of company and individual
performance measures that contribute to shareholder value, as determined at the
end of the year by the Committee in its sole discretion.


75




In general, the Committee has set the
bonus range as follows:  for the Executive Chairman, President and
CEO, and Chief Financial Officer, the bonus range was 0-200% of base salary,
with a target of 100% of base salary.  For the Vice President -
Projects and the Vice President - Mine Development, the bonus range was 0-100%
of base salary, with a target of 50% of base salary.





Determination of
Individual Annual Cash Bonus Awards




Near the
end of each year, the Committee reviews and approves individual bonus awards for
the current year based on company and individual performance measures as
determined at the end of the year by the Committee in its sole
discretion.  Company performance measures are approved by the
Committee based on forecast results for the current year.  The
Executive Chairman’s individual performance is determined directly by the
Committee.  The Committee also considers whether an adjustment is
appropriate in light of changes in business strategies, unforeseeable challenges
or other events or developments.  The Committee then approves an award
amount for each Named Executive Officer at the end of the year in its sole
discretion.





In
December 2008, the Committee reviewed company and individual performance and
determined that payouts under the Bonus Plan to the Named Executive Officers for
2008 would be 0% for each of Messrs. Oliphant, Threlkeld, and Semple, 27% of
base salary for Mr. Hanson, and 38% of base salary for Mr.
Penny.  This level of annual cash bonus awards was based on the fact
that target production levels for the Mesquite Mine were not met during the
year, resulting in lower than forecast production, earnings and cash
flow.  The annual cash bonuses that were awarded recognized
exceptional individual contributions to the Company during the year, despite
company performance being weaker than expected.





Equity
Incentive Compensation


Named
Executive Officers are eligible to receive equity-based incentive compensation
awards under our stock option plan.  The equity-based incentive
compensation element of our executive compensation program is intended to
provide Named Executive Officers with a continuing stake in the long-term
success of the Company.  It is the Committee’s practice to consider
annual grants of equity awards in the form of non-qualified stock options under
the stock option plan to employees (including the Named Executive Officers) at
the end of the fourth quarter of each year, when compensation decisions for the
current year are made, as part of the overall executive compensation
program.  The Committee considers shareholder dilution, the percentage
of outstanding stock option awards and accounting expense in determining the
amount and type of these awards.  The Committee retains the right to
adjust the amount of each Named Executive Officer’s equity award upward or
downward if it determines that such adjustment is appropriate and consistent
with the objectives and principles of our executive compensation
program.
  The stock
option awards will have value only if the trading price of our common shares
exceeds the exercise price of the stock option.  For 2008, the
Committee approved stock option grants that vest in three equal installments
commencing on the first anniversary following the stock option grant date and
remain exercisable until the fifth anniversary of the stock option grant
date.  Pursuant to the terms of the equity incentive plan, the
Committee sets the exercise price of a stock option based on the closing price
of the common shares two full trading days following the grant date, as
determined by the Committee.
  The
Committee determined that for 2008, stock option awards would further our
executive compensation program’s objectives of linking incentive compensation to
the Company’s performance, creating long-term shareholder value, and aligning
the interests of Named Executive Officers and our shareholders.  On
November 25, 2008, 950,000 stock option awards were granted to our Named
Executive Officers with an exercise price equal to the closing price of our
common shares on November 27, 2008.   Information regarding the
fair value and the number of stock options awarded to the Named Executive
Officers for 2008 is set forth on the Grants of Plan-Based Awards Table on
page included with of this document.


Healthcare
Benefits





We
provide employees with a range of healthcare benefits that are designed to
assist the Company in attracting and retaining employees critical to the
Company’s long-term success and to reflect the competitive practices of the
companies in the Peer Group.  Active employee benefits such as
medical, dental, life insurance and disability coverage are made available to
our employees.  As we are a Canadian company, these benefits
supplement and complement the existing Canadian Health Care benefits provided to
all Canadian residents.





Perquisites
and Executive Benefits





The Company does not grant or pay any
perquisites or executive benefits to its Named Executive Officers.




76




Employment
Contracts, Termination of Employment and Change of Control
Arrangements


Our
executive compensation program is designed to provide for the payment of
severance benefits to our Named Executive Officers upon certain types of
employment terminations.  Providing severance and change of control
benefits assists us in attracting and retaining executive talent and reduces the
personal uncertainty that executives are likely to feel when considering a
corporate transaction.  These arrangements also provide valuable
retention incentives that focus executives on completing such transactions, thus
enhancing long-term shareholder value.  The Named Executive Officers
are provided with severance benefits under individual severance agreements.The terms
of the individual arrangements are set forth under the Terms of Severance and
Change of Control Arrangements included within this document.





Compensation
Committee Report





The
Committee has reviewed and discussed the preceding “Compensation Discussion and
Analysis” with management.  Based on such review and discussions, the
Committee recommended to the Board that the Compensation Discussion and Analysis
be included in this Annual Report on Form 10-K for the year ended
December 31, 2008.





The
foregoing report on executive compensation for 2008 has been furnished on behalf
of the Board by the undersigned members of the compensation
committee.




Members
of the Compensation Committee





Vahan
Kololian (Chairman)


Martyn
Konig


Gerald
Ruth


77


Summary
Compensation Table





The
following table sets forth the compensation of our Executive Chairman, President
and Chief Executive Officer, Chief Financial Officer, and the other two most
highly compensated executive officers (the “Named Executive Officers”) who were
serving as executive officers as of December 31, 2008.  The positions
shown in the table are the officer’s positions with the Company as of December
31, 2008.  Figures are expressed in Canadian dollars.





Name and
                  Principal Position
                Year
                
                Salary
                  ($)(1)
                
                
                Bonus
                  ($)(1)
                
                
                Option
                  Awards
                  ($)(2)
                
                
                All Other
                  Compensation
                  ($)
                
                
                Total
                  ($)Randall Oliphant (3)
                2008
                
                
                275,000
                
                
                
                —
                
                
                
                571,192
                
                
                
                —
                
                
                
                846,192Chairman of the Board
                2007
                
                
                250,000
                
                
                
                500,000
                
                
                
                —
                
                
                
                —
                
                
                
                750,0002006
                
                
                68,269
                
                
                
                —
                
                
                
                949,823
                
                
                
                —
                
                
                
                1,018,092Raymond Threlkeld
                2008
                
                
                275,000
                
                
                
                —
                
                
                
                114,383
                
                
                
                —
                
                
                
                389,383President and Chief Executive Officer
                2007
                
                
                250,000
                
                
                
                400,000
                
                
                
                —
                
                
                
                —
                
                
                
                650,0002006
                
                
                208,333
                
                
                
                —
                
                
                
                474,912
                
                
                
                —
                
                
                
                683,245Brian Penny
                2008
                
                
                200,000
                
                
                
                75,000
                
                
                
                343,149
                
                
                
                —
                
                
                
                618,149Chief Financial Officer
                2007
                
                
                200,000
                
                
                
                300,000
                
                
                
                —
                
                
                
                —
                
                
                
                500,0002006
                
                
                166,667
                
                
                
                —
                
                
                
                379,929
                
                
                
                —
                
                
                
                546,596Paul Semple (4)
                2008
                
                
                112,500
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                112,500Vice President – Projects
                2007
                
                
                150,000
                
                
                
                75,000
                
                
                
                —
                
                
                
                —
                
                
                
                225,0002006
                
                
                125,000
                
                
                
                20,000
                
                
                
                265,950
                
                
                
                —
                
                
                
                410,950Wes
      Hanson
                2008
                
                
                112,500
                
                
                
                30,000
                
                
                
                57,192
                
                
                
                —
                
                
                
                199,692Vice President – Mine Development
                2007
                
                
                150,000
                
                
                
                75,000
                
                
                
                —
                
                
                
                —
                
                
                
                225,0002006
                
                
                68,750
                
                
                
                10,000
                
                
                
                983,185
                
                
                
                —
                
                
                
                1,061,935





(1)
            Salary
      and bonus was paid in Canadian dollars. The average exchange rate per US
      dollar for 2008 was 1.066, for 2007 was 1.075, and for 2006 was
      1.134.


(2)
            The
      amount recognized for financial accounting purposes in accordance with
      SFAS 123R (without reduction for risk or forfeiture) is determined based
      on assumptions set forth in Note 18 to our Consolidated Financial
      Statements.   The terms applicable to stock option awards
      granted in 2008 are set forth in the Grant of Plan Based Awards Table
      within this document.  Amounts reported represent our accounting
      expense only and the extent that the Named Executive Officer will realize
      value depends on the price of our common stock and the Named Executive
      Officer’s continued
employment.


(3)
            Mr.
      Oliphant assumed executive duties effective September 23,
      2006.  Prior to that date he was compensated as Chairman of the
      Board of Directors.


(4)
            Mr.
      Semple resigned from the Company effective January 1,
  2009.


78





Grants
of Plan-Based Awards Table





The
following table sets forth certain information with respect to awards under our
stock option plan to the Named Executive Officers for the fiscal year ended
December 31, 2008.  Figures are expressed in Canadian
dollars.





Names
              Grant Date
              
              All Other Stock
                Option Awards
                Number of Shares (1)
              
              
              Exercise or Base Price
                of Stock Option
                Awards
              
              
              Closing Price on
                Grant
                Date
              
              
              Grant Date Fair
                Value of Option
                Awards (2)Randall
      Oliphant
              11/27/2008
              
              
              500,000
              
              
              $
              1.75
              
              
              $
              1.75
              
              
              
              571,915Ray
      Threlkeld
              11/27/2008
              
              
              100,000
              
              
              $
              1.75
              
              
              $
              1.75
              
              
              
              114,383Brian
      Penny
              11/27/2008
              
              
              300,000
              
              
              $
              1.75
              
              
              $
              1.75
              
              
              
              343,149Wes
      Hanson
              11/27/2008
              
              
              50,000
              
              
              $
              1.75
              
              
              $
              1.75
              
              
              
              57,192





(1)
            On
      November 25, 2008, the Committee took action to grant stock options to the
      Named Executive Officers effective as of November 27,
      2008.  Under the stock option plan, the exercise price was
      determined based on the closing price of our common stock on the Toronto
      Stock Exchange on the effective date of the grant of the stock options
      (November 27, 2008).  The stock options will vest in three equal
      annual installments commencing on the first anniversary of the grant
      date.


(2)
            The
      fair value of stock option awards was determined using the Black-Scholes
      Option Pricing Model, based on assumptions as set forth in note 17 to our
      Consolidated Financial Statements. The fair value of stock option awards
      has been converted to Canadian dollars at the exchange rate applicable on
      the effective grant date of the stock options.  The rate applied
      for 2008 was 1.23242.





Outstanding
Equity Awards Table





The
following table sets forth certain information with respect to all outstanding
equity awards held by the Named Executive Officers as of December 31,
2008.  There are no shares of common stock awarded under the executive
compensation program.





Names
                                        
                                        Number of Securities
                                          Underlying Unexercised
                                          Stock Options
                                        
                                        
                                        Number of Securities
                                          Underlying Unexercised
                                          Stock Options
                                        
                                        
                                        Stock Option
                                          Exercise Price (C$)
                                        
                                        Stock Option
                                          Expiration Date(# Exercisable)
                                        
                                        
                                        
                                        (# Unexercisable) (3)Randall
      Oliphant
                                        
                                        
                                        2,500,000
                                        (1)
                                        
                                        
                                        —
                                        
                                        
                                        
                                        0.42
                                        
                                        2/12/2013—
                                        
                                        
                                        
                                        500,000
                                        
                                        
                                        
                                        1.75
                                        
                                        11/26/2013Ray
      Threlkeld
                                        
                                        
                                        1,250,000
                                        (1)
                                        
                                        
                                        —
                                        
                                        
                                        
                                        0.42
                                        
                                        2/12/2013—
                                        
                                        
                                        
                                        100,000
                                        
                                        
                                        
                                        1.75
                                        
                                        11/26/2013Brian
      Penny
                                        
                                        
                                        1,000,000
                                        (1)
                                        
                                        
                                        —
                                        
                                        
                                        
                                        0.42
                                        
                                        2/12/2013—
                                        
                                        
                                        
                                        300,000
                                        
                                        
                                        
                                        1.75
                                        
                                        11/26/2013Paul
      Semple
                                        
                                        
                                        480,000
                                        (1)
                                        
                                        
                                        —
                                        
                                        
                                        
                                        0.42
                                        
                                        2/12/2013—
                                        
                                        
                                        
                                        —Wes
      Hanson
                                        
                                        
                                        400,000
                                        (2)
                                        
                                        
                                        —
                                        
                                        
                                        
                                        0.42
                                        
                                        6/13/2013—
                                        
                                        
                                        
                                        50,000
                                        
                                        
                                        
                                        1.75
                                        
                                        11/26/2013





(1)
            Stock
      options were awarded on February 13, 2006. One third of the award vested
      immediately on February 13, 2006 and became exercisable on June 24, 2006,
      another one third vested and became exercisable on February 13, 2007, and
      the final one third vested and became exercisable on February 13,
      2008.


(2)
            Stock
      options were awarded on June 14, 2006. One third of the award vested
      immediately on June 14, 2006, another one third vested and became
      exercisable on June 14, 2007, and the final one third vested and became
      exercisable on June 14, 2008.


(3)
            Stock
      options were awarded on November 27, 2008.  One third of the
      award vests on November 27, 2009, another one third vests on November 27,
      2010, and the final one third vests on November 27,
  2011.


79




Stock
Option Exercises and Stock Vested Table





In 2008,
no stock option awards were exercised and no stock vested with respect to our
Named Executive Officers.




Pension
Plans and Deferred Compensation
 
 We do not
have any deferred compensation or retirement plans.
 
 Terms
of Severance and Change of Control Arrangements
 
 In 2006, Messrs. Oliphant, Threlkeld,
Penny, Semple, and Hanson each entered into a severance agreement with the
Company.  The severance agreements are substantially identical for
each Named Executive Officer.   Under the severance agreements,
if the executive employment is terminated by the Company without cause (as
defined below) and not within 18 months following a change of control (as
defined below), then the executive is entitled to a lump-sum payment equal to
his current annual salary, target bonus (equalling the previous year’s bonus up
to 25% of annual salary) and benefits (equal to 10% of annual salary)
(the "Annual Compensation"), plus an additional
amount equal to one month’s Annual Compensation for each completed year of
employment up to a maximum of 18 months.  In addition, any vested
stock options held by the executive will remain exercisable until six months
following the date of termination, and any unvested stock options as of the date
of termination will be immediately forfeited without payment.  The
executive is also entitled to continue receiving employee benefits for a period
of 12 months following the date of termination.  If the executive’s
employment is terminated for cause, the Company has no obligation to make any
payment under the severance agreements.  If the executive’s employment
is terminated due to disability (which is defined as incapacity due to physical
or mental illness that causes the executive to be absent from or unable to
perform his duties with the Company) the executive will receive the Annual
Compensation amount until the 12 month anniversary of such termination, and
thereafter, any amount as may be determined by the Company in its sole
discretion.
 
 The severance agreements provide for
enhanced benefits upon the executive’s termination of employment within 18
months following a change of control of the Company.  If, within
18 months following a change of control, employment is terminated by the
Company other than for death, disability or cause, or by the executive within
six months following a “triggering event” (as set forth below), then the
executive will be entitled to a lump sum equal to two times the Annual
Compensation, and accelerated vesting of all outstanding stock options held by
the executive, which stock options will remain exercisable until the expiration
of their original term. The Company will also pay reasonable legal fees and
expenses incurred by an executive as a result of the Company contesting or
disputing the executive’s termination or in seeking to obtain or enforce any
right or benefit owed to the executive by the Company as a result of a
termination after a change of control.
 
 For the purposes of the severance
agreements:
 
 A “change of control” is defined to
include the following events: (i) any merger, amalgamation or other
reorganization in which the Company is not the surviving entity (or the
Company survives only as a subsidiary of an entity other than a previously
wholly-owned subsidiary of the Company); (ii) the selling, leasing or
exchanging of greater than 35% of the Company’s assets to a person or entity
other than any of its subsidiaries; (iii) the dissolution or liquidation of the
Company; (iv) the acquisition or gaining of ownership or control of more than
35% of the Company's outstanding voting securities by any person, entity or
group of persons or entities acting jointly or in concert; or (v) as a
result of a merger, amalgamation or other reorganization, or a contested
election of directors, the persons who were directors before such election,
merger, amalgamation or other reorganization ceasing to constitute a majority of
the board of directors.
 
 “Cause” generally means the termination
of employment by the Company, or its subsidiary or successor, due to the
executive’s  (i) gross negligence in the performance of his duties;
(ii) wilful and continued failure to substantially perform his duties determined
on a historic basis prior to a change in control; (iii) wilful engagement in
conduct which is materially injurious to the Company or its subsidiaries
(monetarily or otherwise); or (iv) conviction of a criminal offence involving
moral turpitude.
 
 A “triggering event” is defined as any
of the following events without the express written agreement of the executive:
(i) a material adverse change in the executive’s salary or benefits as they
exist prior to a change of control; (ii) a removal of the executive’s title or a
material adverse change in his responsibilities, duties, powers, rights, and
discretion associated with his title prior to a change of control, (iii) a
change in the person or body to whom the executive reports immediately prior to
a change of control; or (iv) a change in the location at which the executive is
regularly required to report immediately prior to a change of control (which is
greater than 50 kilometres from the city of Toronto).
 
 As a condition to the executive’s
receipt of the severance payments under the severance agreements, the executive
must execute a release in favor of the Company.  If the executive
fails to execute or revokes a release, the Company’s sole obligation to the
executive is a payment equal to two weeks’ salary.
 
 Mr. Semple’s employment with the
Company terminated as of January 1, 2009.  Pursuant to his severance
agreement, he received a lump sum equal to 14 months’ Annual Compensation
totalling Cdn. $177,200 the extension of his health, medical and dental benefits
until the earlier of December 31, 2009, or when he obtains alternative
employment; and the extension of the expiration date of his vested stock options
to purchase 480,000 shares of WGI, until July 1, 2009.




Compensation
of Directors


2008
DIRECTOR COMPENSATION


(All
figures in Canadian dollars)





Name
                  
                  Fees Earned or
                    Paid in Cash
                    $
                  
                  
                  Option
                    Awards
                    $
      (2)
                  
                  
                  All Other
                    Compensation
                    $
                  
                  
                  Total
                    $Randall
      Oliphant (1)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Raymond
      Threlkeld (1)
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Vahan
      Kololian
                  
                  
                  30,000
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  30,000Martyn
      Konig
                  
                  
                  30,000
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  30,000Gerald
      Ruth
                  
                  
                  30,000
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  30,000





(1) No
director retainer is paid to directors who are employed by the
Company.


(2) Stock
options held as of December 31, 2008 included:  Randall Oliphant:
3,000,000; Raymond Threlkeld: 1,350,000; Vahan Kololian: 750,000; Martyn Konig:
750,000; and Gerald Ruth: 800,000.





We have established a compensation
plan for our non-management directors. Non-management directors receive an
annual retainer at a rate of Cdn. $30,000 per annum. We also compensate our
directors by granting them nonqualified stock options upon their election or
appointment to the Board.  We also reimburse the directors for
reasonable out of pocket expenses that they incur in connection with attendance
at Board and Committee meetings.  Directors do not receive any
non-equity incentive compensation (i.e., cash bonuses), equity awards, or
additional compensation for their service on the Board.


80





ITEM 12.   SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS





The
following table sets forth certain information with respect to the beneficial
ownership of our equity securities as of March 5, 2009 by:





·
            each
      security holder known by us to be the beneficial owner of more than 5% of
      the Company’s outstanding
securities;





·
            each
      of our directors;





·
            each
      of our executive officers; and





·
            all
      directors and executive officers as a
group.





Unless
otherwise specified, the address of each of the persons set forth below is in
care of Western Goldfields Inc., 200 Bay Street, Suite 3120, PO Box 167,
Toronto, Ontario M5J 2J4.





Name and Address of Beneficial Owner
                                                          
                                                          Amount and
                                                            Nature of
                                                            Beneficial
                                                            Ownership(1)
                                                          
                                                          
                                                          Percent of
                                                            Outstanding
                                                            SharesPersons Owning Greater
      than 5%Wellington
      Management Company, LLP
                                                            75
      State Street
                                                            Boston, MA
      02109
                                                          
                                                          
                                                          17,168,412
                                                          
                                                          
                                                          
                                                          12.7
                                                          %Beutal
      Goodman & Company Limited
                                                            20
      Eglinton Avenue West, Suite 2000
                                                            Toronto,
      ON Canada M4R 1K8
                                                          
                                                          
                                                          13,890,300
                                                          
                                                          
                                                          
                                                          10.2
                                                          %Capital
      Group International, Inc.
                                                            11100
      Santa Monica Blvd., 15th
      Floor
                                                            Los
      Angeles, CA 90025
                                                          
                                                          
                                                          11,271,810
                                                          
                                                          
                                                          
                                                          8.3
                                                          %Directors and
      OfficersRandall
      Oliphant
                                                          
                                                          
                                                          6,750,000
                                                          (2)
                                                          
                                                          
                                                          4.98
                                                          %Raymond
      Threlkeld
                                                          
                                                          
                                                          1,752,221
                                                          (3)
                                                          
                                                          
                                                          1.29
                                                          %Brian
      Penny
                                                          
                                                          
                                                          1,499,999
                                                          (4)
                                                          
                                                          
                                                          1.11
                                                          %Wesley
      Hanson
                                                          
                                                          
                                                          400,000
                                                          (5)
                                                          
                                                          
                                                          0.30
                                                          %Vahan
      Kololian
                                                          
                                                          
                                                          2,075,001
                                                          (6)
                                                          
                                                          
                                                          1.53
                                                          %Martyn
      Konig
                                                          
                                                          
                                                          1,250,000
                                                          (7)
                                                          
                                                          
                                                          0.92
                                                          %Gerald
      Ruth
                                                          
                                                          
                                                          2,037,918
                                                          (8)
                                                          
                                                          
                                                          1.50
                                                          %All
      executive officers and directors as a group (7 persons)
                                                          
                                                          
                                                          15,765,139
                                                          
                                                          
                                                          
                                                          11.63
                                                          %




(1)
            A
      person is deemed to be the beneficial owner of a security if such person
      has or shares the power to vote or direct the voting of such security or
      the power to dispose or direct the disposition of such security. A person
      is also deemed to be a beneficial owner of any securities if that person
      has the right to acquire beneficial ownership within 60 days of the date
      hereof. Except as otherwise indicated the named entities or individuals
      have sole voting and investment power with respect to the shares of Common
      Stock beneficially owned.


(2)
            Includes
      stock options to purchase 2,500,000 shares of Common Stock and 4,250,000
      shares of Common stock owned by Rockcliff Group
  Limited.


(3)
            Includes
      stock options to purchase 1,250,000 shares of Common Stock and 502,221
      shares of Common Stock.


(4)
            Includes
      stock options to purchase 1,000,000 shares of Common Stock and 499,999
      shares of Common Stock.


(5)
            Includes
      stock options to purchase 400,000 shares of our Common
    Stock.


(6)
            Includes
      stock options to purchase 750,000 shares of Common Stock and 1,325,001
      shares of Common Stock owned by TerraNova Partners
  L.P.


(7)
            Includes
      stock options to purchase 750,000 shares of Common Stock and 500,001
      shares of Common Stock


(8)
            Includes
      stock options to purchase 733,333 shares of Common Stock, 477,668 shares
      of Common Stock Shares of Common Stock owned by Muriel Ruth (mother) and
      826,917 shares of Common Stock owned by Sandra Meddick-Ruth
      (spouse).


81




Equity compensation plan
information





The
following table presents information relating to the Company’s equity
compensation plans as of December 31, 2008:





Plan
      Category
                        
                        Number of Securities to be
                          Issued Upon Exercise of
                          Outstanding Options
                        
                        
                        Weighted-Average
                          Exercise Price of
                          Outstanding Options
                        
                        
                        Number of
      Securities
                          Remaining
      Available for
                          Future IssuanceEquity
      compensation plans approved by security holders
                        
                        
                        4,023,333
                        
                        
                        $
                        3.52
                        
                        
                        
                        976,667Equity
      compensation plans not approved by security holders (1)
                        
                        
                        9,645,385
                        
                        
                        $
                        0.66
                        
                        
                        
                        —Total
                        
                        
                        13,668,718
                        
                        
                        $
                        0.91
                        
                        
                        
                        976,667





(1)
  Consists of individual compensation arrangements covered by stock option
agreements entered into prior to the approval of the Company’s 2006 Stock
Incentive Plan on June 14, 2006, and includes both vested and unvested stock
options.





ITEM 13.   CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS




Exercises
of warrants





In 2008,
Mr. Martyn Konig exercised 166,667warrants,
and Mr. Raymond Threlkeld exercised 166,667 warrants, both at an exercise price
of US$0.45.




Issuances
of stock options


In
November 2008, we issued 500,000 stock options to Randall Oliphant, 300,000 to
Brian Penny; 100,000 to Raymond Threlkeld; and 50,000 to Wesley Hanson, all as
part of the Company’s executive compensation program.





Director
Independence





Each of
Vahan Kololian, Martyn Konig and Gerald Ruth is independent, as independence is
defined in the listing standards of the NYSE
Alternextand Canadian governance requirements.


82





ITEM 14.   PRINCIPAL ACCOUNTANT FEES AND
SERVICES





The
following table presents the fees for professional audit services rendered and
fees billed for other services rendered by PricewaterhouseCoopers LLP (“PWC”),
our independent registered public accounting firm. PWC were engaged by us
effective September 21, 2007.




Fees
billed for services rendered by PricewaterhouseCoopers LLP





2008
                
                
                2007Audit
      fees (1)
                
                $
                386,000
                
                
                $
                100,000Audit-related
      fees
                
                $
                110,000
                
                
                $
                —Tax
      fees
                
                $
                31,000
                
                
                $
                55,350




The
following table presents the fees for professional audit services rendered and
fees billed for other services rendered by HJ Associates LLC (“HJ”), our
independent registered public accounting firm, for the fiscal years ended
December 31, 2007 and 2006. HJ resigned as our independent public accountants
effective September 19, 2007.





Fees
billed for services rendered by HJ & Associates LLC





2008
                
                
                2007Audit
      fees (1)
                
                $
                —
                
                
                $
                60,676Audit-related
      fees
                
                $
                —
                
                
                $
                —Tax
      fees
                
                $
                —
                
                
                $
                9,720





(1)
            Fees charged for audit services
      in respect of the fiscal years noted and for review of quarterly financial
      statements and other regulatory filings for these
      years.




Audit
Fees





This
category includes fees paid for the audit of our annual financial statements and
review of financial statements included in our quarterly reports on Form
10-Q(SB).  In addition to fees for services necessary to perform an
audit or review in accordance with Generally Accepted Auditing Standards, this
category includes services that generally only the independent accountant
reasonably can provide, such as comfort letters, statutory audits, attest
services, consents, and assistance or review of documents filed with the
SEC.





Audit-Related
Fees





This
category covers assurance and related services that traditionally are performed
by the independent accountant. More specifically, these services would include,
among others: employee benefit plan audits, due diligence related to mergers and
acquisitions, accounting consultations and audits in connection with
acquisitions, internal control reviews, attest services that are not required by
statute or regulation and consultation concerning financial and reporting
standards.





Tax
Fees





This
category consists of professional services rendered for tax compliance and tax
advice. The services for the fees disclosed under this category include tax
advisory services associated with our ongoing business.




All
Other Fees





There
were no additional fees for services not reported in the other
categories.





Audit
Committee Pre-Approval Policies




The Audit
Committee reviews and approves audit and permissible non-audit services
performed by our independent auditors, as well as the fees charged for such
services.  In its review of non-audit service fees and the appointment
of its independent auditors as our independent accountants, the Audit Committee
considered whether the provision of such services is compatible with maintaining
its auditors’ independence. All of the services provided and fees charged by its
independent auditors in 2008 and 2007 were pre-approved by the Audit
Committee.


83





SIGNATURES





Pursuant
to the requirement of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.




WESTERN
      GOLDFIELDS INC.Dated:
      March 5, 2009
                By:
                /s/
      Raymond ThrelkeldRaymond Threlkeld, President and Chief Executive Officer




Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacity and on the dates indicated.




Signature
                                                                                
                                                                                Title
                                                                                
                                                                                Date/s/
      Raymond Threlkeld
                                                                                
                                                                                President, Chief Executive Officer, and Director
                                                                                
                                                                                March
      5, 2009Raymond
      Threlkeld
                                                                                
                                                                                (Principal
      Executive Officer)/s/
      Brian Penny
                                                                                
                                                                                Chief
      Financial Officer (Principal Financial
                                                                                
                                                                                March
      5, 2009Brian
      Penny
                                                                                
                                                                                and
      Accounting Officer)/s/
      Randall Oliphant
                                                                                
                                                                                Chairman
      of the Board
                                                                                
                                                                                March
      5, 2009Randall
      Oliphant/s/
      Vahan Kololian
                                                                                
                                                                                Director
                                                                                
                                                                                March
      5, 2009Vahan
      Kololian/s/
      Martyn Konig
                                                                                
                                                                                Director
                                                                                
                                                                                March
      5, 2009Martyn
      Konig/s/
      Gerald Ruth
                                                                                
                                                                                Director
                                                                                
                                                                                March
      5, 2009Gerald
      Ruth


84


PART
IV


ITEM 15.   EXHIBITS AND FINANCIAL
STATEMENTS




Exhibit
                  No.
                
                Document
      Description3.1(7)
                
                Articles
      of Incorporation of Western Goldfields Inc. (Annex II)3.2(7)
                
                Bylaws
      of Western Goldfields Inc. (Annex III)4.3(8)
                
                Warrant,
      dated November 7, 2003, by Western Goldfields, Inc. in favor of Hospah
      Coal Company (Exhibit 4.2)4.4(8)
                
                Warrant,
      dated March 16, 2004, by Western Goldfields, Inc. in favor of Hospah Coal
      Company (Exhibit
      4.3)4.4
      (8)
                
                Warrant,
      dated March 16, 2004, by Western Goldfields Inc. in favour of Hospah Coal
      Company (Exhibit
      4.4)4.7
      (9)
                
                Form
      of Stock Certificate for Western Goldfields Inc. common shares (Exhibit
      4.1)4.8(7)
                
                Shareholder
      Rights Plan of Western Goldfields Inc. (Annex IV)10.1(110.1(1)
                
                Registration
      Rights Agreement between Western Goldfields, Inc. and the Investors in the
      November-December 2003 Private Placement (Exhibit
      10.1)10.10(1)
                
                Asset
      Purchase Agreement, dated effective November 7, 2003, among Western
      Mesquite Mines, Inc., Western Goldfields, Inc., Hospah Coal Company, and
      Newmont USA Limited dba Newmont Mining Corporation (Exhibit
      10.10)10.11(1)
                
                Registration
      Rights Agreement, dated as of November 7, 2003, between Western
      Goldfields, Inc. and Hospah Coal Company (Exhibit
      10.11)10.11.1(1)
                
                Agreement
      Regarding Return of Shares, dated January 20, 2004, by and between Western
      Goldfields, Inc. and Hospah Coal Company (Exhibit
      10.11.1)10.12(1)
                
                Net
      Operating Cash Flow Royalty Agreement, dated November 7, 2003, between
      Western Mesquite Mines, Inc. and Hospah Coal Company (Exhibit
      10.12)10.13(1)
                
                Royalty
      Agreement, dated November 7, 2003, between Western Mesquite Mines, Inc.
      and Hospah Coal Company (Exhibit
      10.13)10.14(1)
                
                Guaranty,
      dated November 7, 2003, by Western Goldfields, Inc. in favor of Newmont
      USA Limited and Hospah Coal Company (Exhibit
      10.14)10.18(1)
                
                Mineral
      Lease and Landfill Facilities Lease Agreement, dated as of June 11, 1993,
      by and between Hanson Natural Resources Company, Hospah Coal Company and
      Santa Fe Pacific Minerals Corporation (Exhibit
      10.18)10.29*
                
                Severance
      Agreement, dated November 6, 2006 by and between Western Goldfields
      (Canada) Inc. and Randall Oliphant.10.30*
                
                Severance
      Agreement, dated August 9, 2006 by and between Western Goldfields (Canada)
      Inc. and Raymond Threlkeld.10.31*
                
                Severance
      Agreement, dated August 9, 2006 by and between Western Goldfields (Canada)
      Inc. and Brian Penny.10.32*
                
                Severance
      Agreement, dated August 9, 2006 by and between Western Goldfields (Canada)
      Inc. and Wesley Hanson.





10.33(3)
                  
                  Form
      of Securities Purchase Agreement relating to the February 2006 private
      placement (Exhibit 10.1)10.33(4)
                  
                  Form
      of Securities Purchase Agreement relating to the February 2006 private
      placement (Exhibit 10.1)10.34(6)
                  
                  Underwriting
      Agreement, dated as of January 18, 2007, among Western Goldfields, Inc.,
      Wellington West Capital Markets (USA) Inc., BMO Capital Markets Corp., RBC
      Capital Markets Corporation, GMP Securities L.P. and Research Capital USA
      Inc., as underwriters(Exhibit
      99.1).10.34*
                  
                  Underwriting
      Agreement, dated September 26, 2007, among Western Goldfields Inc.,
      Wellington West Capital Markets Inc., and Scotia Capital Inc., as
      underwriters.10.35
      (10)
                  
                  Amendment
      and Restatement Agreement, including Amended and Restated Credit
      Agreement, between Western Goldfields, Inc., Investec Bank (UK) Limited,
      and the financial institutions party thereto dated May 31, 2007 (Exhibit
      10.2)10.36
      (10)
                  
                  Rights
      Agreement between Western Goldfields, Inc. and Computershare Investor
      Services Inc., dated as of June 29, 2007 (Exhibit 10.1)10.37
      (10)
                  
                  Development
      Plan Amendment relating to the credit facility agreement, between Western
      Goldfields, Inc., Investec Bank (UK) Limited and Commonwealth Bank of
      Australia dated June 29, 2007 (Exhibit 10.3)10.38*
                  
                  Restructuring
      Amendment relating to the credit facility agreement, between Western
      Goldfields Inc., Investec Bank (UK) Limited, and Commonwealth Bank of
      Australia dated July 16, 2007.10.39*
                  
                  Syndication
      Amendment relating to the credit facility agreement, between Western
      Goldfields Inc., Investec Bank (UK) Limited, and Commonwealth Bank of
      Australia dated August 14, 2007.10.40*
                  
                  Repayment
      Schedule Amendment relating to the credit facility agreement, between
      Western Goldfields Inc., Investec Bank (UK) Limited, and Commonwealth Bank
      of Australia dated August 14, 2008.10.41*
                  
                  Repayment
      Schedule, Longstop Date and New Development Plan Amendment relating to the
      credit facility agreement, between Western Goldfields Inc., Investec Bank
      (UK) Limited, and Commonwealth Bank of Australia dated December 18,
      2008.10.42*
                  
                  Fuel
      Price Hedging Amendment relating to the credit facility agreement, between
      Western Goldfields Inc., Investec Bank (UK) Limited, and Commonwealth Bank
      of Australia dated January 9, 2009.10.43(11)
                  
                  Business
      Combination Agreement between New Gold Inc. and Western Goldfields Inc.
      dated March 3, 2009 (Exhibit 99.1)14.1(5)
                  
                  Code
      of Ethics (Exhibit 14.1)21.1(5)
                  
                  List
      of Subsidiaries (Exhibit 21.1)23.1*
                  
                  Consent
      of HJ & Associates,
LLC


85





23.2*
              
              Consent
      of PricewaterhouseCoopers LLP31.1
      *
              
              Certification
      of principal executive officer pursuant to Section 302 of the Sarbanes -
      Oxley Act of 200231.2
      *
              
              Certification
      of principal financial and accounting officer pursuant to Section 302 of
      the Sarbanes - Oxley Act of 200232.1
      *
              
              Certification
      of principal executive officer pursuant to Section 906 of the
      Sarbanes - Oxley Act of 200232.2
      *
              
              Certification
      of principal financial officer pursuant to Section 906 of the
      Sarbanes-Oxley Act of 200299.1*
              
              Audit
      Committee Charter




(1)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfields, Inc.’s Registration Statement on Form SB-2, Registration No.
      333-112036 filed with the Securities and Exchange Commission on January
      20, 2004(2)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfields, Inc.’s Amendment No. 1 to Registration Statement on Form SB-2,
      Registration No. 333-112036, filed with the Securities and Exchange
      Commission on May 7, 2004(3)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfield, Inc.’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on February 17, 2006(4)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfield, Inc.’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on February 23, 2006(5)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfields, Inc.’s Annual Report on Form 10-KSB for the year ended
      December 31, 2005 filed with the Securities and Exchange Commission on
      April 13, 2006(6)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfields, Inc.’s Current Report on Form 8-K filed with the Securities
      and Exchange Commission on January 19, 2007(7)
                          Incorporated
      by reference to the annex shown in parenthesis included in Western
      Goldfields Inc.’s Registration Statement on Form S-4, Registration
      Statement No. 333-141595, as amended, filed with the Securities and
      Exchange Commission on March 27, 2007(8)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfields Inc.’s Registration Statement on Form S-3, Registration
      Statement No. 333-144685, filed with the Securities and Exchange
      Commission on July 19, 2007(9)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfields Inc.’s Amendment No. 1 to Registration Statement on Form S-3,
      Registration Statement No. 333-144685, filed with the Securities and
      Exchange Commission on August 6, 2007(10)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfields Inc.’s Quarterly Report on Form 10QSB filed with the Securities
      and Exchange Commission on August 7, 2007(11)
                          Incorporated
      by reference to the exhibit shown in parenthesis included in Western
      Goldfields Inc.’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on March 10,
2009.




*
            Filed
      herewith.


86