Michael Durante Western Reserve 4Q04

Fourth Quarter 2004 January 13, 2005
100 Crescent Court, Suite 400 • Dallas, Texas 75201• (214)871-6720 • (214)871-6713 Fax
1Q04 2Q04 3Q04 Oct Nov Dec 4Q04 YTD
WRHE Gross 5.2% (1.5%) 3.0% 2.7% 7.7% 7.8% 19.1% 27.1%
WRHE Class A, Net 1
3.9% (1.5%) 2.1% 2.0% 6.0% 6.1% 14.8% 20.0%
WRHE Class B, Net 1
4.0% (1.6%) 2.2% 2.1% 6.3% 6.3% 15.4% 20.7%
S&P 500 1.3% 1.3% (2.3%) 1.4% 3.9% 3.3% 8.8% 9.1%
NASDAQ Composite (0.5%) 2.7% (7.4%) 4.1% 6.2% 3.8% 14.8% 8.6%
1
Class A shares are subject to a one year lock-up and a 20% performance fee;
Class B shares are subject to a three year lock-up and a 17% performance fee.
“The road to success is always under construction”
-Lily Tomlin
Dear Partners:
The partnership posted a very profitable 2004. Western Reserve Hedged Equity, LP (“WRHE”
or the “Fund”) returned 27.1% gross and 20.0% and 20.7%, net of all fees and expenses for Class
A and B shares, respectively. With the broad market advancing about 9% in 2004, WRHE
comfortably achieved one of its primary goals of ‘twice the performance for half the risk.’ There
are several things for which we are thankful as we reflect upon the year and look ahead to 2005
and beyond. In this letter, however, we will spend more time looking forward than reflecting on
the past.
You might be wondering from where I found the quote from esteemed actress and comedian Lily
Tomlin exploited above. Truth be told, I borrowed it out of a quote book I was randomly
thumbing through at a Barnes & Noble. However, it reminded me of something my mentor, best
friend and entrepreneur father, Colin Durante, always said about business – “To be successful,
you need only work half the day… you then may take the other twelve hours off.”
The twelve hour days never end in this or any inordinately competitive business, of course, and
success is a continuum, which remains under construction ad infinitum. The Western Reserve
team will never forget those important tenets. And on that onerous thought, I candidly expect
2005 to be no less challenging than the year just past for equities (and probably more so…). The
stock market can be a humbling place to make a career and we have our work laid before us in
the coming year to be sure.
Before getting into the comings and goings in our research, the first couple weeks of 2005 have
been too interesting in the market not to comment upon, if ever so briefly…

January 13, 2005
The new year has started out with strategists and traders, seemingly wanton to take shortcuts
from the top down, making for one of the more fundamentally conflicted ‘January effect’ trades
we have seen. However, most ‘January effect’ trades are seldom underpinned by actual
fundamentals and valuation. As the fund manager’s almanac suggests for date changes – “sell
last year’s winners and load the boat with the losers.”
Last year, and for the past six straight years (or so I’m told), small capitalization stocks easily
bested larger ones. Thus, Wall Street’s market sages all but unanimously agreed that this year
will be the year of the “mega caps.” The rationale? They use a fancy statistical term as the sole
support to this very broad market call – a ‘reversion to the mean.’ Put simply – a reversal.
Large will beat small merely because last year, small happened to beat large. I have no comment
on the aforementioned statistical rationale. It is the first few weeks of 2005 after all and such
date change axioms do tend to work for a spell. However, I do have some fundamental
revelations to throw out…
In 2004, the accepted small cap stock barometer, the Russell 2000, rose about 17% versus the
large cap S&P 500’s 9% advance and the 3% showing for the mega cap Dow Jones. For the
term, the 2000 small companies represented in the Russell grew cash earnings on average 15%-
16%; the 500 firms in the S&P about 8%-9%; and the 30 Dow companies reported profits 1%
lower than the year previous. One probably doesn’t need a calculator to figure out what
happened last year. Earnings (we prefer cash equivalents) appear to be the key driver of stocks
and earnings are WRHE’s key research focus, of course.
To confront a little reality for a moment, large U.S. companies are facing a serious revenue
growth challenge, in our view, and are not able to produce attractive rates of growth to drive
their stocks higher outside another bubble (to drive valuations to extremes again). At 20x this
year’s consensus earnings forecast e.g., the Dow is hardly a bargain. The street again is
expecting abysmal growth in 2005 for the largest firms, giving perhaps a new meaning to the
term “Dow Dogs.”
Western Reserve succeeds or fails largely on the back of our research. It mostly comes down to
whether or not we have worked hard enough to find companies growing earnings much faster
than the economy and executing at valuations below their growth rates, generally well below the
broader market, and at discounts to their private market value.
As of this writing, the Fund’s forward long P/E stands at under 11x or 60% of the broader market
and a fraction of the more aggressive segments of the market e.g. NASDAQ closer to 30x. For
the coming year, our research team projects that the Fund’s current longs can produce earnings
growth that exceeds 20% on average, bearing a highly attractive 50% discount valuation relative
to earnings growth. The broader market garners nearly a 100% premium to growth by
comparison. On a relative basis, the Fund’s longs are growing at more than twice the pace of a
broader group of stocks for about half the valuation.

January 13, 2005
The Fund’s shorts, on the other hand, trade at 24x forward earnings relative our single digit
growth expectations, at best. And there also is a material difference in the accounting quality of
earnings between the Fund’s longs and shorts as well.
One would never hope to compete with Morgan Stanley’s clever Byron Wien and the “Ten
Surprises for the New Year” he has published to the pleasure of institutional investors for years.
His annual consensus probe always is as intriguing as it is elegant. As mere stock pickers, I
thought we might risk mentioning five names from our research that might lead to intrigue in
2005. I didn’t select the Fund’s largest positions per se as much as I tried to select research that
carried more controversy or leaned in the direction of the more provocative.
Sirius Satellite Radio (SIRI) may come under intense competition from iPods. Satellite radio
subscribers will increasingly pass on satellite radio for iPods rigged with FM transmitters. An
“iPod nation” driven by no commercials, your favorite music categorized into your own
groupings and played at your pleasure anywhere, including your favorite place to play music –
the car stereo. If we’re wrong, SIRI’s $9 billion market valuation, zero cash flow and 179x
sales multiple should also cause investors some pause in the year ahead. Last we checked with
Street consensus to compare to our own forecast, SIRI appeared in no immediate danger of
turning a profit. Seriously! Since one struggles to comfortably value a business with no profits
in sight, we believe the downside here is quite considerable.
Primus Guarantee (PRS) shares should power ahead some 50% this year. PRS is the market
leader in the rapidly expanding and huge $4.5 trillion market for credit swaps. They arrange
credit trades among banks, insurers and investment banks and earn lucrative fees, similar to other
debt guarantors. It is a high recurring cash revenue business with low credit risk. Their clients
are highly rated large financial institutions (losses run just 7bp annually). Margins exceed 50%.
Core cash EPS should grow 60% in 2005 and another 50% to 60% in 2006. The current 2005E
P/E is just 16x and 2006E is only 10x for a firm whose earnings will double over the next two
years. Our twelve month price target is $24, 50% above recent market.
Stamps.com (STMP) appears to have been left twisting in the wind by the U.S. Postal Service
(USPS), yet the stock is not lacking for investor enthusiasm at 100x current earnings
expectations. STMP has never produced an annual profit in its six years as a publicly traded
company. It’s not a bad company mind you, we even like the website. But, STMP lacks some
advantages normally associated with a successful business in our view. They have no product of
their own and their sole supplier also happens to be their biggest competitor (USPS.com) and, of
course, it’s a monopoly. The eight-hundred pound gorilla postal service isn’t shy either and likes
to flex its muscle as it did last year when it yanked the personalized stamp program from STMP.
We also worry about the experience of the CEO and CFO, both of whom were Wall Street
analysts. There are few things more worrisome than former investment bankers running a public
company, but former analysts doing so is one. Even if the postal service tries another test this
year with STMP (we do not believe they will), the most optimistic analyst forecasts call for a
profit that places the stock’s forward P/E multiple at 75x to 85x. We are against convention here
as several major hedge funds (not just mutual funds) are long this stock. Our six month target
price is $9, more than 40% below recent market.

January 13, 2005
VCA Antech (WOOF) insiders may be telling us something if recent insider sales are a signal
of forthcoming fundamentals. Recently, two founders of the company sold over 50% of their
holdings, a key financial backer has cashed out completely, both the chief financial officer and
the comptroller each have relieved themselves of 50% and 100% of their stock, respectively, and
the CEO has dumped close to 25% of his stock. WOOF, a “roll-up” of animal hospitals, is the
type of growth story we tend to eschew and often short because growth is acquired and supported
primarily via purchase accounting. WOOF lacks organic growth and has increasingly relied
upon larger and larger acquisitions to keep GAAP earnings growing and the stock’s multiple
aloft. The bi-product of WOOF’s rabid acquisition-driven growth is a toxic balance sheet.
Acquisition related “goodwill” represents a worrisome 230% of the firm’s stated book value and
roughly 400% of “hard” assets. In addition to a negative tangible net worth, the company
generates limited free cash flow in support of reported earnings. Trading at 23x reported
earnings with low organic growth, increased competition from PetsMart, and debatable financial
soundness, we are doing exactly what the insiders are doing - selling stock. Six month target
price is $13-14, 30% below market.
Euronet Worldwide (EEFT) is an emerging leader in secure electronic financial transaction
solutions. They operate the largest independent pan-European ATM network and are a leading
electronic prepaid distribution services provider e.g. prepaid mobile airtime. We believe that
EEFT, one of WRHE’s most profitable positions in 2004, remains poised to again deliver strong
gains for the partnership in 2005. The company’s entrance into the fast growing Indian ATM
market and penetration of high growth prepaid distribution markets in Europe should help drive
another year of 30% or more top line growth. Like many classic WRHE longs, the business is
highly scalable and recurring, which will drive perhaps as much as 50% cash flow growth as
operating leverage scales. This highly predictable and significant growth opportunity trades at
just 11.5x our 2005 operating cash flow estimate and well under 10x 2006. Our twelve month
price target is $35, or more than 40% above recent market.
As I noted earlier, the Western Reserve team has many things (and people) for which to be
thankful this past year. While anything I say would be insufficient relative to the importance of
our supporters and partners over the past year, some special thanks are well in order.
First, we owe much gratitude to Bucky Lyon and his team at Gryphon Partners, LP. The
importance of smart, visionary advisors like Bucky is invaluable in building an enterprise.
Thanks Bucky!
Second, the senior research analysts at Western Reserve, Ted Brynn and Rod Hinze, have gelled
exceptionally well under our very focused strategy and thus have excelled beyond even my
ambitious expectations. They are the most focused and productive senior analyst team with
whom I have worked (and I will make sure that they never read this letter either). A patient and
focused hiring strategy aimed at distinct private capital markets experience and highly skilled
analytical talents has begun to pay off for the Fund’s partners with Ted and Rod. They are 12-
hour a day guys!

January 13, 2005
Third, I thank the Fund’s limited partners, which needs little in the way of explanation. It’s your
support and confidence that makes Western Reserve. Thank you! The research team and I
promise to work very hard for you in 2005 to reaffirm your confidence in us and our strategy.
Since it is year-end, I also thought a quick business update was timely. Western Reserve’s assets
under management (AUM) grew more than five fold in 2004 as we were fortunate to have added
a number of quality institutions and individuals as partners and investors. We have tried to be
very careful and do not believe there are any “hot money” investors in WRHE.
Western Reserve invested heavily in technology and built a strong infrastructure during its first
year of operations in an effort to ensure that my time is spent researching and managing the
portfolio and that the research team has the tools necessary to be highly efficient. Through our
relationship with Gryphon, the firm has a CFO that performs portfolio accounting, an in-house
counsel, and a director of investor relations. Building a strong infrastructure was very important
to me from the onset and therefore my conservative financial projections did not show the
management company making a profit until early 2006. However, the management company
turned profitable this past August, which was almost eighteen months ahead of plan and which
enabled us to extinguish all debt at the end of 2004, a full year ahead of plan.
I strive to run the business like the companies we favor in our research – low or no debt, highly
scalable, structurally sound, and financially very liquid. With some luck, we hope these
favorable trends will continue in 2005 and beyond…
To our partners, we again extend the invitation to come see us in the New Year. Talking to you
and others that have interest in what we do and in how we invest is among the great pleasures of
managing capital for individuals and institutions. We have a passion for this business despite its
vagaries and like to share that enthusiasm, sometimes uncontrollably, with friends and even
perfect strangers alike.
Regards,
Michael P. Durante
Managing Partner

January 13, 2005
Long
Short
Total (Gross)
Total Class A (Net)2
Total Class B (Net)2
Sector Long Short Gross Net
Business Services 9% -2% 11% 7%
Consumer 7% -11% 18% -4%
Financial Institutions 25% -12% 37% 13%
Financial Services 17% -4% 21% 13%
Healthcare 2% -1% 3% 1%
Industrial 2% -5% 7% -3%
Preferred Stock 4% 0% 4% 4%
Technology 2% -2% 4% 0%
Technology Services 18% -6% 24% 12%
Real Estate 25% -5% 30% 20%
111% -48% 159% 63%
Long Short
Top 5 21% 14%
Top 10 35% 21%
Jan Feb Mar Apr May Jun Jul Aug Sept Oct Nov Dec YTD
WRHE Gross 2.0% 2.2% 1.0% -3.1% 0.3% 1.3% -2.1% 0.6% 4.6% 2.7% 7.7% 7.8% 27.1%
WRHE Class A Net 1.5% 1.6% 0.7% -2.6% 0.2% 0.9% -1.8% 0.4% 3.6% 2.0% 6.0% 6.1% 20.0%
WRHE Class B Net 1.5% 1.7% 0.7% -2.7% 0.2% 0.9% -1.9% 0.4% 3.7% 2.1% 6.3% 6.3% 20.7%
S&P 500 1.7% 1.2% -1.6% -1.7% 1.2% 1.8% -3.4% 0.2% 0.9% 1.4% 3.9% 3.3% 9.0%
NASDAQ 3.1% -1.8% -1.8% -3.7% 3.5% 3.1% -7.8% -2.6% 3.2% 4.1% 6.2% 3.8% 8.7%
1
Freely tradable securities. Immaterial position sizes omitted.
2
Class A shares are subject to a one year lock-up and a 20% performance fee; Class B shares are subject to a three year lock-up and a 17% performance fee.
Summary for the Quarter and Year Ended
December 31, 2004
Quarter Ended
2004
December 31, 2004
Positions1
Ending
Exposure1
Krispy Kreme
143%
39%
Capital One Financial
Long
Signature Bank
Short
Top 5 Winners
Top 5 Long
Comparative Returns2
53
33
86
24.2%
-4.5%
19.1%
111%
-48%
159%
63%
Providian Financial
Feldman Mall Properties
Pacific Premiere
Euronet Worldwide
TRM Corp
New Century Financial
Alliance Gaming
Netflix
Fair Isaac
Commercial Capital
Alliance Data Systems
Performance Performance
91%
52%
Average
Exposure
1
37.5%
eSpeed
FY2004
Western Reserve Hedged Equity, LP
Composition by Sector (% of Capital)
Percent of Capital1
-8.2%
27.1%
20.0%
20.7%
14.8%
15.4%
Western Reserve Hedged Equity, LP
Cumulative Performance Since Inception (Gross)
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Western Reserve Hedged Equity
S&P 500
NASDAQ

Michael Durante Western Reserve 4Q04

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