Quarterly Letters

Roumell

Quarterly Update

January 31, 2008

Performance Summary

  Annualized as of 12/31/07
  4Q 2007 1 Year 3 Year 5 Year Since
Inception
(1/1/99)
Roumell Equity -6.75% -7.67% 6.64% 14.01% 13.50%
S&P 500 -3.33% 5.49% 8.62% 12.83% 3.65%
Russell 2000 -4.58% -1.57% 6.80% 16.24% 8.21%
Russell 2000 Value -7.28% -9.78% 5.27% 15.80% 10.93%
Roumell Balanced (Net) -5.95% -7.58% 5.27% 11.31% 9.60%
Thomson US Balanced Index -1.25% 5.76% 6.78% 9.25% 4.29%
Please refer to performance disclosures at end of document.

Roumell Asset Management LLC is in compliance on a firm-wide basis with the requirements of the Global Investment Performance Standards (GIPS®) as adopted by the CFA Institute. Ashland Partners & Co LLP, our independent verifier, completed its examination of the firm’s performance returns for the period of 1999 (inception) through September 30, 2007. Please refer to the annual disclosure presentations at the end of this document.

Notwithstanding the market’s current volatility, we feel quite good about our current holdings and are optimistic about positioning accounts for the next few years. Our cash position of roughly 25% should allow us to take advantage of value creation opportunities as compared to the typically fully invested equity fund. In addition, we hold about 15% of our portfolio in deeply discounted closed-end bond funds. Seeds planted in today’s environment should be successfully harvested in time. Recently, we have been able to purchase some real “battleships” that have been elusive to us in previous years because of pricing: Legg Mason (discussed in the 3rd quarter letter), which manages over $1 trillion in assets; Whirlpool, which dominates the North American appliance market (50%) with a growing international business; and Toyota Industries, an operating company with a portfolio of blue chip Japanese securities that includes Toyota Motors, one of the truly great international brands in the world. The logic that went into our Toyota Industries purchase was similar to that of our purchases of Berkshire Hathaway and Capital Southwest in recent years – summing pieces that together equate to far more than our purchase price.

We hold a high percentage of companies where insiders are actively buying stock on the open market (roughly 50% of current holdings) and others where insiders simply own meaningful stakes in our businesses, providing us some measure of safety in company capital allocation decisions. Several of the smaller companies we own (many of which are significantly underwater on a mark-to-market basis) have been added to upon further analysis. We remain convinced we own some very inexpensive businesses that are extremely well financed and will work out quite satisfactorily over time in our opinion. For instance, it is comforting to see a dynamic software company’s founders accumulate shares on the open market, adding to their already significant 37% equity stake. We have sat down with this company’s CEO and met several of its clients. We believe strongly in the investment thesis and consequently have added to our position. In other words, we like what we own. We have sold (and will continue to sell) when our analysis no longer indicates a real value proposition.

Accustomed as we’ve been to providing strong risk-adjusted returns, we performed poorly last year, particularly against the standards we have set for ourselves. We have already discussed in previous correspondence the causes: distinct small cap value disfavor (Russell Value 2000 was down 10% in 2007 and off 15% from its high reached in the middle of the year); still too many financial holdings even after several prescient sales in August and our expectation of deep housing turmoil and credit restriction; and underestimation of specific company and industry challenges of several micro-cap holdings. In an August letter to clients, we indicated our sales were the result of “further declining real estate values” and “a dramatic change in credit markets.” In retrospect, we should have sold more. That said, in our opinion, the overwhelming majority of unrealized losses in our accounts today are mark-to-market losses having more to do with selling pressure as a result of quant funds simultaneously liquidating positions and general market fears surrounding smaller companies. The bifurcation of the stock market in the past 52 weeks (as of 1/8/08) is quite stunning: the return on stocks that have a market capitalization less than $250 million (2,092 issues) is -23%, while the return on stocks with a market capitalization greater than $20 billion (290 issues) is 21%; a spread of over 40%. In our opinion, current prices of our holdings do not reflect underlying value. There really is a difference between price and value, and in time, the gap should close.

In our 3rd quarter letter, we noted that “…the pitfalls posed to our domestic economy as a result of the housing bubble bursting are real, and moreover, the full consequences are really not known. One can only speculate on the impact that steadily dropping home values will have on American consumers. We believe this reverse wealth effect is quite real and as a result we are cautious in selecting new investments. However, the market appears not to be overly concerned.” Further, we commented that the total domestic market capitalization as a percentage of GDP was extremely high on an historical basis. Of late, large capitalization companies have pulled back, too, increasingly providing us access to “battleship-like” companies to complement our smaller capitalization holdings.

Several clients have mentioned the S&P 500’s performance last year (it beat us for the first time in nine years), and seemed to wonder why. Longer-term clients are aware that from 2000 to 2002 the S&P 500 was down almost 40%. Our equity accounts were up roughly 30% during the exact same period. It wasn’t so this past year. There is nothing safe about a particular index and different ones will invariably be in style or out of style. Over time, our goal is to at least double the risk-free rate of return and manage in terms of a total real return. Historically, we’ve accomplished that and expect to do so in the coming years.

A Personal Note from Jim Roumell

I recognize the disappointment in last year’s performance. I welcome the challenge over the next few years to grow our accounts and we all are committed to doing just that. I cannot predict to what extent the economy’s challenges will affect share prices this year, but believe, as Warren Buffett has said, “The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.” We will be diligent about the price we pay and remain committed to our deep value discipline. We no doubt did learn some new lessons in 2007 about assessing downside risk. I will personally be traveling from Rhode Island to California this quarter in order to meet one-on-one with the management teams of our holdings. I remain one of our firm’s largest accounts, owning everything our clients do and precluding myself and the firm’s other senior employees from owning any public securities outside of the ones we own for clients.

For our clients, we have included with this quarter’s letter a summary analysis of each of our current holdings so that you can easily reference them and the reasoning underpinning each purchase. This summary will be updated regularly on our website. Please call or email us for the user name and password.

Thank you for your continued trust, confidence, and patience. –Jim Roumell

Our Three Top Purchases

Van Kampen Credit Opportunities Fund, VTA. VTA is a closed-end fund consisting principally of senior secured bank loans issued to corporations. Over the years, we have made several closed-end bond investments in this area of the marketplace. These loans are senior in the capital structure – above both equity and traditional debt – often issued by corporations rated below investment grade. To us, they are high class, high yield bonds. The fund is well diversified and offers protection against single issue risk. The portfolio is over $1.3 billion with an average loan size of $6.5 million. The top holding represents roughly 3.5% of net asset value and the top ten holdings account for less than 20% of total value. To wit, a 5% portfolio position equates to an individual account having a 0.18% exposure to each of the top two issues (currently, Tribune Company and Metro-Goldwyn-Mayer Studios, Inc.).

There are several reasons why we purchased this security and did so in a meaningful fashion. Van Kampen is a seasoned senior loan manager, and this fund represented an opportunity to exploit the credit crisis that occurred in the 3rd and 4th quarters. The fund was issued earlier this year at $20/share ($19.10 original NAV after accounting for underwriting fees) and still had approximately 50% of its assets in cash in August when credit soured. Hence, the fund was able to buy into maximum stress and purchase cheaply. Further, we paid a substantial discount to the fund’s stated NAV. In fact, this discount is in addition to the discount embedded in the portfolio in that the average loan was priced at about 94% of par at the time of purchase. Hence, a 12% discount to the portfolio’s NAV plus a 6% embedded discount to par represents a discount to the underlying paper of roughly 18%. The fund pays a substantial dividend and our yield is roughly 11% at the price we paid.

What are the risks? First, there is little in the way of interest rate risk in that these loans regularly adjust to Libor. The fund uses a modest amount of leverage, roughly 33% as opposed to the 300% to 1000% leverage often found in mortgage REITs. There is credit risk. However, the credit quality of senior loans has held up significantly better than straight high-yield debt in past periods. Recoverables are much greater (80%+ in past default cycles) given the typical superior placement in the capital structure of a senior loan versus equity or traditional debt in the event of a default. At the discount to NAV we paid (plus the embedded discount to par value), 30% of the portfolio could default with recoverables of only 50% and we would still have an asset value greater than our purchase price (assuming par value). These loans are made to corporations and are typically held to maturity. They are not mortgage loans. We feel that at the price we paid, the dividend yield, diversification, and wide discount to both NAV and par value provide us with a very attractive risk/reward opportunity.

Whirlpool, WHR. Whirlpool is the world’s #1 producer of major home appliances. The company manufactures in 13 countries under various brands (Whirlpool and KitchenAid in North America) and acquired Maytag in March 2006.

There is a lot to like about this true global brand with 40% of sales coming from abroad (principally Latin America, and growing in Asia and Europe), while controlling 50% of the North American combined appliance market (washers, dryers, refrigerators, freezers, dishwashers, and stoves). The company has sold off given concerns about America’s housing slowdown and the expectation of lower appliance sales. We have looked for companies getting oversold in reaction to this concern – staying away from home-builders and furnishings companies – and believe Whirlpool is one such example for at least two important reasons. First, as mentioned above, international sales now account for 40% of revenues and these markets are growing. In fact, international growth is currently offsetting North American sales declines such that top line revenues are essentially flat. Second, in reviewing data going back many years, it is apparent that a large percentage of North American sales are driven by replacement demand; i.e., major home appliances break down and need to be replaced.

The price appears to offer a great opportunity to invest in a global franchise, stewarded by a strong and seasoned management team levered to the world’s growth in appliances. With bear case Wall Street earnings estimates of $8 for 2008 and $9 for 2009, Whirlpool trades at less than 10x earnings based on the price we paid and it generates significant free cash flow. Even after accounting for a significant increase in material input costs, we still expect the company to earn at least $7.50/share in 2008. If 2008 North American sales are slower than estimated, we do not believe it detracts from the long-term attractiveness of this story. Whirlpool fits into a greater desire by the firm to be exposed to companies levered to the world’s growth. Finally, insiders have recently been making open-market purchases for the first time in several years.

Toyota Industries Corp., TYIDF/6201 JP. Toyota Industries (“Industries”) traces its roots all the way back to the invention of the Toyoda automatic loom by renowned inventor Sakichi Toyoda in 1924. Today, Industries is a diversified holding company primarily engaged in the automotive vehicle and parts manufacturing industry. In addition to its operating businesses, Industries possesses a sizable portfolio of Japanese blue chip stocks that includes a 5.5% stake in Toyota Motor Corp. (“Motor”), established in 1933 as the Automobile Department of Industries (then known as Toyoda Automatic Loom Works, Ltd.).

The thesis behind our investment in Industries is centered on acquiring the common stock at a meaningful discount to a conservatively derived sum-of-the-parts net asset value. There are three distinct components that constitute Industries’ NAV:

  1. Industries’ operating businesses are valued at roughly $17/share; 7x trailing twelve month operating income net of estimated before-tax minority interest.
  2. Industries’ stake in Toyota Motor Corp. translates into $36/share at its public market price (currently down 25% from its 52-week high).
  3. Industries’ portfolio of Japanese blue chip stocks is valued at roughly $18/share.
  4. These parts sum to $71/share. After subtracting out net debt of about $11/share, we’re left with an NAV of about $60/share. Our investment in Industries was made at approximately a 30% discount to our estimated NAV.

    Another way to value Industries is to “bleed through” the earnings of affiliates that are part of its marketable securities portfolio based on Industries’ respective ownership stake. After adding incremental look-through earnings to the existing after tax earnings of the operating company, our investment was made at roughly 8x pro-forma earnings per share, a multiple that we feel is attractive.

    In essence, an investment in Toyota Industries provides a much cheaper entry into Toyota Motor and a basket of other Japanese blue-chip companies. The story of Motor is truly remarkable. From its genesis, Motor has been a leader in automotive innovation. Today, it is leading the marketplace toward a more environmentally friendly automobile. If all of the aforementioned pieces of Industries’ NAV with the exception of Motor were subtracted from our average purchase price, the implied valuation for Motor would be roughly a 45% discount to its public market value. In Toyota Industries, we have the opportunity to invest in Toyota Motor, a leading global franchise and a de facto investment in the world’s growth at a sizable discount to its public market price.

    Disclosure: The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients and the reader should not assume that investments in the securities identified and discussed were or will be profitable. The top three securities purchased in the quarter are based on the largest absolute dollar purchases made in the quarter.

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    ROUMELL ASSET MANAGEMENT, LLC
    EQUITY COMPOSITE
    ANNUAL DISCLOSURE PRESENTATION

      Total Firm Composite Assets Annual Performance Results
    Year Assets USD Number of Composite S&P Russell Russell Composite
    End (millions) (millions) Accounts Net 500 2000 2000 Value Dispersion
    2007 270 178 549 -7.67% 5.49% -1.57% -9.78 2.68
    2006 280 176 458 16.89% 15.79% 18.37% 23.48% 2.18%
    2005 199 111 312 12.38% 4.91% 4.55% 4.71% 2.59%
    2004 123 47 125 20.18% 10.88% 18.33% 22.25% 2.69%
    2003 66 15 46 32.13% 28.69% 47.25% 46.03% 4.04%
    2002 41 8 44 -10.15% -22.10% -20.48% -11.43% 4.33%
    2001 31 5 30 32.76% -11.89% 2.49% 14.02% 6.33%
    2000 19 2 12 7.97% -9.10% -3.02% 22.83% 4.05%
    1999 16 2 9 26.02% 21.04% 21.26% -1.49% 3.92%

     

    Equity Composite contains fully discretionary equity accounts and for comparison purposes is measured against the S&P 500, Russell 2000, and Russell 2000 Value Indices. The S&P 500 Index is used for comparative purposes only and is not meant to be indicative of the Equity Composite performance. In presentations shown prior to March 31, 2005, the composite was also compared against the Nasdaq Index. The benchmark was eliminated since it did not represent the strategy of the composite.

    Roumell Asset Management, LLC has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS®).

    Roumell Asset Management, LLC is an independent registered investment adviser. The firm maintains a complete list and description of composites, which is available upon request.

    Results are based on fully discretionary accounts under management, including those accounts no longer with the firm. Past performance is not indicative of future results.

    The U.S. Dollar is the currency used to express performance. Returns are presented net of management fees and include the reinvestment of all income. Net of fee performance was calculated using actual management fees. Net returns are reduced by all fees and transaction costs incurred. Wrap fee accounts pay a fee based on a percentage of assets under management. Other than brokerage commissions, this fee includes investment management, portfolio monitoring, consulting services, and in some cases, custodial services. As of December 31, 2006 and 2007, wrap fee accounts made up 33% and 36% of the composite, respectively. Wrap fee schedules are provided by independent wrap sponsors and are available upon request from the respective wrap sponsor. Returns include the effect of foreign currency exchange rates. Exchange rate source utilized by the portfolios within the composite may vary. Composite performance is presented net of foreign withholding taxes. Withholding taxes may vary according to the investor’s domicile.

    The annual composite dispersion presented is an asset-weighted standard deviation calculated for the accounts in the composite the entire year. Dispersion calculations are greater as a result of managing accounts on a client relationship basis. Securities are bought based on the combined value of all portfolios of a client relationship and then allocated to one account within a client relationship. Therefore, accounts within a client relationship will hold different securities. The result is greater dispersion amongst accounts. Additional information regarding the policies for calculating and reporting returns is available upon request.

    The investment management fee schedule for the composite is as follows: For Direct Portfolio Management Services: 1.75% on the first $200,000, 1.50% on the next $300,000, and 1.00% on assets over $500,000; For Sub-Adviser Services: determined by adviser; For Wrap Fee Services: determined by sponsor. Actual investment advisory fees incurred by clients may vary.

    The Equity Composite was created January 1, 1999. Roumell Asset Management, LLC's compliance with the GIPS® standards has been verified for the period January 1, 1999 through September 30, 2007 by Ashland Partners & Company LLP. In addition, a performance examination was conducted on the Equity Composite beginning January 1, 1999. A copy of the verification report is available upon request.






    ROUMELL ASSET MANAGEMENT, LLC
    BALANCED COMPOSITE
    ANNUAL DISCLOSURE PRESENTATION

      Total Firm Composite Assets Annual Performance Results
    Year Assets USD Number of Composite Thomson US Balanced Composite
    End (millions) (millions) Accounts Net Mutual Fund Dispersion
    2007 270 75 154 -7.58% 5.76% 3.71%
    2006 280 87 158 14.00% 10.47% 3.69%
    2005 199 73 142 8.56% 4.22% 2.67%
    2004 123 66 119 16.48% 7.79% 3.82%
    2003 66 42 100 28.26% 18.60% 3.94%
    2002 41 27 79 -9.70% -11.36% 3.77%
    2001 31 17 39 21.18% -4.19% 4.75%
    2000 19 10 23 8.47% 1.95% 4.53%
    1999 16 9 22 12.53% 8.35% 2.63%

    Balanced Composite contains fully discretionary balanced accounts (consisting of equity, fixed income, and cash investments) and for comparison purposes is measured against the Thomson US Balanced Mutual Fund Index. In presentations shown prior to March 31, 2006, the composite was also compared against the Lipper Balanced Index. Additionally, in presentations prior to December 2006, the composite was measured against the Vanguard Balanced Index Fund. The Thomson US Balanced Mutual Fund Index is a blend of over 500 balanced mutual funds and is therefore deemed to more accurately reflect the strategy of the composite.

    Roumell Asset Management, LLC has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS®).

    Roumell Asset Management, LLC is an independent registered investment adviser. The firm maintains a complete list and description of composites, which is available upon request.

    Results are based on fully discretionary accounts under management, including those accounts no longer with the firm. Past performance is not indicative of future results.

    The U.S. Dollar is the currency used to express performance. Returns are presented net of management fees and include the reinvestment of all income. Net of fee performance was calculated using actual management fees. Net returns are reduced by all fees and transaction costs incurred. Wrap fee accounts pay a fee based on a percentage of assets under management. Other than brokerage commissions, this fee includes investment management, portfolio monitoring, consulting services, and in some cases, custodial services. As of December 31, 2007, there are no wrap fee accounts in the composite. As of December 31, 2006, wrap fee accounts made up less than 1% of the composite. Wrap fee schedules are provided by independent wrap sponsors and are available upon request from the respective wrap sponsor. Returns include the effect of foreign currency exchange rates. Exchange rate source utilized by the portfolios within the composite may vary. Composite performance is presented net of foreign withholding taxes. Withholding taxes may vary according to the investor’s domicile.

    The annual composite dispersion presented is an asset-weighted standard deviation calculated for the accounts in the composite the entire year. Dispersion calculations are greater as a result of managing accounts on a client relationship basis. Securities are bought based on the combined value of all portfolios of a client relationship and then allocated to one account within a client relationship. Therefore, accounts within a client relationship will hold different securities. The result is greater dispersion amongst accounts. Additional information regarding the policies for calculating and reporting returns is available upon request.

    The investment management fee schedule for the composite is as follows: For Direct Portfolio Management Services: 1.75% on the first $200,000, 1.50% on the next $300,000, and 1.00% on assets over $500,000; For Sub-Adviser Services: determined by adviser; For Wrap Fee Services: determined by sponsor. Actual investment advisory fees incurred by clients may vary.

    The Balanced Composite was created January 1, 1999. Roumell Asset Management, LLC's compliance with the GIPS® standards has been verified for the period January 1, 1999 through September 30, 2007 by Ashland Partners & Company LLP. In addition, a performance examination was conducted on the Balanced Composite beginning January 1, 1999. A copy of the verification report is available upon request.

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