Quarterly Letters

Quarterly Update

Second Quarter Summary

In the second quarter, our Equity Composite was up 3.9%, bringing year-to-date performance to 5.1%. Our Balanced Composite was up 2.3% in the second quarter, bringing year-to-date performance to 5.0%. In spite of the overall market rise, we have been able to find several compelling investments that have met our deep value criteria. At the end of the second quarter, firm-wide cash levels declined to less than 15%. We will continue to methodically and opportunistically seek investments that make sense based on the unique characteristics of each individual company.

Leading by Example

In our marketing brochure, we state the following in the section entitled "People Matter": "In selecting investments, we ask ourselves: Do we want to partner with this management team? Are they prepared to outwork the competition? Are they honest? Are they smart operators?" We found such a team in Capital Southwest, Inc. several years ago. In particular, we found in Capital's CEO, Bill Thomas, a dedicated individual with an unparalleled sense of responsibility and commitment to his fellow shareholders. Bill Thomas joined Capital in 1961 and is retiring this summer. Capital has been our firm's largest holding for several years; hence, it's worth marking this occasion by honoring the principal architect behind this fascinating company.

Capital is a relatively small company - market capitalization of about $600 million - but in fact is one of the nation's largest publicly-owned venture capital investment companies. The company is organized as a Business Development Company, a type of closed-end fund. The company states its purpose clearly: "We finance those managers who have a proven record of achievement, exceptional ability, unyielding determination, and unquestionable integrity." The results are impressive since Bill's arrival. The company reports in its March 31, 2007 annual report, "A $10,000 investment in CSWC stock on April 1, 1962 had a March 31, 2007 market value of $5,472,000 ($10,000 invested in the S&P 500 was worth $880,000)." Roumell Asset Management began buying Capital shares in the fall of 2002 (at one point owning 5% of outstanding shares) and continues to own shares today.

Long before the current private equity craze, we found in Capital a vehicle for participating in the financing and incubation of promising young companies; and here's the real kicker - at a fraction of the cost. Bill has been a tireless advocate for common shareholders and has acted accordingly. To wit, typical private equity funds (aka hedge funds) often charge their clients between 1% and 2% of assets plus 20% of profits. Capital's fees are roughly 50 basis points (0.50%) per year in operating expenses plus very modest option disbursements. As investors, we have participated in Capital's diverse holdings of both public and private businesses: Palm Harbor (manufactured housing), RectorSeal (industrial fluids), Encore Wire (copper cabling), Lifemark (cemeteries), Alamo (commercial/municipal lawn cutting equipment) and Heely's (the unique "wheel in the heel" sneaker company that went public last year). An added pleasure of being Capital shareholders has been access to Bill's shareholder letters - always educational, candid and often prescient.

In Capital's June of 1999 report, Bill stated emphatically, "There will be a day of reckoning and an eventual collapse of the irrational market prices that have little or no fundamental support." We also did not participate in the mania of that time choosing to bypass (with minor exception) internet investments. The math didn't work and anyone seriously putting pencil to paper couldn't argue otherwise.

Bill unfailingly told his shareholders the truth. In March of 2001, reflecting on some sharp losses Capital suffered in a few embryonic technology investments, he said, "In the future, we believe it will be more efficient and profitable to send each stockholder a cash dividend and a ticket to Las Vegas." Although Capital's long-term performance appears exceptional from today's vantage point, and often did along the way, it wasn't always so. The uneven returns associated with most great investors occurred on Bill's watch as well. Reflecting on the prior five years' performance in his June of 2003 annual report, he told investors it was "dismal." He identified the causes as, "1. Too many risky investments, and 2. Too much reliance on buy and hold." He sought solutions and committed management to restoring Capital's growth. Superior investors don't beat the market each and every year; they beat it over time or produce superior risk-adjusted returns.

Finally, and perhaps most noteworthy from an average citizen's point of view, Bill took on the excessive compensation too often awarded to America's corporate chiefs and lamented the dramatic drop in the public's perception of the "business executive." In March of 2003 (after 40 years in business) he wrote, "My experience with many small businesses and a few large ones convinces me that there is a major difference…between the thousands of unsung managers who originate and run entrepreneurial businesses and the famous and infamous elite managers who oversee Corporate America's large businesses. Successful entrepreneurs are usually entitled to the rewards they have earned by their creativity, hard work and risk tolerance. Conversely, hired managers of Fortune 500 companies and other big businesses often have a distorted sense of entitlement. These elitists demand and receive inordinate rewards that have little or no relation to the welfare of their shareholders and their rank and file employees." In his 2005 annual report, under the heading "Really Outrageous Compensation," he noted that according to Forbes, the median 2004 compensation (includes market appreciation of stock) of the 100 highest-paid CEOs was $23,750,000 - 60% above 2003. The median compensation of Forbes' top 500 CEOs was $4,689,000 - 38% above the previous year. The average production worker was paid $27,460 in 2004, an increase of 2.1% from 2003, according the Bureau of Labor Statistics. Candidly, Bill encouraged enlightened CEOs, to "…wake up and act like statesmen, not con-men, and subordinating their own interests to the interests of their companies' real owners."

We suspect we know Bill's opinion on the current debate about private equity managers cleverly characterizing their carried interest fees as capital gains and thus paying 15% tax rather than the appropriate 35% income tax. As Warren Buffett recently pointed out, he pays a lower tax rate than his secretary (given the favored status afforded dividends and capital gains over wage income). We most assuredly believe, that among other things, America's business is business; but it is also about fair play. We have been fortunate to have an individual like Bill Thomas at the helm of what has been our largest financial commitment during the past several years and we thank him for his efforts on our behalf. If you know of any like-minded individuals running publicly-traded companies, please let us know…we're always interested.

Our Three Top Purchases

BankAtlantic Bancorp, Inc., BBX. BankAtlantic Bancorp, Inc. operates as the holding company for BankAtlantic, which offers consumer and commercial banking services in Florida. The bank offers its services through roughly 93 branches. Additionally, the company owns 16% of the well-regarded financial services firm Stifel Financial Corporation (Ticker "SF"). Banks earn a net interest margin on the spread between their cost of funds (deposits) and what they receive for lending such funds to commercial and consumer borrowers (loans). It is a very nice business when it works (and it often does for disciplined lenders), which is probably why bankers aren't particularly loved by consumers. It's arbitrage at its best, and so long as the credit side of the equation can be managed, everything is fine. In today's real estate lending market, however, not everything is fine. Things are downright nasty in such places as Florida which is reeling from its over built - and over lent - real estate market. The market price of BBX stock has collapsed as its nonperforming assets, "NPAs", have increased and investor fear of major defaults lingers. Additionally, the company is sacrificing current earnings to facilitate its growth through a major branch building effort.

Why invest in a company levered to real estate wherein 35% of its mortgages are collateralized by Florida properties? First, it is important to note that none of BBX's residential mortgages are sub-prime, although about 18% of its loans are for construction and development. More importantly, it's the math. We add the company's current tangible book value to a figure assigning value to the bank's core deposits. These deposits have value to acquirers because they constitute an oftentimes inexpensive source of funds. In particular, BBX has a low core deposit cost of funds: an average of 1.09% paid on $3 billion. Summing the bank's tangible equity of roughly $7.30/share and a 15% premium (often paid for similarly situated banks when they are acquired) on BBX's core deposits (roughly $7.35/share) totals $14.65/share. The bank's current NPAs are 1.06% of its roughly $4.6 billion in outstanding loans, or about $46 million. If we assume that NPAs grow substantially and the bank has to ultimately write off a draconian scenario of $200 million (actual defaults after any resale value to collateral), the hit against book value is about $2/share after-tax. The net result is an intrinsic value of $12.65/share (nearly 50% greater than our purchase price). Moreover, the above analysis does not assign any franchise value to the bank's branch system and/or brand value in a state that is among the fastest growing in the nation.

Our BBX investment is effectively in the hands of owner operators as insiders (directors and executive officers) own about 21% of the bank. In our view, the market is over-discounting credit concerns and penalizing the company for its growth initiatives resulting in an opportunistic entry point in its common stock.

ICT Group, Inc., ICTG. ICT Group is a leading global provider of outsourced customer relationship management (CRM) and business process outsourcing (BPO) solutions. Roughly two-thirds of ICT's revenue originates from outsourced telephonic customer service contracts, primarily with Fortune 500 companies in the financial services and technology/telecom industries. Simply put, ICT operates sophisticated call centers for its clients: JP Morgan, Johnson & Johnson, Wells Fargo and Chase among others.

ICT's first quarter earnings were hurt by cost overruns and penalties triggered by unseasonable high demand from two large customers. The company reduced its 2007 revenue and earnings guidance and its stock price fell about 30% on the news. However, after meeting directly with top management, we are confident that missteps have been corrected and should not be recurring in nature. We have sound reason for our optimism. ICT has grown its revenue (organically) at 20% annually since its IPO in 1996 (it was founded in 1986). The firm had nearly $500m in revenue in 2006. In recent years, margins have expanded, the revenue base has been diversified and the company enjoys a high level of repeat business in a growing industry. ICT is debt-free and cash-flow positive.

From a valuation standpoint, our investment in ICT is anchored on applying recent comparable private market transaction multiples to ICT's financials. Recent transactions (ClientLogic's acquisition of Sitel and private equity investors' acquisition of West Corp.) suggest a valuation of 8.0x EV/EBITDA. We purchased shares of ICT for just under 7x EV/TTM EBITDA and less than 5x estimated 2008 EBITDA. John Brennan (Chairman, CEO and President), along with his brother Donald (Vice Chairman and an early stage investor in ICT with significant Wall Street banking experience and savvy), owns approximately 41% of shares outstanding. We are confident that the Brennans' interests are aligned with ours and other value-oriented ICT shareholders. Management has shown itself to be a superior operator and we are grateful for the execution stumble that gave us access to own such a proven industry leader at a deep discount price.

Harris Stratex Networks, Inc., HSTX. Harris Stratex Networks is a leading supplier of turnkey wireless network solutions serving both fixed and mobile transport requirements. Harris Stratex's products consist of a suite of sophisticated wireless telecommunication equipment with embedded software that provides for network management and monitoring. HSTX was created in January 2007 through a merger between Stratex Networks and the Microwave Communications Division of Harris Corporation, a Fortune 500 IT company.

As with ICT, Harris Stratex also missed first quarter analyst estimates…its first quarter as a combined entity. The company is experiencing difficulty integrating the two legacy sales forces in areas of high overlap: Europe, Middle East and Russia. The lack of sales production coupled with the delay of a few contracts produced a sub-par quarter. Although Harris Stratex is experiencing some post-merger headaches, we are confident that continually increasing demand for data transmission to wireless devices, coupled with its leadership position, will provide ample opportunity for growth.

Our investment in HSTX is based on a private market analysis. In the case of HSTX, we did not have to look any further than the newly formed company itself. As recently as six months prior to our investment in Harris Stratex, the company's equity was valued in the merger agreement between Harris Corp. and Stratex Networks at just over $1.2 billion or approximately 1.9x EV/TTM Sales. Typically, we discount deals where stock is the form of currency used by an acquirer, but with Harris Corporation maintaining a controlling equity ownership interest - 56% - along with a majority of seats on HSTX's board of directors, we believe a discount is not warranted. We purchased shares of HSTX at about 1.4x EV/TTM Sales, a 30% discount to the implied merger valuation. In addition, following a meeting with management at their corporate headquarters in Raleigh, NC, we are confident that HSTX is being led by a team of knowledgeable and competent professionals that are focused on enhancing shareholder value.

We are proud to announce that 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. As noted on the CFA Institute's web site, "The GIPS standards are a set of ethical principles used by investment management firms in order to establish a globally standardized, industry-wide approach to creating performance presentations that communicate investment results to prospective clients. The underlying spirit of the Standards is fair representation and full disclosure." Ashland Partners & Company LLP, an industry leader in GIPS verification, completed its examination of the firm's performance returns for the period of 1999 (inception) through 2006. Our relationship with Ashland Partners will be ongoing to insure compliance with the GIPS Standards for future years' performance.

Once again, we want to thank you for the trust and confidence you have placed in us. We invest alongside our clients in order to insure that our interests are aligned with yours. Further, we preclude ourselves from buying any public securities not also being purchased for our clients. We eat our own cooking (and no one else's in fact).

Pertinent securities laws require us to make available to you every year the latest version of our ADV brochure (filed with the SEC) which has been prepared in accordance with current regulations. If you would like to receive a copy of our ADV, please contact us via email or letter.

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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Equity Composite contains fully discretionary equity accounts and for comparison purposes is measured against the S&P 500 and Russell 2000 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 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, 2006, wrap fee accounts made up 33% of the composite. Wrap fee schedules are provided by independent wrap sponsors and are available upon request from the respective wrap sponsor. 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 advisor; 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 December 31, 2006 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.

Balanced Composite contains fully discretionary balanced accounts (comprised 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 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, 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. 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 December 31, 2006 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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