Quarterly Letters

Quarterly Update

Flat Third Quarter—Holding Cash, Buying Bonds and Cash/Asset-Rich Companies

Times are tough, no doubt about it. The financial condition of the average American consumer is troubling. In the third quarter we became increasingly concerned about major consumer retrenchment. This outlook was a primary factor in our exiting eight positions, a move that greatly contributed to a relatively fl at quarter. As a result, we enter the fourth quarter of 2008 in an opportunistic position with more than 30% cash across the total portfolio. Further, our willingness to focus on our core holdings—and dollar cost average down—should provide comfort to our clients. We do not own companies being forced to de-lever. In fact, 85% of our equity investments (dollar-weighted) are in companies that are not leveraged. Make no mistake, even though the economyis in a very rough patch, bear markets are the time to cautiously, but persistently, plant seeds.

Our growing concern about the consumer is pretty straightforward:

1. Most individuals are coping with their largest asset, their home, declining in value at an unprecedented rate. American homeowners, by and large, have never experienced home price defl ation of this magnitude. They are, thus, confronted with a new fi nancial fear: how far will the value of their home drop? Historical data suggest that homeowners could experience further home value declines as (a) for-sale inventory grows due to increasing foreclosures and (b) prices fall to a level more in line with historical multiples of rent and/or income. Similarly, today’s investor is wondering how far his or her investment portfolio can decline. We believe the dual effects of home defl ation and portfolio losses will have a signifi cant negative impact on the U.S. economy, as the consumer, who represents roughly two-thirds of the GDP, will rightfully rein in spending. Might saving money make a comeback?



2. As a result of the consumer pullback, corporate profi ts will be squeezed. In order to maintain a viable, solvent business, large and small companies alike will look to reduce expenses, with job cuts often a means of achieving this goal. Rising unemployment has the potential not only to prevent the economy from growing but also to exacerbate the housing problem, as prime homeowners with high credit scores but little savings become unable to fund their mortgage payments.



3. In recent weeks, banks have been reluctant to lend money to each other, allegedly out of fear that they would not be paid back. In reality, there is no money in a fi nancial system that is de-leveraging... i.e., shrinking, not growing, balancing sheets. In short, what is being witnessed is the destruction of the multiplier effect of lending. The overall lack of funding has a negative trickle-down effect on the economy and the consumer, with signifi cant job loss a likely consequence. The freeze in bank lending is one of the core problems that recent legislative, Federal Reserve, and Treasury Department actions are attempting to combat. It is highly unlikely that de-leveraging and “orderly” can live peaceably alongside each other. While helpful, Fed and Treasury actions do not replace the market process of properly assigning value to various assets in a credit-constrained world.

With all this in mind, where does an equity investor go from here? Bonds? We believe the answer is “yes,” particularly in the context of purchasing deeply discounted diversifi ed closed-end bond funds (senior loan, high yield, corporate investment grade, and municipal). First, credit spreads have widened such that yields are very attractive. Second, there is currently an historic degree of ineffi ciency in the closed-end bond fund market, with fund shares often trading at discounts in excess of 20% of net asset value (NAV); i.e., approximate liquidation value. To us, the discount to NAV is ultimately less important than the discount from par, given the volatility of NAVs. For example, in high yield and senior loans, we are effectively paying 50% to 70% of par value. In essence, the high yield and senior loan closed-end fund investor is currently receiving a “double discount”; i.e., a fund’s underlying portfolio has a market value, NAV, of 70% of par, with fund shares trading at an additional 20% discount to NAV, or roughly 56% of par (70% x 20% discount = 56%). These portfolios’ par values are more or less constant even though NAVs are quite volatile given the bond/loan market’s sell-off. While waiting for the market to regain its footing and for pricing to improve, investors are being compensated with high current dividend yields. Particularly noteworthy are high yield and senior loan funds with yields averaging about 15%. Effective yields to maturity should be much higher than current dividend yields, given the embedded discount from par we are paying even after stressing these portfolios for probable defaults.

The closed-end fund structure itself is key to our investment thesis, given the lack of liquidity in many of the funds’ underlying bonds/loans. This is important because it allows the closed-end fund manager to utilize a long-term strategy without having to sell fund assets at unattractive valuations in order to meet redemptions, as is the case today for open-end mutual funds, hedge funds, and fi nancial institutions that have been forced to de-lever. Many closed-end bond funds do employ a modest degree of leverage as a means of enhancing the current yield of the portfolio, but they are limited by the Investment Company Act of 1940, which states that funds leveraged through auction rate preferreds may lever up to 50% of total assets, while those leveraged through debt are limited to 33% of total assets. A closed-end fund’s source of leverage is typically either a one-year line of credit from a bank or perpetual auction rate preferred securities. Unlike highly leveraged fi nancial institutions such as Bear Stearns and Lehman Brothers that relied in large part on short-term fi nancing, a closed-end fund’s source of funding cannot evaporate overnight. It is true that levered closed-end funds have had to sell some assets to meet leverage restrictions imposed by the 1940 act (a shrewd restriction in our mind since these funds are precluded from levering excessively and taking on undue risk—the primary cause of the sinking of today’s leading fi nancial institutions). These sales are not ideal, but they are relatively modest and certainly do not undermine the investment thesis at the prices we are currently paying.

In summary, closed-end bond funds are a vehicle for investing in a diversifi ed portfolio of fi xed-income securities with signifi cant upside potential as (1) the portfolio matures as the bonds in the portfolio march to maturity and NAV moves higher to a level more in line with par and (2) the historic discount to NAV that currently exists in the market closes as investors regain confi dence and seek higher yield opportunities. We are diversifi ed amongst senior loan, high yield, investment grade, and municipal bond funds. Given the size of our position in any one fund (and the diversifi cation within each fund), our maximum exposure to any one particular bond is about fi fteen basis points. Though our senior loan investments in particular have been disappointing so far given unprecedented yield spreads—we were a bit early to the space—the thesis is sound and that is why we have added to these positions. Finally, we would expect to be able to initiate certain open-ending events, as we have in the past, allowing us to realize full net asset value in time.

In addition to our purchases of closed-end bond funds, we continue to see opportunities to invest in well-capitalized, cash-rich companies possessing sound business models at attractive valuations. However, given the current market volatility, we are demanding a higher discount to our estimates of intrinsic value and will be judicious in putting our end-of-quarter 30%-plus overall cash position to work. Our top-ten equity holdings now amount to roughly 75% of total equity investments as a result of our conviction regarding these securities’ underlying value. With little exception, we are holding solidly financed companies perhaps marked down, but not experiencing real capital impairment like many levered companies.

Our Three Top Purchases

Comstock Resources, Inc., CRK. Comstock Resources is an independent domestic onshore energy exploration and production company with operations primarily focused on the discovery of natural gas. CRK’s proved reserves are located mostly in Texas and Louisiana; the company also maintains signifi cant land interest in the heralded Haynesville Shale located in northwest Louisiana. As many of you know, we have invested in CRK in the past. We are quite familiar with its business and have a long history with CEO Jay Allison and CFO Roland Burns, both of whom we respect and trust. Allison and Burns have almost their entire net worth invested in CRK stock. It is important to note that neither sold a share of their CRK position (with the exception of selling shares held as stock options that were soon to expire) when the stock ran up to $90 in early July of this year.

The investment thesis in CRK is a straightforward proposition that consists of valuing the company’s proved reserves and its Haynesville Shale reserve potential. CRK’s interest in Haynesville is signifi cant, as it owns almost 68,000 net acres with estimated potential reserves ranging from 1,700 to 4,400 billion cubic feet equivalent (Bcfe). Assuming the company discovers 2,000 Bcfe of proved reserves by the end of 2012, and applying $3/million cubic feet equivalent (Mcfe) less estimated capital expenditures, Haynesville has a present value of about $52/share using a 10% discount rate. Summing CRK’s existing proved reserves with the Haynesville play equals $90/share. CRK is fi nancially well positioned as it does not require outside capital to fund its operations, an enviable position in this tight credit environment, following its recent timely divestiture of Bois d’Arc Energy.

We believe CRK’s managers when they say “Haynesville is real.” CRK’s current estimate of 68,000 Haynesville acres only includes what it considers to be “grade A” property and does not include acreage that may be added as more data arrive. We are confi dent that CRK will experience a meaningful increase in proved reserves in the near future, as its value will be enhanced even in the face of a potential devaluation of natural gas. Finally, we view natural gas as part of the solution to both America’s dependence on Middle Eastern oil and the need to curb global warming. CRK has sold off from our initial entry point along with all energy-related companies. We have continued to add to our position as shares have become cheaper.

First Trust/Four Corners Senior Floating Rate Income Fund II, FCT. FCT is a closed-end fund that invests solely in senior fl oating rate term loans. In our fourth quarter 2007 letter, we discussed our investment in a similar closed-end fund, the Van Kampen Credit Opportunities Fund, VTA. The primary difference between FCT and VTA is that FCT has a stronger credit quality portfolio. In exchange for investing in better credit companies, the portfolio earns a lower coupon or, in this case, a smaller spread over LIBOR, the base fl oating rate. Additionally, 97% of FCT’s portfolio is in fi rst-lien positions, compared with roughly 75% in VTA’s portfolio. The rationale that supports our investment in FCT is exactly the same as that behind VTA: (1) we’re investing in “senior” loans; i.e., these securities are senior to all others in the capital structure; (2) as discussed earlier, we are acquiring the underlying paper at a “double discount” via purchasing a deeply discounted closed-end fund (the average purchase price of our FCT investment was at roughly 70% of the underlying portfolio’s par value); and (3) the paper’s fl oating interest rate virtually eliminates interest rate risk, as payments regularly adjust to LIBOR plus the applicable spread. When the dotcom bubble burst, high yield default rates peaked at 15% with a 30% recovery rate and senior loans defaulted at about 10% with a 70% recovery rate. Even in scenarios of signifi cantly higher distress, which we tested internally, we believe that FCT will provide a mid-teens yield to maturity at a minimum over the next three to four years as the underlying portfolio reaches maturity.

Global Industries Ltd., GLBL. Global Industries Ltd. is a global offshore oil fi eld construction company that installs underwater pipelines and offshore production platforms along with providing maintenance and complementary services. The company owns a fl eet of fourteen major construction vessels that supports its operations. This is our second time investing in GLBL; oddly enough, the stock is trading at roughly the same price at which we purchased shares in late 2004, even though the asset value of the company’s fl eet of ships has increased signifi - cantly during this period as the cost of steel has skyrocketed. GLBL recently announced an earnings loss for the third quarter, prompting a management shake-up, with the company’s founder and 10% shareholder, William Dore, returning to the company as a member of the board. We believe Dore’s return is a positive development for the company, as GLBL’s recent operating performance has been poor.

Our investment in GLBL is based on acquiring the stock at a deep discount to the replacement value of its existing fl eet. Back in 2004, we believed that GLBL was a compelling value trading at 6x forward EBITDA with a record order backlog and an estimated fl eet replacement value of about $1.4 billion. Today, the company’s earnings power is meaningfully higher than what it was then, the balance sheet is much improved with a net cash position, and replacement value is undoubtedly higher with the cost of steel up signifi cantly. Given little change to GLBL’s fl eet over the last four years, even if we assume that replacement value has not increased at all since 2004, it would cost about $12.25 per GLBL share to build a replicate fl eet, about a 60% premium to our initial average cost. Underscoring our asset valuation is a recent GLBL fl eet insurance appraisal that indicated a current market value of roughly $10/share. Further, at its current valuation, GLBL trades at about 2x estimated 2009 EBITDA. We have continued to purchase GLBL shares as the stock has pulled back over recent weeks because, in our view, the stock offers compelling value.

Our purchase of GLBL was made with eyes wide open to the potential for near-term stock price volatility given the rapid slide in oil prices. However, unlike drillers that are strictly levered to the development of new wells, GLBL also generates revenue from maintenance and related subsea work on existing platforms and pipelines. We also believe very strongly in Bill Dore, one of the most honest, candid managers we have met. His commitment to GLBL’s shareholders is noteworthy. In our third quarter 2004 letter we wrote the following about Bill’s response to his family’s suggestion to diversify his wealth by liquidating a portion of his GLBL stake at about $4/share: “[Dore] said he would only sell at a price at least equal to Global’s last secondary offering of $9/share. In other words, he said he would not sell one single share at a dime less than what the company had most recently represented to investors as the value of the company, even though the stock would have to more than double to meet the goal. Pretty classy.” People matter and we are pleased to again have the opportunity to invest alongside Bill Dore.

In reviewing our current portfolio, we are quite happy with the collection of assets, management teams, and outlooks for these securities. We remain confi dent in the balance sheets underlying these investments and believe we will be rewarded handsomely in time.

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

Summary

We realize that the past year has been particularly difficult. Although our equity returns were a cumulative 30% for 2005 and 2006, returns for 2007 and year-to-date 2008 through June 30 are a cumulative -20%. A poor twelve months not only obviously affects one-year returns, but also has a significant impact on three- and five-year returns. Value investors particularly seem to be out of favor of late. For example, after beating the S&P 500 for fifteen years in a row, Bill Miller’s Legg Mason Value Trust is down about 32% as of this writing, after being down almost 7% in 2007. Dodge & Cox Stock Fund, which incepted January 1965, is down about 19%. The list goes on…

The purchases this quarter reflect our belief that real value is being created in this marketplace. We do not believe we need to live with the substantial risks that lie in leveraged financial models. We would rather take advantage of companies with strong balance sheets and solid real assets and live with the consequences of an undefined economic slowdown while feeling confident in the assets themselves. We will continue to deploy cash very cautiously and seek instances where we believe there is a substantial spread between underlying value and current market price.

For our clients, we have posted a complete listing of our holdings that describes each company and the rationale behind each purchase on our Web site (www.roumellasset.com). Please contact us either by phone or email if you would like the user name and password to access this document or, alternatively, if you would like a printed copy.

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 each 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 March 31, 2008 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 Compositecontains 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 each 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 March 31, 2008 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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