UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-21842
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FIRST TRUST STRATEGIC HIGH INCOME FUND II
-----------------------------------------------------
(Exact name of registrant as specified in charter)
1001 Warrenville Road, Suite 300
LISLE, IL 60532
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(Address of principal executive offices) (Zip code)
W. Scott Jardine, Esq.
First Trust Portfolios L.P.
1001 Warrenville Road, Suite 300
LISLE, IL 60532
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(Name and address of agent for service)
registrant's telephone number, including area code: (630) 241-4141
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Date of fiscal year end: OCTOBER 31
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Date of reporting period: APRIL 30, 2008
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
(VALHALLA LOGO)
FIRST TRUST
STRATEGIC
HIGH INCOME
FUND II
SEMI-ANNUAL
REPORT
FOR THE SIX MONTHS ENDED
APRIL 30, 2008
TABLE OF CONTENTS
FIRST TRUST STRATEGIC HIGH INCOME FUND II (FHY)
SEMI-ANNUAL REPORT
APRIL 30, 2008
Shareholder Letter .......................................................... 1
At A Glance ................................................................. 2
Portfolio Commentary ........................................................ 3
Portfolio of Investments .................................................... 5
Statement of Assets and Liabilities ......................................... 10
Statement of Operations ..................................................... 11
Statements of Changes in Net Assets ......................................... 12
Statement of Cash Flows ..................................................... 13
Financial Highlights ........................................................ 14
Notes to Financial Statements ............................................... 15
Additional Information ...................................................... 21
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended. Forward-looking
statements include statements regarding the goals, beliefs, plans or current
expectations of First Trust Advisors L.P. ("First Trust" or the "Advisor")
and/or Valhalla Capital Partners, LLC ("Valhalla" or the "Sub-Advisor") and
their respective representatives, taking into account the information currently
available to them. Forward-looking statements include all statements that do not
relate solely to current or historical fact. For example, forward-looking
statements include the use of words such as "anticipate," "estimate," "intend,"
"expect," "believe," "plan," "may," "should," "would" or other words that convey
uncertainty of future events or outcomes.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
First Trust Strategic High Income Fund II (the "Fund") to be materially
different from any future results, performance or achievements expressed or
implied by the forward-looking statements. When evaluating the information
included in this report, you are cautioned not to place undue reliance on these
forward-looking statements, which reflect the judgment of the Advisor and/or
Valhalla and their respective representatives only as of the date hereof. We
undertake no obligation to publicly revise or update these forward-looking
statements to reflect events and circumstances that arise after the date hereof.
PERFORMANCE AND RISK DISCLOSURE
There is no assurance that the Fund will achieve its investment objectives. The
Fund is subject to market risk, which is the possibility that the market values
of securities owned by the Fund will decline and that the value of the Fund
shares may therefore be less than what you paid for them. Accordingly, you can
lose money investing in the Fund. See "Risk Considerations" in the Notes to
Financial Statements for a discussion of other risks of investing in the Fund.
Performance data quoted represents past performance, which is no guarantee of
future results, and current performance may be lower or higher than the figures
shown. For the most recent month-end performance figures, please visit
http://www.ftportfolios.com or speak with your financial advisor. Investment
returns, net asset value and common share price will fluctuate and Fund shares
may be worth more or less than their original cost.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment. It
includes details about the Fund and presents data and analysis that provide
insight into the Fund's performance and investment approach.
By reading the portfolio commentary by the portfolio management team at the
Sub-Advisor, you may obtain an understanding of how the market environment
affected the Fund's performance. The statistical information that follows may
help you understand the Fund's performance compared to that of relevant market
benchmarks.
It is important to keep in mind that the opinions expressed by personnel of
Valhalla are just that: informed opinions. They should not be considered to be
promises or advice. The opinions, like the statistics, cover the period through
the date on the cover of this report. The risks of investing in the Fund are
spelled out in the prospectus, this report and other regulatory filings.
SHAREHOLDER LETTER
FIRST TRUST STRATEGIC HIGH INCOME FUND II (FHY)
SEMI-ANNUAL REPORT
APRIL 30, 2008
Dear Shareholders:
The year 2007 and the first quarter of 2008 were somewhat challenging times for
the financial markets and for many investors. Yet, regardless of the market,
First Trust Advisors L.P. ("First Trust") believes that in order to be
successful in reaching your financial goals, you should be invested for the
long-term. We also believe that investors should seek professional help from a
financial advisor who has been through many types of markets, knows the range of
investments available, and is committed to bringing you investments suitable to
your particular situation.
Our goal at First Trust has always been to offer a wide range of investment
products, including our family of closed-end funds, to help financial advisors
give you the opportunity to meet your financial objectives. We have continued to
expand our product line to ensure that you have many choices to fit your
investment needs.
The report you hold contains detailed information about your investment in First
Trust Strategic High Income Fund II. It contains a portfolio commentary from the
Fund's management team that provides a market recap for the period, a
performance analysis and a market and Fund outlook. Additionally, the report
provides the Fund's financial statements for the period covered by this report.
I encourage you to read this report and discuss it with your financial advisor.
First Trust has been through many types of markets and remains committed to
bringing you quality investment solutions regardless of the inevitable ups and
downs experienced in the market. We offer a variety of products that may fit
many financial plans to help those investors seeking long-term investment
success. As well, we are committed to giving you up-to-date information about
your investments so you and your financial advisor are always current on your
portfolio.
We continue to value our relationship with you and we thank you for the
opportunity to assist you in achieving your financial goals.
Sincerely,
/S/ JAMES A. BOWEN
James A. Bowen
President of First Trust Strategic High Income Fund II
Page 1
FIRST TRUST STRATEGIC HIGH INCOME FUND II
"AT A GLANCE"
AS OF APRIL 30, 2008 (UNAUDITED)
FUND STATISTICS
Symbol on New York Stock Exchange FHY
Common Share Price $ 13.87
Common Share Net Asset Value $ 12.44
Premium/(Discount) to NAV 11.50%
Net Assets Applicable to Common Shares $ 117,673,923
Current Monthly Distribution per Common Share (1) $ 0.1667
Current Annualized Distribution per Common Share $ 2.0004
Current Distribution Rate on Closing Common Share Price (2) 14.42%
Current Distribution Rate on NAV (2) 16.08%
COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE)
[PERFORMANCE GRAPH]
Mkt NAV
----- -----
4/30/07 21.07 20.21
5/4/07 21 19.95
5/11/07 20.82 19.95
5/18/07 20.9 19.93
5/25/07 20.47 20.07
6/1/07 20.5 19.77
6/8/07 20.29 19.68
6/15/07 20.32 19.81
6/22/07 19.94 19.74
6/29/07 19.59 19.64
7/6/07 19.56 19.35
7/13/07 18.56 19.11
7/20/07 18 19.06
7/27/07 18.2 19.06
8/3/07 17.25 18.23
8/10/07 15.01 17.15
8/17/07 15 17.04
8/24/07 15.89 16.95
8/31/07 16.23 16.87
9/7/07 15.81 16.48
9/14/07 15.43 16.14
9/21/07 15.52 16.33
9/28/07 15.82 16.76
10/5/07 16.17 16.52
10/12/07 16.19 16.49
10/19/07 15.66 16.43
10/26/07 14.84 16.25
11/2/07 14.54 15.87
11/9/07 12.79 15.6
11/16/07 12.93 15.45
11/23/07 13.03 15.22
11/30/07 13.98 15.1
12/7/07 13.77 14.82
12/14/07 13.45 14.57
12/21/07 12.76 14.04
12/28/07 12.97 13.84
1/4/08 12.81 13.76
1/11/08 12.56 13.7
1/18/08 12.69 13.9
1/25/08 13.22 14.02
2/1/08 13.63 13.8
2/8/08 13.33 13.78
2/15/08 13.41 13.83
2/22/08 13.72 13.88
2/29/08 13.88 13.99
3/7/08 12.33 13.61
3/14/08 12.1 13.21
3/20/08 12.14 12.91
3/28/08 12 13.02
4/4/08 12.49 12.84
4/11/08 12.8 12.57
4/18/08 12.79 12.44
4/25/08 13.18 12.45
4/30/08 13.87 12.44
PERFORMANCE
Average Annual
Total Return
6 Months Ended 1 Year Ended Inception (3/28/2006)
4/30/2008 4/30/2008 to 4/30/2008
-------------- ------------ ---------------------
Fund Performance
NAV (3) -17.62% -29.55% -9.19%
Market Value (4) -1.12% -24.66% -6.43%
Index Performance
Lehman Ba Index 0.23% 0.34% 5.16%
% OF TOTAL
ASSET CLASSIFICATION INVESTMENTS
- --------------------- ------------
Manufactured Housing Loans 24.5%
Collateralized Debt Obligations 22.5
Franchise Loans 20.3
Residential Mortgage-Backed Securities 10.6
Corporate Bonds 8.9
Commercial Mortgage-Backed Securities 6.6
Equity 5.0
Equipment Lease Receivable 1.6
---------
Total 100.0%
=========
% OF TOTAL
CREDIT QUALITY (5) INVESTMENTS
- ------------------ -----------
AAA 3.5%
AA 0.9
A 5.5
BBB 6.2
BB 4.8
B 16.2
CCC 26.7
CC 14.4
C 11.8
D 4.1
NR 5.9
---------
Total 100.0%
=========
(1) Most recent distribution paid or of record through 4/30/08. Subject to
change in the future.
(2) Distribution rates are calculated by annualizing the most recent
distribution paid or of record through the report date and then dividing
by market price or NAV, as applicable, as of 4/30/08.
(3) Total return based on net asset value is the combination of reinvested
dividend distributions and reinvested capital gain distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in net
asset value per share and does not reflect sales load. Past performance is
not indicative of future results.
(4) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in Common
Share price. Past performance is not indicative of future results.
(5) The credit quality information represented reflects the ratings assigned
by one or more nationally recognized statistical rating organizations
(NRSROs). For situations in which a security is rated by more than one
NRSRO and ratings are not equivalent, the ratings are averaged.
Page 2
PORTFOLIO COMMENTARY
SUB-ADVISOR
Valhalla Capital Partners, LLC ("Valhalla" or the "Sub-Advisor"), the
Sub-Advisor to First Trust Strategic High Income Fund II (NYSE: FHY), is a
boutique asset management firm focused on managing high-yield portfolios with an
emphasis on structured finance securities. Valhalla was founded in 2005 and is
currently managed by its Managing Partners, Ken L. Mathis, Ramond P. Mecherle
and Justin L. Ventura. Valhalla is a Kentucky limited liability company located
at 2527 Nelson Miller Parkway, Suite 207, Louisville, Kentucky 40223. As of
April 30, 2008, Valhalla had approximately $455 million in assets under
management.
PORTFOLIO MANAGEMENT TEAM
RAMOND P. MECHERLE, CFA, PORTFOLIO MANAGER
Mr. Mecherle is a founding Managing Partner of Valhalla. He has nine years of
experience in the financial industry. Mr. Mecherle currently serves as
Co-Manager of First Trust Strategic High Income Fund (New York Stock Exchange
(NYSE: FHI), First Trust Strategic High Income Fund II (NYSE: FHY) and First
Trust Strategic High Income Fund III (NYSE: FHO). Mr. Mecherle was a dual
employee of Hilliard Lyons Asset Management and Valhalla from Valhalla's
inception in 2005 through April 2006. From October 2004 to April 2006, Mr.
Mecherle was employed by Hilliard Lyons Asset Management as Director of Fixed
Income and Co-Manager of FHI. Prior to that, Mr. Mecherle was employed by Morgan
Keegan Asset Management for seven years. There, Mr. Mecherle was an Assistant
Portfolio Manager for three high-yield funds: the Regions Morgan Keegan Select
High Income Fund (MKHIX), an open-end fund; RMK High Income Fund (NYSE: RMH), a
closed-end fund; RMK Strategic Income Fund (NYSE: RSF), a closed-end fund; and
separate accounts. Mr. Mecherle received a B.A. from the University of Virginia
and an M.B.A. from the Johnson Graduate School of Management, Cornell
University.
JUSTIN L. VENTURA, PORTFOLIO MANAGER
Mr. Ventura is a founding Managing Partner of Valhalla. He has fourteen years of
experience in the financial industry. Mr. Ventura currently serves as Co-Manager
of First Trust Strategic High Income Fund (NYSE: FHI), First Trust Strategic
High Income Fund II (NYSE: FHY) and First Trust Strategic High Income Fund III
(NYSE: FHO). Mr. Ventura was a dual employee of Hilliard Lyons Asset Management
and Valhalla from Valhalla's inception in 2005 through April 2006. From June
2005 to April 2006, Mr. Ventura was employed by Hilliard Lyons Asset Management
as Co-Manager of FHI. Prior to that, Mr. Ventura was employed by State Street
Bank for six years as Vice President, Capital Markets Portfolio/ABS-MBS-CDO
Sectors. Mr. Ventura began his career with Fitch IBCA, Inc. where he worked for
five years and was a Director of Structured Finance/Mortgage and Asset-Backed
Securities. Mr. Ventura received a B.A. from the University of Massachusetts
and a J.D. from George Mason School of Law.
FIRST TRUST STRATEGIC HIGH INCOME FUND II
The primary investment objective of the First Trust Strategic High Income Fund
II (FHY) is to seek a high level of current income. The Fund seeks capital
growth as a secondary objective. The Fund seeks to achieve its investment
objectives by investing in a diversified portfolio of below-investment grade and
investment grade debt securities and equity securities that the Sub-Advisor
believes offer attractive yield and/or capital appreciation potential. There can
be no assurance that the Fund will achieve its investment objectives. The Fund
may not be appropriate for all investors.
MARKET RECAP
For the First Trust Strategic High Income Fund II, the six months ending April
30, 2008 were painfully similar to the previous semi-annual period ending
October 31, 2007. Persistent, systemic illiquidity and troublesome macroeconomic
conditions kept pricing in all but the safest asset classes under heavy
pressure. By period-end, cumulative, global credit losses had grown to more than
$300 billion since the crisis began in the summer of 2007. The real story of the
last six months, however, was Bear Stearns' abrupt disappearance from the
financial landscape. In mid-March fretful clients and customers produced an
old-fashioned "run-on-the-bank" and cut its stock price 92% in three trading
days. To avert a total catastrophe, the Federal Reserve took decisive action. It
forced a sale of the 85-year old, top-five institution to JP Morgan Chase and in
its first emergency meeting in almost 30 years, cut the discount rate 25 basis
points and became the lender of last resort to all primary dealers.
Cumulatively, over the six-month period, the Federal Reserve made significant
cuts to rates to help unwind the tight credit conditions; it reduced both the
Federal Funds Rate and Discount Rate by 250 and 275 basis points, respectively,
cutting each more than 50%.
Page 3
PORTFOLIO COMMENTARY (CONTINUED)
PERFORMANCE ANALYSIS
These destructive market trends, along with underperformance in several asset
sectors in the portfolio, caused negative net asset value (NAV) and market
performance for FHY for the period. The Fund's NAV total return was -17.62% and
its market-price performance, -1.12%. In contrast, the Lehman Bros. Ba Index
returned +0.23%. The Fund's focus on structured finance securities caused the
wide divergence in NAV performance from its stated benchmark, which is composed
almost entirely of high-yield corporate debentures. In general, corporate debt
has experienced less pricing pressure than the structured markets, which have
been the focus of much of the fear plaguing financial systems worldwide.
This anxiety hit all of the Fund's holdings, but it was residential
mortgage-backed securities (RMBS) that declined the most in price. Liquidity in
this asset class remained far below normal for the period and further declines
in housing prices led a growing number of obligors to stop paying their
mortgages. The result has been a rise in delinquencies and foreclosures
nationwide and deterioration in the collateral profile of all types of
mortgage-backed securities. The Fund's RMBS have experienced this strain as
well, and over the coming quarters may see a reduction in cash flows. While RMBS
pricing already reflects a very negative outcome for the residential housing
market, any potentially adverse dividend impact will be dictated by the
resulting level and timing of losses on the underlying mortgage collateral.
Ultimately, the performance of the underlying loans will depend on a host of
factors, not the least of which is an improving macroeconomic environment.
These challenging conditions penalized other asset classes in the Fund's
portfolio as well. Collateralized debt obligations (CDOs) were, on average,
sharply negative over the semi-annual period and second only to mortgage-backed
securities in negative price performance. Growing credit concerns worked against
this sector and continue to impede any broad recovery. Commercial mortgage-
backed securities (CMBS) and corporate bonds also suffered. Limited buyers and
fears of a recession hitting the commercial property market weighed heavily on
CMBS, even though the overall collateral performance has remained healthy.
Corporate bonds traded off in price due to a deteriorating economic picture and
rising default expectations amongst investors. Finally, asset-backed securities,
such as those collateralized by franchise loans, manufactured housing, and
aircraft leases, also dropped in price. While most of these assets are
"seasoned," older deals that have maintained a favorable credit profile, the
market's widespread re-pricing of structured credit risk hurt the Fund's
holdings in these categories.
MARKET & FUND OUTLOOK
Obviously, overall market conditions remain difficult. Secondary trading
languishes far below normal levels. Primary issuance is virtually non-existent
except in credit card, auto, and student loan-backed deals. In addition, the
uncertainty of a recession continues to hang over the market. On a positive
note, however, we believe attractive assets have begun to reappear, albeit
intermittently, as bid lists and forced liquidations hit the market. Over time
we anticipate that the Fund should be able to acquire bonds at prices offering
the potential for attractive long-term total return. This will be a gradual
process but one that should reward patient investors, as the financial world
stabilizes and liquidity, at both the corporate and consumer levels, returns to
normal.
Page 4
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS (a)
APRIL 30, 2008 (UNAUDITED)
PRINCIPAL STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
- --------------- ----------------------------------------------------------- ------ -------- --------------
ASSET-BACKED SECURITIES - 91.0%
ABCLO, Ltd.
$ 1,500,000 Series 2007-1A, Class D (b) (c) ....................... 6.61% 04/15/21 $ 1,050,000
ACE Securities Corp., Home Equity Loan Trust
2,171,143 Series 2004-HE4, Class M11 (c) ........................ 6.40% 12/25/34 70,982
3,000,000 Series 2007-HE4, Class M8 (c) ......................... 5.40% 05/25/37 262,500
ACLC Business Loan Receivables Trust
5,000,000 Series 1998-2, Class B (b) ............................ 6.85% 04/15/20 4,722,942
2,499,846 Series 1999-2, Class B (b) ............................ 8.75% 01/15/21 2,349,855
1,499,907 Series 1999-2, Class D (b) ............................ 9.35% 01/15/21 1,424,912
Argent Securities, Inc.
3,510,996 Series 2004-PW1, Class M10 (b) (c) .................... 6.15% 06/25/34 166,495
Asset Backed Securities Corp., Home Equity Loan Trust
777,146 Series 2005-HE2, Class M8 (b) (c) ..................... 5.40% 02/25/35 73,022
Atherton Franchisee Loan Funding
4,698,196 Series 1999-A, Class A2 (b) ........................... 7.23% 03/15/21 4,897,128
BankAmerica Manufactured Housing Contract Trust II
2,300,000 Series 1997-1, Class B1 ............................... 6.94% 06/10/21 1,053,850
Bear Stearns Alt-A Trust
2,392,421 Series 2006-8, Class 2A2 .............................. 5.54% 08/25/46 1,256,021
Bear Stearns Asset Backed Security Trust
5,103,000 Series 2007-HE3, Class M9 (c) ......................... 5.15% 04/25/37 561,330
Bear Stearns Second Lien Trust
1,002,688 Series 2007-1, Class 2M6 (c) .......................... 5.90% 08/25/37 140,376
BNC Mortgage Loan Trust
5,750,000 Series 2007-2, Class B1 (b) (c) ....................... 5.40% 05/25/37 470,350
1,400,000 Series 2007-2, Class B2 (b) (c) ....................... 5.40% 05/25/37 101,185
2,000,000 Series 2007-3, Class B2 (b) (c) ....................... 5.40% 07/25/37 152,380
Bombardier Capital Mortgage Securitization Corp.
684,485 Series 1999-B, Class A3 ............................... 7.18% 12/15/15 401,171
Captec Franchise Trust
5,607,216 Series 1999-1, Class D (b) ............................ 8.59% 01/25/13 1,136,071
Citigroup Mortgage Loan Trust, Inc.
2,301,000 Series 2003-HE3, Class M4 (c) ......................... 5.90% 12/25/33 348,588
Conseco Finance Securitizations Corp.
3,803,830 Series 1999-6, Class M1 (d) ........................... 7.96% 06/01/30 330,587
1,700,000 Series 2001-3, Class M1 ............................... 7.15% 05/01/33 760,929
3,000,000 Series 2002-2, Class M2 ............................... 9.16% 03/01/33 2,384,863
EMAC Owner Trust, LLC
3,460,258 Series 1998-1, Class A3 (b) ........................... 6.63% 01/15/25 3,096,931
3,697,814 Series 2000-1, Class A1 (b) ........................... 6.43% 01/15/27 2,403,579
4,398,534 Series 2000-1, Class A2 (b) ........................... 6.43% 01/15/27 2,859,047
Encore Credit Receivables Trust
3,000,000 Series 2005-4, Class M11 (b) (c) ...................... 5.40% 01/25/36 210,000
See Notes to Financial Statements
Page 5
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
APRIL 30, 2008 (UNAUDITED)
PRINCIPAL STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
- --------------- ----------------------------------------------------------- ------ -------- --------------
ASSET-BACKED SECURITIES - (CONTINUED)
FMAC Loan Receivables Trust
$ 1,580,748 Series 1996-B, Class A2 (b) (c) ....................... 4.12% 11/15/18 $ 1,232,983
936,086 Series 1997-A, Class B (b) ............................ 7.66% 04/15/19 941,282
16,078,421 Series 1997-C, Class AX (b) (e) ....................... 0.00% 12/15/19 1,004,901
6,000,000 Series 1998-CA, Class A3 (b) .......................... 6.99% 09/15/20 5,340,000
Green Tree Financial Corp.
1,744,908 Series 1995-6, Class B1 ............................... 7.70% 09/15/26 1,314,213
2,115,857 Series 1996-6, Class B1 ............................... 8.00% 09/15/27 632,024
2,000,000 Series 1997-3, Class M1 ............................... 7.53% 03/15/28 1,361,273
8,500,000 Series 1998-6, Class M1 ............................... 6.63% 06/01/30 4,445,939
1,000,000 Series 1998-8, Class M1 ............................... 6.98% 09/01/30 515,701
16,347,179 Series 1999-4, Class M1 ............................... 7.60% 05/01/31 1,811,509
20,396,155 Series 1999-5, Class M1 ............................... 8.05% 03/01/30 2,379,462
GreenPoint Manufactured Housing Contract Trust
11,000,000 Series 1999-5, Class M2 ............................... 9.23% 12/15/29 5,351,847
GSAMP Trust
1,000,000 Series 2006-S3, Class A2 .............................. 5.77% 05/25/36 269,056
897,495 Series 2006-S5, Class A1 (c) .......................... 2.99% 09/25/36 258,436
Halyard Multi Asset CBO I, Ltd.
2,734,748 Series 1A, Class B (b) (c) ............................ 3.95% 03/24/10 1,914,323
Helios Series I Multi Asset CBO, Ltd.
9,317,203 Series 1A, Class C (b) (c) ............................ 7.71% 12/13/36 2,096,371
IMC Home Equity Loan Trust
3,086,972 Series 1997-3, Class B ................................ 7.87% 08/20/28 1,566,564
4,542,493 Series 1997-5, Class B ................................ 7.59% 11/20/28 1,836,672
Independence lll CDO, Ltd.
2,000,000 Series 3A, Class C1 (b) (c) ........................... 5.18% 10/03/37 1,000,000
Liberty Square CDO, Ltd.
2,100,000 Series 2001-1X, Class C (b) (c) ....................... 7.31% 04/15/13 1,575,000
Long Beach Mortgage Loan Trust
2,000,000 Series 2006-A, Class A2 ............................... 5.55% 05/25/36 520,000
Longhorn CDO, Ltd.
1,873,379 Series 1, Class C (b) (c) ............................. 9.35% 05/10/12 749,352
Madison Avenue Manufactured Housing Contract Trust
16,333,000 Series 2002-A, Class B2 (c) ........................... 6.15% 03/25/32 7,501,874
Merit Securities Corp.
8,506,000 Series 13, Class M2 ................................... 8.65% 12/28/33 2,930,335
Morgan Stanley ABS Capital I, Inc.
791,842 Series 2004-NC5, Class B4 (c) (d) ..................... 6.65% 05/25/34 83,247
North Street Referenced Linked Notes
5,000,000 Series 2000-1A, Class B (b) (c) ....................... 4.30% 04/28/11 4,000,000
7,000,000 Series 2000-1A, Class D1 (b) (c) ...................... 5.50% 04/28/11 4,830,000
Oakwood Mortgage Investors, Inc.
1,664,451 Series 1999-B, Class M1 ............................... 7.18% 12/15/26 516,417
2,506,907 Series 2001-C, Class A3 (b) ........................... 6.61% 02/15/21 1,507,450
3,000,000 Series 2002-B, Class M1 ............................... 7.62% 06/15/32 1,450,794
See Notes to Financial Statements
Page 6
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
APRIL 30, 2008 (UNAUDITED)
PRINCIPAL STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
- --------------- ----------------------------------------------------------- ------ -------- --------------
ASSET-BACKED SECURITIES - (CONTINUED)
Park Place Securities, Inc.
$ 1,788,245 Series 2004-WCW1, Class M9 (c) (d) .................... 6.40% 09/25/34 $ 217,244
3,071,273 Series 2005-WCH1, Class M10 (b) (c) ................... 5.40% 01/25/36 286,700
5,000,000 Series 2005-WCW3, Class M11 (b) (c) ................... 5.40% 08/25/35 500,000
Pebble Creek LCDO, Ltd.
1,500,000 Series 2007-2A, Class E (b) (c) ....................... 5.85% 06/22/14 930,000
Pegasus Aviation Lease Securitization III
3,160,515 Series 2001-1A, Class A3 (b) (c) ...................... 3.40% 03/10/14 2,433,596
Rosedale CLO, Ltd.
4,000,000 Series I-A, Class II (b) .............................. 0.00% 07/24/21 2,400,000
Signature 5, Ltd.
1,000,000 Series 5A, Class C (b) ................................ 12.56% 10/27/12 888,000
Soundview Home Equity Loan Trust
1,304,000 Series 2006-OPT1, Class M9 (b) (c) .................... 5.40% 03/25/36 117,230
1,884,000 Series 2007-OPT3, Class M10 (b) (c) ................... 5.40% 08/25/37 188,400
Structured Asset Securities Corp.
3,000,000 Series 2002-HF2, Class M3 (c) ......................... 4.90% 07/25/32 1,071,099
453,072 Series 2004-S3, Class M9 (b) (c) ...................... 6.50% 11/25/34 6,792
3,527,000 Series 2007-BC3, Class B1 (b) (c) ..................... 5.40% 05/25/47 423,240
2,000,000 Series 2007-OSI, Class M10 (c) ........................ 5.40% 06/25/37 138,120
UCFC Manufactured Housing Contract
913,000 Series 1996-1, Class M ................................ 7.90% 01/15/28 635,898
2,000,000 Series 1998-3, Class M1 ............................... 6.51% 01/15/30 720,000
Wilbraham CBO, Ltd.
3,000,000 Series 1A, Class A2 (b) (c) ........................... 4.86% 07/13/12 2,460,000
--------------
TOTAL ASSET-BACKED SECURITIES........................................................ 107,038,438
(Cost $ 139,348,567) --------------
COLLATERALIZED MORTGAGE OBLIGATIONS - 4.4%
Countrywide Alternative Loan Trust
3,946,540 Series 2005-56, Class B4 (b) (c)....................... 4.15% 11/25/35 394,654
3,453,223 Series 2005-56, Class M4 (c)........................... 3.82% 11/25/35 1,657,547
3,133,971 Series 2006-OA2, Class B2 (c).......................... 5.05% 05/20/46 250,718
Countrywide Home Loans, Inc.,
Pass-Through Certificates
1,120,629 Series 2004-23, Class B4 (c)........................... 4.15% 11/25/34 537,902
Deutsche Alt-A Securities, Inc. Mortgage Loan Trust
3,000,496 Series 2007-OA4, Class M10 (c)......................... 5.90% 08/25/47 351,621
HarborView Mortgage Loan Trust
1,505,312 Series 2004-2, Class B5 (c)............................ 3.80% 06/19/34 677,391
1,144,900 Series 2004-8, Class B5 (c)............................ 4.05% 11/19/34 572,450
Washington Mutual Pass-Through Certificates
4,148,362 Series 2006-AR2, Class B13 (b) (c)..................... 4.65% 04/25/46 248,902
1,391,494 Series 2006-AR4, Class B13 (b) (c)..................... 4.10% 05/25/46 250,469
3,428,832 Series 2006-AR4, Class B14 (b) (c)..................... 4.10% 05/25/46 240,018
--------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS............................................ 5,181,672
(Cost $ 15,437,950) --------------
See Notes to Financial Statements
Page 7
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
APRIL 30, 2008 (UNAUDITED)
PRINCIPAL STATED
VALUE DESCRIPTION COUPON MATURITY VALUE
- --------------- ----------------------------------------------------------- ------ -------- --------------
COMMERCIAL MORTGAGE-BACKED SECURITIES - 8.7%
Banc of America Large Loan, Inc.
$ 1,000,000 Series 2005-MIB1, Class L (b) (c) ..................... 5.72% 03/15/22 $ 749,570
CS First Boston Mortgage Securities Corp.
268,055 Series 1995-WF1, Class G (b) .......................... 8.57% 12/21/27 269,269
FannieMae-ACES
12,929,485 Series 1998-M7, Class N, IO (e) (f) ................... 0.66% 05/25/36 281,006
GE Capital Commercial Mortgage Corp.
955,269 Series 2000-1, Class G (b) ............................ 6.13% 01/15/33 777,920
Government National Mortgage Association
73,347,970 Series 2001-44, Class IO, IO (e) ...................... 0.51% 07/16/41 1,241,840
40,403,137 Series 2003-59, Class XA, IO (e) ...................... 1.69% 06/16/34 3,220,635
LB-UBS Commercial Mortgage Trust
4,948,222 Series 2001-C7, Class S (b) ........................... 5.87% 11/15/33 2,578,040
Morgan Stanley Capital I, Inc.
5,000,000 Series 2003-IQ5, Class O (b) .......................... 5.24% 04/15/38 1,113,118
--------------
TOTAL COMMERCIAL MORTGAGE-BACKED SECURITIES ......................................... 10,231,398
(Cost $15,903,335) --------------
CORPORATE BONDS AND NOTES - 11.7%
3,000,000 Americast Technologies, Inc. (b) .......................... 11.00% 12/01/14 2,715,000
1,000,000 Coleman Cable, Inc. ....................................... 9.88% 10/01/12 920,000
2,500,000 Dayton Superior Corp ...................................... 13.00% 06/15/09 2,143,750
1,000,000 International Coal Group, Inc.............................. 10.25% 07/15/14 1,015,000
1,500,000 Lexington Precision Corp., Units (g) ...................... 0.00% 08/01/09 1,455,000
2,500,000 MSX International UK, MXS International
Business Service FR/MXS International GmBH (b) ............ 12.50% 04/01/12 2,012,500
1,000,000 PNA Intermediate Holding Corp. PIK (c) (h) ................ 10.07% 02/15/13 837,500
1,498,000 Rafealla Apparel Group, Inc., Series B .................... 11.25% 06/15/11 1,056,090
2,500,000 The Restaurant Company .................................... 10.00% 10/01/13 1,612,500
--------------
TOTAL CORPORATE BONDS AND NOTES ..................................................... 13,767,340
(Cost $16,217,014) --------------
STRUCTURED NOTES - 9.4%
Babson CLO, Ltd.
5,000,000 Series 2005-1A, Subordinated Note (b) ................. 0.00% 04/15/19 3,750,000
Flagship CLO
1,000,000 Series 2005-4I, Subordinated Note (b) ................. 0.00% 06/01/17 725,000
Kenmore Street Synthetic CDO
10,000,000 Series 2006-1A, Note (b) (c) .......................... 7.54% 04/30/14 1,800,000
MM Community Funding III
6,500,000 Series 3A, Subordinated Notes (b) ..................... 0.00% 05/01/32 3,152,500
2,000,000 Preferred Term Securities XXV, Ltd. (b) ................... 0.00% 06/22/37 1,567,600
--------------
TOTAL STRUCTURED NOTES .............................................................. 10,995,100
(Cost $ 14,484,033) --------------
See Notes to Financial Statements
Page 8
FIRST TRUST STRATEGIC HIGH INCOME FUND II
PORTFOLIO OF INVESTMENTS (a) - (CONTINUED)
APRIL 30, 2008 (UNAUDITED)
SHARES DESCRIPTION VALUE
- ------------ --------------------------------------------------------------- ----------------
PREFERRED SECURITIES - 6.6%
3,000 AMMC CLO IV, Ltd. (b) (i) .................................... $ 1,260,000
2,000 Babson CLO, Ltd. (b) (i) ..................................... 1,040,000
350 Independence III CDO, Ltd., Series 3A, Class PS (b) (i) ...... 455,000
4,775 Pro Rata Funding, Ltd., Inc. (b) (i) ......................... 3,342,500
2,000 Soloso CDO, Ltd., Series 2005-1 (b) (i) ...................... 1,176,250
3,000 White Marlin CDO, Ltd., Series AI (b) (i) .................... 540,000
----------------
TOTAL PREFERRED SECURITIES ................................... 7,813,750
(Cost $12,375,962) ----------------
TOTAL INVESTMENTS - 131.8% ................................... 155,027,698
(Cost $213,766,861) (j)
LOAN OUTSTANDING - (45.9)% ................................... (54,000,000)
NET OTHER ASSETS AND LIABILITIES - 14.1% ..................... 16,646,225
----------------
NET ASSETS - 100.0% .......................................... $ 117,673,923
================
- ---------------
(a) All percentages shown in the Portfolio of Investments are based on net
assets.
(b) This security, sold within the terms of a private placement memorandum, is
exempt from registration under Rule 144A of the Securities Act of 1933, as
amended (the "1933 Act"), and may be resold in transactions exempt from
registration, normally to qualified institutional buyers. Pursuant to
procedures adopted by the Fund's Board of Trustees, this security has been
determined to be liquid by Valhalla Capital Partners, LLC , the Fund's
investment sub-advisor. At April 30, 2008, securities noted as such
amounted to $92,097,827 or 78.3% of net assets.
(c) Floating-rate security. The interest rate shown reflects the rate in
effect at April 30, 2008.
(d) This security, sold within the terms of a private placement memorandum, is
exempt from registration under Rule 144A under the 1933 Act, and may be
resold in transactions exempt from registration, normally to qualified
institutional buyers (See Note 2C- Restricted Securities in the Notes to
Financial Statements).
(e) IO - Interest only
(f) ACES - Alternative Credit Enhancement Securities
(g) The issuer is in default. Income is not being accrued.
(h) PIK - Payment in Kind
(i) Zero coupon.
(j) Aggregate cost for federal income tax and financial reporting purposes.
IO Interest Only
PIK Payment in Kind
See Notes to Financial Statements
Page 9
FIRST TRUST STRATEGIC HIGH INCOME FUND II
STATEMENT OF ASSETS AND LIABILITIES
APRIL 30, 2008 (UNAUDITED)
ASSETS:
Investments, at value
(Cost $ 213,766,861) ....................................................................... $ 155,027,698
Cash ............................................................................................ 13,901,826
Prepaid expenses ................................................................................ 19,953
Receivables:
Interest ................................................................................... 2,014,716
Investment securities sold ................................................................. 1,245,042
Dividends .................................................................................. 21,924
------------------
Total Assets ............................................................................ 172,231,159
------------------
LIABILITIES:
Payables:
Outstanding loan ........................................................................... 54,000,000
Interest and fees due on loan .............................................................. 257,359
Investment advisory fees ................................................................... 127,809
Printing fees .............................................................................. 43,564
Legal fees ................................................................................. 32,961
Audit and tax fees ......................................................................... 29,623
Custodian fees ............................................................................. 14,914
Administrative fees ........................................................................ 14,201
Trustees' fees and expenses ................................................................ 8,348
Transfer agent fees ........................................................................ 5,709
Accrued expenses and other liabilities .......................................................... 22,748
------------------
Total Liabilities ....................................................................... 54,557,236
------------------
NET ASSETS ...................................................................................... $ 117,673,923
==================
NET ASSETS CONSIST OF:
Paid-in capital ................................................................................. $ 179,974,841
Par value ....................................................................................... 94,577
Accumulated net investment income (loss) ........................................................ 10,243,051
Accumulated net realized gain (loss) on investments ............................................. (13,899,383)
Net unrealized appreciation (depreciation) on investments ....................................... (58,739,163)
------------------
NET ASSETS ...................................................................................... $ 117,673,923
==================
NET ASSET VALUE, per common share (par value $0.01 per Common Share) ............................ $ 12.44
==================
Number of Common Shares outstanding (unlimited number of Common Shares has been authorized) ..... 9,457,668
==================
See Notes to Financial Statements
Page 10
FIRST TRUST STRATEGIC HIGH INCOME FUND II
STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED APRIL 30, 2008 (UNAUDITED)
INVESTMENT INCOME:
Interest ........................................................................................ $ 14,066,797
Dividends ....................................................................................... 176,554
------------------
Total investment income .................................................................... 14,243,351
------------------
EXPENSES:
Interest and fees on outstanding loan ........................................................... 1,590,603
Investment advisory fees ........................................................................ 850,279
Excise tax expense .............................................................................. 617,843
Administrative fees ............................................................................. 94,294
Audit and tax fees .............................................................................. 48,641
Printing fees ................................................................................... 38,902
Legal fees ...................................................................................... 34,773
Trustees' fees and expenses ..................................................................... 25,263
Transfer agent fees ............................................................................. 22,145
Custodian fees .................................................................................. 16,440
Other ........................................................................................... 103,493
------------------
Total expenses ............................................................................. 3,442,676
------------------
NET INVESTMENT INCOME ........................................................................... 10,800,675
------------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on investments ...................................................... (12,696,611)
Net change in unrealized appreciation (depreciation) on investments .......................... (25,210,477)
------------------
NET REALIZED AND UNREALIZED GAIN (LOSS) ......................................................... (37,907,088)
------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS ................................. $ (27,106,413)
==================
See Notes to Financial Statements
Page 11
FIRST TRUST STRATEGIC HIGH INCOME FUND II
STATEMENTS OF CHANGES IN NET ASSETS
SIX MONTHS
ENDED YEAR
04/30/2008 ENDED
(UNAUDITED) 10/31/2007
--------------- ----------------
OPERATIONS:
Net investment income (loss) ................................................... $ 10,800,675 $ 22,861,085
Net realized gain (loss) ....................................................... (12,696,611) (310,017)
Net change in unrealized appreciation (depreciation) ........................... (25,210,477) (40,194,912)
--------------- ----------------
Net increase (decrease) in net assets resulting from operations ................ (27,106,413) (17,643,844)
--------------- ----------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income .......................................................... (9,451,474) (18,364,664)
Net realized gain .............................................................. -- (519,156)
--------------- ----------------
Total distributions to shareholders ............................................ (9,451,474) (18,883,820)
CAPITAL TRANSACTIONS:
Proceeds from 8,084 and 27,245 Common Shares reinvested, respectively .......... 101,291 547,387
--------------- ----------------
Net increase (decrease) in net assets .......................................... (36,456,596) (35,980,277)
NET ASSETS:
Beginning of period ............................................................ 154,130,519 190,110,796
--------------- ----------------
End of period .................................................................. $ 117,673,923 $ 154,130,519
=============== ================
Accumulated net investment income (loss) at end of period ...................... $ 10,243,051 $ 8,893,850
=============== ================
See Notes to Financial Statements
Page 12
FIRST TRUST STRATEGIC HIGH INCOME FUND II
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED APRIL 30, 2008 (UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net decrease in net assets resulting from operations ........................... $ (27,106,413)
Adjustments to reconcile net increase (decrease) in net assets resulting
from operations to net cash provided by operating activities:
Purchases of investments .................................................. (5,660,841)
Sales and maturities of investments ....................................... 17,224,213
Net amortization/accretion of premium/discount on investments ............. (2,601,482)
Net realized loss on investments .......................................... 12,696,611
Net change in unrealized appreciation/depreciation on investments ......... 25,210,477
CHANGES IN ASSETS AND LIABILITIES:
Decrease in interest receivable ........................................... 340,579
Decrease in dividend receivable ........................................... 36,572
Increase in prepaid expenses .............................................. (8,709)
Increase in receivable for investment securities sold ..................... (1,245,042)
Decrease in interest and fees due on loan ................................. (120,384)
Decrease in investment advisory fees payable .............................. (43,070)
Decrease in audit and tax fees payable .................................... (14,477)
Increase in legal fees payable ............................................ 14,714
Increase in printing fees payable ......................................... 17,139
Increase in transfer agent fees payable ................................... 2,953
Decrease in administrative fees payable ................................... (4,385)
Increase in custodian fees payable ........................................ 5,455
Increase in Trustees' fees and expenses payable ........................... 5,636
Increase in accrued expenses and other liabilities ........................ 19,910
--------------
CASH PROVIDED BY OPERATING ACTIVITIES .......................................... $ 18,769,456
--------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from shares sold ................................................. 101,291
Distributions to Common Shareholders ...................................... (9,451,474)
Repayments of loan ........................................................ (13,000,000)
--------------
CASH USED BY FINANCING ACTIVITIES .............................................. (22,350,183)
--------------
Decrease in cash ............................................................... (3,580,727)
Cash at beginning of period .................................................... 17,482,553
--------------
Cash at end of period .......................................................... $ 13,901,826
==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest and fees .............................. $ 1,710,987
==============
See Notes to Financial Statements
Page 13
FIRST TRUST STRATEGIC HIGH INCOME FUND II
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD
SIX MONTHS
ENDED YEAR PERIOD
4/30/2008 ENDED ENDED
(UNAUDITED) 10/31/2007 10/31/2006 (a)
------------- ------------- ---------------
Net asset value, beginning of period ........................... $ 16.31 $ 20.18 $ 19.10 (b)
------------- ------------- ---------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) ................................... 1.14 2.42 1.18
Net realized and unrealized gain (loss) ........................ (4.01) (4.29) 0.77
------------- ------------- ---------------
Total from investment operations ............................... (2.87) (1.87) 1.95
------------- ------------- ---------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income .......................................... (1.00) (1.95) (0.83)
Net realized gain .............................................. -- (0.05) --
------------- ------------- ---------------
Total distributions ............................................ (1.00) (2.00) (0.83)
------------- ------------- ---------------
Common Shares offering costs charged to paid-in capital ........ -- -- (0.04)
------------- ------------- ---------------
Net asset value, end of period ................................. $ 12.44 $ 16.31 $ 20.18
============= ============= ===============
Market value, end of period .................................... $ 13.87 $ 15.15 $ 20.88
============= ============= ===============
TOTAL RETURN BASED ON NET ASSET VALUE (c) (d) .................. (17.62)% (9.92)% 10.13%
============= ============= ===============
TOTAL RETURN BASED ON MARKET VALUE (d) (e) ..................... (1.12)% (19.21)% 8.93%
============= ============= ===============
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) ........................... $ 117,674 $ 154,131 $ 190,111
Ratio of total expenses to average net assets .................. 5.26% (f) 4.19% 2.13% (f)
Ratio of total expenses to average net assets excluding interest
expense...................................................... 2.83% (f) 1.74% 1.40% (f)
Ratio of net investment income to average net assets ........... 16.50% (f) 12.64% 10.15% (f)
Portfolio turnover rate ........................................ 1% 21% 24%
INDEBTEDNESS:
Loan outstanding (in 000's) .................................... $ 54,000 $ 67,000 $ 62,000
Asset coverage per $1,000 of indebtedness (g) .................. $ 3,179 $ 3,300 $ 4,066
- -----------------
(a) Initial seed date of March 21, 2006. The Fund commenced operations on
March 28, 2006.
(b) Net of sales load of $0.90 per share on initial offering.
(c) Total return based on net asset value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in net
asset value per share and does not reflect sales load.
(d) Total return is not annualized for periods less than one year.
(e) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in Common
Share market price.
(f) Annualized.
(g) Calculated by subtracting the Fund's total liabilities (not including the
loan outstanding) from the Fund's total assets, and dividing by the
outstanding loan balance in 000's.
See Notes to Financial Statements
Page 14
NOTES TO FINANCIAL STATEMENTS
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
1. FUND DESCRIPTION
First Trust Strategic High Income Fund II (the "Fund") is a diversified,
closed-end management investment company organized as a Massachusetts business
trust on January 18, 2006 and is registered with the Securities and Exchange
Commission ("SEC") under the Investment Company Act of 1940, as amended (the
"1940 Act"). The Fund trades under the ticker symbol FHY on the New York Stock
Exchange ("NYSE").
The Fund's primary investment objective is to seek a high level of current
income. The Fund seeks capital growth as a secondary objective. The Fund seeks
to achieve its investment objectives by investing in a diversified portfolio of
below-investment grade and investment grade debt securities, and equity
securities that Valhalla Capital Partners, LLC ("Valhalla" or the "Sub-Advisor")
believes offer attractive yield and/or capital appreciation potential. There can
be no assurance that the Fund will achieve its investment objectives. The Fund
may not be appropriate for all investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statements. Actual results could differ from those estimates.
A. PORTFOLIO VALUATION:
The net asset value ("NAV") of the Common Shares of the Fund is determined daily
as of the close of regular trading on the NYSE, normally 4:00 p.m. Eastern time,
on each day the NYSE is open for trading. Domestic debt securities and foreign
securities are priced using data reflecting the earlier closing of the principal
markets for those securities. The NAV per Common Share is calculated by dividing
the value of all assets of the Fund (including accrued interest and dividends),
less all liabilities (including accrued expenses, dividends declared but unpaid
and any borrowings of the Fund) by the total number of Common Shares
outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value according
to procedures adopted by the Fund's Board of Trustees. Securities for which
market quotations are readily available are valued at market value, which is
currently determined using the last reported sale price on the business day as
of which such value is being determined or, if no sales are reported on such day
(as in the case of some securities traded over-the-counter), the last reported
bid price, except that certain U.S. government securities are valued at the mean
between the last reported bid and asked prices. The Fund values mortgage-backed
securities and other debt securities not traded in an organized market on the
basis of valuations provided by dealers who make markets in such securities or
by an independent pricing service approved by the Board of Trustees which uses
information with respect to transactions in such securities, quotations from
dealers, market transactions for comparable securities, various relationships
between securities and yield to maturity in determining value. In the Fund's
financial statements, the Statement of Assets and Liabilities includes
investments with a value of $78,255,944 (50.5% of total investments) as of April
30, 2008, whose values have been determined based on prices supplied by dealers
in the absence of readily determinable values. These values may differ from the
values that would have been used had an independent price for these investments
existed, and the differences could be material. The remaining investments, with
a value of $76,771,754 (49.5% of total investments), were valued by an
independent pricing service.
Debt securities having a remaining maturity of less than sixty days when
purchased are valued at cost adjusted for amortization of premiums and accretion
of discounts.
In the event that market quotations are not readily available, the
pricing service or dealer does not provide a valuation for a particular
security, or the valuations are deemed unreliable, First Trust Advisors L.P.
("First Trust") may use a fair value method to value the Fund's securities and
investments. Additionally, if events occur after the close of the principal
markets for particular securities (e.g., domestic debt and foreign securities),
but before the Fund values its assets, that could materially affect NAV, First
Trust may use a fair value method to value the Fund's securities and
investments. As a general principle, the fair value of a security is the amount
which the Fund might reasonably expect to receive for the security upon its
current sale. A variety of factors may be considered in determining the fair
value of such securities including 1) the fundamental business data relating to
the issuer; 2) an evaluation of the forces which influence the market in which
these securities are purchased and sold; 3) type of holding; 4) financial
statements of the issuer; 5) cost at date of purchase; 6) credit quality and
cash flow of the issuer based on external analysis; 7) information as to any
transactions in or offers for the holding; 8) price and extent of public trading
in similar securities of the issuer/borrower, or comparable companies; and 9)
other relevant factors. The use of fair value pricing by the Fund is governed by
valuation procedures adopted by the Fund's Board of Trustees, and in accordance
with the provisions of the 1940 Act. When fair value pricing of securities is
employed, the prices of securities used by the Fund to calculate its NAV may
differ from market quotations or official closing prices. In light of the
judgment involved in fair valuations, there can be no assurance that a fair
value assigned to a particular security will be the amount which the Fund might
be able to receive upon its current sale.
Page 15
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
The Fund invests a significant portion of its assets in below-investment grade
debt securities, including mortgage-backed securities, asset-backed securities,
corporate bonds and collateralized debt obligations. The value and related
income of these securities is sensitive to changes in economic conditions,
including delinquencies and/or defaults. Recent instability in the markets for
fixed income securities, particularly mortgage-backed and asset-backed
securities, has resulted in increased volatility of market prices and periods of
illiquidity that have adversely impacted the valuation of certain securities
held by the Fund.
B. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on the accrual basis. Amortization of premiums and accretion of discounts are
recorded using the effective interest method.
The Fund follows the provisions of Emerging Issues Task Force No. 99-20 ("EITF
99-20"), "Recognition of Interest Income and Impairment on Purchased and
Retained Beneficial Interests in Securitized Financial Assets," for certain
lower credit quality securitized assets that have contractual cash flows (for
example, asset-backed securities, collateralized mortgage obligations and
commercial mortgage-backed securities). Under EITF 99-20, if there is a change
in the estimated cash flows for any of these securities, based on an evaluation
of current information, then the estimated yield is adjusted on a prospective
basis over the remaining life of the security. Investment income is recorded net
of foreign taxes withheld where recovery of such taxes is uncertain. Debt
obligations may be placed on non-accrual status and related interest income may
be reduced by ceasing current accruals and writing off interest receivables when
the collection of all or a portion of interest has become doubtful based on
consistently applied procedures. A debt obligation is removed from non-accrual
status when the issuer resumes interest payments or when collectability of
interest is reasonably assured.
Securities purchased or sold on a when-issued or delayed-delivery basis may be
settled a month or more after the trade date; interest income on such securities
is not accrued until settlement date. The Fund maintains liquid assets with a
current value at least equal to the amount of its when-issued or
delayed-delivery purchase commitments. At April 30, 2008, the Fund had no
when-issued or delayed-delivery purchase commitments.
C. RESTRICTED SECURITIES:
The Fund invests in restricted securities, which are securities that may not be
offered for public sale without first being registered under the Securities Act
of 1933, as amended (the "1933 Act"). Prior to registration, restricted
securities may only be resold in transactions exempt from registration under
Rule 144A of the 1933 Act, normally to qualified institutional buyers. As of
April 30, 2008, the Fund held restricted securities as shown in the table below
that the Sub-Advisor has deemed illiquid pursuant to procedures adopted by the
Fund's Board of Trustees. The Fund does not have the right to demand that such
securities be registered. These securities are valued according to the valuation
procedures as stated in the Portfolio Valuation footnote (Note 2A) and are not
expressed as a discount to the carrying value of a comparable unrestricted
security. There are no unrestricted securities with the same maturity dates and
yields for these issuers.
% OF
ACQUISITION PRINCIPAL CARRYING CARRYING NET
SECURITY DATE VALUE VALUE PER SHARE COST VALUE ASSETS
- ------------------------------------------------------ ----------- ----------- --------------- ----------- ---------- ------
Conseco Finance Securitizations Corp., Series 1999-6,
Class M1, 7.96%, 06/01/30 04/27/06 $ 3,803,830 $ 8.69 $ -- $ 330,587 0.28%
Morgan Stanley ABS Capital I, Inc., Series 2004-NC5,
Class B4, 6.65%, 05/25/34 06/14/06 791,842 10.51 813,651 83,247 0.07
Park Place Securities, Inc., Series 2004-WCW1,
Class M9, 6.40%, 09/25/34 06/08/06 1,788,245 12.15 1,630,510 217,244 0.19
----------- ----------- ---------- ----
$ 6,383,917 $ 2,444,161 $ 631,078 0.54%
=========== =========== ========== ====
D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
The Fund will distribute to holders of its Common Shares monthly dividends of
all or a portion of its net income after the payment of interest and dividends
in connection with leverage. Distributions will automatically be reinvested into
additional Common Shares pursuant to the Fund's Dividend Reinvestment Plan
unless cash distributions are elected by the shareholder.
Distributions from income and capital gains are determined in accordance with
income tax regulations, which may differ from accounting principles generally
accepted in the United States of America. These differences are primarily due to
differing treatments of income and gains on various investment securities held
by the Fund, timing differences and differing characterization of distributions
made by the Fund.
Page 16
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
The tax character of distributions paid during the fiscal year ended October 31,
2007, was as follows:
Distributions paid from:
Ordinary Income................................ $ 18,883,820
As of October 31, 2007, the components of distributable earnings on a tax basis
were as follows:
Capital Loss Carryforward...................... $ (1,202,026)
Undistributed Ordinary Income.................. 13,582,644
Net Unrealized Appreciation (Depreciation)..... (37,892,787)
E. INCOME TAXES:
The Fund intends to continue to qualify as a regulated investment company by
complying with the requirements under Subchapter M of the Internal Revenue Code
of 1986, as amended, and by distributing substantially all of its net investment
income and net realized gains to shareholders. Accordingly, no provision has
been made for federal or state income taxes.
The Fund intends to utilize provisions of the federal income tax laws, which
allows it to carry a realized capital loss forward for eight years following the
year of the loss and offset such loss against any future realized capital gains.
At October 31, 2007, the Fund had an available realized capital loss of
$1,202,026 to offset future net capital gains through the fiscal year ended
2015.
In June 2006, Financial Accounting Standards Board ("FASB") Interpretation No.
48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement 109 ("FIN 48"), was issued and is effective for fiscal years beginning
after December 15, 2006. This Interpretation prescribes a minimum threshold for
financial statement recognition of the benefit of a tax position taken or
expected to be taken in a tax return. As of April 30, 2008, management has
evaluated the application of FIN 48 to the Fund, and has determined that there
is no material impact resulting from the adoption of this Interpratation on the
Fund's financial statements.
F. EXPENSES:
The Fund pays all expenses directly related to its operations.
G. ACCOUNTING PRONOUNCEMENT:
In September 2006, Statement of Financial Accounting Standards No. 157, Fair
Value Measurements ("SFAS 157") was issued and is effective for fiscal years
beginning after November 15, 2007. SFAS 157 defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value
measurements. At this time, management is evaluating the implications of SFAS
157 and its impact on the Fund's financial statements, if any, has not been
determined.
3. INVESTMENT ADVISORY FEE AND OTHER AFFILIATED TRANSACTIONS
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. First Trust
serves as investment advisor to the Fund pursuant to an Investment Management
Agreement. First Trust is responsible for the ongoing monitoring of the Fund's
investment portfolio, managing the Fund's business affairs and certain
administrative services necessary for the management of the Fund. For these
investment management services, First Trust is entitled to a monthly fee
calculated at an annual rate of 0.90% of the Fund's Managed Assets (the value of
the securities and other investments the Fund holds plus cash or other assets,
including interest accrued but not yet received minus accrued liabilities other
than the principal amount of any borrowings).
Valhalla, a boutique asset management firm focused on managing high-yield
portfolios with an emphasis on structured finance securities, serves as the
Fund's Sub-Advisor and manages the Fund's portfolio subject to First Trust's
supervision. The Sub-Advisor receives a portfolio management fee at an annual
rate of 0.40% of Managed Assets that is paid monthly by First Trust from its
investment advisory fee. First Trust Portfolios L.P., an affiliate of First
Trust, owns a minority interest in Valhalla.
PFPC Inc. ("PFPC"), an indirect, majority-owned subsidiary of The PNC Financial
Services Group, Inc., serves as the Fund's Administrator and Transfer Agent in
accordance with certain fee arrangements. PFPC Trust Company, an indirect,
majority-owned subsidiary of The PNC Financial Services Group, Inc., serves as
the Fund's Custodian in accordance with certain fee arrangements.
Each Trustee who is not an officer or employee of First Trust, any sub-advisor
or any of their affiliates ("Independent Trustees") is paid an annual retainer
of $10,000 per trust for the first 14 trusts of the First Trust Fund Complex and
an annual retainer of $7,500 per trust for each subsequent trust added to the
First Trust Fund Complex. The annual retainer is allocated equally among each of
the trusts. No additional meeting fees are paid in connection with board or
committee meetings.
Page 17
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
Additionally, the Lead Independent Trustee is paid $10,000 annually and the
Chairman of the Audit Committee is paid $5,000 annually, with such compensation
paid by the trusts in the First Trust Fund Complex and divided among those
trusts. Trustees are also reimbursed by the trusts in the First Trust Fund
Complex for travel and out-of-pocket expenses in connection with all meetings.
Effective January 1, 2008, each of the chairmen of the Nominating and Governance
Committee and the Valuation Committee are paid $2,500 annually to serve in such
capacities with such compensation paid by the trusts in the First Trust Fund
Complex and divided among those trusts. Also effective January 1, 2008, the Lead
Independent Trustee and each Committee chairman will serve two year terms.
4. PURCHASES AND SALES OF SECURITIES
Cost of purchases and proceeds from sales of investment securities, excluding
U.S. government and short-term investments, for the six months ended April 30,
2008, were $5,660,841 and $2,602,020, respectively.
As of April 30, 2008, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was $12,485,347
and the aggregate gross unrealized depreciation for all securities in which
there was an excess of tax cost over value was $71,224,510.
5. COMMON SHARES
As of April 30, 2008, 9,457,668 of $0.01 par value Common Shares were issued. An
unlimited number of Common Shares has been authorized under the Fund's Dividend
Reinvestment Plan.
6. PREFERRED SHARES OF BENEFICIAL INTEREST
The Fund's Declaration of Trust authorizes the issuance of an unlimited number
of preferred shares of beneficial interest, par value $0.01 per share (the
"Preferred Shares"), in one or more classes or series, with rights as determined
by the Board of Trustees without the approval of Common Shareholders. As of
April 30, 2008, no Preferred Shares had been issued.
7. REVOLVING LOAN AGREEMENT
On May 31, 2006, the Fund entered into a Revolving Credit and Security Agreement
with Liberty Street Funding Corp., as conduit lender, and The Bank of Nova
Scotia, as secondary lender, which provides for a revolving credit facility to
be used as leverage for the Fund. The credit facility provides for a secured
line of credit for the Fund, where Fund assets are pledged against advances made
to the Fund. Under the requirements of the 1940 Act, the Fund, immediately after
any such borrowings, must have an "asset coverage" of at least 300% (33 1/3% of
the Fund's total assets after borrowings). In addition, the Fund has agreed to
pay facility commitment fees on the unutilized line of credit, which are
included in "Interest and fees on outstanding loan" on the Statement of
Operations. The total commitment under the Revolving Credit and Security
Agreement is $92,000,000. For the six months ended April 30, 2008, the average
amount outstanding was $58,516,484. The high and low annual interest rates
during the six months ended April 30, 2008 were 5.66% and 3.07%, respectively,
and the weighted average interest rate was 4.98%. The Revolving Credit and
Security Agreement has been amended subsequent to April 30, 2008 with the
following terms. The total commitment under the Revolving Credit and Security
Agreement was changed to $60,000,000 through July 30, 2008. On July 31, 2008,
through August 29, 2008, the total commitment under the Revolving Credit and
Security Agreement will be $30,000,000. The maturity date for the Revolving
Credit and Security Agreement is August 29, 2008. If the Fund is unable to renew
the revolving credit facility or find a replacement facility, the Fund will need
to liquidate portfolio securities in an amount necessary to repay the facility.
8. RISK CONSIDERATIONS
INVESTMENT RISK: An investment in the Fund's Common Shares is subject to
investment risk, including the possible loss of the entire principal invested.
An investment in Common Shares represents an indirect investment in the
securities owned by the Fund. The value of these securities, like other market
investments, may move up or down, sometimes rapidly and unpredictably. Common
Shares at any point in time may be worth less than the original investment, even
after taking into account the reinvestment of Fund dividends and distributions.
Security prices can fluctuate for several reasons including the general
condition of the bond market, or when political or economic events affecting the
issuers occur.
RESIDENTIAL MORTGAGE-BACKED SECURITIES CONCENTRATION RISK: The Fund will invest
at least 25% of its total Managed Assets in residential mortgage-backed
securities under normal market conditions. The Fund's total assets will be
concentrated in residential mortgage-backed securities. A fund concentrated in a
single industry is likely to present more risks than a fund that is broadly
diversified over several industries. Mortgage-backed securities may have less
potential for capital appreciation than comparable fixed-income securities, due
to the likelihood of increased prepayments of mortgages as interest rates
decline. If the Fund buys mortgage-backed securities at a premium, mortgage
foreclosures and prepayments of principal by mortgagors (which usually may be
made at any time without penalty) may result in some loss of the Fund's
principal investment to the extent of the premium paid. Alternatively, in a
rising
Page 18
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
interest rate environment, the value of mortgage-backed securities may be
adversely affected when payments on underlying mortgages do not occur as
anticipated, resulting in the extension of the security's effective maturity and
the related increase in interest rate sensitivity of a longer-term instrument.
The value of mortgage-backed securities may also change due to shifts in the
market's perception of issuers and regulatory or tax changes adversely affecting
the markets as a whole. In addition, mortgage-backed securities are subject to
the credit risk associated with the performance of the underlying mortgage
properties. In certain instances, third-party guarantees or other forms of
credit support can reduce the credit risk.
The Fund may also invest in mortgage-backed securities which are interest-only
("IO") securities and principal-only ("PO") securities. Generally speaking, when
interest rates are falling and prepayment rates are increasing, the value of a
PO security will rise and the value of an IO security will fall. Conversely,
when interest rates are rising and prepayment rates are decreasing, generally
the value of a PO security will fall and the value of an IO security will rise.
In addition to the foregoing, residential mortgage-backed securities are subject
to additional risks, including: (i) the United States residential mortgage
market has recently encountered various difficulties and changed economic
conditions. In addition, recently, residential property values in various states
have declined or remained stable, after extended periods of appreciation. A
continued decline or an extended flattening in those values may result in
additional increases in delinquencies and losses on residential mortgage loans
generally; (ii) if a residential mortgage obligation is secured by a junior lien
it will be subordinate to the rights of the mortgagees or beneficiaries under
the related senior mortgages or deeds of trust; and (iii) depending on the
length of a residential mortgage obligation underlying a residential
mortgage-backed security, unscheduled or early payments of principal and
interest may shorten the security's effective maturity and the prevailing
interest rates may be higher or lower than the current yield of the Fund's
portfolio at the time the Fund receives the payments for reinvestment.
VALUE INVESTING RISK: The Fund focuses its investments on securities that the
Sub-Advisor believes are undervalued or inexpensive relative to other
investments. Such securities are subject to the risk of misestimating certain
fundamental factors. Disciplined adherence to a "value" investment mandate
during periods in which that style is "out of favor" can result in significant
underperformance relative to overall market indices and other managed investment
vehicles that pursue growth style investments and/or flexible style mandates.
BELOW-INVESTMENT GRADE SECURITIES RISK: The Fund invests in below-investment
grade securities. The market values for high-yield securities tend to be very
volatile, and these securities are less liquid than investment grade debt
securities. For these reasons, your investment in the Fund is subject to the
following specific risks: (a) increased price sensitivity to changing interest
rates and to a deteriorating economic environment; (b) greater risk of loss due
to default or declining credit quality; (c) adverse company specific events are
more likely to render the issuer unable to make interest and/or principal
payments; and (d) a negative perception of the high-yield market may depress the
price and liquidity of high-yield securities.
DISTRESSED SECURITIES RISK: The Fund may invest up to 40% of its managed assets
in securities issued by companies in a bankruptcy reorganization proceeding,
subject to some other form of a public or private debt restructuring or
otherwise in default or in significant risk of default in the payment of
interest or repayment of principal or trading at prices substantially below
other below-investment grade debt securities of companies in similar industries.
Distressed securities frequently do not produce income while they are
outstanding. The Fund may be required to incur certain extraordinary expenses in
order to protect and recover its investment. Therefore, to the extent the Fund
seeks capital appreciation through investment in distressed securities, its
ability to achieve current income may be diminished.
ECONOMIC CONDITIONS RISK: Adverse changes in economic conditions are more likely
to lead to a weakened capacity of a high-yield issuer to make principal payments
and interest payments than an investment grade issuer. An economic downturn
could severely affect the ability of highly leveraged issuers to service their
debt obligations or to repay their obligations upon maturity. Under adverse
market or economic conditions, the secondary market for high-yield securities
could contract further, independent of any specific adverse changes in the
condition of a particular issuer and these securities may become illiquid. As a
result, the Fund could find it more difficult to sell these securities or may be
able to sell the securities only at prices lower than if such securities were
widely traded.
FIXED-INCOME SECURITIES RISK: Debt securities, including high yield securities,
are subject to certain risks, including: (i) issuer risk, which is the risk that
the value of fixed-income securities may decline for a number of reasons which
directly relate to the issuer, such as management performance, financial
leverage and reduced demand for the issuer's goods and services; (ii)
reinvestment risk, which is the risk that income from the Fund's portfolio will
decline if the Fund invests the proceeds from matured, traded or called bonds at
market interest rates that are below the Fund portfolio's current earnings rate;
(iii) prepayment risk, which is the risk that during periods of declining
interest rates, the issuer of a security may exercise its option to prepay
principal earlier than scheduled, forcing the Fund to reinvest in lower yielding
securities; and (iv) credit risk, which is the risk that a security in the
Fund's portfolio will decline in price or the issuer fails to make interest
payments when due because the issuer of the security experiences a decline in
its financial status.
Page 19
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
INTEREST RATE RISK: The Fund is also subject to interest rate risk. Interest
rate risk is the risk that fixed-income securities will decline in value because
of changes in market interest rates. Investments in debt securities with
long-term maturities may experience significant price declines if long-term
interest rates increase.
9. INDEMNIFICATION
The Fund has a variety of indemnification obligations under contracts with its
service providers. The Fund's maximum exposure under these arrangements is
unknown. However, the Fund has not had prior claims or losses pursuant to these
contracts and expects the risk of loss to be remote.
10. SUBSEQUENT EVENTS
On April 21, 2008, the Fund declared a dividend of $0.1667 per share, which
represents a dividend from net investment income to Common Shareholders of
record May 5, 2008, payable May 15, 2008.
On May 19, 2008, the Fund declared a dividend of $0.1667 per share, which
represents a dividend from net investment income to Common Shareholders of
record June 4, 2008, payable June 16, 2008.
Page 20
ADDITIONAL INFORMATION
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Shares will be automatically reinvested by PFPC
Inc. (the "Plan Agent"), in additional Common Shares under the Plan. If you
elect to receive cash distributions, you will receive all distributions in cash
paid by check mailed directly to you by the Plan Agent, as dividend paying
agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
1) If Common Shares are trading at or above NAV at the time of
valuation, the Fund will issue new shares at a price equal to the
greater of (i) NAV per Common Share on that date or (ii) 95% of the
market price on that date.
2) If Common Shares are trading below NAV at the time of valuation, the
Plan Agent will receive the dividend or distribution in cash and
will purchase Common Shares in the open market, on the NYSE or
elsewhere, for the participants' accounts. It is possible that the
market price for the Common Shares may increase before the Plan
Agent has completed its purchases. Therefore, the average purchase
price per share paid by the Plan Agent may exceed the market price
at the time of valuation, resulting in the purchase of fewer shares
than if the dividend or distribution had been paid in Common Shares
issued by the Fund. The Plan Agent will use all dividends and
distributions received in cash to purchase Common Shares in the open
market within 30 days of the valuation date except where temporary
curtailment or suspension of purchases is necessary to comply with
federal securities laws. Interest will not be paid on any uninvested
cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (800) 334-1710, in
accordance with such reasonable requirements as the Plan Agent and Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized, although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing PFPC Inc., 301 Bellevue
Parkway, Wilmington, Delaware 19809.
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how
to vote proxies and information on how the Fund voted proxies relating to
portfolio securities during the most recent 12-month period ended June 30 is
available (1) without charge, upon request, by calling (800) 988-5891; (2) on
the Fund's website located at http://www.ftportfolios.com; and (3) on the
Securities and Exchange Commission's website at http://www.sec.gov.
Page 21
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available (1) by calling (800)
988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3)
on the SEC's website at http://www.sec.gov; and (4) for review and copying at
the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding
the operation of the PRR may be obtained by calling (800) SEC-0330.
SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
The Joint Annual Meeting of Shareholders of the Common Shares of Macquarie/First
Trust Global Infrastructure/Utilities Dividend & Income Fund, Energy Income and
Growth Fund, First Trust Enhanced Equity Income Fund, First Trust/Aberdeen
Global Opportunity Income Fund, First Trust/FIDAC Mortgage Income Fund, First
Trust Strategic High Income Fund, First Trust Strategic High Income Fund II,
First Trust/Aberdeen Emerging Opportunity Fund, First Trust/Gallatin Specialty
Finance and Financial Opportunities Fund and First Trust Active Dividend Income
Fund and Shareholders of the Preferred Shares of First Trust Tax-Advantaged
Preferred Income Fund, was held on April 14, 2008. At the Annual Meeting,
Independent Trustee Robert F. Keith was elected for a three-year term. The
number of votes cast in favor of Mr. Keith was 8,592,204, the number of votes
withheld was 59,555 and the number of abstentions was 797,825.
CHANGE IN INVESTMENT POLICY
Previously, the Fund was permitted to invest up to 15% of its Managed Assets in
securities rated below "CCC" (or a comparable rating) by at least one nationally
recognized statistical rating organization or, if unrated, determined to be of
comparable quality by the Fund's Sub-Advisor. At the December 10, 2007 meeting,
the Board of Trustees amended that policy to allow up to 20% of the Fund's
Managed Assets to be invested in such securities. The new policy was effective
on or about March 1, 2008.
The change in investment policy described above was not required to be, and was
not, approved by the shareholders of the Fund. The new policy may be changed by
the Board of Trustees without shareholder approval.
ADVISORY AND SUB-ADVISORY AGREEMENTS
BOARD CONSIDERATIONS REGARDING APPROVAL OF INVESTMENT MANAGEMENT
AND SUB-ADVISORY AGREEMENTS
The Board of Trustees of First Trust Strategic High Income Fund II (the "Fund"),
including the Independent Trustees, unanimously approved the continuation of the
Investment Management Agreement (the "Advisory Agreement") between the Fund and
First Trust Advisors L.P. (the "Advisor") and the Investment Sub-Advisory
Agreement (the "Sub-Advisory Agreement" and together with the Advisory
Agreement, the "Agreements") among the Fund, the Advisor and Valhalla Capital
Partners LLC (the "Sub-Advisor"), at a meeting held on March 3, 2008. The Board
determined that the terms of the Agreements are fair and reasonable and that the
Agreements continue to be in the best interests of the Fund.
To reach this determination, the Board considered its duties under the
Investment Company Act of 1940, as amended (the "1940 Act"), as well as under
the general principles of state law in reviewing and approving advisory
contracts; the requirements of the 1940 Act in such matters; the fiduciary duty
of investment advisors with respect to advisory agreements and compensation; the
standards used by courts in determining whether investment company boards have
fulfilled their duties; and the factors to be considered by the Board in voting
on such agreements. To assist the Board in its evaluation of the Agreements, the
Independent Trustees received a separate report from each of the Advisor and the
Sub-Advisor in advance of the Board meeting responding to a request for
information from counsel to the Independent Trustees. The reports, among other
things, outlined the services provided by the Advisor and the Sub-Advisor
(including the relevant personnel responsible for these services and their
experience); the advisory and sub-advisory fees for the Fund as compared to fees
charged by investment advisors and sub-advisors to comparable funds and as
compared to fees charged to other clients of the Advisor and the Sub-Advisor;
expenses of the Fund as compared to expense ratios of comparable funds; the
nature of expenses incurred in providing services to the Fund and the potential
for economies of scale, if any; financial data on the Advisor and the
Sub-Advisor; any fall out benefits to the Advisor and the Sub-Advisor; and
information on the Advisor's and the Sub-Advisor's compliance programs. The
Independent Trustees also met separately with their independent legal counsel to
discuss the information provided by the Advisor and the Sub-Advisor. The Board
applied its business judgment to determine whether the arrangements between the
Fund and the Advisor and among the Fund, the Advisor and the Sub-Advisor are
reasonable business arrangements from the Fund's perspective as well as from the
perspective of shareholders.
In reviewing the Agreements, the Board considered the nature, quality and extent
of services provided by the Advisor and the Sub-Advisor under the Agreements.
With respect to the Advisory Agreement, the Board considered that the Advisor is
responsible for the overall management and administration of the Fund, including
the oversight of the Sub-Advisor. The Board noted the compliance program that
had been developed by the Advisor and considered that the compliance program
includes policies and procedures for
Page 22
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
monitoring the Sub-Advisor's compliance with the 1940 Act and the Fund's
investment objectives and policies. The Board noted that First Trust Portfolios
L.P., an affiliate of the Advisor, has a minority ownership interest in the
Sub-Advisor and that this investment allows for more informed oversight of the
Sub-Advisor by the Advisor. With respect to the Sub-Advisory Agreement, the
Board received a presentation from representatives of the Sub-Advisor discussing
the services that the Sub-Advisor provides to the Fund and how the Sub-Advisor
meets the Fund's investment objectives. The Board considered the investment
policy change approved by shareholders at the 2007 annual meeting that
authorized the Sub-Advisor to concentrate the Fund's investments in residential
mortgage-backed securities, and noted the difficult market environment for these
securities that existed, particularly in the second half of 2007. In light of
the information presented and the considerations made, the Board concluded that
the nature, quality and extent of services provided to the Fund by the Advisor
and the Sub-Advisor under the Agreements have been and are expected to remain
satisfactory and that the Sub-Advisor has managed the Fund consistent with its
investment objectives and policies.
The Board considered the advisory and sub-advisory fees paid under the
Agreements. The Board reviewed data prepared by Lipper Inc. ("Lipper"), an
independent source, showing the management fees and expense ratios of the Fund
as compared to the management fees and expense ratios of one peer group selected
by Lipper and a second peer group selected by the Advisor. The Board discussed
with representatives of the Advisor the differences between the two peer groups
and the limitations in creating a relevant peer group for the Fund. The Board
considered the difficulties in comparing funds with different amounts of assets
and using different types of leverage. Based on the information provided, the
Board noted that the Fund's management fees were in the fourth quintile of the
Lipper peer group and the second highest in the Advisor peer group and that the
Fund's expense ratio was in the fifth quintile of the Lipper peer group and the
highest in the Advisor peer group. The Board also considered the sub advisory
fee rate and how it related to the overall management fee structure of the Fund
and noted that the Advisor pays the Sub-Advisor out of the advisory fees it
receives from the Fund. Finally, the Board considered the advisory fees paid to
the Advisor by similar funds, and noted that the Advisor does not provide
advisory services to clients with investment objectives and policies similar to
the Fund's, other than to two other closed end funds (for which the fees are
identical). The Board also considered information provided by the Sub-Advisor as
to the fees it charges to other clients, particularly two other closed end funds
for which the Advisor also serves as investment manager (the fees are
identical).
The Board also considered the Fund's performance for the one-year period ended
September 30, 2007, as compared to the performance of a relevant benchmark index
and to a performance group selected by Lipper. The Board considered the
difficulty in creating a relevant performance group for the Fund given its
unique strategy and asset mix. The Board noted that the Fund's performance was
in the fourth quintile in the performance group for the one-year period and that
the Fund underperformed its benchmark for the one-year period, although the
Boards also considered that the benchmark had a higher average credit quality
than the Fund's portfolio. The Board also considered performance data provided
by the Advisor for the one-year and since-inception periods ended December 31,
2007. The Board noted that, while the Fund had negative performance for both the
one-year and since-inception periods ended December 31, 2007, the Fund had
substantially outperformed the median of the funds included in the Advisor peer
group. The Board considered the market factors affecting the Fund's performance,
noting, particularly, the events in the residential mortgage-backed securities
market. The Board also considered an analysis prepared by the Advisor on
benefits provided by the Fund's leverage. The Board considered an analysis of
the Fund's premium/discount prepared by the Advisor and noted that the Fund's
premium/discount was generally indicative of the asset class and market events.
The Board concluded that the Fund's performance was consistent with the Fund's
investment strategy and reflective of the asset class.
On the basis of all the information provided on the fees, expenses and
performance of the Fund, the Board concluded that the advisory and sub-advisory
fees were reasonable and appropriate in light of the nature, quality and extent
of services provided by the Advisor and Sub-Advisor under the Agreements.
The Board noted that the Advisor has continued to invest in personnel and
infrastructure and had noted that the advisory fee is not structured to pass the
benefits of any economies of scale on to the shareholders of the Fund. The Board
concluded that the management fee reflects an appropriate level of sharing of
any economies of scale. The Board also considered the costs of the services
provided and profits realized by the Advisor from serving as investment manager
to closed end funds for the twelve months ended December 31, 2007, as set forth
in the materials provided to the Board. The Board noted the inherent limitations
in the profitability analysis, and concluded that the Advisor's profitability
appeared to be not excessive in light of the services provided to the Fund. In
addition, the Board considered and discussed any ancillary benefits derived by
the Advisor from its relationship with the Fund and noted that the typical fall
out benefits to the Advisor such as soft dollars are not present. The Board
concluded that any other fall out benefits received by the Advisor or its
affiliates would appear to be attenuated.
The Board considered the Sub-Advisor's representation that because of the amount
of evaluation and administration necessary for maintaining the securities in the
portfolio there are only very limited economies of scale available in connection
with its sub-advisory services. The Board noted that the Sub-Advisor believes
the sub-advisory fee is reasonable in light of any economies of scale. The Board
considered that the sub-advisory fee rate was negotiated at arm's length between
the Advisor and the Sub-Advisor. The Board considered
Page 23
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST STRATEGIC HIGH INCOME FUND II
APRIL 30, 2008 (UNAUDITED)
the Sub-Advisor's representation that its profitability, if any, is based solely
on the advisory fees it receives from the Fund and two other closed end funds in
the First Trust Fund Complex. The Board concluded that the profitability
analysis for the Advisor was more relevant. The Board noted that the Sub-Advisor
does not maintain any soft-dollar arrangements and that the Sub-Advisor did not
identify any material fall out benefits from its relationship to the Fund.
Based on all of the information considered and the conclusions reached, the
Board, including the Independent Trustees, determined that the terms of the
Agreements continue to be fair and reasonable and that the continuation of the
Agreements is in the best interests of the Fund. No single factor was
determinative in the Board's analysis.
Page 24
This Page Left Blank Intentionally.
(FIRST TRUST LOGO)
INVESTMENT ADVISOR
First Trust Advisors L.P.
1001 Warrenville Road
Lisle, IL 60532
INVESTMENT SUB-ADVISOR
Valhalla Capital Partners, LLC
2527 Nelson Miller Parkway
Louisville, KY 40223
ADMINISTRATOR, CUSTODIAN,
FUND ACCOUNTANT,
TRANSFER AGENT &
BOARD ADMINISTRATOR
PFPC Inc.
301 Bellevue Parkway
Wilmington, DE 19809
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
111 S. Wacker Drive
Chicago, IL 60606
LEGAL COUNSEL
Chapman and Cutler LLP
111 W. Monroe Street
Chicago, IL 60603
ITEM 2. CODE OF ETHICS.
Not applicable.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
Not applicable.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Not applicable.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
Not applicable.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to
shareholders filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
Not applicable.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
There has been no change, as of the date of this filing, in any of the
portfolios managers identified in response to paragraph (a)(1) of this Item in
the Registrant's most recently filed annual report on Form N-CSR.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these
controls and procedures required by Rule 30a-3(b) under the 1940 Act
(17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the
Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's second
fiscal quarter of the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Not applicable.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act
and Section 906 of the Sarbanes-Oxley Act of 2002 are attached
hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) FIRST TRUST STRATEGIC HIGH INCOME FUND II
By (Signature and Title)* /S/ JAMES A. BOWEN
-------------------------------------------------------
James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date JUNE 26, 2008
----------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /S/ JAMES A. BOWEN
-------------------------------------------------------
James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date JUNE 26, 2008
----------------------------------------------------------------------------
By (Signature and Title)* /S/ MARK R. BRADLEY
-------------------------------------------------------
Mark R. Bradley, Treasurer, Controller, Chief Financial
Officer and Chief Accounting Officer
(principal financial officer)
Date JUNE 26, 2008
----------------------------------------------------------------------------
* Print the name and title of each signing officer under his or her signature.