DEBT
STRATEGIES
FUND, INC.
[GRAPHIC OMITTED]
STRATEGIC
Performance
Annual Report
February 28, 1998
<PAGE>
DEBT STRATEGIES FUND, INC.
The Benefits and Risks of Leveraging
Debt Strategies Fund, Inc. has the ability to utilize leverage through
borrowings or issuance of short-term debt securities or shares of Preferred
Stock. The concept of leveraging is based on the premise that the cost of assets
to be obtained from leverage will be based on short-term interest rates, which
normally will be lower than the return earned by the Fund on its longer-term
portfolio investments. Since the total assets of the Fund (including the assets
obtained from leverage) are invested in higher-yielding portfolio investments,
the Fund's Common Stock shareholders are the beneficiaries of the incremental
yield. Should the differential between the underlying interest rates narrow, the
incremental yield "pick up" will be reduced. Furthermore, if long-term interest
rates rise, the Common Stock's net asset value will reflect the full decline in
the entire portfolio holdings resulting therefrom since the assets obtained from
leverage do not fluctuate.
Leverage creates risks for holders of Common Stock including the likelihood of
greater net asset value and market price volatility. In addition, there is the
risk that fluctuations in interest rates on borrowings (or in the dividend rates
on any Preferred Stock, if the Fund were to issue Preferred Stock) may reduce
the Common Stock's yield and negatively impact its market price. If the income
derived from securities purchased with assets received from leverage exceeds the
cost of leverage, the Fund's net income will be greater than if leverage had not
been used. Conversely, if the income from the securities purchased is not
sufficient to cover the cost of leverage, the Fund's net income will be less
than if leverage had not been used, and therefore the amount available for
distribution to Common Stock shareholders will be reduced. In this case, the
Fund may nevertheless decide to maintain its leveraged position in order to
avoid capital losses on securities purchased with leverage. However, the Fund
will not generally utilize leverage if it anticipates that its leveraged capital
structure would result in a lower rate of return for its Common Stock than would
be obtained if the Common Stock were unleveraged for any significant amount of
time.
Portfolio Profile As of February 28, 1998
- --------------------------------------------------------------------------------
Quality Ratings Percent of
S&P/Moody's Market Value*
- --------------------------------------------------------------------------------
BBB/Baa ................................................................. 0.4%
BB/Ba ................................................................... 26.0
B/B ..................................................................... 47.0
CCC/Caa ................................................................. 0.8
NR (Not Rated) .......................................................... 25.7
- --------------------------------------------------------------------------------
* Total may not equal 100%.
- --------------------------------------------------------------------------------
Percent of
Five Largest Industries Total Assets
- --------------------------------------------------------------------------------
Health Services ........................................................ 10.1%
Paper .................................................................. 6.2
Telecommunications ..................................................... 5.8
Chemicals .............................................................. 5.6
Metals & Mining ........................................................ 5.5
- --------------------------------------------------------------------------------
<PAGE>
Debt Strategies Fund, Inc., February 28, 1998
DEAR SHAREHOLDER
Since inception (May 30, 1997) through February 28, 1998, the total investment
return on the Fund's Common Stock was +7.99%, based on a change in per share net
asset value from $10.00 to $10.15, and assuming reinvestment of $0.629 per share
income dividends. During the same period, the net annualized yield of the Fund's
Common Stock was 9.26%. At the end of the February quarter, the Fund was
leveraged in an amount equal to 31% of total assets, having borrowed $142.6
million of its $160.0 million credit facility at an average borrowing cost of
5.99%. (For a complete explanation of the benefits and risks of leveraging, see
page 1 of this report to shareholders.)
Portfolio Strategy
Although the high-yield market has been very strong since the beginning of 1998,
we have continued to increase the weighting of bank loans in the Fund, since
floating rate bank loans are more attractive than high-yield bonds from a
risk/reward standpoint. As long-term US interest rates moved lower, those
leveraged senior secured floating rate bank loans that are set at a spread above
the London Interbank Offered Rate (LIBOR) are priced in the new-issue market at
yields that are often equivalent to the pricing of unsecured subordinated bonds
of the same issuer. In the absence of a significant change in the current
interest rate environment, we intend at the present time to maintain a minimum
45% weighting in floating rate loans.
As of February 28, 1998, more than 96% of the Fund's investments in corporate
loans were accruing interest at a yield spread above LIBOR, the rate that major
international banks charge each other for US dollar-denominated deposits outside
of the United States. Since the average reset on the Fund's floating rate
investments is 43 days, the yield on the bank loan portion of the Fund is likely
to move up within a one-month-two-month period after any rate increase. At
February 28, 1998, floating rate securities made up 51.8% of the market value of
the Fund's investments, with an additional 48.2% invested in fixed-rate
high-yield bonds. Approximately $58.6 million remains available under the
leverage facility. The leveraged loan market continued to be strong,
particularly during the last half of the fiscal year. Demand for bank loans was
robust, as banks and other institutional investors competed for the fees and
high spreads available in this sector. This demand continued the trend in
growing liquidity and the run up in prices for leveraged bank loans that
commenced at the beginning of 1998. Leveraged loan new-issue volume increased
44% last year to $194.0 billion. (Leveraged loans are those at a spread of at
least 1.5% over LIBOR.) This is the highest total of the 1990s. At the same
time, secondary trading volume of leveraged loans reached $62.0 billion in 1997,
the highest level on record.
With almost uninterrupted inflows of investor assets, yield spreads in the
high-yield bond market remained at historically narrow levels throughout most of
1997. The high-yield bond market benefited from strong demand, a good economy, a
record-breaking US stock market, and low default rates. High-yield bonds
generated a third consecutive year of positive double-digit returns. With a
total return of +12.83% for 1997, the unmanaged Merrill Lynch High Yield Master
Index was up from +11.06% in 1996. This improvement reflected the boost from
declining interest rates as the ten-year Treasury fell from 6.42% to 5.75%
during the year. This was partially offset by the slight widening of the Index's
spread over Treasury securities from 296 basis points to 312 basis points (2.96%
to 3.12%).
New high-yield bond issuance broke all previous records in 1997. The dollar
volume of $118.7 billion was up 64%, breaking the previous record of $72.3
billion set in 1993. From an industry standpoint, telecommunications grew to
over 12% of the market in 1997. Companies such as Sprint PCS and Iridium issued
high-yield bonds to fund their huge capital needs for the build out of their
systems in the next generation of wireless telephony. By year-end, cable
television and telecommunications accounted for over 25% of the outstanding
bonds in the high-yield universe. This is reflected in the fact that these two
sectors now make up a sizable portion of the Fund.
Overall, fundamentals for both the bank loan and high-yield bond market remain
positive as favorable quarterly earnings and more rating upgrades than
downgrades continued into the first calendar quarter of this year. Defaults,
although expected to increase this year, are at historically low levels. Our
focus will continue to be to invest in those companies that are generating
improved earnings trends or whose securities we believe are undervalued. The
industry focus has been on those companies that have leading market shares,
strong managements and improving cash flows. The best-performing industry
sectors included cable television, publishing, and radio and television
broadcasting. These industries not only had more stable cash flows than many of
their cyclical counterparts, but also benefited from the substantial mergers and
acquisition activity in these sectors. A number of cyclical sectors
underperformed the market at large. Paper and metals and mining underperformed
in the second half of the year, resulting from the concerns over the longer-term
effects of the Asian currency crisis on these industries. In certain cyclical
names, we have been more willing to trade out of the unsecured bond and into the
senior secured bank debt in order to limit the Fund's downside volatility. Other
underperforming sectors included diversified financial services and the grocery
segment. Both segments were hurt by both disappointing earnings reports and the
announcements of debt restructuring for specific companies in the respective
industries. The Fund reduced its holdings in each of these sectors during the
last six months.
At February 28, 1998, the Fund was fully invested. The Fund's average stated
maturity was 7.5 years but, based upon past experience, the Fund can be expected
to have a real average life of approximately 2 years-3 years as a result of the
shorter average life of bank loans which are freely prepayable without call
protection. At February 28, 1998, the Fund's floating rate investments were
spread across 46 borrowers in 23 industries. Fixed-rate investments were spread
across 99 borrowers in 35 industries. The largest industry concentrations based
on total assets were: telecommunications (5.8%); health services (10.1%); paper
(6.2%); chemicals (5.6%); and metals and mining (5.5%).
Stronger companies are taking advantage of attractive public debt and equity
markets to improve their balance sheets and reduce debt. With a low ten-year
Treasury and strong investor demand in the bank loan and high-yield bond
markets, the first quarter of 1998 appears to be on the same rapid pace of new
issuance as non-investment grade investors rush to market to refinance with
lower-cost debt and refinance existing facilities.
Over the coming months, we expect high-yield bond and leveraged bank loan
pricing to be firm. With the Federal Reserve Board adopting a neutral position
for the short term, fixed-income investors are positive on the bond and loan
markets. Flows into the high-yield bond and loan market are, and should remain,
steady. Although we expect the forward calendar to continue to be strong, we
remain cautious in light of the full valuations seen today. We will continue to
be opportunistic in our high-yield bond purchases, selling overvalued bonds and
sectors and buying undervalued ones. In the meantime, we will maintain a
defensive position in secured floating rate bank debt, buying new issues in the
high-yield market and buying into the secondary market when undervalued
investments are available. We believe the Fund is well positioned to provide
shareholders with the benefit of an increase in interest rates or a stable rate
environment.
The Fund continued to have less than 10% of its assets in companies domiciled
outside of the United States, focusing primarily in Latin America and Europe. As
a result, performance for the three months ended February 28, 1998 was less
volatile, even with the downturn in Asian markets. At February 28, 1998, the
portion of the Fund's investments in distressed securities was less than 1% of
net assets. We continue to believe that this market is less attractive after six
years of sustained economic growth. We expect to see more compelling
opportunities during the coming months.
In Conclusion
We appreciate your ongoing investment in Debt Strategies Fund, Inc., and we look
forward to reviewing our strategy with you again in our next report to
shareholders.
Sincerely,
/s/ Arthur Zeikel
Arthur Zeikel
President
/s/ R. Douglas Henderson
R. Douglas Henderson
Senior Vice President and
Portfolio Manager
April 13, 1998
2 & 3
<PAGE>
Debt Strategies Fund, Inc., February 28, 1998
SCHEDULE OF INVESTMENTS
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations** Cost (Note 1b)
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Advertising--1.0% B Ba2 $ 3,000,000 Outdoor Systems, Inc., 8.875% due 6/15/2007 (b) $ 2,976,605 $ 3,146,250
====================================================================================================================================
Aerospace--1.7% NR* Ba3 2,940,000 KF Industries Inc., Term B, due 10/15/2005 2,958,375 2,962,050
NR* NR* 2,605,317 Whittaker Corporation, Revolving Credit, due 4/09/2001 2,605,233 2,595,644
----------- -----------
5,563,608 5,557,694
====================================================================================================================================
Agricultural B B2 3,000,000 Sun World International Inc., 11.25% due 4/15/2004 3,146,250 3,277,500
Products--1.0%
====================================================================================================================================
Aircraft & B- B3 1,500,000 Argo-Tech Corp., 8.625% due 10/01/2007 (b) 1,500,000 1,533,750
Parts--0.5%
====================================================================================================================================
Amusement & B B2 2,000,000 AMC Entertainment Inc., 9.50% due 3/15/2009 (b) 2,082,500 2,090,000
Recreational AMF Group, Inc.:
Services--4.8% NR* Ba3 1,965,993 Revolving Credit, due 3/31/2002 1,965,993 1,964,764
NR* Ba3 1,493,902 Term C, due 3/31/2002 1,490,396 1,492,969
B- B3 1,000,000 Hollywood Theater Inc., 10.625% due 8/01/2007 1,000,000 1,080,000
CCC NR* 3,000,000 Marvel Entertainment Group Inc., Term B, due 2/28/2002 2,095,042 1,725,000
Metro Goldwyn Mayer (MGM):
NR* NR* 1,305,000 Revolving Credit, due 9/30/2003 1,305,000 1,287,056
NR* NR* 2,000,000 Term A, due 12/31/2005 1,990,333 1,972,500
B B2 3,350,000 Riddell Sports, Inc., Senior Notes, 10.50% due
7/15/2007 (b) 3,393,875 3,534,250
----------- -----------
15,323,139 15,146,539
====================================================================================================================================
Apparel--1.9% Arenabrands:
NR* NR* 1,726,267 Term A, due 6/01/2002 1,728,425 1,732,741
NR* NR* 3,142,861 Term B, due 6/01/2002 3,146,789 3,154,647
B- B3 1,175,000 GFSI, Inc., 9.625% due 3/01/2007 1,198,500 1,239,625
----------- -----------
6,073,714 6,127,013
====================================================================================================================================
Automotive B- B3 3,000,000 AM General Corporation, 12.875% due 5/01/2002 3,037,500 3,217,500
Equipment--5.4% NR* B1 1,443,924 Advanced Accessory, Term B, due 10/30/2004 1,441,193 1,444,827
B- B3 2,000,000 Cambridge Industries, Inc., 10.25% due 7/15/2007 2,000,000 2,090,000
B- B3 1,000,000 Newcor Inc., 9.875% due 3/01/2008 (b) 1,000,000 1,000,000
B- B3 3,000,000 Oxford Automotive, Inc., 10.125% due 6/15/2007 (b) 2,995,716 3,168,750
B- B3 3,000,000 Safety Components International, Inc., 10.125%
due 7/15/2007 3,000,000 3,120,000
B- B2 1,000,000 Trident Automotive, 10% due 12/15/2005 1,000,000 1,030,000
B+ B2 2,000,000 Walbro Corp., 10.125% due 12/15/2007 2,000,000 2,075,000
----------- -----------
16,474,409 17,146,077
====================================================================================================================================
Broadcast--Radio & B- B3 1,000,000 ACME Television LLC, 10.875% due 9/30/2004 (b)(d) 760,923 800,000
Television--2.6% B- B2 4,000,000 Capstar Broadcasting Partner, 9.25% due 7/01/2007 (b) 3,984,936 4,180,000
B- Caa 3,000,000 EchoStar DBS Communications Corporation, 12.50% due
7/01/2002 (b) 3,000,000 3,322,500
----------- -----------
7,745,859 8,302,500
====================================================================================================================================
Building NR* NR* 5,000,000 Dal-Tile International Inc., Term B, due 12/31/2003 4,977,066 4,800,000
Materials--6.6% NR* NR* 6,239,676 Euramax/Amerimax Holding, Inc., Term, due 6/30/2004 6,232,393 6,239,676
NR* B1 3,739,286 Falcon Building Products, Inc., Term, due 6/30/2005 3,725,255 3,734,612
BB- Ba3 5,500,000 John's Manville International Group, 10.875% due
12/15/2004 6,181,250 6,091,250
----------- -----------
21,115,964 20,865,538
====================================================================================================================================
Building & BB Ba2 2,000,000 Kaufman and Broad Home Corporation, 7.75% due 10/15/2004 1,984,739 1,990,000
Construction--0.6%
====================================================================================================================================
Cable--1.4% NR* NR* 4,617,347 Marcus Cable Operating Co., Term A, due 12/31/2002 4,617,347 4,610,132
====================================================================================================================================
Cable B+ B1 4,485,000 Telewest Communications PLC, 9.625% due 10/01/2006 4,715,463 4,776,525
Television--1.5%
====================================================================================================================================
Capital Goods--0.7% BB- B1 2,000,000 Essex Group Inc., 10% due 5/01/2003 2,110,000 2,090,000
====================================================================================================================================
Casinos--2.2% B+ B2 3,000,000 Autotote Corporation (Class A), 10.875% due 8/01/2004 3,000,000 3,180,000
BB Ba3 3,500,000 Grand Casinos, Inc., 10.125% due 12/01/2003 3,703,750 3,788,750
----------- -----------
6,703,750 6,968,750
====================================================================================================================================
Chemicals--8.3% B+ B1 2,000,000 DI Industries, Inc., 8.875% due 7/01/2007 1,990,586 2,040,000
NR* NR* 1,000,000 Dine, S.A. de C.V., 8.75% due 10/15/2007 992,658 967,500
Foamex International, Inc.:
NR* NR* 1,989,368 Term B, due 6/30/2005 2,004,288 2,000,558
NR* NR* 2,369,048 Term C, due 6/30/2006 2,386,815 2,382,374
Huntsman Corporation:
B+ B2 6,000,000 (Floater), 9.093% due 7/01/2007 6,000,000 6,225,000
NR* Ba2 2,475,000 Term B, due 3/15/2004 2,513,672 2,492,016
NR* Ba2 2,475,000 Term C, due 3/15/2005 2,513,672 2,492,016
NR* B1 4,987,500 Pioneer American Holding Corporation, Term, due 12/05/2006 4,982,741 4,962,563
BB- NR* 3,000,000 Trikem S.A., 10.625% due 7/24/2007 2,996,151 2,670,000
----------- -----------
26,380,583 26,232,027
====================================================================================================================================
Computer NR* B1 4,987,500 DecisionOne Corporation, Term B, due 8/07/2005 4,980,368 4,968,797
Equipment--1.6%
====================================================================================================================================
Consumer E&S Holdings Corp.:
Products--2.9% NR* B1 1,944,445 Term B, due 9/30/2004 1,954,167 1,918,924
NR* B1 1,944,445 Term C, due 9/30/2005 1,954,167 1,920,139
NR* B1 1,111,111 Term D, due 3/31/2005 1,116,667 1,097,917
NR* B1 2,179,687 Hedstrom Corp., Term B, due 6/30/2005 2,172,040 2,182,412
B Ba3 2,000,000 Shop-Vac Corp., 10.625% due 9/01/2003 2,180,000 2,180,000
----------- -----------
9,377,041 9,299,392
====================================================================================================================================
Diversified--2.7% AmeriServe Food Company:
B+ B1 3,000,000 8.875% due 10/15/2006 3,000,000 3,097,500
B- B3 3,000,000 10.125% due 7/15/2007 3,000,000 3,247,500
B+ B3 2,000,000 Insilco Corporation, 10.25% due 8/15/2007 2,000,000 2,140,000
----------- -----------
8,000,000 8,485,000
====================================================================================================================================
</TABLE>
4 & 5
<PAGE>
Debt Strategies Fund, Inc., February 28, 1998
SCHEDULE OF INVESTMENTS (continued)
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations** Cost (Note 1b)
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Drilling--2.0% B B1 $ 3,000,000 Cliffs Drilling Company (Series B), 10.25% due 5/15/2003 $ 3,255,000 $ 3,270,000
B+ Ba3 3,000,000 Falcon Drilling Company, Inc., 9.75% due 1/15/2001 3,172,500 3,112,500
----------- -----------
6,427,500 6,382,500
====================================================================================================================================
Drug Stores--0.8% NR* NR* 2,500,000 Duane Reade Co., Term B, due 2/15/2005 2,492,221 2,518,750
====================================================================================================================================
Electronics/
Electrical NR* Ba3 4,265,625 Amphenol Corporation, Term B, due 5/19/2005 4,345,605 4,294,187
Components--3.3% NR* B3 1,000,000 High Voltage Engineering Corp., 10.50% due 8/15/2004 1,000,000 1,050,000
NR* B1 4,984,424 International Wire Group, Inc., Term B, due 9/30/2003 4,979,887 4,996,885
----------- -----------
10,325,492 10,341,072
====================================================================================================================================
Energy--5.8% B B1 2,000,000 Belco Oil & Gas Corp. (Series B), 8.875% due 9/15/2007 2,000,000 2,037,500
B- B3 3,000,000 Belden & Blake Energy Company, 9.875% due 6/15/2007 (b) 3,000,000 3,000,000
NR* Ba2 3,000,000 Clark Refining, Term, due 11/15/2004 3,000,000 3,022,500
B B2 2,000,000 Cross Timbers Oil Company (Series B), 8.75% due 11/01/2009 2,000,000 2,050,000
B B2 2,000,000 Forcenergy Inc., 8.50% due 2/15/2007 1,976,254 2,025,000
B+ B2 4,000,000 Snyder Oil Corporation, 8.75% due 6/15/2007 3,979,021 4,040,000
B- B2 2,000,000 United Refining Company, 10.75% due 6/15/2007 2,000,000 2,120,000
----------- -----------
17,955,275 18,295,000
====================================================================================================================================
Financial B+ B1 3,000,000 Delta Financial Corporation, 9.50% due 8/01/2004 2,986,413 2,925,000
Services--2.2% BBB- A2 4,000,000 SB Treasury Company LLC (Sumitomo), 9.40% due 12/29/2049 4,090,000 4,080,000
----------- -----------
7,076,413 7,005,000
====================================================================================================================================
Food & Kindred B- B3 4,000,000 Envirodyne Industries, Inc., 10.25% due 12/01/2001 4,030,000 3,990,000
Products--5.1% NR* NR* 2,500,000 Fargo Bridge, Term, due 10/30/2003 2,478,132 2,487,500
NR* NR* 4,000,000 Favorite Brands International, Senior Notes, 10.25%
due 8/20/2007 3,975,694 3,987,500
International HomeFoods, Inc.:
NR* Ba3 145,161 Revolving Credit, due 11/21/2001 145,161 144,526
NR* Ba3 3,387,097 Term A, due 11/21/2001 3,384,706 3,384,980
BB- B2 2,000,000 SC International Services, Inc., 9.25% due 9/01/2007 2,041,222 2,110,000
----------- -----------
16,054,915 16,104,506
====================================================================================================================================
Foreign BB B1 2,000,000 Republic of Brazil, 10.125% due 5/15/2027 1,865,152 1,942,500
Government
Obligations--0.6%
====================================================================================================================================
Forest Products-- B B3 3,000,000 Ainsworth Lumber Company, 12.50% due 7/15/2007 (c) 2,919,881 3,019,848
1.4% BB B1 1,500,000 Tembec Finance Corp., 9.875% due 9/30/2005 1,556,250 1,571,250
----------- -----------
4,476,131 4,591,098
====================================================================================================================================
Furniture & NR* NR* 5,000,000 Furniture Brands International Inc., Term, due 6/27/2007 5,000,000 5,009,375
Fixtures--2.6% B- B3 3,000,000 Omega Cabinets Ltd., 10.50% due 6/15/2007 3,000,000 3,165,000
----------- -----------
8,000,000 8,174,375
====================================================================================================================================
General Merchandise Speciality Retailers, Inc. (b):
Stores--1.0% NR* B2 1,500,000 8.50% due 7/15/2005 1,500,000 1,545,000
NR* B2 1,500,000 9% due 7/15/2007 1,495,127 1,552,500
----------- -----------
2,995,127 3,097,500
====================================================================================================================================
Health Services-- BB+ B1 3,000,000 Abbey Healthcare Group Inc., 9.50% due 11/01/2002 3,138,750 3,150,000
14.9% NR* Ba3 2,992,500 FPA Medical Management, Inc., Term, due 9/30/2001 2,988,585 2,985,019
B- B3 3,000,000 Graham-Field Health Products, Inc., 9.75% due 8/15/2007 3,000,000 3,202,500
Magellan Health Services, Inc.:
NR* Ba3 2,500,000 Term B, due 2/12/2005 2,496,270 2,507,812
NR* Ba3 2,500,000 Term C, due 2/12/2006 2,496,267 2,507,812
B B1 3,000,000 Physician Sales & Service Inc., 8.50% due 10/01/2007 2,988,602 3,153,750
NR* NR* 5,000,000 Sterling Diagnostic Imaging, Inc., Term B, due 9/30/2005 4,988,067 4,987,500
Sun Healthcare Group Inc.:
B- B2 3,000,000 9.50% due 7/01/2007 (b) 3,000,000 3,135,000
NR* Ba3 5,000,000 Term B, due 9/30/2003 5,015,194 5,021,874
NR* Ba3 5,000,000 Term C, due 9/30/2003 5,015,194 5,021,874
NR* NR* 5,000,000 Total Renal Care Holdings, Inc., Revolving Credit,
due 9/30/2007 5,000,000 5,000,000
B B1 4,000,000 Vencor, Inc., 8.625% due 7/15/2007 4,050,000 4,430,000
NR* NR* 2,500,000 Wilson Great Batch, 13% due 7/10/2007 (b) 2,188,340 2,181,620
----------- -----------
46,365,269 47,284,761
====================================================================================================================================
Industrial--2.0% BB- Ba1 1,000,000 Advanced Micro Devices, Inc., 11% due 8/01/2003 1,112,500 1,075,000
B- B3 2,000,000 Diamond Cable Communications PLC, 10.338% due
2/15/2007 (d) 1,361,506 1,330,000
BBB- Ba3 2,000,000 Compania Naviera Perez Companc S.A.C.F.I.M.F.A., 8.125%
due 7/15/2007 1,955,737 1,977,500
BB- Ba2 2,000,000 Gulf Canada Resources Limited, 9.25% due 1/15/2004 2,105,000 2,105,080
----------- -----------
6,534,743 6,487,580
====================================================================================================================================
Manufacturing--3.5% B+ B1 2,000,000 Bucyrus International, Inc., 9.75% due 9/15/2007 2,006,250 2,015,000
Goodman Mann:
NR* NR* 2,389,087 Term B, due 9/30/2004 2,389,087 2,395,060
NR* NR* 2,389,087 Term C, due 9/30/2005 2,389,087 2,395,060
B- B3 500,000 Roller Bearing Co. of America, 9.625% due 6/15/2007 (b) 500,000 515,000
NR* B3 3,500,000 Tokheim Corporation, 11.50% due 8/01/2006 3,928,750 3,902,500
----------- -----------
11,213,174 11,222,620
====================================================================================================================================
Metals & Mining-- NR* NR* 2,952,381 Adience, Inc., Holdco, Term, due 4/15/2005 2,942,020 2,948,690
8.0% B B1 2,000,000 Anker Coal Group Inc., 9.75% due 10/01/2007 (b) 2,030,000 2,030,000
NR* B1 3,000,000 CSN Iron Panama, 9.125% due 6/01/2007 (b) 2,987,089 2,613,750
NR* NR* 4,927,884 Doe Run Resources Corp., Term, due 10/23/2003 4,909,912 4,915,565
B B2 5,000,000 G.S. Technologies Operating Co., 12% due 9/01/2004 5,425,000 5,550,000
BB Ba2 2,000,000 Grupo Imsa S.A., 8.93% due 9/30/2004 1,999,407 2,030,000
BB- Ba3 2,000,000 Murrin, Murrin Holdings Party, 9.375% due 8/31/2007 2,000,000 1,960,000
B B3 3,000,000 Westmin Resources Ltd., 11% due 3/15/2007 3,166,250 3,480,000
----------- -----------
25,459,678 25,528,005
====================================================================================================================================
</TABLE>
6 & 7
<PAGE>
Debt Strategies Fund, Inc., February 28, 1998
SCHEDULE OF INVESTMENTS (concluded)
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations** Cost (Note 1b)
====================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Packaging--1.8% NR* NR* $ 1,000,000 Packaging Resources Inc., 13% due 6/30/2003 (b)(c) $ 958,713 $ 752,825
B B2 4,975,000 Silgan Corp., Term B, due 6/30/2005 4,999,875 4,981,219
----------- -----------
5,958,588 5,734,044
====================================================================================================================================
Paper--9.1% NR* B 5,000,000 Gaylord Container Corp., 9.75% due 6/15/2007 5,000,000 5,025,000
B- B2 2,000,000 PT Pabrik Kertas Tjiwi Kimia, 10% due 8/01/2004 1,989,742 1,580,000
B- B2 1,000,000 Pindo Deli Finance Mauritius, 10.75% due 10/01/2007 (b) 997,052 790,000
CCC B2 6,000,000 Repap New Brunswick, Inc., 8.937% due 7/15/2000 5,939,098 5,910,000
B+ B1 5,678,010 Riverwood International, Inc., Term A, due 2/28/2003 5,685,107 5,681,558
NR* Ba3 9,893,618 Stone Container Corporation, Term B, due 4/01/2000 9,826,920 9,912,786
----------- -----------
29,437,919 28,899,344
====================================================================================================================================
Printing & NR* NR* 5,000,000 21st Century Newspapers, Inc., Term B, due 9/15/2005 4,995,232 5,021,875
Publishing--2.7% NR* B2 2,000,000 Big Flower Press Holdings, Inc., 8.875% due
7/01/2007 1,984,309 2,035,000
B- B3 1,500,000 T/SF Communications Corp., 10.375% due 11/01/2007 1,477,827 1,515,000
----------- -----------
8,457,368 8,571,875
====================================================================================================================================
Real Estate--0.5% NR* NR* 2,000,000 Rockefeller Center Properties, Trust (Convertible),
11.404% due 12/31/2000 (d) 1,476,300 1,487,500
====================================================================================================================================
Retail
Specialty--0.6% NR* B3 2,000,000 United Auto Group, Inc., 11% due 7/15/2007 1,971,593 1,880,000
====================================================================================================================================
Shipping--1.9% B+ B3 4,000,000 Equiman Shipholdings, Ltd., 9.875% due 7/01/2007 (b) 4,000,000 3,800,000
B+ B2 2,500,000 Global Ocean Carriers Ltd., 10.25% due 7/15/2007 2,463,409 2,275,000
----------- -----------
6,463,409 6,075,000
====================================================================================================================================
Steel--0.9% BB Ba3 3,000,000 Hysla, S.A. de C.V., 9.25% due 9/15/2007 (b) 2,983,339 3,001,500
====================================================================================================================================
Telecommunications-- Brooks Fiber Properties, Inc.:
8.5% NR* NR* 3,000,000 10.501% due 3/01/2006 (d) 2,231,889 2,587,500
NR* NR* 1,250,000 10% due 6/01/2007 (b) 1,267,188 1,442,188
Cellular Inc.:
NR* B1 586,527 Term B, due 9/30/2006 585,067 585,061
NR* B1 1,161,440 Term C, due 3/31/2007 1,158,548 1,158,536
NR* B1 3,252,033 Term D, due 9/30/2007 3,243,933 3,243,903
B B2 2,000,000 Intermedia Communications of Florida, Inc., 8.875%
due 11/01/2007 2,000,000 2,110,000
NR* NR* 3,500,000 Metronet Communications, Inc., 12% due 8/15/2007 (e) 3,465,273 4,042,500
B+ B3 2,000,000 PTC International Finance B.V., 10.269% due 7/01/2007 (d) 1,319,278 1,370,000
NR* NR* 4,987,500 Price Communications Corp., Term B, due 9/30/2006 4,977,834 5,018,672
NR* B3 2,000,000 RCN Corp., 10% due 10/15/2007 2,000,000 2,107,500
Telegroup Inc.:
NR* NR* 1,500,000 8% due 5/01/2000 (d) 1,224,646 1,230,000
NR* NR* 1,500,000 8% due 4/15/2005 1,500,000 2,100,000
----------- -----------
24,973,656 26,995,860
====================================================================================================================================
Telephone B+ B2 2,500,000 Grupo Iusacell S.A., 10% due 7/15/2004 2,500,000 2,606,250
Communications-- Nextel Communications, Inc.:
5.2% NR* B1 10 Revolving Credit, due 3/31/2003 10 10
NR* B1 936,330 Term C, due 3/31/2003 924,585 931,355
NR* B1 5,000,000 Term E, due 6/30/2003 4,995,339 4,993,750
NR* B1 5,000,000 Sprint Spectrum L.P., Term, due 6/29/2001 5,062,500 5,003,125
B- NR* 2,000,000 Telesystems International Wireless, Inc., 11.929%
due 6/30/2007 (b)(d) 1,261,588 1,350,000
NR* NR* 2,000,000 Unifi Communications, Inc., 14% due 3/01/2004 (b) 1,837,994 1,780,000
----------- -----------
16,582,016 16,664,490
====================================================================================================================================
Television--1.0% B+ Ba3 3,000,000 TV Azteca S.A. de C.V., 10.50% due 2/15/2007 3,228,750 3,225,000
====================================================================================================================================
Textile Mill Joan Fabrics:
Products--1.7% NR* NR* 3,618,421 Term B, due 6/30/2005 3,613,244 3,625,206
NR* NR* 1,881,579 Term C, due 6/30/2006 1,878,864 1,885,107
----------- -----------
5,492,108 5,510,313
====================================================================================================================================
Textiles--0.9% Ithaca Industries, Inc.:
NR* NR* 947,368 Revolving Credit, due 8/31/1999 947,369 939,079
NR* NR* 1,892,790 Term, due 8/31/1999 1,802,472 1,880,960
----------- -----------
2,749,841 2,820,039
====================================================================================================================================
Transportation--
3.5% BB- B1 2,000,000 Allied Holdings Inc., 8.625% due 10/01/2007 (b) 2,025,000 2,065,000
B- B3 3,000,000 Ameritruck Distribution, 12.25% due 11/15/2005 3,210,000 2,992,500
B NR* 3,000,000 MRS Logistica S.A., 10.625% due 8/15/2005 (b) 2,967,455 2,857,500
BB- Ba2 3,000,000 Stena AB, 8.75% due 6/15/2007 3,000,000 3,090,000
----------- -----------
11,202,455 11,005,000
====================================================================================================================================
Transportation NR* Ba3 4,931,757 Atlas Freight, Term, due 5/29/2004 4,920,428 4,944,086
Services--4.4% BB- NR* 4,250,000 Autopistas del Sol S.A., 10.25% due 8/01/2009 4,293,750 4,133,125
B+ B1 3,000,000 Coach USA, Inc., 9.375% due 7/01/2007 3,000,000 3,120,000
B- B3 2,000,000 Trism Inc., 10.75% due 12/15/2000 2,010,000 1,760,000
----------- -----------
14,224,178 13,957,211
====================================================================================================================================
Utilities--0.8% B+ Ba1 2,500,000 AES Corporation, 8.50% due 11/01/2007 2,495,110 2,575,000
====================================================================================================================================
Total Investments in Corporate Debt Obligations--144.1% 453,726,559 457,900,927
====================================================================================================================================
<CAPTION>
Shares
Held Warrants (a)
====================================================================================================================================
<S> <C> <C> <C> <C>
High Technology-- 318,830 WGL Holdings, Inc. 318,830 318,830
0.1%
====================================================================================================================================
Telecommunications-- 3,500 Metronet Communications, Inc. (b) 35,875 122,500
0.1%
====================================================================================================================================
</TABLE>
8 & 9
<PAGE>
SCHEDULE OF INVESTMENTS (concluded)
<TABLE>
<CAPTION>
Shares Value
INDUSTRIES Held Warrants (a) Cost (Note 1b)
====================================================================================================================================
<S> <C> <C> <C> <C>
Telephone 2,000 Unifi Communications, Inc. (b) $ 113,180 $ 40,000
Communications--
0.0%
====================================================================================================================================
Total Investments in Warrants--0.2% 467,885 481,330
====================================================================================================================================
Total Investments--144.3% $454,194,444 458,382,257
============
Liabilities in Excess of Other Assets--(44.3%) (140,647,565)
------------
Net Assets--100.0% $317,734,692
============
====================================================================================================================================
</TABLE>
(a) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock/face amount of bonds. The purchase price and number of
shares/face amount are subject to adjustments under certain conditions
until the expiration date.
(b) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(c) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
(d) Represents a zero coupon bond or step bond; the interest rate shown is the
effective yield at the time of purchase by the Fund. See Notes to
Financial Statements.
(e) Each $1,000 face amount contains one warrant of Metronet Communications,
Inc.
* Not Rated.
** Floating or Variable Rate Corporate Debt--The interest rates on floating
or variable rate corporate debt are subject to change periodically based
on the change in the prime rate of a US Bank, LIBOR (London Interbank
Offered Rate) or, in some cases, another base lending rate. Corporate
loans represent 61.8% of the Fund's net assets.
Ratings of issues shown have not been audited by Deloitte & Touche llp.
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<TABLE>
<CAPTION>
As of February 28, 1998
====================================================================================================================================
<S> <C> <C>
Assets:
Investments, at value (identified cost--$454,194,444) (Note 1b) ................................... $ 458,382,257
Interest receivable ............................................................................... 7,597,740
Deferred facility fees ............................................................................ 50,109
Deferred organization expenses (Note 1g) .......................................................... 50,720
Prepaid expenses and other assets ................................................................. 50,000
-------------
Total assets ...................................................................................... 466,130,826
-------------
====================================================================================================================================
Liabilities:
Loans (Note 6) .................................................................................... 142,600,000
Payables:
Custodian bank (Note 1j) .......................................................................... $ 1,710,550
Interest on loans (Note 6) ........................................................................ 1,408,749
Securities purchased .............................................................................. 1,000,000
Investment adviser (Note 2) ....................................................................... 210,873
Commitment fees ................................................................................... 131,211 4,461,383
-------------
Accrued expenses and other liabilities ............................................................ 1,334,751
-------------
Total liabilities ................................................................................. 148,396,134
-------------
====================================================================================================================================
Net Assets:
Net assets ........................................................................................ $ 317,734,692
=============
====================================================================================================================================
Capital:
Common Stock, $.10 par value, 200,000,000 shares authorized ....................................... $ 3,130,300
Paid-in capital in excess of par .................................................................. 309,465,971
Undistributed investment income--net .............................................................. 2,482,893
Accumulated realized capital losses on investments and foreign currency transactions--net (Note 7) (1,532,285)
Unrealized appreciation on investments--net ....................................................... 4,187,813
-------------
Net Assets--Equivalent to $10.15 per share based on 31,302,998 shares of capital stock outstanding
(market price--$10.5625) .......................................................................... $ 317,734,692
=============
====================================================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Period May 30, 1997+ to February 28, 1998
====================================================================================================================================
<S> <C> <C>
Investment Income (Note 1f):
Interest and discount earned ...................................................................... $ 26,958,954
Facility and other fees ........................................................................... 290,848
-------------
Total income ...................................................................................... 27,249,802
-------------
====================================================================================================================================
Expenses:
Loan interest expense (Note 6) .................................................................... $ 3,819,768
Investment advisory fees (Note 2) ................................................................. 1,654,171
Professional fees ................................................................................. 101,650
Borrowing costs (Note 6) .......................................................................... 70,000
Accounting services (Note 2) ...................................................................... 56,039
Directors' fees and expenses ...................................................................... 36,892
Transfer agent fees (Note 2) ...................................................................... 32,444
Printing and shareholder reports .................................................................. 23,761
Custodian fees .................................................................................... 23,105
Listing fees ...................................................................................... 18,739
Amortization of organization expenses (Note 1g) ................................................... 8,951
Pricing services .................................................................................. 4,228
Other ............................................................................................. 2,047
-------------
Total expenses before reimbursement ............................................................... 5,851,795
Reimbursement of expenses (Note 2) ................................................................ (635,093)
-------------
Expenses after reimbursement ...................................................................... 5,216,702
-------------
Investment income--net ............................................................................ 22,033,100
-------------
====================================================================================================================================
Realized & Unrealized Gain (Loss) on Investments & Foreign Currency
Transactions--Net (Notes 1c, 1d, 1f & 3):
Realized loss from:
Investments--net .................................................................................. (1,370,901)
Foreign currency transactions--net ................................................................ (80,692) (1,451,593)
-------------
Unrealized appreciation on investments--net ....................................................... 4,187,813
Net Increase in Net Assets Resulting from Operations .............................................. $ 24,769,320
=============
====================================================================================================================================
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
10 & 11
<PAGE>
Debt Strategies Fund, Inc., February 28, 1998
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Period
May 30, 1997+ to
Increase (Decrease) in Net Assets: February 28, 1998
====================================================================================================================================
Operations:
<S> <C>
Investment income--net ................................................................................. $ 22,033,100
Realized loss on investments and foreign currency transactions--net .................................... (1,451,593)
Unrealized appreciation on investments--net ............................................................ 4,187,813
Net increase in net assets resulting from operations ................................................... 24,769,320
====================================================================================================================================
Dividends to Shareholders (Note 1h):
Investment income--net ................................................................................. (19,630,899)
-------------
Net decrease in net assets resulting from dividends to shareholders .................................... (19,630,899)
-------------
====================================================================================================================================
Capital Share Transactions (Notes 1g & 4):
Proceeds from issuance of Common Stock ................................................................. 312,000,000
Value of shares issued in reinvestment of dividends .................................................... 936,916
Offering and underwriting cost resulting from the issuance of shares ................................... (440,645)
Net increase in net assets resulting from capital share transactions ................................... 312,496,271
====================================================================================================================================
Net Assets:
Total increase in net assets ........................................................................... 317,634,692
Beginning of period .................................................................................... 100,000
End of period* ......................................................................................... $ 317,734,692
=============
* Undistributed investment income--net (Note 1i) ....................................................... $ 2,482,893
=============
====================================================================================================================================
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Period
May 30, 1997+ to
February 28, 1998
====================================================================================================================================
Cash Provided by Operating Activities:
<S> <C>
Net increase in net assets resulting from operations .......................................................... $ 24,769,320
Adjustments to reconcile net increase in net assets resulting from operations to net cash provided by
operating activities:
Increase in receivables ....................................................................................... (7,597,740)
Increase in other assets ...................................................................................... (150,829)
Increase in other liabilities ................................................................................. 4,796,134
Realized and unrealized loss on investments and foreign currency transactions--net ............................ (2,736,220)
Amortization of discount ...................................................................................... (2,914,432)
---------------
Net cash provided by operating activities ..................................................................... 16,166,233
====================================================================================================================================
Cash Used for Investing Activities:
Proceeds from sales of long-term investments .................................................................. 170,634,805
Purchases of long-term investments ............................................................................ (623,914,132)
Purchases of short-term investments ........................................................................... (2,543,296,646)
Proceeds from sales and maturities of short-term investments .................................................. 2,544,844,368
---------------
Net cash used for investing activities ........................................................................ (451,731,605)
====================================================================================================================================
Cash Provided by Financing Activities:
Cash receipts on capital shares sold .......................................................................... 312,000,000
Cash payments resulting from the issuance of shares ........................................................... (440,645)
Cash receipts from borrowings ................................................................................. 224,835,000
Cash payments on borrowings ................................................................................... (82,235,000)
Dividends paid to shareholders ................................................................................ (18,693,983)
---------------
Net cash provided by financing activities ..................................................................... 435,465,372
====================================================================================================================================
Cash:
Net decrease in cash .......................................................................................... (100,000)
Cash at beginning of period ................................................................................... 100,000
---------------
Cash at end of period ......................................................................................... $ --
===============
====================================================================================================================================
Cash Flow Information:
Cash paid for interest ........................................................................................ $ 2,411,019
===============
====================================================================================================================================
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
12 & 13
<PAGE>
Debt Strategies Fund, Inc., February 28, 1998
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
The following per share data and ratios have been derived For the Period
from information provided in the financial statements. May 30, 1997+ to
Increase (Decrease) in Net Asset Value: February 28, 1998
===============================================================================================================================
Per Share Operating Performance:
<S> <C>
Net asset value, beginning of period ..................................................................... $ 10.00
----------------
Investment income--net ................................................................................... .71
Realized and unrealized gain on investments and foreign currency transactions--net ....................... .09
----------------
Total from investment operations ......................................................................... .80
----------------
Less dividends from investment income--net ............................................................... (.63)
----------------
Capital charge resulting from the issuance of Common Stock ............................................... (.02)
----------------
Net asset value, end of period ........................................................................... $ 10.15
================
Market price per share, end of period .................................................................... $ 10.5625
================
===============================================================================================================================
Total Investment Return:**
Based on market price per share .......................................................................... 12.38%++
================
Based on net asset value per share ....................................................................... 7.99%++
================
===============================================================================================================================
Ratios to Average Net Assets:
Expenses, net of reimbursement and excluding interest expense ............................................ .61%*
================
Expenses, net of reimbursement ........................................................................... 2.28%*
================
Expenses ................................................................................................. 2.56%*
================
Investment income--net ................................................................................... 9.64%*
================
===============================================================================================================================
Leverage:
Amount of borrowings, end of period (in thousands) ....................................................... $ 142,600
================
Average amount of borrowings outstanding during the period (in thousands) ................................ $ 85,903
================
Average amount of borrowings outstanding per share during the period ..................................... $ 2.79
================
===============================================================================================================================
Supplemental Data:
Net assets, end of period (in thousands) ................................................................. $ 317,735
================
Portfolio turnover ....................................................................................... 43.79%
================
===============================================================================================================================
</TABLE>
+ Commencement of operations.
* Annualized.
** Total investment returns exclude the effects of sales loads. Total investment
returns based on market value, which can be significantly greater or lesser
than the net asset value, may result in substantially different returns.
++ Aggregate total investment return.
See Notes to Financial Statements.
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies: Debt Strategies Fund, Inc. (the "Fund") is
registered under the Investment Company Act of 1940 as a diversified, closed-end
management investment company. Prior to commencement of operations on May 30,
1997, the Fund had no operations other than those relating to organizational
matters and the issuance of 10,000 shares of Common Stock to Fund Asset
Management, L.P. ("FAM") for $100,000 on May 20, 1997. The Fund determines and
makes available for publication the net asset value of its Common Stock on a
weekly basis. The Fund's Common Stock is listed on the New York Stock Exchange
under the symbol DBS.
(a) Corporate debt obligations--The Fund invests principally in debt obligations
of companies, including corporate loans made by banks and other financial
institutions and both privately and publicly offered corporate bonds and notes.
Because agents and intermediaries are primarily commercial banks, the Fund's
investment in corporate loans could be considered concentrated in financial
institutions.
(b) Valuation of investments--Corporate loans will be valued in accordance with
guidelines established by the Board of Directors. Under the Fund's current
guidelines, corporate loans will be valued at the average of the mean between
the bid and asked quotes received by one or more brokers, if available.
Other portfolio securities may be valued on the basis of prices furnished by one
or more pricing services which determines prices for normal, institutional-size
trading units of such securities using market information, transactions for
comparable securities and various relationships between securities which are
generally recognized by institutional traders. In certain circumstances,
portfolio securities are valued at the last sale price on the exchange that is
the primary market for such securities, or the last quoted bid price for those
securities for which the over-the-counter market is the primary market or for
listed securities in which there were no sales during the day. The value of
interest rate swaps, caps, and floors is determined in accordance with a formula
and then confirmed periodically by obtaining a bank quotation. Positions in
options are valued at the last sale price on the market where any such option is
principally traded. Short-term securities with remaining maturities of sixty
days or less are valued at amortized cost, which approximates market value.
Securities and assets for which market price quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Fund.
(c) Derivative financial instruments--The Fund may engage in various portfolio
strategies to seek to increase its return by hedging its portfolio against
adverse movements in the debt markets. Losses may arise due to changes in the
value of the contract or if the counterparty does not perform under the
contract.
o Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts for the purpose of hedging the
market risk on existing securities or the intended purchase of securities.
Futures contracts are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a contract, the
Fund deposits and maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the contract, the
Fund agrees to receive from or pay to the broker an amount of cash equal to the
daily fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or loss equal to
the difference between the value of the contract at the time it was opened and
the value at the time it was closed.
o Options--The Fund is authorized to write covered call and put options and
purchase call and put options. When the Fund writes an option, an amount equal
to the premium received by the Fund is reflected as an asset and an equivalent
liability. The amount of the liability is subsequently marked to market to
reflect the current market value of the option written. When a security is
purchased or sold through an exercise of an option, the related premium paid (or
received) is added to (or deducted from) the basis of the security acquired or
deducted from (or added to) the
14 & 15
<PAGE>
Debt Strategies Fund, Inc., February 28, 1998
NOTES TO FINANCIAL STATEMENTS (concluded)
proceeds of the security sold. When an option expires (or the Fund enters into a
closing transaction), the Fund realizes a gain or loss on the option to the
extent of the premiums received or paid (or gain or loss to the extent the cost
of the closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
o Interest rate transactions--The Fund is authorized to enter into interest rate
swaps and purchase or sell interest rate caps and floors. In an interest rate
swap, the Fund exchanges with another party their respective commitments to pay
or receive interest on a specified notional principal amount. The purchase of an
interest rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below) a predetermined interest rate, to
receive payments of interest equal to the difference between the index and the
predetermined rate on a notional principal amount from the party selling such
interest rate cap (or floor).
(d) Foreign currency transactions--Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets or liabilities expressed in
foreign currencies into US dollars. Realized and unrealized gains or losses from
investments include the effects of foreign exchange rates on investments.
(e) Income taxes--It is the Fund's policy to comply with the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no Federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(f) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Dividend income is recorded on the ex-dividend dates. Interest income (including
amor-tization of discount) is recognized on the accrual basis. Realized gains
and losses on security transactions are determined on the identified cost basis.
Facility fees are accreted to income over the term of the related loan.
(g) Deferred organization expenses--Deferred organization expenses are amortized
on a straight-line basis over a five-year period. Direct expenses relating to
the public offering of the Fund's Common Stock were charged to capital at the
time of issuance of the shares.
(h) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
(i) Reclassification--Generally accepted accounting principles require that
certain components of net assets be adjusted to reflect permanent differences
between financial and tax reporting. Accordingly, current year's permanent
book/tax differences of $80,692 have been reclassified between accumulated net
realized capital losses and undistributed net investment income. These
reclassifications have no effect on net assets or net asset value per share.
(j) Custodian bank--The Fund recorded an amount payable to the Custodian Bank
reflecting an overnight overdraft which resulted from an unpro jected payment of
net investment income dividends.
2. Investment Advisory Agreement and Transactions with Affiliates: The Fund has
entered into an Investment Advisory Agreement with FAM. The general partner of
FAM is Princeton Services, Inc. ("PSI"), an indirect wholly-owned subsidiary of
Merrill Lynch & Co., Inc. ("ML & Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services the Fund pays a monthly fee at
an annual rate of 0.60% of the Fund's average weekly net assets plus the
proceeds of any outstanding borrowings used for leverage. For the period May 30,
1997 to February 28, 1998, FAM earned fees of $1,654,171, of which $635,093 was
voluntarily waived.
For the period May 30, 1997 to February 28, 1998, the Fund paid Merrill Lynch
Security Pricing Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith
Inc. ("MLPF&S"), $342 for security price quotations to compute the net asset
value of the Fund.
Accounting services are provided to the Fund by FAM at cost.
The Fund's leverage facility is currently provided by Merrill Lynch
International Bank Limited, an affiliate of FAM (as further described in Note
6).
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, and/or ML & Co.
3. Investments: Purchases and sales of investments, excluding short-term
securities, for the period May 30, 1997 to February 28, 1998 were $624,914,132
and $170,634,805, respectively.
Net realized gains (losses) for the period May 30, 1997 to February 28, 1998 and
unrealized gains as of February 28, 1998 were as follows:
- --------------------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains
- --------------------------------------------------------------------------------
Long-term investments ..................... $(1,370,962) $ 4,187,813
Short-term investments .................... 61 --
Foreign currency transactions ............. (80,692) --
----------- -----------
Total ..................................... $(1,451,593) $ 4,187,813
=========== ===========
- --------------------------------------------------------------------------------
As of February 28, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $4,173,624, of which $8,463,462 related to appreciated
securities and $4,289,838 related to depreciated securities. The aggregate cost
of investments at February 28, 1998 for Federal income tax purposes was
$454,208,633.
4. Capital Stock Transactions: The Fund is authorized to issue 200,000,000
shares of Common Stock, par value $.10 per share. Shares issued and outstanding
during the period May 30, 1997 to February 28, 1998 increased by 31,210,000 from
shares sold and by 82,998 as a result of dividend reinvestment.
5. Unfunded Loan Interests: As of February 28, 1998, the Fund had unfunded loan
commitments of $46,380,264, which would be extended at the option of the
borrower, pursuant to the following loan agreements:
- --------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in thousands)
- --------------------------------------------------------------------------------
AMF Group Inc. .............................................. $ 1,688
Ameriserve Food Company ..................................... 3,288
Federal Mogul Corp. ......................................... 10,000
International HomeFoods, Inc. ............................... 6,794
Ithaca Industries ........................................... 3,116
Metro Goldwyn Mayer (MGM) ................................... 1,925
Nextel Communications, Inc. ................................. 5,824
Omnipoint Communications .................................... 3,125
Total Renal Care Holdings ................................... 5,000
Von Hoffman Press Inc. ...................................... 3,836
Whittaker Corporation ....................................... 1,784
- --------------------------------------------------------------------------------
6. Short-Term Borrowings: On August 7, 1997, the Fund entered into a credit
agreement with Merrill Lynch International Bank Limited, an affiliate of FAM,
through August 7, 1998. The agreement is a $160,000,000 credit facility bearing
interest at the Federal Funds rate plus 0.25% and/or LIBOR plus 0.25%. For the
period May 30, 1997 to February 28, 1998, the maximum amount borrowed was
$153,500,000, the average amount borrowed was approximately $85,903,000 and the
daily weighted average interest rate was 5.88%. For the period May 30, 1997 to
February 28, 1998, facility and commitment fees aggregated approximately
$70,000.
7. Capital Loss Carryforward: At February 28, 1998, the Fund had a net capital
loss carryforward of approximately $263,000, all of which expires in 2006. This
amount will be available to offset like amounts of any future taxable gains.
8. Subsequent Event: On March 9, 1998, the Fund's Board of Directors declared an
ordinary income dividend to Common Stock shareholders in the amount of $.074452
per share, payable on March 31, 1998 to shareholders of record as of March 23,
1998.
16 & 17
<PAGE>
Debt Strategies Fund, Inc., February 28, 1998
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Debt Strategies Fund, Inc.:
We have audited the accompanying statement of assets, liabilities and capital,
including the schedule of investments, of Debt Strategies Fund, Inc. as of
February 28, 1998, the related statements of operations, changes in net assets,
cash flows, and the financial highlights for the period May 30, 1997
(commencement of operations) to February 28, 1998. These financial statements
and the financial highlights are the responsibility of the Fund's management.
Our responsibility is to express an opinion on these financial statements and
the financial highlights based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements and the financial highlights
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. Our
procedures included confirmation of securities owned at February 28, 1998 by
correspondence with the custodian, brokers and financial intermediaries or other
alternative procedures. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Debt Strategies
Fund, Inc. as of February 28, 1998, the results of its operations, the changes
in its net assets, its cash flows, and the financial highlights for the period
May 30, 1997 to February 28, 1998 in conformity with generally accepted
accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
April 20, 1998
PORTFOLIO INFORMATION
<TABLE>
<CAPTION>
Percent of
As of February 28, 1998 Total Assets
====================================================================================================================================
Ten Largest Holdings
<S> <C> <C>
Sun Healthcare Group Inc. Sun Healthcare, through its direct and indirect subsidiaries, is a leading provider of 2.9%
long-term, subacute and related specialty healthcare services. The company also provides
rehabilitation therapy, respiratory therapy, temporary therapy staffing services and
pharmaceutical products and services to both affiliated and nonaffiliated facilities in the
United States and outpatient therapy in Canada.
- ------------------------------------------------------------------------------------------------------------------------------------
Nextel Communications, Inc. Nextel is the leading provider of specialized mobile radio wireless communications services in 2.6
nine of the ten largest metropolitan areas in the United States. Nextel's operating revenues
primarily arise from dispatch and mobile phone service provided on frequencies licensed to
its subsidiaries by the Federal Communications Commission and to a lesser extent, from sales
and maintenance of equipment.
- ------------------------------------------------------------------------------------------------------------------------------------
Huntsman Corp. Huntsman is one of the largest privately held chemical companies in North America and 2.4
is a leading integrated producer of commodity and specialty chemicals and polymers.
- ------------------------------------------------------------------------------------------------------------------------------------
Federal Mogul Corp. Federal Mogul is a world leader in the design, manufacturing, marketing and distribution of 2.2
a broad line of gaskets for the auto industry's original equipment manufacturers. Additionally,
the company is a leading supplier of heavy-duty diesel engine parts, high performance drive-line
components, and specialty lubricants, sealants, adhesives and other products.
- ------------------------------------------------------------------------------------------------------------------------------------
Stone Container Corp. Stone Container is a major international pulp and paper company engaged principally in the 2.2
production and sale of paper, packaging and market pulp.
- ------------------------------------------------------------------------------------------------------------------------------------
AmeriServe Food AmeriServe is North America's largest systems food service distributor specializing in 2.1
Company distribution to chain restaurants, the fastest growing segment of the domestic
restaurant industry.
- ------------------------------------------------------------------------------------------------------------------------------------
Euramax/Amerimax Euramax is a leading international downstream producer of aluminum and steel products 1.4
Holding, Inc. with facilities in the United States, the United Kingdom, the Netherlands and
France.
- ------------------------------------------------------------------------------------------------------------------------------------
John's Manville John's Manville is a leading manufacturer of installation and building products. 1.3
International Group
- ------------------------------------------------------------------------------------------------------------------------------------
Repap New Brunswick, Inc. Repap New Brunswick is an integrated producer of high-quality, coated groundwood paper, 1.3
northern bleached softwood kraft pulp and lumber.
- ------------------------------------------------------------------------------------------------------------------------------------
Sprint Spectrum L.P. Sprint Spectrum is a development stage enterprise formed for the purpose of establishing 1.1
a nationwide personal communications service wireless telecommunications network.
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
18 & 19
<PAGE>
Officers and Directors
Arthur Zeikel, President and Director
Ronald Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Richard R. West, Director
Terry K. Glenn, Executive Vice President
R. Douglas Henderson, Senior Vice President
Joseph T. Monagle Jr., Senior Vice President
Donald C. Burke, Vice President
Gerald M. Richard, Treasurer
Patrick D. Sweeney, Secretary
Custodian
The Bank of New York
110 Washington Street
New York, NY 10286
Transfer Agent
The Bank of New York
101 Barclay Street
New York, NY 10286
NYSE Symbol
DBS
This report, including the financial information herein, is transmitted to the
shareholders of Debt Strategies Fund, Inc. for their information. It is not a
prospectus, circular or representation intended for use in the purchase of
shares of the Fund or any securities mentioned in the report. Past performance
results shown in this report should not be considered a representation of future
performance. The Fund has leveraged its Common Stock to provide Common Stock
shareholders with a potentially higher rate of return. Leverage creates risk for
Common Stock shareholders, including the likelihood of greater volatility of net
asset value and market price of Common Stock shares, and the risk that
fluctuations in short-term interest rates may reduce the Common Stock's yield.
Statements and other information herein are as dated and are subject to change.
Debt Strategies
Fund, Inc.
Box 9011
Princeton, NJ
08543-9011 DEBT01--2/98
Printed on post-consumer recycled paper
