DEBT
STRATEGIES
FUND, INC.
[GRAPHIC OMITTED]
STRATEGIC
Performance
Annual Report
February 28, 1999
<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.
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
DEAR SHAREHOLDER
For the year ended February 28, 1999, the total investment return on the Fund's
Common Stock was -10.36%, based on a change in per share net asset value from
$10.15 to $8.20, and assuming reinvestment of $0.934 per share income dividends.
During the same period, the net annualized yield of the Fund's Common Stock was
11.26%. For the six-month period ended February 28, 1999, the Fund's total
investment return was -5.08%, based on a change in per share net asset value
from $9.12 to $8.20, and assuming reinvestment of $0.452 per share income
dividends. During the same period, the net annualized yield of the Fund's Common
Stock was 10.72%. At the end of the February quarter, the Fund was 29.76%
leveraged as a percentage of total assets, having borrowed $112 million of its
$160 million credit facility at an average rate of 5.74%. (For a complete
explanation of the benefits and risks of leverage, see page 1 of this report to
shareholders.)
Portfolio Strategy
In early summer, the high-yield market was pressured by disruptions in equity
and emerging markets that resulted in a marked decrease in liquidity and a
decrease in prices virtually across the board in all three markets. This
scenario negatively impacted the leveraged bank loan market as well. The bid
side of the dealer market experienced downward pressure primarily as a result of
many hedge fund managers and crossover mutual fund investors selling their bonds
and loan positions to provide needed liquidity. While the credit environment has
not significantly changed, the problems of other fixed-income and equity markets
impacted the high-yield bond and leveraged loan markets.
Beginning in November 1998, the high-yield bond and bank loan environments
stabilized significantly. Both markets have experienced some improvement from
their lows of September prices but remain below pre-August levels. While this
has had an adverse impact on the Fund's net asset value, the yield has improved
as spreads continue to remain wide. Both markets have experienced slow
improvement, and we see significant upside potential in both markets over the
next 6 months-18 months.
By February 28, 1999, 68.26% of the Fund's investments in corporate loans were
accruing interest at a yield spread above the London Interbank Offered Rate
(LIBOR), the rate that major international banks charge each other for US
dollar-denominated deposits outside of the United States. LIBOR has tracked very
closely with other short-term interest rates in the United States, particularly
the Federal Funds rate. Since the average reset on the Fund's floating rate
investments is 42 days, the yield on the bank loan portion of the Fund is likely
to move up or down within a two-month period after any Federal Funds rate
change. At February 28, 1999, floating rate securities made up 48.3% of the
market value of the Fund's investments, with an additional 51.6% invested in
fixed-rate, high-yield bonds. Approximately $13 million remained available under
the leverage facility at the close of the period. Given the current environment,
we intend to maintain at least a 40% weighting in floating rate loans.
As a result of the uncertainties experienced last summer, leveraged loan
new-issue volume for the second half of 1998 was approximately $70 billion, a
46% decrease from the $130 billion recorded during the comparable period in 1998
and a 50% decrease from the first half volume of $140 billion. (Leveraged loans
are those at a spread of at least 1.5% over LIBOR.) At the same time, secondary
trading volume of leveraged loans reached a record level of $67 billion during
1998 as compared to the previous record level of $62 billion for all of 1997.
Year-to-date 1999 volume appears on track to exceed last year's total.
The market upheaval of August and September 1998 temporarily halted the almost
uninterrupted investor inflows into the high-yield market. This adjustment of
investor sentiment and the liquidity concerns of certain large investors shifted
the markets' supply/ demand balance markedly. Despite the continuation of a
strong US economy, a rebound in the stock market and low default rates, returns
generated in the high-yield bond and leveraged loan markets were below recent
years' performance. High-yield bonds generated a total return of -3.46% for the
second half of 1998 and a full year return of +0.55%, as measured by the
unmanaged Donaldson, Lufkin and Jenrette (DLJ) High Yield Index. Bank loans
generated a total return of +1.32% for the second half of 1998 and a full year
return for 1998 of +5.61%, as measured by the unmanaged DLJ Leveraged Loan
Index. These returns reflect the dramatic reduction in market liquidity and the
general "flight to quality" sentiment.
The bellwether ten-year Treasury yield decreased from 5.47% at June 30, 1998 to
4.64% at year-end. As of February 28, 1999, the yield had moved back up to
5.09%. High-yield bond spreads over Treasury securities have remained very wide
relative to comparable spreads last summer. The spread over Treasury securities
increased from 3.73% at June 30, 1998 to 5.88% at year-end, as measured by the
Merrill Lynch Master Index. Those yield spreads have eased since year-end, but
still remained at a very attractive 5.56% by February 28, 1999.
As was the case in the bank loan market, new-issue activity slowed dramatically
in the latter half of 1998. The second half of 1998 dollar volume was $37
billion, down 45% from last year's comparable $67 billion. From an industry
standpoint, telecommunications continued at over 25% of the market in 1998. This
sector now makes up a sizable portion of the Fund (7.75% of net assets) but is
clearly underweighted to the market.
By February 28, 1999, the Fund's average stated maturity was 6.7 years but had
an expected 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. The Fund's floating rate investments were spread across 45 borrowers
in 19 industries. Fixed rate investments were spread across 128 borrowers in 40
industries. (The "Portfolio Information" section on page 22 of this report to
shareholders provides listings of the five largest industries and ten largest
holdings represented in the Fund.)
Overall, fundamentals for both the bank loan and high-yield bond markets have
improved dramatically since last summer, and we believe there remains
significant upside movement as market technicals improve. Although defaults
across the high-yield bond and bank loan markets have increased somewhat over
the last several months, they remain below historic averages. Our focus has and
will likely continue to be to invest in those companies that are generating
improved earnings trends or whose securities we believe are undervalued.
Our industry focus continues to be 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 merger and
acquisition activity in these sectors. A number of cyclical sectors
underperformed the market at large. Paper, metals and mining, energy and
healthcare were such industry groups. Concerns over the long-term effects of the
Asian currency crisis and/or regulatory changes on these industries had an
adverse effect on performance. We believe the industry fundamentals in both the
paper and energy sectors will begin to improve over the first half of 1999 with
expected improvements in the steel and healthcare sectors in late 1999 or early
2000. 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 seek to limit
the Fund's downside volatility.
The disruption experienced in the high-yield and equity markets severely reduced
investor liquidity and dampened interest in new issues in the second half of
1998. With long-term bond yields at near historic lows, a gradual improvement in
the high-yield new-issue market is materializing as market liquidity improves
and required spreads over benchmark Treasury securities remain very attractive.
The demand for leveraged bank loans continues to be very strong as high-yield
demand still lags behind the levels of early 1998. Bank loan spreads over LIBOR
and upfront fees are likely to remain attractive as a result.
We expect the Federal Reserve Board to maintain a neutral stance with regard to
interest rates for the near term. Fixed-income investors may be somewhat
cautious while crossover investors may increase their portfolio weighting in the
bank loan market if they foresee increasing interest rates. Flows into the
high-yield bond and loan markets have been generally positive from November 1998
through February 1999 and are likely to remain steady. We are cautiously
optimistic for a pick-up in both high-yield bond and bank activity through the
second quarter of 1999. We will continue to be opportunistic in our high-yield
bond purchases, selling overvalued bonds and sectors and buying undervalued
bonds and sectors (with an emphasis on the secondary market). 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.
In Conclusion
We appreciate your ongoing investment in Debt Strategies Fund, Inc., and
2 & 3
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
we look forward to reviewing our strategy with you again in our next report to
shareholders.
Sincerely,
/s/ Terry K. Glenn
Terry K. Glenn
President and Director
/s/ Joseph T. Monagle Jr.
Joseph T. Monagle Jr.
Senior Vice President
April 14, 1999
================================================================================
We are pleased to announce that Richard C. Kilbride, Paul Travers and Gilles
Marchand have each been appointed Vice President and Portfolio Manager of Debt
Strategies Fund, Inc. Mr. Kilbride has almost 20 years experience in the
fixed-income markets and has previously served as a Managing Director of Fixed
Income for Merrill Lynch Asset Management, L.P. (MLAM) and its affiliated asset
management companies in London and in Los Angeles. Mr. Travers joined MLAM's
Bank Loan Portfolio Group last year, bringing with him 15 years of diversified
professional experience in the bank loan industry. He was previously Head of
U.S. Corporate Banking in the New York branch of BHF-BANK. Mr. Marchand has been
a Bank Loan Credit Analyst for MLAM for the last three years and has almost 10
years buy side experience in a wide range of fixed-income securities.
These appointments follow the resignation of R. Douglas Henderson as Senior
Portfolio Manager. Mr. Henderson has left MLAM to pursue opportunities on the
sell side of the loan participation market. We appreciate the contribution Mr.
Henderson made to the growth of the Fund and we wish him well for the future. We
continue to have an excellent team of portfolio managers and analysts in place,
and we look forward to building upon the successful performance of the Fund to
date. You will be hearing directly from Messrs. Kilbride, Travers and Marchand
in subsequent reports.
================================================================================
PROXY RESULTS
During the 12-month period ended February 28, 1999, Debt Strategies Fund, Inc.
shareholders voted on the following proposals. The proposals were approved at a
shareholders' meeting on July 9, 1998. The description of each proposal and
number of shares voted are as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Shares Voted Shares Withheld
For From Voting
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
1. To elect the Fund's Board of Directors: Ronald W. Forbes 30,680,226 420,734
Cynthia A. Montgomery 30,660,678 440,282
Charles C. Reilly 30,664,045 436,915
Kevin A. Ryan 30,662,362 438,598
Richard R. West 30,666,348 434,612
Arthur Zeikel 30,657,729 443,231
- ----------------------------------------------------------------------------------------------------------------------
<CAPTION>
Shares Voted Shares Voted Shares Voted
For Against Abstain
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
2. To ratify the selection of Deloitte & Touche LLP as the
independent auditors of the Fund to serve for the current fiscal year. 30,581,774 200,797 318,389
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
After more than 20 years of service, Arthur Zeikel recently retired as Chairman
of Merrill Lynch Asset Management, L.P. (MLAM). Mr. Zeikel served as President
of MLAM from 1977 to 1997 and as Chairman since December 1997. Mr. Zeikel is one
of the country's most respected leaders in asset management and presided over
the growth of Merrill Lynch's asset management business. During his tenure,
client assets under management grew from $300 million to over $500 billion. Mr.
Zeikel will remain on Debt Strategies Fund, Inc.'s Board of Directors. We are
pleased to announce that Terry K. Glenn has been elected President and Director
of the Fund. Mr. Glenn has held the position of Executive Vice President of MLAM
since 1983.
Mr. Zeikel's colleagues at MLAM join the Fund's Board of Directors in wishing
him well in his retirement from Merrill Lynch and are pleased that he will
continue as a member of the Fund's Board of Directors.
SCHEDULE OF INVESTMENTS
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
===================================================================================================================================
<S> <C> <C> <C> <C> <C> <C>
Advertising--1.2% B B1 US$ 3,000,000 Outdoor Systems Inc., 8.875% due 6/15/2007 $ 2,978,300 $ 3,225,000
===================================================================================================================================
Agricultural B B2 3,000,000 Sun World International, Inc., 11.25% due 4/15/2004 3,146,250 3,150,000
Products--1.2%
===================================================================================================================================
Amusement & AMC Entertainment Inc. (b):
Recreational B- B3 2,000,000 9.50% due 3/15/2009 2,082,500 1,985,000
Services--5.2% B- B3 850,000 9.50% due 2/01/2011 850,000 839,375
NR* NR* 1,211,890 AMF Group, Inc., Term, due 3/31/2002** 1,209,662 1,127,058
B B2 475,000 Carmike Cinemas Inc., 9.375% due 2/01/2009 (b) 476,312 482,125
D Ca 1,000,000 Hollywood Theatres, Inc., 10.625% due 8/01/2007 (f) 1,000,000 425,000
B+ B1 500,000 Intrawest Corp., 9.75% due 8/15/2008 515,000 515,625
NR* NR* 5,000,000 Metro Goldwyn Mayer Co. (MGM), Term A, due
12/31/2005** 4,888,085 4,909,375
B B2 3,350,000 Riddell Sports, Inc., 10.50% due 7/15/2007 3,393,875 3,149,000
------------ ------------
14,415,434 13,432,558
===================================================================================================================================
Apparel--2.2% ArenaBrands**:
NR* NR* 1,554,958 Term A, due 6/01/2002 1,556,902 1,556,902
NR* NR* 3,103,328 Term B, due 6/01/2002 3,107,207 3,107,207
B- B3 1,175,000 GFSI Inc., 9.625% due 3/01/2007 1,198,500 1,092,750
------------ ------------
5,862,609 5,756,859
===================================================================================================================================
Automotive B+ B1 1,417,430 Advanced Accessory Systems, Term B, due 10/30/2004** 1,415,096 1,415,096
Equipment--8.7% BB B1 4,436,190 Breed Technologies Inc., Term B, due 4/27/2006** 3,638,505 3,726,400
B- B3 2,500,000 Cambridge Industries Inc., 10.25% due 7/15/2007 2,416,550 1,975,000
B B2 500,000 Hayes Lemmerz International Inc., 8.25% due
12/15/2008 (b) 500,000 502,500
B- B3 1,850,000 Key Plastics, Inc., 10.25% due 3/15/2007 1,822,432 1,803,750
B- B3 1,000,000 Newcor Inc., 9.875% due 3/01/2008 1,000,000 890,000
Safelite Glass Corp.**:
BB B2 2,061,429 Term B, due 12/23/2003 2,057,668 2,020,839
BB B2 2,061,429 Term C, due 12/23/2004 2,057,649 2,020,839
B- B3 950,000 Special Devices Inc., 11.375% due 12/15/2008 (b) 950,000 959,500
</TABLE>
4 & 5
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
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>
Automotive B- B2 US$ 1,000,000 Trident Automotive, 10% due 12/15/2005 $ 1,000,000 $ 1,020,000
Equipment B+ B2 1,800,000 Venture Holdings Trust, 9.50% due 7/01/2005 1,803,000 1,746,000
(concluded) Walbro Corp.:
B+ B2 2,500,000 9.875% due 7/15/2005 2,485,372 2,450,000
B+ B2 2,000,000 10.125% due 12/15/2007 2,000,000 2,030,000
------------ ------------
23,146,272 22,559,924
===================================================================================================================================
Broadcast--Radio B B2 1,700,000 Ackerley Group Inc., 9% due 1/15/2009 (b) 1,747,875 1,742,500
& Television-- B- B3 1,000,000 Acme Television/Finance, 10.875% due 9/30/2004 (d) 845,675 840,000
3.0% B- B2 4,000,000 Capstar Broadcasting, 9.25% due 7/01/2007 3,986,005 4,230,000
B- B3 675,000 Granite Broadcasting, 8.875% due 5/15/2008 673,106 671,625
NR* Caa1 675,000 Radio Unica Corp., 11.75% due 8/01/2006 (d) 458,544 371,250
------------ ------------
7,711,205 7,855,375
===================================================================================================================================
Building & B- B2 850,000 Webb (Del E.) Corp., 10.25% due 2/15/2010 836,334 846,813
Construction--
0.3%
===================================================================================================================================
Building NR* NR* 4,960,000 Dal-Tile International, Inc., Term B, due
Materials--3.7% 12/31/2003** 4,940,461 4,798,800
NR* NR* 3,717,857 Falcon Building Products, Inc., Term, due
6/30/2005** 3,705,375 3,713,210
NR* NR* (euro)1,022,584 Thyssen Schulte Bautechnik GmbH & Co. KG, Term B,
due 12/02/2003** 1,094,735 1,110,564
------------ ------------
9,740,571 9,622,574
===================================================================================================================================
Cable Television B B3 US$ 2,575,000 @ Entertainment Inc., 17.50% due 2/01/2009 (b)(d) 1,019,527 1,055,750
Services--5.0% B+ NR* 2,000,000 Avalon Cable, Term B, due 10/31/2006** 1,985,416 2,015,000
CSC Holdings Inc.:
BB+ Ba2 500,000 7.25% due 7/15/2008 500,000 502,500
BB+ Ba2 650,000 7.625% due 7/15/2018 649,365 666,250
B B3 1,000,000 Coaxial Communications/Phoenix, 10% due 8/15/2006 1,052,500 1,060,000
CCC+ Caa1 1,000,000 Coaxial LLC/Coaxial Finance, 11.864% due
8/15/2008 (d) 620,362 600,000
B+ B2 1,000,000 Globo Comunicacoes e Participacoes SA, 10.625% due
12/05/2008 (b) 1,003,000 547,500
NR* NR* 3,959,184 Marcus Cable Operating Co., Term A, due
12/31/2002** 3,959,184 3,951,760
CCC+ B3 500,000 Park 'N View Inc., 13% due 5/15/2008 469,404 400,000
NR* B3 775,000 RCN Corp., 11.002% due 7/01/2008 (d) 486,941 418,500
B- B3 1,000,000 Rifkin Acquisition Partners LP, 11.125% due
1/15/2006 1,108,750 1,120,000
CCC B3 1,000,000 Supercanal Holdings SA, 11.50% due 5/15/2005 (b) 1,000,000 435,000
------------ ------------
13,854,449 12,772,260
===================================================================================================================================
Chemicals--8.7% BBB- Baa3 2,000,000 Equistar Chemicals LP, 8.75% due 2/15/2009 (b) 1,994,372 2,042,500
Foamex Corporation**:
B Ba3 1,969,374 Term B, due 6/30/2005 1,984,145 1,947,219
B Ba3 1,790,340 Term C, due 6/30/2006 1,803,768 1,772,996
B+ B2 6,000,000 Huntsman Corp., 8.33% due 7/01/2007 (b) 6,000,000 5,640,000
NR* NR* 5,215,227 Lyondell Chemical Co., Term B, due 6/30/2005** 5,223,298 5,065,289
NR* B1 4,925,000 Pioneer American Holding Corporation, Term, due
12/05/2006** 4,925,000 4,925,000
BB- NR* 3,000,000 Trikem SA, 10.625% due 7/24/2007 (b) 2,996,405 1,050,000
------------ ------------
24,926,988 22,443,004
===================================================================================================================================
Computer B+ B1 4,937,500 DecisionOne Corporation, Term B, due 8/07/2005** 4,931,159 2,073,750
Equipment--0.8%
===================================================================================================================================
Consumer E & S Holdings Corp.**:
Products--3.5% B- B3 1,142,356 Term B, due 9/30/2004 1,148,067 925,308
B- B3 1,142,356 Term C, due 9/30/2005 1,148,067 913,884
B- B3 657,689 Term D, due 3/31/2005 660,977 532,728
B+ B1 2,148,438 Hedstrom Corp., Term B, due 6/30/2005** 2,141,686 2,141,686
B B3 675,000 Home Products International Inc., 9.625% due
5/15/2008 675,000 661,500
BB- Ba3 725,000 Polaroid Corporation, 11.50% due 2/15/2006 725,000 744,938
B+ B2 870,000 Scotts Company, 8.625% due 1/15/2009 (b) 870,000 896,100
B+ Ba3 2,000,000 Shop-Vac Corp., 10.625% due 9/01/2003 2,180,000 2,187,500
------------ ------------
9,548,797 9,003,644
===================================================================================================================================
Diversified--1.2% NR* Ba3 3,000,000 Superior/Essex Corp., Term, due 11/27/2006** 2,970,394 2,979,375
====================================================================================================================================
Drilling--2.8% BB+ Ba2 3,000,000 Cliffs Drilling, 10.25% due 5/15/2003 3,255,000 3,060,000
BBB- Ba1 3,000,000 Falcon Drilling Co. Inc., 9.75% due 1/15/2001 3,172,500 2,940,000
B+ B1 1,450,000 Parker Drilling Co., 9.75% due 11/15/2006 1,244,220 1,102,000
------------ ------------
7,671,720 7,102,000
===================================================================================================================================
Drug Stores--1.0% B+ B1 2,475,000 Duane Reade Co., Term B, due 2/15/2005** 2,468,160 2,465,719
===================================================================================================================================
Electronics/ B B2 1,881,000 Advanced Glassfiber Yarn, 9.875% due 1/15/2009 (b) 1,843,612 1,895,107
Electrical B B2 939,000 BGF Industries Inc., 10.25% due 1/15/2009 (b) 920,334 948,390
Components--1.5% B+ B3 1,000,000 High Voltage Engineering, 10.50% due 8/15/2004 1,000,000 950,000
------------ ------------
3,763,946 3,793,497
===================================================================================================================================
Energy--6.7% B B1 2,000,000 Belco Oil & Gas Corp., 8.875% due 9/15/2007 2,000,000 1,860,000
CCC B3 3,000,000 Belden & Blake Corp., 9.875% due 6/15/2007 3,000,000 1,800,000
CCC Caa1 625,000 Continental Resources, 10.25% due 8/01/2008 625,000 487,500
B B2 2,000,000 Cross Timbers Oil Company, 8.75% due 11/01/2009 2,000,000 1,800,000
CCC- Caa2 2,000,000 Forcenergy, Inc., 8.50% due 2/15/2007 1,978,093 720,000
B B2 2,000,000 Forest Oil Corporation, 10.50% due 1/15/2006 1,976,369 2,010,000
BB- Ba2 2,000,000 Gulf Canada Resources Ltd., 9.25% due 1/15/2004 2,105,000 1,997,180
B+ B1 1,000,000 Nuevo Energy Co., 8.875% due 6/01/2008 955,150 920,000
BBB- Ba3 2,000,000 Perez Company SA, 8.125% due 7/15/2007 (b) 1,958,981 1,670,000
B+ B2 4,000,000 Snyder Oil Corp., 8.75% due 6/15/2007 3,980,732 3,980,000
------------ ------------
20,579,325 17,244,680
===================================================================================================================================
Financial NR* NR* 500,000 Investcorp SA, Term B, due 10/21/2008** 500,000 500,000
Services--0.7% B+ Ba3 1,425,000 Willis Corroon Corporation, 9% due 2/01/2009 (b) 1,425,000 1,425,000
------------ ------------
1,925,000 1,925,000
===================================================================================================================================
Food & Kindred B+ B1 1,200,000 Canandaigua Brands Inc., 8.50% due 3/01/2009 1,200,000 1,200,000
Products--10.2% B- Caa1 4,000,000 Envirodyne Industries, 10.25% due 12/01/2001 4,030,000 3,120,000
Favorite Brands International Inc.**:
B- B3 4,000,000 Senior Subnote, due 8/20/2007 3,977,285 1,700,000
B- B2 3,104,167 Term B, due 5/19/2005 3,099,884 2,809,271
</TABLE>
6 & 7
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
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>
Food & Kindred NR* NR* US$ 2,500,000 GoldenState Foods, Term, due 5/01/2008** $ 2,462,577 $ 2,443,750
Products BB- Ba3 3,169,355 International HomeFoods, Inc., Term A, due
(concluded) 11/21/2001** 3,167,658 3,158,460
Nebco Evans:
B+ B1 3,000,000 8.875% due 10/15/2006 3,000,000 2,550,000
B- B3 3,000,000 10.125% due 7/15/2007 3,000,000 2,400,000
B B2 2,000,000 SC International Services, Inc., 9.25% due 9/01/2007 2,041,311 2,040,000
Specialty Foods, Inc.**:
NR* NR* 1,832,299 Revolving Credit, due 1/31/2000 1,832,299 1,823,137
NR* NR* 3,159,563 Term A, due 1/31/2000 3,121,479 3,141,791
------------ ------------
30,932,493 26,386,409
===================================================================================================================================
Forest Products-- B B3 3,000,000 Ainsworth Lumber Company, 12.50% due 7/15/2007 (c) 2,924,631 3,015,000
2.7% B+ B3 350,000 Millar Western Forest, 9.875% due 5/15/2008 350,000 287,000
BB Ba3 1,500,000 Tembec Finance Corporation, 9.875% due 9/30/2005 1,556,250 1,590,000
B B3 3,000,000 Uniforet Inc., 11.125% due 10/15/2006 2,221,662 2,190,000
------------ ------------
7,052,543 7,082,000
===================================================================================================================================
Furniture & B- B3 1,800,000 Formica Corp., 10.875% due 3/01/2009 (b) 1,800,000 1,788,750
Fixtures--0.7%
===================================================================================================================================
Gaming--3.0% B+ B2 3,000,000 Autotote Corp., 10.875% due 8/01/2004 3,000,000 3,142,500
BB+ Ba2 700,000 Harrah's Operating Co. Inc., 7.875% due 12/15/2005 700,000 705,250
B B2 700,000 Hollywood Park Inc., 9.25% due 2/15/2007 (b) 700,000 702,625
BB- Ba3 825,000 Mohegan Tribal Gaming Authority, 8.75% due
1/01/2009 (b) 825,000 825,000
BB+ Ba2 1,500,000 Park Place Entertainment, 7.875% due 12/15/2005 (b) 1,500,000 1,470,000
B B2 975,000 Trump Atlantic City Associates/Funding Inc., 11.25%
due 5/01/2006 836,372 828,750
------------ ------------
7,561,372 7,674,125
===================================================================================================================================
Health Services-- B+ Ba3 4,950,000 Integrated Health Services, Inc., Term C, due
7.0% 12/31/2005** 4,974,750 4,430,250
NR* NR* 4,250,407 MedPartners, Inc., Term B, due 6/08/2001** 4,237,926 4,237,926
Paracelsus Healthcare Corp.**:
NR* NR* 1,344,000 Term A, due 3/31/2003 1,338,103 1,338,103
NR* NR* 2,000,000 Term B, due 3/31/2004 1,990,983 1,990,983
Sun Healthcare Group Inc.:
CCC+ B2 3,000,000 9.50% due 7/01/2007 3,000,000 840,000
NR* NR* 2,745,557 Term B, due 11/12/2004** 2,754,137 2,093,488
NR* NR* 2,745,453 Term C, due 11/12/2005** 2,753,978 2,093,408
BB- Ba3 1,000,000 Tenet Healthcare Corp., 8.125% due 12/01/2008 (b) 996,307 1,000,000
------------ ------------
22,046,184 18,024,158
===================================================================================================================================
Hotels--5.0% B- B2 500,000 Extended Stay America, 9.15% due 3/15/2008 477,640 485,000
HMH Properties, Inc.:
BB Ba2 1,575,000 7.875% due 8/01/2008 1,565,185 1,500,187
BB Ba2 800,000 8.45% due 12/01/2008 797,350 784,000
NR* NR* 10,000,000 Starwood Hotels and Resorts Worldwide, Inc.,
Bridge, due 2/23/2003** 10,000,000 9,996,875
------------ ------------
12,840,175 12,766,062
===================================================================================================================================
Leasing & Rental B B3 500,000 National Equipment Services, Inc., 10% due
Services--2.6% 11/30/2004 (b) 489,441 510,000
B B3 250,000 Neff Corp., 10.25% due 6/01/2008 (b) 246,342 247,500
NR* NR* 5,000,000 Panavision Inc., Term B, due 3/31/2005** 4,993,825 4,975,000
B B3 1,000,000 Universal Hospital Services, 10.25% due
3/01/2008 (b) 850,803 890,000
------------ ------------
6,580,411 6,622,500
===================================================================================================================================
Manufacturing-- B+ B1 2,000,000 Bucyrus International, 9.75% due 9/15/2007 2,006,250 1,500,000
1.1% B- B2 575,000 Globe Manufacturing Corp., 10% due 8/01/2008 (b) 575,000 506,000
B- B3 725,000 Russell-Stanley Holdings Inc., 10.875% due
2/15/2009 (b) 719,563 710,500
------------ ------------
3,300,813 2,716,500
===================================================================================================================================
Medical CC Caa1 3,000,000 Graham Field Health PDS, 9.75% due 8/15/2007 (b) 3,000,000 1,740,000
Equipment--1.5% NR* NR* 2,500,000 Wilson Great Batch, 13% due 7/10/2007 (b) 2,204,709 2,162,500
------------ ------------
5,204,709 3,902,500
===================================================================================================================================
Metals & Mining-- NR* NR* 2,952,381 Adience, Inc., Term, due 4/15/2005** 2,943,107 2,943,107
6.8% CCC Caa1 2,000,000 Anker Coal Group, Inc., 9.75% due 10/01/2007 2,030,000 1,100,000
B B1 550,000 Bayou Steel Corp., 9.50% due 5/15/2008 545,017 536,250
Centennial Resources Inc., Revolving Credit (f)**:
NR* NR* 438,500 due 6/30/1999 438,500 436,308
NR* NR* 3,000,000 due 3/31/2002 3,000,000 562,500
B B2 5,000,000 GS Technologies Operating Co., 12% due 9/01/2004 5,425,000 3,375,000
Ispat International NV**:
BB Ba3 1,293,500 Term B, due 7/15/2005 1,291,996 1,243,377
BB Ba3 1,293,500 Term C, due 7/15/2006 1,291,976 1,243,377
CCC+ Caa1 1,000,000 Metal Management Inc., 10% due 5/15/2008 1,000,000 635,000
B+ B2 550,000 Pen Holdings Inc., 9.875% due 6/15/2008 545,879 552,750
NR* Ba2 5,000,000 UCAR Global Enterprises, Term B, due 12/31/2002** 4,957,979 4,987,500
------------ ------------
23,469,454 17,615,169
===================================================================================================================================
Online Services-- B- B3 500,000 Verio Inc., 11.25% due 12/01/2008 (b) 500,000 537,500
0.2%
===================================================================================================================================
Packaging--0.2% BB- B1 400,000 Consumers Packaging Inc., 9.75% due 2/01/2007 (b) 400,000 412,500
===================================================================================================================================
Paging--0.2% CCC+ B3 525,000 Metrocall Inc., 11% due 9/15/2008 (b) 521,386 493,500
===================================================================================================================================
Paper--6.9% B- Caa1 5,000,000 Gaylord Container Corp., 9.75% due 6/15/2007 5,000,000 4,775,000
NR* NR* 4,500,000 Repap New Brunswick, Inc., Term B, due 6/01/2004** 4,540,000 4,308,750
NR* Ba3 8,707,734 Stone Container Corporation, Term B, due 4/01/2000** 8,660,678 8,729,503
------------ ------------
18,200,678 17,813,253
===================================================================================================================================
Printing & Big Flower Press Holdings:
Publishing--4.8% B+ B2 2,000,000 8.875% due 7/01/2007 1,985,438 2,050,000
B+ B2 850,000 8.625% due 12/01/2008 (b) 850,000 858,500
B+ B1 475,000 Mail-Well Corp., 8.75% due 12/15/2008 (b) 475,000 486,875
B- B3 750,000 Phoenix Color Corporation, 10.375% due 2/01/2009 (b) 750,000 763,125
B B3 475,000 Premier Graphics Inc., 11.50% due 12/01/2005 (b) 475,000 463,125
</TABLE>
8 & 9
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
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>
Printing & B- B3 US$ 575,000 Regional Independent Media, 10.50% due 7/01/2008 $ 575,000 $ 575,000
Publishing B- B3 1,500,000 T/SF Communications Corp., 10.375% due 11/01/2007 1,479,229 1,545,000
(concluded) BB- B1 500,000 World Color Press Inc., 8.375% due 11/15/2008 (b) 500,000 500,000
BB Ba2 5,000,000 Ziff-Davis Inc., Term B, due 3/31/2006** 5,000,000 5,012,500
------------ ------------
12,089,667 12,254,125
===================================================================================================================================
Property NR* NR* 2,000,000 Rockefeller Center Property Trust, 11.404% due
Management--0.6% 12/31/2000 (Convertible) (d) 1,645,474 1,500,000
===================================================================================================================================
Refineries-- BB Ba3 5,000,000 Clark Refining & Marketing Inc., Term, due
Petroleum--2.3% 11/15/2004** 4,933,377 4,600,000
B- B3 2,000,000 United Refining Co., 10.75% due 6/15/2007 2,000,000 1,400,000
------------ ------------
6,933,377 6,000,000
===================================================================================================================================
Retail Specialty-- B B3 1,000,000 TM Group Holdings, 11% due 5/15/2008 (b) 1,000,000 1,010,000
1.0% B- Caa1 2,000,000 United Auto Group, Inc., 11% due 7/15/2007 1,973,423 1,540,000
------------ ------------
2,973,423 2,550,000
===================================================================================================================================
Satellite Echostar DBS Corp. (b):
Telecommunication B B2 400,000 9.25% due 2/01/2006 400,000 405,000
Distribution B B2 1,925,000 9.375% due 2/01/2009 1,925,000 1,929,812
Systems--1.0% B- B3 250,000 Pegasus Communications, 9.75% due 12/01/2006 (b) 250,000 261,250
------------ ------------
2,575,000 2,596,062
===================================================================================================================================
Shipping--2.2% B+ NR* 4,000,000 Equimar Shipholdings Ltd., 9.875% due 7/01/2007 (b) 4,000,000 2,840,000
BB Ba2 3,000,000 Stena AB, 8.75% due 6/15/2007 3,000,000 2,842,500
------------ ------------
7,000,000 5,682,500
===================================================================================================================================
Textile Mill B B3 1,400,000 Galey & Lord, Inc., 9.125% due 3/01/2008 1,107,760 1,057,000
Products--3.0% Joan Fabrics Corp.**:
NR* NR* 3,496,881 Term B, due 6/30/2005 3,492,414 3,492,510
NR* NR* 1,815,942 Term C, due 6/30/2006 1,813,554 1,822,752
BB Ba3 1,300,000 Westpoint Stevens Inc., 7.875% due 6/15/2008 1,283,613 1,348,750
------------ ------------
7,697,341 7,721,012
===================================================================================================================================
Transportation D Ca 3,000,000 Ameritruck Distribution Corp., 12.25% due
Services--2.2% 11/15/2005 (f) 3,210,000 240,000
BB- NR* 4,250,000 Autopistas del Sol SA, 10.25% due 8/01/2009 (b) 4,293,750 3,187,500
B NR* 3,000,000 MRS Logistica SA, 10.625% due 8/15/2005 (b) 2,970,471 1,350,000
B- Caa2 2,000,000 Trism Inc., 10.75% due 12/15/2000 2,010,000 980,000
------------ ------------
12,484,221 5,757,500
===================================================================================================================================
Utilities--1.0% B+ Ba1 2,500,000 AES Corporation, 8.50% due 11/01/2007 2,495,452 2,468,750
===================================================================================================================================
Waste BB Ba2 900,000 Allied Waste North America, 7.875% due 1/01/2009 (b) 898,453 922,500
Management--0.4%
===================================================================================================================================
Wired NR* NR* 2,100,000 E. Spire Communications, 10.52% due 7/01/2008 (d) 1,350,363 766,500
Telecommunications Esprit Telecom Group PLC:
- --6.1% B- Caa1 650,000 10.875% due 6/15/2008 650,000 672,750
B- Caa1 (euro) 306,775 11% due 6/15/2008 336,587 347,691
B B3 US$ 300,000 Hermes Europe Railtel BV, 10.375% due 1/15/2009 (b) 300,000 318,750
B B2 2,000,000 Intermedia Communications Inc., 8.875% due
11/01/2007 2,000,000 1,920,000
B B3 750,000 Level 3 Communications, 10.50% due 12/01/2008 (b)(d) 461,011 436,875
B B2 500,000 Metromedia Fiber Network, 10% due 11/15/2008 (b) 500,000 520,000
Metronet Communications:
B B3 3,500,000 12% due 8/15/2007 (e) 3,467,382 3,955,000
B B3 1,050,000 9.95% due 6/15/2008 (d) 691,993 719,250
Nextlink Communications:
B B3 1,500,000 9% due 3/15/2008 1,497,165 1,417,500
NR* B3 3,000,000 9.45% due 4/15/2008 (d) 2,049,454 1,755,000
Primus Telecommunications Group:
B- B3 500,000 11.75% due 8/01/2004 517,500 515,000
B- B3 850,000 11.25% due 1/15/2009 (b) 850,000 862,750
Telegroup Inc.:
NR* NR* 1,500,000 8% due 11/01/2004 (d)(f) 1,339,219 600,000
NR* NR* 1,500,000 8% due 4/15/2005 (Convertible) (b) 1,500,000 45,000
B- B3 900,000 Worldwide Fiber Inc., 12.50% due 12/15/2005 (b) 900,000 931,500
------------ ------------
18,410,674 15,783,566
===================================================================================================================================
Wireless NR* NR* 4,000,000 American Tower Systems Co., Term, due 12/16/2006** 3,990,574 3,990,574
Communications-- Cellular, Inc.**:
11.1% NR* Ba3 586,527 Term B, due 9/30/2006 585,192 587,993
NR* Ba3 1,161,440 Term C, due 3/31/2007 1,158,774 1,164,344
NR* Ba3 3,252,033 Term D, due 9/30/2007 3,244,505 3,260,163
B- Caa1 850,000 Dolphin Telecom PLC, 11.50% due 6/01/2008 (d) 528,297 374,000
B B2 5,000,000 Iridium Operating LLC, Term, due 12/29/2000** 4,913,687 4,887,500
CCC+ B3 2,475,000 Nextel Partners Inc., 14% due 2/01/2009 (b)(d) 1,271,373 1,287,000
NR* B2 3,101,562 Omnipoint Communications Corp., Term C, due
2/17/2006** 3,101,562 2,791,406
B+ Ba3 500,000 Orange PLC, 8% due 8/01/2008 501,875 517,500
NR* B3 2,000,000 PTC International Finance BV, 10.269% due
7/01/2007 (d) 1,449,628 1,440,000
NR* NR* 5,000,000 Telecorp PCS, Inc., Term B, due 1/15/2008** 4,990,438 4,950,000
CCC+ Caa1 2,000,000 Telesystem International Wireless Inc., 11.929% due
6/30/2007 (d) 1,397,162 880,000
NR* NR* 2,500,000 Western PCS Holdings Corp., Term B, due 6/30/2007** 2,495,258 2,497,656
------------ ------------
29,628,325 28,628,136
===================================================================================================================================
Total Investments in Corporate Debt Obligations--
141.2% 405,718,538 363,951,109
===================================================================================================================================
<CAPTION>
Shares
Held Preferred Stocks & Warrants
===================================================================================================================================
<S> <C> <C> <C> <C>
Broadcast--Radio & 23 Paxson Communications (Convertible) (b)(c) 232,990 228,438
Television--0.2% 47 Paxson Communications (Units) (c) 462,192 381,874
22 Paxson Communications (Warrants) (a)(b) 0 0
------------ ------------
695,182 610,312
===================================================================================================================================
</TABLE>
10 & 11
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
SCHEDULE OF INVESTMENTS (Continued)
<TABLE>
<CAPTION>
Shares Value
INDUSTRIES Held Preferred Stocks & Warrants Cost (Note 1b)
===================================================================================================================================
<S> <C> <C> <C> <C>
Cable Television 500 Park 'N View (Warrants) (a) $ 31,000 $ 17,500
Services--0.0%
===================================================================================================================================
High Technology-- 318,830 WGL Holdings (Warrants) (a) 318,830 159,415
0.1%
====================================================================================================================================
Wired 3,500 Metronet Communications (Warrants) (a)(b) 35,875 254,282
Telecommunications 2,000 Unifi Communications (Warrants) (a)(b) 113,180 20
- --0.1% ------------ ------------
149,055 254,302
===================================================================================================================================
Total Investments in Preferred Stocks & Warrants--
0.4% 1,194,067 1,041,529
===================================================================================================================================
<CAPTION>
Face
Amount Short-Term Securities
===================================================================================================================================
<S> <C> <C> <C> <C>
Commercial US$ 819,000 General Electric Capital Corp., 4.875% due
Paper***--0.3% 3/01/1999 819,000 819,000
===================================================================================================================================
Total Investments in Short-Term Securities--0.3% 819,000 819,000
===================================================================================================================================
Total Investments--141.9% $407,731,605 365,811,638
============
Unrealized Appreciation on Forward Foreign Exchange
Contracts--Net****--0.0% 87,454
Liabilities in Excess of Other Assets--(41.9%) (108,119,777)
------------
Net Assets--100.0% $257,779,315
============
===================================================================================================================================
</TABLE>
(a) Warrants entitle the Fund to purchase a predetermined number of
shares of common stock and are non-income producing. The purchase
price and number of shares are subject to adjustment 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 or step bond; the interest rate shown is
the effective yield at the time of purchase by the Fund.
(e) Each $1,000 face amount contains one warrant of Metronet
Communications.
(f) Non-income producing security.
* 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 66.5% of the Fund's net
assets.
*** Commercial Paper is traded on a discount basis; the interest rate
shown reflects the discount rate paid at the time of purchase by the
Fund.
**** Forward foreign exchange contracts as of February 28, 1999 were as
follows:
--------------------------------------------------------------------
Foreign Expiration Unrealized
Currency Sold Date Appreciation (Note 1c)
--------------------------------------------------------------------
(euro)1,415,120 March 1999 $ 87,454
--------------------------------------------------------------------
Total Unrealized Appreciation on
Forward Foreign Exchange Contracts--Net
(US$ Commitment--$1,641,780) $ 87,454
==========
--------------------------------------------------------------------
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<TABLE>
<CAPTION>
As of February 28, 1999
===============================================================================================================================
<S> <C> <C> <C>
Assets: Investments, at value (identified cost--$407,731,605) (Note 1b) .................. $365,811,638
Cash ............................................................................. 146,776
Unrealized appreciation on forward foreign exchange contracts (Note 1c) .......... 87,454
Receivables:
Interest ....................................................................... $ 5,887,508
Principal paydowns ............................................................. 997,828 6,885,336
------------
Deferred facility fees ........................................................... 13,370
Deferred organization expenses (Note 1g) ......................................... 38,786
Prepaid expenses and other assets ................................................ 155,374
------------
Total assets ..................................................................... 373,138,734
------------
===============================================================================================================================
Liabilities: Loans (Note 6) ................................................................... 112,000,000
Payables:
Securities purchased ........................................................... 2,025,000
Interest on loans (Note 6) ..................................................... 825,019
Dividends to shareholders (Note 1h) ............................................ 194,829
Investment adviser (Note 2) .................................................... 168,437
Commitment fees ................................................................ 10,103 3,223,388
------------
Deferred income (Note 1f) ........................................................ 4,284
Accrued expenses and other liabilities ........................................... 131,747
------------
Total liabilities ................................................................ 115,359,419
------------
===============================================================================================================================
Net Assets: Net assets ....................................................................... $257,779,315
============
===============================================================================================================================
Capital: Common Stock, $.10 par value, 200,000,000 shares authorized ...................... $ 3,142,523
Paid-in capital in excess of par ................................................. 310,639,558
Undistributed investment income--net ............................................. 1,930,842
Accumulated realized capital losses on investments and foreign currency
transactions--net (Note 7) ....................................................... (16,098,674)
Unrealized depreciation on investments and foreign currency transactions--net .... (41,834,934)
------------
Total--Equivalent to $8.20 per share based on 31,425,226 shares of capital
stock outstanding (market price--$7.625) ......................................... $257,779,315
============
===============================================================================================================================
</TABLE>
See Notes to Financial Statements.
12 & 13
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Year Ended February 28, 1999
===============================================================================================================
<S> <C> <C> <C>
Investment Income Interest and discount earned .......................... $ 38,545,248
(Note 1f): Facility and other fees ............................... 463,341
Dividends ............................................. 35,182
------------
Total income .......................................... 39,043,771
------------
===============================================================================================================
Expenses: Loan interest expense (Note 6) ........................ $ 6,904,203
Investment advisory fees (Note 2) ..................... 2,456,383
Borrowing costs (Note 6) .............................. 185,519
Accounting services (Note 2) .......................... 166,455
Professional fees ..................................... 101,905
Printing and shareholder reports ...................... 38,758
Directors' fees and expenses .......................... 38,044
Custodian fees ........................................ 37,069
Transfer agent fees (Note 2) .......................... 34,661
Listing fees .......................................... 32,840
Amortization of organization expenses (Note 1g) ....... 11,934
Pricing services ...................................... 9,315
Other ................................................. 47,324
---------
Total expenses ........................................ 10,064,410
------------
Investment income--net ................................ 28,979,361
------------
===============================================================================================================
Realized & Realized loss from:
Unrealized Gain (Loss) Investments--net .................................... (14,718,789)
On Investments & Foreign currency transactions--net .................. (89,616) (14,808,405)
Foreign Currency ------------
Transactions--Net Change in unrealized appreciation/depreciation on:
(Notes 1c, 1d, 1f & 3): Investments--net .................................... (46,107,780)
Foreign currency transactions--net .................. 85,033 (46,022,747)
------------ ------------
Net Decrease in Net Assets Resulting from Operations.. $(31,851,791)
============
===============================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Year For the Period
Ended May 30, 1997+
February 28, to February 28,
Increase (Decrease) in Net Assets: 1999 1998
=================================================================================================================================
<S> <C> <C> <C>
Operations: Investment income--net .................................................. $ 28,979,361 $ 22,033,100
Realized loss on investments and foreign currency transactions--net ..... (14,808,405) (1,451,593)
Change in unrealized appreciation/depreciation on investments and
foreign currency transactions--net ...................................... (46,022,747) 4,187,813
------------- -------------
Net increase (decrease) in net assets resulting from operations ......... (31,851,791) 24,769,320
------------- -------------
=================================================================================================================================
Dividends to Investment income--net .................................................. (29,289,396) (19,630,899)
Shareholders ------------- -------------
(Note 1h): Net decrease in net assets resulting from dividends to shareholders ..... (29,289,396) (19,630,899)
------------- -------------
=================================================================================================================================
Capital Share Proceeds from issuance of Common Stock .................................. -- 312,000,000
Transactions Value of shares issued in reinvestment of dividends ..................... 1,185,810 936,916
(Notes 1g & 4): Offering costs resulting from the issuance of Common Stock .............. -- (440,645)
------------- -------------
Net increase in net assets resulting from capital share transactions .... 1,185,810 312,496,271
------------- -------------
=================================================================================================================================
Net Assets: Total increase (decrease) in net assets ................................. (59,955,377) 317,634,692
Beginning of period ..................................................... 317,734,692 100,000
------------- -------------
End of period* .......................................................... $ 257,779,315 $ 317,734,692
============= =============
=================================================================================================================================
*Undistributed investment income--net (Note 1i) .......................... $ 1,930,842 $ 2,482,893
============= =============
=================================================================================================================================
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
14 & 15
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year Ended February 28, 1999
=================================================================================================================================
<S> <C> <C>
Cash Provided by Net decrease in net assets resulting from operations ..................................... $ (31,851,791)
Operating Activities: Adjustments to reconcile net decrease in net assets resulting from operations to net
cash provided by operating activities:
Decrease in receivables ................................................................... 1,710,232
Increase in other assets .................................................................. (56,701)
Decrease in other liabilities ............................................................. (3,656,544)
Realized and unrealized loss on investments and foreign currency transactions--net ........ 60,831,152
Amortization of discount .................................................................. (2,171,856)
--------------
Net cash provided by operating activities ................................................. 24,804,492
-------------
=================================================================================================================================
Cash Provided by Proceeds from sales of long-term investments 282,708,276
Investing Activities: Purchases of long-term investments (248,057,743)
Purchases of short-term investments (90,051,492)
Proceeds from sales and maturities of short-term investments 89,252,000
-------------
Net cash provided by investing activities 33,851,041
-------------
=================================================================================================================================
Cash Used for Cash receipts from borrowings ............................................................. 197,500,000
Financing Activities: Cash payments from borrowings ............................................................. (228,100,000)
Dividends paid to shareholders ............................................................ (27,908,757)
-------------
Net cash used for financing activities .................................................... (58,508,757)
-------------
=================================================================================================================================
Cash: Net increase in cash ...................................................................... 146,776
Cash at beginning of year ................................................................. 0
-------------
Cash at end of year ...................................................................... $ 146,776
=============
=================================================================================================================================
Cash Flow Cash paid for interest .................................................................. $ 7,487,933
Information: =============
=================================================================================================================================
Non-Cash Capital shares issued on reinvestment of dividends paid to shareholders .................. $( 1,185,810
Financing Activities: =============
=================================================================================================================================
</TABLE>
See Notes to Financial Statements.
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
The following per share data and ratios have been derived For the Year For the Period
from information provided in the financial statements. Ended May 30, 1997+
February 28, to February 28,
Increase (Decrease) in Net Asset Value: 1999 1998
==============================================================================================================================
<S> <C> <C> <C>
Per Share Net asset value, beginning of period ............................ $ 10.15 $ 10.00
Operating ------------ ------------
Performance: Investment income--net .......................................... .91 .71
Realized and unrealized gain (loss) on investments and foreign
currency transactions--net ...................................... (1.93) .09
------------ ------------
Total from investment operations ................................ (1.02) .80
------------ ------------
Less dividends from investment income--net ...................... (.93) (.63)
------------ ------------
Capital charge resulting from the issuance of Common Stock ...... -- (.02)
------------ ------------
Net asset value, end of period .................................. $ 8.20 $ 10.15
============ ============
Market price per share, end of period ........................... $ 7.625 $ 10.5625
============ ============
==============================================================================================================================
Total Investment Based on market price per share ................................. (19.90%) 12.38%++
Return:** ============ ============
Based on net asset value per share .............................. (10.36%) 7.99%++
============ ============
==============================================================================================================================
Ratios to Average Expenses, net of reimbursement and excluding interest expense ... 1.09% .61%*
Net Assets: ============ ============
Expenses, net of reimbursement .................................. 3.48% 2.28%*
============ ============
Expenses ........................................................ 3.48% 2.56%*
============ ============
Investment income--net .......................................... 10.03% 9.64%*
============ ============
==============================================================================================================================
Leverage: Amount of borrowings, end of period (in thousands) .............. $ 112,000 $ 142,600
============ ============
Average amount of borrowings outstanding during the period (in
thousands) ...................................................... $ 120,528 $ 85,903
============ ============
Average amount of borrowings outstanding per share during the
period .......................................................... $ 3.84 $ 2.79
============ ============
==============================================================================================================================
Supplemental Net assets, end of period (in thousands) ........................ $ 257,779 $ 317,735
Data: ============ ============
Portfolio turnover .............................................. 61.30% 43.79%
============ ============
==============================================================================================================================
</TABLE>
* 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.
+ Commencement of operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
16 & 17
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
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.
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. 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 for which an active secondary market exists and for
which the Investment Adviser can obtain at least two quotations from banks or
dealers in Corporate Loans will be valued by calculating the mean of the last
available bid and asked prices in the markets for such Corporate Loans, and then
using the mean of those two means. If only one quote for a particular Corporate
Loan is available, such Corporate Loan will be valued on the basis of the mean
of the last available bid and asked prices in the market. For Corporate Loans
for which an active secondary market does not exist to a reliable degree in the
opinion of the Investment Adviser, such Corporate Loans will be valued by the
Investment Adviser at fair value, which is intended to approximate market value.
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. Options written
or purchased are valued at the last sale price in the case of exchange-traded
options. In the case of options traded in the over-the-counter market, valuation
is the last asked price (options written) or the last bid price (options
purchased). 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 and currency 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 Forward foreign exchange contracts--The Fund is authorized to enter into
forward foreign exchange contracts as a hedge against either specific
transactions or portfolio positions. Such contracts are not entered on the
Fund's records. However, the effect on operations is recorded from the date the
Fund enters into such contracts.
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 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
amortization 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 period not exceeding five years. In accordance
with Statement of Position 98-5, any unamortized organization expenses will be
expensed on the first day of the next fiscal year beginning after December 15,
1998. This charge will not have any material impact on the operations of the
Fund. 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.
18 & 19
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
NOTES TO FINANCIAL STATEMENTS (concluded)
(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 $80,632 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.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management, L.P. ("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 perform the investment advisory function. 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 year ended February 28, 1999, the Fund paid Merrill Lynch Security
Pricing Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S"), $413 for security price quotations to compute the net
asset value of the Fund.
Accounting services are provided to the Fund by FAM at cost.
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
year ended February 28, 1999 were $249,082,743 and $283,706,104, respectively.
Net realized gains (losses) for the year ended February 28, 1999 and net
unrealized gains (losses) as of February 28, 1999 were as follows:
- --------------------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- --------------------------------------------------------------------------------
Long-term investments ...................... $(14,718,789) $(41,919,967)
Forward foreign exchange contracts ......... (91,455) 87,454
Foreign currency transactions .............. 1,839 (2,421)
------------ ------------
Total ...................................... $(14,808,405) $(41,834,934)
============ ============
- --------------------------------------------------------------------------------
As of February 28, 1999, net unrealized depreciation for Federal income tax
purposes aggregated $41,960,004, of which $2,797,184 related to appreciated
securities and $44,757,188 related to depreciated securities. The aggregate cost
of investments at February 28, 1999 for Federal income tax purposes was
$407,771,642.
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 year ended February 28,
1999 increased by 122,228 as a result of dividend reinvestment and 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, 1999, the Fund had unfunded loan commitments of $4,403,349,
which would be extended at the option of the borrower, pursuant to the following
loan agreements:
- -------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in thousands)
- -------------------------------------------------------------------------------
Centennial Resources Inc. ..................................... $ 156
International HomeFoods, Inc. ................................. 914
Teligent, Inc. ................................................ 3,333
- -------------------------------------------------------------------------------
6. Short-Term Borrowings:
On August 4, 1998, the Fund entered into a one-year credit agreement with The
Bank of New York, Fleet National Bank and certain other institutions party
thereto. The agreement is a $160,000,000 credit facility bearing interest at the
Prime rate, Federal Funds rate plus 0.50% and/or LIBOR plus 0.50%. For the year
ended February 28, 1999, the average amount borrowed by the Fund was
approximately $120,528,000 and the daily weighted average interest rate was
5.74%. For the year ended February 28, 1999, facility and commitment fees were
approximately $186,000.
7. Capital Loss Carryforward:
At February 28, 1999, the Fund had a net capital loss carryforward of
approximately $12,330,000, of which $263,000 expires in 2006 and $12,067,000
expires in 2007. This amount will be available to offset like amounts of any
future taxable gains.
8. Subsequent Event:
On March 8, 1999, the Fund's Board of Directors declared an ordinary income
dividend to Common Stock shareholders in the amount of $.064008 per share,
payable on March 31, 1999 to shareholders of record as of March 24, 1999.
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, 1999, the related statements of operations and cash flows for the
year then ended and the statement of changes in net assets and the financial
highlights for the year then ended and 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 audits.
We conducted our audits 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, 1999 by correspondence with the custodian, brokers and financial
intermediaries. 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 audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights present
fairly, in all material respects, the financial position of Debt Strategies
Fund, Inc. as of February 28, 1999, the results of its operations, the changes
in its net assets, its cash flows, and the financial highlights for the
respective stated periods in conformity with generally accepted accounting
principles.
Deloitte & Touche LLP
Princeton, New Jersey
April 20, 1999
20 & 21
<PAGE>
Debt Strategies Fund, Inc., February 28, 1999
PORTFOLIO INFORMATION
As of February 28, 1999
================================================================================
Percent of
Quality Ratings Long-Term
S&P/Moody's Investments
- --------------------------------------------------------------------------------
BBB/Baa .................................................................. 1.8%
BB/Ba .................................................................... 23.2
B/B .................................................................... 47.8
CCC/Caa or lower ......................................................... 2.0
NR (Not Rated) ........................................................... 25.2
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Percent of
Five Largest Industries Total Assets
- --------------------------------------------------------------------------------
Wireless Communications .................................................. 7.7%
Food & Kindred Products .................................................. 7.1
Automotive Equipment .................................................. 6.0
Chemicals ................................................................ 6.0
Health Services .......................................................... 4.8
- --------------------------------------------------------------------------------
Percent of
Ten Largest Holdings Total Assets
- --------------------------------------------------------------------------------
Starwood Hotels and Resorts Worldwide, Inc. .............................. 2.7%
Stone Container Corporation .............................................. 2.3
Huntsman Corp. ........................................................... 1.5
Joan Fabrics Corp. ....................................................... 1.4
Lyondell Chemical Co. .................................................... 1.4
Sun Healthcare Group Inc. ................................................ 1.3
Cellular, Inc............................................................. 1.3
Ziff-Davis Inc. .......................................................... 1.3
UCAR Global Enterprises .................................................. 1.3
Panavision Inc. .......................................................... 1.3
- --------------------------------------------------------------------------------
YEAR 2000 ISSUES
Many computer systems were designed using only two digits to designate years.
These systems may not be able to distinguish the Year 2000 from the Year 1900
(commonly known as the "Year 2000 Problem"). The Fund could be adversely
affected if the computer systems used by the Fund's management or other Fund
service providers do not properly address this problem before January 1, 2000.
The Fund's management expects to have addressed this problem before then, and
does not anticipate that the services it provides will be adversely affected.
The Fund's other service providers have told the Fund's management that they
also expect to resolve the Year 2000 Problem, and the Fund's management will
continue to monitor the situation as the Year 2000 approaches. However, if the
problem has not been fully addressed, the Fund could be negatively affected. The
Year 2000 Problem could also have a negative impact on the securities in which
the Fund invests, and this could hurt the Fund's investment returns.
OFFICERS AND DIRECTORS
Terry K. Glenn, President and Director
Ronald Forbes, Director
Cynthia A. Montgomery, Director
Charles C. Reilly, Director
Kevin A. Ryan, Director
Richard R. West, Director
Arthur Zeikel, Director
Joseph T. Monagle Jr., Senior Vice President
Richard C. Kilbride, Vice President
Gilles Marchand, Vice President
Paul Travers, Vice President
Donald C. Burke, Vice President and Treasurer
Patrick D. Sweeney, Secretary
- --------------------------------------------------------------------------------
Gerald M. Richard, Treasurer of Debt Strategies Fund, Inc. has recently retired.
His colleagues at Merrill Lynch Asset Management, L.P. join the Fund's Board of
Directors in wishing Mr. Richard well in his retirement.
- --------------------------------------------------------------------------------
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
22 & 23
<PAGE>
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 the ability to leverage 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--2/99
[RECYCLE LOGO] Printed on post-consumer recycled paper
