DEBT
STRATEGIES
FUND II, INC.
[GRAPHIC OMITTED]
STRATEGIC
Performance
Annual Report
February 29, 2000
<PAGE>
DEBT STRATEGIES FUND II, INC.
The Benefits and Risks of Leveraging
Debt Strategies Fund II, 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 II, Inc., February 29, 2000
DEAR SHAREHOLDER
For the 12-month period ended February 29, 2000, Debt Strategies Fund II, Inc.'s
total investment return was +6.26%, based on a change in per share net asset
value from $9.15 to $8.60, and assuming reinvestment of $0.964 per share income
dividends. During the same 12-month period, the net annualized yield of the
Fund's Common Stock was 11.34%. Since inception (March 27, 1998) through
February 29, 2000, the total investment return on the Fund's Common Stock was
+5.10%, based on a change in per share net asset value from $10.00 to $8.60, and
assuming reinvestment of $1.656 per share income dividends. At the end of the
February period, the Fund was 22.9% leveraged as a percentage of total assets.
(For a complete explanation of the benefits and risks of leverage, see page 1 of
this report to shareholders.)
Investment Approach
The Fund largely consists of high-yield bonds and participations in leveraged
bank loans. The high-yield bond and bank loan markets are comprised of similar
industry sectors and often contain overlapping issuers. As a result, general
economic events and trends tend to move the two markets in the same direction,
although the bonds typically move to a greater degree than the bank loans. This
is driven usually by two factors. First, bank loans are often senior secured
obligations, thus offering investors greater principal protection than unsecured
bonds. Second, bank loans are floating rate instruments whose principal value
generally does not move conversely with interest rate fluctuations, as is the
case with fixed-income bonds.
Market Review
Market conditions were difficult for high-yield securities during 1999. While
benefiting from a strong economy, the high-yield market suffered from a rise in
Treasury rates because of inflationary fears and an increase in default rates.
The yield on the ten-year Treasury note rose from 4.65% at the beginning of 1999
to 6.44% at year-end, producing a return of -8.25% for the year. To keep the
economy from overheating and igniting inflation, the Federal Reserve Board
increased the Federal Funds rate (the rate US banks charge each other for
overnight loans) 100 basis points (1.00%) to 5.75% during the Fund's fiscal
year. This sharp increase in interest rates resulted in the high-yield market
posting its second consecutive year of declining prices. The average price of a
bond in the high-yield market fell to 86% of par from 91% at the beginning of
the year. The risk premium, measured by the spread between the yield on the
average high-yield bond and the comparable Treasury bond, narrowed to 5.73% at
year-end as compared to 6.57% at the beginning of the year. The reduction in the
credit risk premium reflects the high-yield market's recovery from its
overreaction to the global financial crisis in the third quarter of 1998.
In 1999, there was approximately $91 billion in new high-yield debt issued
compared to $123 billion in 1998 and $137 billion in 1997. The new-issue market
was not as active as prior years because of investors' concerns about higher
interest rates and the crowding out effect of the equity market, whose sky-high
returns attracted capital from the high-yield market. In addition, capital
deployed by investment banks and dealers to support secondary market trading in
high-yield bonds dissipated throughout the year because of uncertainty about how
liquid the market would be at year-end because of Year 2000 concerns.
Another major factor that affected the high-yield market in 1999 was the higher
default rate. High-yield bond defaults rose to a 5.5% annual rate in 1999, the
highest level in almost a decade, as 86 domestic issuers defaulted in 1999,
representing $22 billion in par amount, compared to 46 issuers and $7.9 billion
in 1998. Ironically, the high level of defaults occurred during a period of
strong economic growth. This was the result of several factors. First, lower
commodity prices, especially in energy and chemicals, from global overcapacity
derived from the 1998 Asian crisis, drove smaller companies to lose access to
capital at a time when business prospects were pressured. Second, in response to
huge demand, heavy issuance of high-yield debt from 1996 to 1998 strained
underwriting standards and lower-quality transactions entered the marketplace.
Moreover, pricing power vanished in the global competitive arena, unfavorably
positioning producers of low value-added products. Finally, the healthcare
industry was specifically damaged by governmental change in reimbursement rates.
Going forward into 2000 and 2001, these trends have already shifted direction.
In general, the global markets have turned around and demand for commodities
should improve, raising prices. In addition, new issuance has been subdued and
healthcare issuance has been almost non-existent. Therefore, we believe there
will be a reduction in the default rate over the near term.
The loan market also experienced more volatility in 1999 than its historical
norm because of the higher default rate. Loan investors, seeking to prevent the
anticipated problems associated with financial restructurings, sold loans that
reported weaker-than-expected financial results faster to avoid potential
problems. This increased trading activity heightened volatility, as dealers
became less optimistic about providing liquidity for borrowers that were not
meeting projected budgets. In addition, loan investors dynamically shifted their
portfolios, increasing exposure to less volatile sectors or adding exposure to
sectors with greater potential for credit improvement. In essence, the loan
market appears to be assuming the portfolio management practices similar to
other markets, substantiating our view that loans do have prices, actively
trade, and should be valued on the basis of available market quotations, rather
than being marked at face value for the life of the loan.
The technical and fundamental problems of the high-yield market have resulted in
high-yield market outflows rather consistently for the past ten months. Because
of fund redemptions and higher interest rates, the high-yield bond sector (as
measured by the Donaldson, Lufkin and Jenrette (DLJ) High Yield Index) had a
poor total return of +1.60% for the six-month period ended February 29, 2000.
Bank loans (as measured by the DLJ Leveraged Loan Index) fared better, given the
floating rate nature of the asset class, and generated a return of +2.27% for
the same period. The Fund underperformed the indexes because of defaults in the
portfolio, limited exposure to emerging markets that performed strongly in 1999
and its leverage, which amplifies losses in a declining market.
Investment Activities
At February 29, 2000, 58% of the Fund's long-term assets were allocated to bonds
and 38% to bank loans. More than 96% of the Fund's bank loan holdings were
accruing interest at a yield spread above the London Interbank Offered Rate
(LIBOR), the rate that major banks charge each other for US denominated deposits
outside of the United States. LIBOR tracks very closely with other short-term
interest rates, such as the Federal Funds rate. Since the average interest rate
reset across the bank loan portion of the portfolio is about 45 days, the yield
on that portion of the Fund will move within a two-month period of any change in
the Federal Funds rate. The portfolio's stated average maturity was about 7
years at February 29, 2000, but based on our experience, the portfolio can be
expected to have an actual average life of approximately three years-four years
because of the freely prepayable nature of the bank loans.
The Fund was nearly 23% leveraged as a percentage of total assets and was
extremely well diversified across 224 issuers in 49 industries. See the
"Portfolio Profile" on page 23 of this report to shareholders, which provides
listings of the Fund's ten largest holdings and five largest industries as of
February 29, 2000.
Investment Strategy
Throughout the six months ended February 29, 2000, our investment strategy has
been unchanged: to invest in leveraged transactions in which borrowers have
strong market shares, experienced managements, consistent cash flows and
appropriate risk/reward characteristics. In addition, we look for companies with
significant underlying asset and franchise value, strong capital structures and
equity sponsors that support their investments. Throughout the last three
months, we have focused on the better-priced new-issue market. The new
transactions were also much more conservatively structured, with lower leverage
and higher interest coverage as investors have become more demanding.
Looking ahead, we expect to emphasize growth sectors, such as wireless
telecommunications, that are
2 & 3
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
exhibiting improving credit trends and have access to equity capital.
Substantial mergers and acquisition activity and better-than-expected subscriber
growth have attracted equity capital to the wireless telecommunications sector.
The Fund's largest holding in this sector is Nextel Communications, Inc. In
1999, Nextel Communications entered the Standard & Poor's 500 Index, a tribute
to its success in meeting investors' high expectations for growth and
profitability. While a potential acquisition with MCI WorldCom Inc. fell through
in 1999, it highlighted the strategic value of the company and since that time
the stock has tripled. Nextel Communications remains a core holding of the Fund
and we expect its credit profile to continue to improve.
While we anticipate that the Federal Reserve Board may increase short-term
interest rates by another 0.50% before year-end and acknowledge that this may
put pressure on high-yield bond prices over the next few months, we are
optimistic about the prospects for the Fund in 2000. This is based on our
expectations for a continuation of the strong economy in the United States with
a relatively stable interest rate environment, a gradual improvement in the
Asian economies, and a gradual decline in credit spreads to a more normal range.
In Conclusion
As difficult as the last six months were for the high-yield bond and leveraged
loan markets and the Fund, their performances illustrate the bank loan market's
ability to weather market fluctuations with less volatility than the high-yield
bond market. This is what differentiates the Fund from a pure high-yield bond
fund. This attribute continues to draw many new institutional buyers to the bank
loan market. We believe that both the technical and fundamental aspects are
improving in both the high-yield bond and bank loan sectors. We also believe we
have positively positioned the Fund to follow further expected improvements in
the marketplace in an effort to enhance total return potential in the coming
months.
We thank you for your investment in Debt Strategies Fund II, Inc., and we look
forward to reviewing our outlook and strategy with you again in our next report
to shareholders.
Sincerely,
/s/ Terry K. Glenn
Terry K. Glenn
President and Director
/s/ Richard C. Kilbride
Richard C. Kilbride
Vice President and
Co-Portfolio Manager
/s/ Gilles Marchand
Gilles Marchand
Vice President and
Co-Portfolio Manager
/s/ Paul Travers
Paul Travers
Vice President and
Co-Portfolio Manager
April 10, 2000
================================================================================
Please be advised that the 2000 Annual Meeting of Stockholders will take place
in August 2000. Any stockholder who intends to present a proposal at the meeting
and desires to have the proposal included in the Fund's proxy statement and form
of proxy for that meeting, must have delivered the proposal to the offices of
the Fund, attention: Bradley J. Lucido, Secretary, by May 15, 2000.
================================================================================
RISK/REWARD OF VARIOUS ASSETS
The graph below plots the annualized return and volatility experienced by
several asset classes averaged over the last eight years. The annualized returns
represent the annualization of the monthly series of returns for each asset
class over the time period indicated. The annualized volatility represents the
annualization of the monthly series of standard deviation for each asset class
over the time period indicated. Asset classes resting on the capital markets
line, linking the risk/return data points for money market securities and the
broad equity market, experienced a proportionate amount of return for the
corresponding amount of risk. Asset classes falling below the line endured a
disproportionate amount of risk relative to the return they achieved. Finally,
asset classes lying above the line achieved higher returns than justified by the
risk they experienced. Leveraged bank loans fall above the line, which
illustrates that, compared to other asset classes, the bank loan market provided
superior risk/reward characteristics over the period.
A line graph depicting the annualized return and volatility for various assets
from 1992 to 1999.
Volatility Return
Broad Equity Market 14.53% 18.25%
Emerging Market Bonds 20.36% 13.79%
High Yield Bonds 5.74% 9.96%
US Long-Term Treasury Bonds 9.03% 8.45%
Leveraged Loans 1.97% 8.15%
Investment-Grade Bonds 5.07% 7.51%
Mortgage Secs 3.29% 6.76%
US Intermediate Treasury Bonds 4.74% 6.19%
Money Market Secs .30% 4.47%
US Inflation .56% 2.54%
Source: Calculated by Merrill Lynch using information and data presented in
Ibbotson Investment Analysis Software, (C) 2000 Ibbotson Associates, Inc. All
rights reserved. Used with permission.
The assets used in the above analysis are represented by the following indexes:
US 30-day Treasury Bill Index (Money Market Securities); Merrill Lynch Mortgage
Index (Mortgage Securities); Ibbotson's US IT (Intermediate Treasuries);
Ibbotson's US LT Index (Long-Term Treasuries); Merrill Lynch Corporate Index
(Investment-Grade Bonds); Donaldson, Lufkin & Jenrette HY Index (High Yield
Bonds); Donaldson, Lufkin & Jenrette Leveraged Loan Index (Leveraged Loans);
EMBI Fixed Rate Index (Emerging Market Bonds); and Standard & Poor's 500 Index
(Broad Equity Market).
Money market securities are managed to maintain stable net asset values and are
highly liquid. US long-term Treasury bonds and US intermediate Treasury bonds
are guaranteed by the US government, and, if held at maturity, offer both a
fixed investment return and a fixed principal value. Investment-grade bonds,
although not guaranteed by the US government, also offer both fixed principal
value and investment return if held at maturity. High-yield bonds, emerging
market bonds and leveraged loans entail greater risk than investment-grade bonds
or loans. Certain leveraged bank loans may be considered illiquid.
Past performance is not a guarantee of future results. The Fund's performance is
not represented in the above chart.
4 & 5
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
==================================================================================================================================
<C> <C> <C> <C> <S> <C>
Advertising -- 0.3% B B2 US$ 1,300,000 Adams Outdoor Advertising Inc., 10.75% due 3/15/2006 $ 1,348,750
==================================================================================================================================
Aircraft & Parts -- 1.1% B- B3 2,500,000 Argo-Tech Corporation, 8.625% due 10/01/2007 2,050,000
B B1 1,000,000 BE Aerospace, 9.50% due 11/01/2008 921,250
B- B3 6,970,000 Compass Aerospace Corp., 10.125% due 4/15/2005 3,136,500
------------
6,107,750
==================================================================================================================================
Amusement & AMC Entertainment Inc.:
Recreational B- B3 1,000,000 9.50% due 3/15/2009 (c) 765,000
Services -- 2.9% B- B3 850,000 9.50% due 2/01/2011 641,750
NR* Ba3 3,095,236 American Ski, Term, due 5/31/2006** 3,033,331
B B2 1,000,000 Carmike Cinemas Inc., 9.375% due 2/01/2009 750,000
B- B3 3,000,000 Hollywood Entertainment, 10.625% due 8/15/2004 (c) 2,715,000
B+ NR* 4,912,500 Kerasotes Theatres, Inc., Term B, due 12/31/2004** 4,900,219
BB- Ba3 1,300,000 Loews Cineplex Entertainment, 8.875% due 8/01/2008 1,007,500
B- B1 2,000,000 SFX Entertainment, Term B, due 6/30/2006** 2,001,750
------------
15,814,550
==================================================================================================================================
Apparel -- 0.6% NR* NR* 3,250,000 CS Brooks Canada, Inc., Term, due 6/25/2006** 3,225,625
==================================================================================================================================
Automotive BB- Ba3 4,250,000 American Axle and Manufacturing Inc., 9.75% due 3/01/2009 4,196,875
Equipment -- 6.0% D Caa1 543,579 +Breed Technologies Inc., Revolving Credit, due 4/27/2004** 319,081
B+ B1 2,000,000 Citation Corporation, Term B, due 12/01/2007** 1,980,626
BB- Ba3 9,900,000 Collins & Aikman Corp., Term C, due 12/31/2005** 9,847,411
B B2 4,500,000 Group 1 Automotive Inc., 10.875% due 3/01/2009 4,252,500
BB- Ba3 3,200,000 Holley Performance Products, 12.25% due 9/15/2007 (c) 3,104,000
CCC+ Caa1 3,000,000 Newcor Inc., 9.875% due 3/01/2008 1,770,000
Safelite Glass Corp.**:
B+ B1 2,051,121 Term B, due 12/23/2003 1,119,912
B+ B1 2,051,121 Term C, due 12/23/2004 1,119,912
B- B3 2,050,000 Special Devices Inc., 11.375% due 12/15/2008 1,394,000
BB B2 2,250,000 Tenneco Inc., 11.625% due 10/15/2009 (c) 2,286,563
B- B3 800,000 Venture Holdings Trust, 12% due 6/01/2009 680,000
------------
32,070,880
==================================================================================================================================
Broadcast -- Radio & B B2 4,875,000 Ackerley Group Inc., 9% due 1/15/2009 4,600,781
Television -- 7.7% B B1 5,000,000 Benedek Broad, Term, due 11/20/2007** 4,992,190
B- B3 1,700,000 Citadel Broadcasting Company, 9.25% due 11/15/2008 1,632,000
Cumulus Media, Inc.:
B+ B3 2,000,000 10.375% due 7/01/2008 2,040,000
B+ B1 1,200,000 Term B, due 9/30/2007** 1,206,376
B+ B1 800,000 Term C, due 2/28/2008** 804,250
NR* NR* 4,200,000 Gocom Communications, Term B, due 12/31/2007** 4,189,500
B+ Ba3 1,525,000 Granite Broadcasting, 9.375% due 12/01/2005 1,448,750
B B3 2,250,000 Jones International Networks Ltd., 11.75% due 7/01/2005 2,261,250
NR* Caa1 18,550,000 Radio Unica Corp., 14.636% due 8/01/2006 (a) 11,872,000
CCC+ NR* 2,950,000 Sirius Satellite, 14.50% due 5/15/2009 2,846,750
B- B3 2,200,000 Spanish Broadcasting System, 9.625% due 11/01/2009 2,161,500
BB- Ba1 1,500,000 Young Broadcasting Inc., 8.75% due 6/15/2007 1,335,000
------------
41,390,347
==================================================================================================================================
Building & B- B2 1,600,000 Webb (Del E.) Corp., 10.25% due 2/15/2010 1,396,000
Construction -- 0.3%
==================================================================================================================================
Building B B3 5,950,000 Amatek Industries, 12% due 2/15/2008 5,593,000
Materials -- 2.6% B B2 5,100,000 Republic Group Inc., 9.50% due 7/15/2008 4,590,000
NR* NR* (euro) 639,115 Schulte GmbH & Co. KG, Term B, due 12/02/2003** 612,263
BB- B1 US$ 3,000,000 Trussway Industries, Term B, due 7/08/2005** 2,985,000
------------
13,780,263
==================================================================================================================================
Business B- B1 7,500,000 Muzak Holdings LLC, 13% due 3/15/2010 (a) 4,500,000
Services -- 0.8%
==================================================================================================================================
Cable Television CSC Holdings Inc.:
Services -- 11.1% BB+ Ba1 1,025,000 7.25% due 7/15/2008 956,889
BB+ Ba1 1,275,000 7.625% due 7/15/2018 1,174,090
Charter Communications Holdings LLC:
B+ B2 2,800,000 8.625% due 4/01/2009 2,548,000
B+ B2 5,000,000 10% due 4/01/2009 (c) 4,968,750
BB+ Ba3 5,000,000 Term B, due 3/18/2008** 5,014,665
Classic Cable Inc.:
B- B3 1,000,000 9.375% due 8/01/2009 937,500
B- B3 2,925,000 10.50% due 3/01/2010 (c) 2,928,656
BB B1 2,605,263 Term C, due 1/31/2008** 2,608,520
CCC+ Caa1 17,000,000 Coaxial LLC, 12.875% due 8/15/2008 (a) 10,625,000
BBB- Ba2 4,300,000 Comcast Corp., 9.375% due 5/15/2005 4,507,604
Echostar DBS Corporation:
B- B2 900,000 9.25% due 2/01/2006 877,500
B B2 4,225,000 9.375% due 2/01/2009 4,129,937
CCC+ B1 4,250,000 Golden Sky Systems, 12.375% due 8/01/2006 4,696,250
B+ Ba3 1,000,000 Insight Midwest/Insight Capital, 9.75% due 10/01/2009 (c) 1,010,000
BB+ B1 2,000,000 Multicanal SA, 10.50% due 4/15/2018 1,615,000
Pegasus Communications:
B- B3 450,000 9.75% due 12/01/2006 434,250
B+ B1 2,000,000 Term, due 4/30/2005** 2,005,834
D Caa3 2,000,000 +Supercanal Holdings SA, 11.50% due 5/15/2005 (c) 1,180,000
Telewest Communications PLC:
B+ B1 1,000,000 11.25% due 11/01/2008 1,062,500
B+ B1 3,800,000 9.875% due 2/01/2010 (c) 3,804,750
B B2 2,500,000 United Pan-Europe Communications, 11.25% due 2/01/2010 (c) 2,518,750
------------
59,604,445
==================================================================================================================================
Chemicals -- 3.4% BBB- Baa3 5,000,000 Equistar Chemicals LP, 8.75% due 2/15/2009 4,873,800
BB Ba2 3,442,437 Huntsman Corp., Term B, due 6/30/2004** 3,445,126
</TABLE>
6 & 7
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
==================================================================================================================================
<C> <C> <C> <C> <S> <C>
Chemicals NR* Ba2 US$ 4,175,707 Koppers Industries, Inc., Term B, due 11/30/2004** $ 4,157,438
(concluded) B Ca 2,700,000 LaRoche Industries Inc., 9.50% due 9/15/2007 810,000
NR* Ba3 4,962,500 Lyondell Petrochemical Co., Term E, due 5/17/2006** 5,094,954
------------
18,381,318
==================================================================================================================================
Computer-Related NR* NR* 4,225,983 Bridge Information Systems, Term B, due 5/29/2005** 4,072,204
Products -- 0.8%
==================================================================================================================================
Consumer CCC- Caa1 2,500,000 Diamond Brands Inc., 12.875% due 4/15/2009 (a) 500,000
Products -- 0.8% CCC+ B3 2,100,000 Diamond Brands Operating, 10.125% due 4/15/2008 1,470,000
B+ B2 1,225,000 Evenflo Company Inc., 11.75% due 8/15/2006 1,188,250
BB B1 1,325,000 Home Products International Inc., 9.625% due 5/15/2008 1,192,500
------------
4,350,750
==================================================================================================================================
Diversified -- 0.4% B+ Ba1 1,995,000 Blount Inc., Term B, due 6/30/2006** 2,007,469
==================================================================================================================================
Drilling -- 3.8% BB- B1 5,000,000 Cliffs Drilling, 10.25% due 5/15/2003 4,975,000
B+ B1 4,987,500 Key Energy Services Inc., Term B, due 9/14/2004** 4,996,852
Parker Drilling Co.:
B- B3 2,500,000 5.50% due 8/01/2004 (Convertible) 1,825,000
B+ B1 3,075,000 9.75% due 11/15/2006 2,928,937
RBF Finance Company:
BB- Ba3 1,100,000 11% due 3/15/2006 1,149,500
BB- Ba3 4,200,000 11.375% due 3/15/2009 4,452,000
------------
20,327,289
==================================================================================================================================
Educational B- B3 1,325,000 La Petite Academy/LPA Holdings, 10% due 5/15/2008 874,500
Services -- 0.2%
==================================================================================================================================
Electronics/Electrical B B2 4,112,000 Advanced Glassfiber Yarn, 9.875% due 1/15/2009 3,783,040
Components -- 3.7% BB- Ba3 1,500,000 Amkor Technologies Inc., 9.25% due 5/01/2006 1,455,000
B B2 2,053,000 BGF Industries Inc., 10.25% due 1/15/2009 1,878,495
B+ B1 1,000,000 Chippac International, Term B, due 7/31/2006** 999,375
B+ B1 4,970,000 Dynamic Details, Term B, due 4/22/2005** 4,929,619
B B1 1,575,000 Filtronic PLC, 10% due 12/01/2005 1,523,812
BB+ Ba2 4,250,000 Flextronics International Ltd., 8.75% due 10/15/2007 4,058,750
B+ B1 1,214,286 Viasystems, Revolving Credit, due 11/30/2002** 1,190,000
------------
19,818,091
==================================================================================================================================
Energy -- 2.4% B- B3 550,000 Belden & Blake Corp., 9.875% due 6/15/2007 275,000
BBB B3 1,000,000 Chesapeake Energy Corp., 9.625% due 5/01/2005 945,000
CCC Caa1 1,275,000 Continental Resources, 10.25% due 8/01/2008 1,211,250
B- Caa1 2,575,000 Energy Corp. of America, 9.50% due 5/15/2007 1,828,250
B B2 2,750,000 Forest Oil Corporation, 10.50% due 1/15/2006 2,777,500
CCC+ B3 1,850,000 Gothic Production Corp., 11.125% due 5/01/2005 1,540,125
B+ B1 3,000,000 Nuevo Energy Company, 9.50% due 6/01/2008 2,925,000
NR* Ba3 1,631,122 Plain Scurlock, Term B, due 5/12/2004** 1,612,772
------------
13,114,897
==================================================================================================================================
Environmental URS Corporation**:
Services -- 0.4% BB Ba3 995,000 Term B, due 6/09/2006 1,003,084
BB Ba3 995,000 Term C, due 6/09/2007 1,003,084
------------
2,006,168
==================================================================================================================================
Financial B B2 3,000,000 Ares Leveraged Fund II, Junior Subordinate Secured
Services -- 3.2% Note, due 10/31/2005(c)(e) 2,723,700
NR* NR* 2,422,081 Blackstone Capital, Term, due 11/30/2000** 2,403,915
NR* NR* 1,000,000 Investcorp SA, Term, due 10/21/2008 993,830
NR* NR* 1,000,000 Pennant CBO Limited, 13.43% due 3/14/2011 (c) 990,000
BB+ Ba3 5,000,000 Sovereign Bank, Term, due 11/17/2003** 5,021,875
NR* NR* 2,378,830 Wasserstein, Term, due 11/30/2000** 2,360,988
B+ Ba3 3,150,000 Willis Corroon Corporation, 9% due 2/01/2009 2,520,000
------------
17,014,308
==================================================================================================================================
Food & Kindred B+ B1 3,250,000 B & G Foods, Term B, due 3/15/2006** 3,245,938
Products -- 3.9% BB- B1 7,500,000 Luigino's Inc., 10% due 2/01/2006 6,150,000
B B2 2,000,000 SC International Services, Inc., 9.25% due 9/01/2007 1,840,000
Specialty Foods, Inc.**:
NR* B3 3,572,648 Revolving Credit, due 1/31/2001 3,554,785
NR* B3 6,097,101 Term, due 1/31/2001 6,112,343
------------
20,903,066
==================================================================================================================================
Forest Products -- 0.6% B B2 2,000,000 Ainsworth Lumber Company, 12.50% due 7/15/2007 (b) 2,155,000
B+ B3 650,000 Millar Western Forest, 9.875% due 5/15/2008 641,875
CCC- Caa1 1,000,000 Uniforet Inc., 11.125% due 10/15/2006 450,000
------------
3,246,875
==================================================================================================================================
Furniture & B- Ba3 3,425,000 Formica Corporation, 10.875% due 3/01/2009 3,031,125
Fixtures -- 0.6%
==================================================================================================================================
Gaming -- 7.1% Aladdin Gaming**:
CCC+ B2 3,000,000 Term B, due 8/26/2006 2,782,500
CCC+ B2 4,500,000 Term C, due 2/26/2008 4,173,750
B- B3 4,250,000 Ameristar Casinos, Inc., 10.50% due 8/01/2004 4,207,500
B B2 1,600,000 Argosy Gaming Company, 10.75% due 6/01/2009 1,644,000
B- Ba3 1,650,000 Coast Hotels & Casino, 9.50% due 4/01/2009 1,546,875
B B1 1,500,000 Eldorado Resorts LLC, 10.50% due 8/15/2006 1,500,000
B B2 4,465,000 Harvey Casino Resorts, 10.625% due 6/01/2006 4,587,787
Hollywood Park Inc.:
B B2 1,350,000 9.25% due 2/15/2007 1,306,125
B B2 2,750,000 9.50% due 8/01/2007 2,667,500
BB+ Ba2 9,200,000 Horseshoe Gaming LLC, 9.375% due 6/15/2007 8,901,000
BB Ba2 4,180,000 Isle of Capri Casinos, 8.75% due 4/15/2009 3,704,525
B- B3 1,950,000 Trump Atlantic City Associates/Funding Inc.,
11.25% due 5/01/2006 1,326,000
------------
38,347,562
==================================================================================================================================
</TABLE>
8 & 9
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
==================================================================================================================================
<C> <C> <C> <C> <S> <C>
Grocery -- 0.9% B B2 US$ 5,000,000 Grand Union Co., Term, due 8/17/2003** $ 4,975,000
==================================================================================================================================
Hotels & B- Ba3 6,000,000 Extended Stay America, 9.15% due 3/15/2008 5,355,000
Motels -- 5.2% NR* NR* 3,000,000 Starwood Hotels & Resorts Trust, Term 2, due 2/23/2003** 3,011,250
Wyndham International, Term**:
B+ B3 6,500,000 due 6/30/2006 6,415,702
B+ B3 13,500,000 due 6/30/2006 13,147,502
------------
27,929,454
==================================================================================================================================
Industrial BB- Ba3 1,750,000 American Plumbing & Mechanic, 11.625% due 10/15/2008 1,592,500
Services -- 0.6% B B2 1,750,000 Building One Services, 10.50% due 5/01/2009 (c) 1,610,000
------------
3,202,500
==================================================================================================================================
Leasing & Rental BB- B2 3,750,000 Anthony Crane Rental, Term, due 7/24/2006** 3,659,374
Services -- 3.7% Avis Rent A Car**:
BB+ Ba3 3,500,000 Term B, due 6/30/2006 3,523,153
BB+ Ba3 3,500,000 Term C, due 6/30/2007 3,525,375
BB- NR* 3,930,000 Coinmach Laundry Corp., Term B, due 6/30/2005** 3,930,817
B B3 550,000 National Equipment Services, 10% due 11/30/2004 530,750
B B3 500,000 Neff Corp., 10.25% due 6/01/2008 450,000
B- B3 900,000 Penhall International, 12% due 8/01/2006 904,500
BB+ Ba2 3,000,000 United Rental, Term C, due 8/12/2006** 2,996,718
B B3 750,000 Universal Hospital Services, 10.25% due 3/01/2008 510,000
------------
20,030,687
==================================================================================================================================
Manufacturing -- 4.8% BB- B1 4,950,000 Environmental Systems, Term B, due 9/30/2005** 4,714,875
B- B2 2,478,000 Fairfield Manufacturing Company Inc., 9.625% due 10/15/2008 2,254,980
NR* NR* 5,000,000 Metokote Corp., Term B, due 11/02/2005** 5,012,500
CCC- Ca 4,500,000 Morris Materials Handling, 9.50% due 4/01/2008 855,000
B- B3 1,575,000 Russell-Stanley Holding Inc., 10.875% due 2/15/2009 1,370,250
BB- Ba3 4,273,065 Terex Corporation, Term B, due 3/06/2005** 4,279,172
NR* NR* 4,500,000 TransTechnology, Term, due 8/31/2009** 4,432,500
B+ Ba3 3,000,000 Westinghouse Air Brake, 9.375% due 6/15/2005 2,940,000
------------
25,859,277
==================================================================================================================================
Medical B+ B1 4,000,000 Hudson Respiratory Care, 9.125% due 4/15/2008 3,200,000
Equipment -- 0.6%
==================================================================================================================================
Metals & CCC- NR* 2,940,000 AEI Resources, Term B, due 12/31/2004** 2,609,250
Mining -- 4.3% NR* B3 2,922,857 Acme Metals Inc., Term, due 12/01/2005** 2,551,654
BB NR* 795,594 Asarco Incorporated, Term 2, due 5/15/2001** 794,102
B Ba3 1,050,000 Bayou Steel Corp., 9.50% due 5/15/2008 968,625
B Caa1 1,625,000 GS Technologies Operating Co., 12% due 9/01/2004 910,000
D C 5,000,000 +Geneva Steel, 9.50% due 1/15/2004 950,000
BB- B1 4,000,000 Golden Northwest Aluminum, 12% due 12/15/2006 4,190,000
BB Ba2 4,000,000 Great Central Mines Ltd., 8.875% due 4/01/2008 3,620,000
B Caa2 2,400,000 Lodestar Holdings Inc., 11.50% due 5/15/2005 600,000
B B2 1,975,000 Metal Management Inc., 10% due 5/15/2008 1,481,250
B- B3 5,000,000 WHX Corp., 10.50% due 4/15/2005 4,700,000
------------
23,374,881
==================================================================================================================================
Online B- B3 1,425,000 PSINet Inc., 11% due 8/01/2009 1,428,562
Services -- 1.0% NR* NR* 3,000,000 Splitrock Services Inc., 11.75% due 7/15/2008 3,195,000
B- B3 1,000,000 Verio Inc., 11.25% due 12/01/2008 1,025,000
------------
5,648,562
==================================================================================================================================
Packaging -- 1.0% B- Caa1 850,000 Consumers Packaging Inc., 9.75% due 2/01/2007 484,500
B- Caa2 1,000,000 Indesco International, 9.75% due 4/15/2008 340,000
B B3 2,500,000 Packaging Corporation of America, 9.625% due 4/01/2009 2,500,000
B B3 2,750,000 Spinnaker Industries Inc., 10.75% due 10/15/2006 2,200,000
------------
5,524,500
==================================================================================================================================
Paging -- 0.1% CCC+ B3 325,000 Metrocall Inc., 11% due 9/15/2008 (c) 269,750
==================================================================================================================================
Paper -- 4.3% B+ B2 2,550,000 Norampac Inc., 9.50% due 2/01/2008 2,537,250
BB Ba2 4,975,000 Pacifica Paper, Term B, due 12/31/2006** 4,999,875
B- B2 6,000,000 Repap New Brunswick, Inc., Term B, due 6/01/2004** 5,876,250
B+ B1 4,000,000 SD Warren Co., 12% due 12/15/2004 4,150,000
B+ Ba3 5,801,556 Stone Container Corporation, Term E, due 10/01/2003** 5,824,971
------------
23,388,346
==================================================================================================================================
Petroleum BB- Ba3 2,000,000 Clark Refining & Marketing Inc., Term, due 11/15/2004** 1,250,000
Refineries -- 0.2%
==================================================================================================================================
Pharmaceuticals -- Dade Behring Inc.**:
0.5% B+ Ba3 1,243,750 Term B, due 6/30/2006 1,247,082
B+ Ba3 1,243,750 Term C, due 6/30/2007 1,247,082
------------
2,494,164
==================================================================================================================================
Printing & B- Caa3 1,050,000 Premier Graphics Inc., 11.50% due 12/01/2005 472,500
Publishing -- 0.3% BBB- Baa3 1,000,000 World Color Press Inc., 8.375% due 11/15/2008 977,767
------------
1,450,267
==================================================================================================================================
Property Ba3 NR* 3,000,000 NRT Incorporated, Term, due 7/31/2004** 2,987,814
Management -- 1.1% B- Ba2 675,000 Prison Realty Trust Inc., 12% due 6/01/2006 648,000
NR* NR* 2,500,000 Rockefeller Center Property Trust, 10.573% due 12/31/2000
(Convertible)(a) 2,087,500
------------
5,723,314
==================================================================================================================================
Restaurants -- 0.8% Domino & Bluefence**:
B+ B1 1,000,000 Term B, due 12/21/2006 1,005,313
B+ B1 2,162,446 Term C, due 12/21/2007 2,174,417
B+ B1 1,160,194 Domino Pizza Funding Corp., Term B, due 12/21/2006** 1,166,358
------------
4,346,088
==================================================================================================================================
</TABLE>
10 & 11
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (continued) (in US dollars)
<TABLE>
<CAPTION>
S&P Moody's Face
INDUSTRIES Ratings Ratings Amount Corporate Debt Obligations Value
==================================================================================================================================
<C> <C> <C> <C> <S> <C>
Retail -- NR* NR* US$ 3,960,000 Asbury Automotive Group, Senior Secured Note,
Specialty -- 1.4% due 3/31/2005** $ 3,910,500
B B3 2,000,000 TM Group Holdings, 11% due 5/15/2008 1,980,000
B- Caa1 1,890,000 United Auto Group, Inc., 11% due 7/15/2007 1,795,500
------------
7,686,000
==================================================================================================================================
Shipping -- 0.2% CCC+ B2 2,000,000 Enterprises Shipholding, 8.875% due 5/01/2008 1,220,000
==================================================================================================================================
Textile Mill B Caa3 6,500,000 Galey & Lord, Inc., 9.125% due 3/01/2008 2,015,000
Products -- 1.2% B- Caa1 1,150,000 Globe Manufacturing Corp., 10% due 8/01/2008 483,000
NR* NR* 3,968,049 Joan Fabrics Corp., Term A, due 6/30/2003** 3,940,769
------------
6,438,769
==================================================================================================================================
Tower Construction & BB- B1 5,000,000 American Tower Systems Co., Term B, due 12/30/2007** 5,038,540
Leasing -- 1.8% B B3 650,000 Crown Castle International Corporation, 9% due 5/15/2011 614,250
NR* NR* 4,000,000 Spectracite, Term B, due 6/30/2006** 4,014,000
------------
9,666,790
==================================================================================================================================
Transportation BB- NR* 1,000,000 Autopistas del Sol SA, 10.25% due 8/01/2009 (c) 825,000
Services -- 2.6% NR* NR*(pound)3,199,000 Eurotunnel, Tier 1 Tranche, due 11/04/2007** 4,144,371
B NR* US$ 5,000,000 MRS Logistica SA, 10.625% due 8/15/2005 (c) 4,287,500
NR* Ba3 4,975,000 Transportation Manufacturing, Term B, due 6/15/2006** 5,002,984
------------
14,259,855
==================================================================================================================================
Utilities -- 0.4% BB Ba1 2,750,000 Monterrey Power, SA de CV, 9.625% due 11/15/2009 (c) 2,447,500
==================================================================================================================================
Waste B- Caa1 2,500,000 ISG Resources Inc., 10% due 4/15/2008 2,231,250
Management -- 1.7% BB- B3 4,590,000 Norcal Waste Systems, 13.50% due 11/15/2005 4,830,975
B+ B3 1,525,000 Safety-Kleen Corporation, 9.25% due 5/15/2009 1,311,500
B B3 725,000 Stericycle Inc., 12.375% due 11/15/2009 741,312
------------
9,115,037
==================================================================================================================================
Wired B+ B2 2,000,000 Call-Net Enterprises Inc., 9.375% due 5/15/2009 1,580,000
Telecommunications -- B B3 3,925,000 Caprock Communications Corporation, 11.50% due 5/01/2009 3,983,875
12.4% NR* NR* 4,275,000 E. Spire Communications, 10.521% due 7/01/2008 (a) 2,094,750
B- Caa1 4,825,000 Global Telesystems Group, 9.875% due 2/15/2005 4,101,250
BB- B2 5,000,000 Globenet Communications Group Ltd., 13% due 7/15/2007 (c) 4,750,000
B B3 650,000 Hermes Europe RailTel BV, 10.375% due 1/15/2009 (c) 609,375
Intermedia Communications Inc.:
B B2 4,000,000 9.046% due 7/15/2007 (a) 3,170,000
B B2 4,250,000 9.50% due 3/01/2009 4,069,375
B+ B1 3,250,000 Level 3 Communications Inc., 9.125% due 5/01/2008 2,941,250
B+ B2 1,000,000 Metromedia Fiber Network, 10% due 11/15/2008 982,500
B B3 1,400,000 Netia Holdings II BV, 13.125% due 6/15/2009 1,491,000
NR* B2 5,000,000 Nextlink Communications, 9.45% due 4/15/2008 (a) 3,125,000
NR* NR* 8,750,000 Pacific Crossing Ltd., Term B, due 7/28/2006** 8,553,125
Primus Telecommunications Group:
B- B3 1,000,000 11.75% due 8/01/2004 990,000
B- B3 1,875,000 11.25% due 1/15/2009 1,781,250
RSL Communications PLC:
B- B2 3,000,000 11.965% due 3/01/2008 (a) 1,627,500
B- B2 1,950,000 9.875% due 11/15/2009 1,628,250
NR* B3 6,129,032 Teligent Inc., Term, due 7/01/2002** 6,017,944
B B2 3,000,000 Time-Warner Telecom LLC, 9.75% due 7/15/2008 3,000,000
NR* NR* 700,000 Versatel Telecom BV, 11.875% due 7/15/2009 (c) 714,000
B- B3 4,000,000 Viatel, Inc., 11.50% due 3/15/2009 3,780,000
Williams Communications Group Inc.:
BB- B2 1,500,000 10.70% due 10/01/2007 1,541,250
BB- B2 1,500,000 10.875% due 10/01/2009 1,530,000
Worldwide Fiber Inc.:
B+ B3 1,950,000 12.50% due 12/15/2005 2,042,625
B+ B3 700,000 12% due 8/01/2009 728,000
------------
66,832,319
==================================================================================================================================
Wireless B B1 8,750,000 CTI Holdings SA, 11.316% due 4/15/2008 (a) 5,775,000
Telecommunications -- Dolphin Telecom PLC (a):
8.6% CCC+ Caa1 700,000 16.331% due 6/01/2008 316,750
CCC+ Caa1 1,500,000 14% due 5/15/2009 630,000
ESAT Telecom Group PLC:
B+ B3 2,225,000 12.427% due 2/01/2007 (a) 2,002,500
B+ B3 8,660,000 11.875% due 12/01/2008 10,045,600
B- B3 1,900,000 Microcell Telecommunications, 12% due 6/01/2009 (a) 1,239,750
Nextel Communications, Inc.**:
BB- Ba2 5,000,000 Term B, due 6/30/2008 5,054,465
BB- Ba2 5,000,000 Term C, due 12/31/2008 5,054,465
CCC+ B3 4,725,000 Nextel Partners Inc., 14% due 2/01/2009 (a) 3,153,938
B+ B2 1,000,000 PTC International Finance II SA, 11.25% due 12/01/2009 (c) 1,010,000
Telesystem International Wireless Inc. (a):
CCC+ Caa1 3,350,000 16.147% due 6/30/2007 2,144,000
CCC+ Caa1 4,250,000 10.052% due 11/01/2007 2,337,500
VoiceStream Wireless Corporation/VoiceStream Wireless
Holding Company:
B- B1 725,000 10.375% due 11/15/2009 (c) 749,469
B+ B1 7,000,000 Term B, due 2/25/2009** 7,041,013
------------
46,554,450
==================================================================================================================================
Total Investments in Corporate Debt Obligations
(Cost -- $722,242,901) -- 124.4% 669,621,742
==================================================================================================================================
</TABLE>
12 & 13
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
SCHEDULE OF INVESTMENTS (concluded) (in US dollars)
<TABLE>
<CAPTION>
Shares
INDUSTRIES Held Stocks & Warrants Value
==================================================================================================================================
<C> <C> <S> <C>
Broadcast -- Radio & 8,850 Sirius Satellite (Warrants) (c)(d) $ 1,150,500
Television -- 0.2%
==================================================================================================================================
Online Services -- 0.1% 3,000 Splitrock Services Inc. (Warrants) (d) 690,000
==================================================================================================================================
Packaging -- 0.6% 26,452 Packaging Corporation of America (Preferred) (b) 3,088,312
==================================================================================================================================
Tower Construction 6,025 Crown Castle International Corporation (Preferred) (b) 6,205,363
& Leasing -- 1.2%
==================================================================================================================================
Wired 17,336 +Viatel, Inc. 976,234
Telecommunications --
0.2%
==================================================================================================================================
Wireless 2,000 Centaur Funding Corp. (Preferred) 2,049,376
Telecommunications -- 4,804 Dobson Communications (Preferred) (b) 5,212,303
1.3% ------------
7,261,679
==================================================================================================================================
Total Investments in Stocks & Warrants
(Cost -- $16,583,812) -- 3.6% 19,372,088
==================================================================================================================================
<CAPTION>
Face
Amount Short-Term Securities
==================================================================================================================================
<C> <C> <S> <C>
Commercial US$ 634,000 Vastar Resources, 5.95% due 3/01/2000 634,000
Paper*** -- 0.1%
==================================================================================================================================
Total Investments in Short-Term Securities
(Cost -- $634,000) -- 0.1% 634,000
==================================================================================================================================
Total Investments (Cost -- $739,460,713) -- 128.1% 689,627,830
Unrealized Appreciation on Forward Foreign
Exchange Contracts -- Net**** -- 0.0% 74,339
Liabilities in Excess of Other Assets -- (28.1%) (151,359,479)
------------
Net Assets -- 100.0% $538,342,690
============
==================================================================================================================================
</TABLE>
(a) Represents a zero coupon or step bond; the interest rate shown reflects
the effective yield at the time of purchase by the Fund.
(b) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
(c) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(d) 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.
(e) Floating rate note.
* 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 50.4% 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 29, 2000 were as
follows:
--------------------------------------------------------------------------
Foreign Expiration Unrealized
Currency Sold Date Appreciation
--------------------------------------------------------------------------
(euro) 638,617 March 2000 $15,786
(pound) 2,760,621 March 2000 58,553
--------------------------------------------------------------------------
Total Unrealized Appreciation on Forward
Foreign Exchange Contracts -- Net
(US$ Commitment -- $5,047,587) $74,339
=======
--------------------------------------------------------------------------
+ Non-income producing security.
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 29, 2000
==================================================================================================================================
<C> <S> <C> <C>
Assets: Investments, at value (identified cost -- $739,460,713) ........................... $689,627,830
Cash .............................................................................. 49,209
Unrealized appreciation on forward foreign exchange contracts ..................... 74,339
Receivables:
Interest ........................................................................ $ 13,253,517
Securities sold ................................................................. 487,563
Dividends ....................................................................... 233,364 13,974,444
------------
Deferred facility fees ............................................................ 4,107
Prepaid expenses .................................................................. 98,220
------------
Total assets ...................................................................... 703,828,149
------------
==================================================================================================================================
Liabilities: Loans ............................................................................. 161,000,000
Payables:
Interest on loans ............................................................... 2,406,730
Dividends to shareholders ....................................................... 1,122,672
Investment adviser .............................................................. 265,844
Securities purchased ............................................................ 260,821
Commitment fees ................................................................. 9,078 4,065,145
------------
Deferred income ................................................................... 50,633
Accrued expenses .................................................................. 369,681
------------
Total liabilities ................................................................. 165,485,459
------------
==================================================================================================================================
Net Assets: Net assets ........................................................................ $538,342,690
============
==================================================================================================================================
Capital: Common Stock, $.10 par value, 200,000,000 shares authorized ....................... $ 6,261,000
Paid-in capital in excess of par .................................................. 619,266,581
Undistributed investment income -- net ............................................ 5,195,536
Accumulated realized capital losses on investments and foreign currency ...........
transactions -- net ............................................................... (42,755,240)
Unrealized depreciation on investments and foreign currency transactions -- net ... (49,625,187)
------------
Net Assets -- Equivalent to $8.60 per share based on 62,610,000 shares of capital
stock outstanding (market price -- $7.1875) ....................................... $538,342,690
============
==================================================================================================================================
</TABLE>
See Notes to Financial Statements.
14 & 15
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Year Ended February 29, 2000
==================================================================================================================================
<C> <S> <C> <C>
Investment Income: Interest and discount earned (net of $35,782 foreign withholding tax) ... $ 75,022,886
Dividends ............................................................... 1,637,840
Facility and other fees ................................................. 685,818
------------
Total income ............................................................ 77,346,544
------------
==================================================================================================================================
Expenses: Loan interest expense ................................................... $ 10,655,187
Investment advisory fees ................................................ 4,459,855
Professional fees ....................................................... 206,308
Borrowing costs ......................................................... 255,584
Accounting services ..................................................... 122,348
Listing fees ............................................................ 94,061
Transfer agent fees ..................................................... 85,477
Custodian fees .......................................................... 60,588
Printing and shareholder reports ........................................ 51,924
Organization expenses ................................................... 42,833
Directors' fees and expenses ............................................ 27,003
Pricing services ........................................................ 15,471
Other ................................................................... 66,848
------------
Total expenses .......................................................... 16,143,487
------------
Investment income-- net ................................................. 61,203,057
------------
==================================================================================================================================
Realized & Realized gain (loss) from:
Unrealized Gain (Loss) Investments -- net .................................................... (29,321,429)
On Investments & Foreign currency transactions -- net .................................. 137,183 (29,184,246)
Foreign Currency ------------
Transactions -- Net: Change in unrealized appreciation/depreciation on:
Investments -- net .................................................... (6,155,982)
Foreign currency transactions -- net .................................. (92,194) (6,248,176)
------------ ------------
Net Increase in Net Assets Resulting from Operations .................... $ 25,770,635
============
==================================================================================================================================
</TABLE>
See Notes to Financial Statements.
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the For the Period
Year Ended March 27, 1998+
February 29, to February 28,
Increase (Decrease) in Net Assets: 2000 1999
==================================================================================================================================
<C> <S> <C> <C>
Operations: Investment income -- net ...................................................... $ 61,203,057 $ 47,590,151
Realized loss on investments and foreign currency transactions -- net ......... (29,184,246) (13,489,541)
Change in unrealized appreciation/depreciation on investments and foreign
currency transactions -- net .................................................. (6,248,176) (43,377,011)
------------ ------------
Net increase (decrease) in net assets resulting from operations ............... 25,770,635 (9,276,401)
------------ ------------
==================================================================================================================================
Dividends to Dividends to shareholders from investment income -- net ....................... (60,330,046) (43,349,079)
Shareholders: ------------ ------------
==================================================================================================================================
Capital Share Proceeds from issuance of Common Stock ........................................ -- 626,000,000
Transactions: Offering costs resulting from the issuance of Common Stock .................... -- (572,419)
------------ ------------
Net increase in net assets resulting from capital share transactions .......... -- 625,427,581
------------ ------------
==================================================================================================================================
Net Assets: Total increase (decrease) in net assets ....................................... (34,559,411) 572,802,101
Beginning of period ........................................................... 572,902,101 100,000
------------ ------------
End of period* ................................................................ $538,342,690 $572,902,101
============ ============
==================================================================================================================================
* Undistributed investment income -- net ........................................ $ 5,195,536 $ 4,159,105
============ ============
==================================================================================================================================
</TABLE>
+ Commencement of operations.
See Notes to Financial Statements.
16 & 17
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
For the Year Ended February 29, 2000
==================================================================================================================================
<C> <S> <C>
Cash Provided by Net increase in net assets resulting from operations ..................................... $ 25,770,635
Operating Activities: Adjustments to reconcile net increase in net assets resulting from
operations to net cash provided by operating activities:
Increase in receivables ................................................................ (1,963,930)
Decrease in other assets ............................................................... 54,261
Increase in other liabilities .......................................................... 1,243,487
Realized and unrealized loss on investments and foreign currency transactions -- net ... 35,432,422
Amortization of discount ............................................................... (9,273,659)
-------------
Net cash provided by operating activities ................................................ 51,263,216
-------------
==================================================================================================================================
Cash Used for Proceeds from sales of long-term investments ............................................. 450,152,458
Investing Activities: Purchases of long-term investments ....................................................... (460,073,831)
Purchases of short-term investments ...................................................... (186,278,653)
Proceeds from sales and maturities of short-term investments ............................. 186,224,000
-------------
Net cash used for investing activities ................................................... (9,976,026)
-------------
==================================================================================================================================
Cash Used for Cash receipts from borrowings ............................................................ 330,000,000
Financing Activities: Cash payments on borrowings .............................................................. (311,000,000)
Dividends paid to shareholders ........................................................... (60,520,118)
-------------
Net cash used for financing activities ................................................... (41,520,118)
-------------
==================================================================================================================================
Cash: Net decrease in cash ..................................................................... (232,928)
Cash at beginning of year ................................................................ 282,137
-------------
Cash at end of year ...................................................................... $ 49,209
=============
==================================================================================================================================
Cash Flow Cash paid for interest ................................................................... $ 9,305,212
Information: =============
==================================================================================================================================
</TABLE>
See Notes to Financial Statements.
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
The following per share data and ratios have been derived For the For the Period
from information provided in the financial statements. Year Ended March 27, 1998+
February 29, to February 28,
Increase (Decrease) in Net Asset Value: 2000 1999
===================================================================================================================================
<C> <S> <C> <C>
Per Share Net asset value, beginning of period ......................................... $ 9.15 $ 10.00
Operating ---------- ----------
Performance: Investment income -- net ..................................................... .97 .76
Realized and unrealized loss on investments and foreign currency
transactions -- net .......................................................... (.56) (.91)
---------- ----------
Total from investment operations ............................................. .41 (.15)
---------- ----------
Less dividends from investment income -- net ................................. (.96) (.69)
---------- ----------
Capital charge resulting from the issuance of Common Stock ................... -- (.01)
---------- ----------
Net asset value, end of period ............................................... $ 8.60 $ 9.15
========== ==========
Market price per share, end of period ........................................ $ 7.1875 $ 7.875
========== ==========
===================================================================================================================================
Total Investment Based on market price per share .............................................. 3.19% (14.87%)++
Return:** ========== ==========
Based on net asset value per share ........................................... 6.26% (1.09%)++
========== ==========
===================================================================================================================================
Ratios to Average Expenses, net of reimbursement and excluding interest expense ................ .98% .54%*
Net Assets: ========== ==========
Expenses, net of reimbursement ............................................... 2.87% .93%*
========== ==========
Expenses ..................................................................... 2.87% 1.20%*
========== ==========
Investment income -- net ..................................................... 10.88% 8.60%*
========== ==========
===================================================================================================================================
Leverage: Amount of borrowings, end of period (in thousands) ........................... $ 161,000 $ 142,000
========== ==========
Average amount of borrowings outstanding during the period (in thousands) .... $ 182,404 $ 42,330
========== ==========
Average amount of borrowings outstanding per share during the period ......... $ 2.91 $ .69
========== ==========
===================================================================================================================================
Supplemental Net assets, end of period (in thousands) ..................................... $ 538,343 $ 572,902
Data: ========== ==========
Portfolio turnover ........................................................... 61.76% 89.76%
========== ==========
===================================================================================================================================
</TABLE>
* Annualized.
** 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. Total investment returns exclude the effects of sales
charges.
+ Commencement of operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Debt Strategies Fund II, 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 DSU.
(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 are valued in accordance with
guidelines established by the Board of Directors. Until July 9, 1999, 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 were valued by calculating the mean of the last 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 was available, such
Corporate Loan was valued on the basis of the mean of the last available bid and
asked prices in the market. As of July 12, 1999, pursuant to the approval of the
Board of Directors, the Corporate Loans are valued at the mean between the last
18 & 19
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
NOTES TO FINANCIAL STATEMENTS (continued)
available bid and asked prices from one or more brokers or dealers as obtained
from Loan Pricing Corporation. 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 that 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) Organization expenses -- In accordance with Statement of Position 98-5,
unamortized organization expenses of $42,833 were expensed during the year ended
February 29, 2000. This was considered to be a change in accounting principle
and had no material impact on the operations of the Fund.
(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 $163,420 have been reclassified between undistributed
net investment income and accumulated net realized capital losses. 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 .60% of the Fund's average weekly net assets
plus the proceeds of any outstanding borrowings used for leverage.
For the year ended February 29, 2000, the Fund paid Merrill Lynch Security
Pricing Service, an affiliate of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S"), $380 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 29, 2000 were $454,974,089 and $450,640,021, respectively.
Net realized gains (losses) for the year ended February 29, 2000 and net
unrealized gains (losses) as of February 29, 2000 were as follows:
- --------------------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Gains (Losses)
- --------------------------------------------------------------------------------
Long-term investments ...................... $(29,321,429) $(49,832,883)
Unfunded corporate loans ................... -- 133,974
Forward foreign exchange contracts ......... 199,438 74,339
Foreign currency transactions .............. (62,255) (617)
------------ ------------
Total ...................................... $(29,184,246) $(49,625,187)
============ ============
- --------------------------------------------------------------------------------
As of February 29, 2000, net unrealized depreciation for Federal income tax
purposes aggregated $50,156,118, of
20 & 21
<PAGE>
Debt Strategies Fund II, Inc., February 29, 2000
NOTES TO FINANCIAL STATEMENTS (concluded)
which $8,634,497 related to appreciated securities and $58,790,615 related to
depreciated securities. The aggregate cost of investments at February 29, 2000
for Federal income tax purposes was $739,783,948.
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 29,
2000 remained constant and during the period March 27, 1998 to February 28, 1999
increased by 62,600,000 from shares sold.
5. Unfunded Loan Interests:
As of February 29, 2000, the Fund had unfunded loan commitments of approximately
$1,595,000, which would be extended at the option of the borrower, pursuant to
the following loan agreements:
- --------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in Thousands)
- --------------------------------------------------------------------------------
Breed Technologies Inc. ..................................... $ 15
Metro-Goldwyn-Mayer Inc. (MGM) .............................. 1,500
Specialty Foods, Inc. ....................................... 80
- --------------------------------------------------------------------------------
6. Short-Term Borrowings:
On July 14, 1999, the Fund extended its one-year credit agreement with The Bank
of New York and Harris Trust and Savings Bank. The agreement is a $225,000,000
credit facility bearing interest at the Prime rate, the Federal Funds rate plus
.55% and/or Eurodollar plus .55%. For the year ended February 29, 2000, the
average amount borrowed was approximately $182,404,000 and the daily weighted
average interest rate was 5.84%. For the year ended February 29, 2000, facility
and commitment fees aggregated approximately $256,000.
7. Capital Loss Carryforward:
At February 29, 2000, the Fund had a net capital loss carryforward of
approximately $29,650,000, of which $5,992,000 expires in 2007 and $23,658,000
expires in 2008. This amount will be available to offset like amounts of any
future taxable gains.
8. Subsequent Event:
On March 7, 2000, the Fund's Board of Directors declared an ordinary income
dividend to Common Stock shareholders in the amount of $.080372 per share,
payable on March 31, 2000 to shareholders of record as of March 17, 2000.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders,
Debt Strategies Fund II, Inc.:
We have audited the accompanying statement of assets, liabilities and capital,
including the schedule of investments, of Debt Strategies Fund II, Inc. as of
February 29, 2000, 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 March 27, 1998
(commencement of operations) to February 28, 1999. 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
29, 2000 by correspondence with the custodian and financial intermediaries;
where replies were not received from financial intermediaries, we performed
other auditing 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
audits provide 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
II, Inc. as of February 29, 2000, 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 17, 2000
PORTFOLIO PROFILE (unaudited)
As of February 29, 2000
Percent of
Five Largest Industries Total Assets
- --------------------------------------------------------------------------------
Wired Telecommunications ............................................. 9.6%
Cable Television Services ............................................ 8.5
Wireless Telecommunications .......................................... 7.6
Broadcast -- Radio & Television ...................................... 6.0
Gaming ............................................................... 5.4
- --------------------------------------------------------------------------------
Percent of
Ten Largest Holdings Total Assets
- --------------------------------------------------------------------------------
Wyndham International ................................................ 2.8%
Charter Communications Holdings LLC .................................. 1.8
ESAT Telecom Group PLC ............................................... 1.7
Radio Unica Corp. .................................................... 1.7
Coaxial LLC .......................................................... 1.5
Nextel Communications, Inc. .......................................... 1.4
Collins & Aikman Corp. ............................................... 1.4
Specialty Foods, Inc. ................................................ 1.4
Horseshoe Gaming LLC ................................................. 1.3
Pacific Crossing Ltd. ................................................ 1.2
- --------------------------------------------------------------------------------
Percent of
Quality Ratings Long-Term
S&P/Moody's Investments
- --------------------------------------------------------------------------------
BBB/Baa .............................................................. 1.7%
BB/Ba ................................................................ 31.1
B/B .................................................................. 51.6
CCC/Caa or lower ..................................................... 6.1
NR (Not Rated) ....................................................... 9.5
- --------------------------------------------------------------------------------
Percent of
Long-Term
Breakdown of Investments by Country Investments
- --------------------------------------------------------------------------------
United States ........................................................ 90.1%
United Kingdom ....................................................... 2.8
Canada ............................................................... 2.0
Ireland .............................................................. 1.8
Brazil ............................................................... 0.6
Argentina ............................................................ 0.5
Australia ............................................................ 0.5
Netherlands .......................................................... 0.5
Mexico ............................................................... 0.4
Poland ............................................................... 0.2
Greece ............................................................... 0.2
Luxembourg ........................................................... 0.1
Cayman Islands ....................................................... 0.1
Germany .............................................................. 0.1
Belgium .............................................................. 0.1
- --------------------------------------------------------------------------------
22 & 23
<PAGE>
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
Bradley J. Lucido, Secretary
Custodian and Transfer Agent
The Bank of New York
110 Washington Street
New York, NY 10286
NYSE Symbol
DSU
This report, including the financial information herein, is transmitted to the
shareholders of Debt Strategies Fund II, 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 II, Inc.
Box 9011
Princeton, NJ
08543-9011 #DEBTII -- 2/00
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