UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSRS
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-3290
Name of Fund: Merrill Lynch Variable Series Funds, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Terry K. Glenn, President, Merrill Lynch
Variable Series Funds, Inc., 800 Scudders Mill Road, Plainsboro, NJ, 08536.
Mailing address: P.O. Box 9011, Princeton, NJ, 08543-9011
Registrant's telephone number, including area code: (609) 282-2800
Date of fiscal year end: 12/31/04
Date of reporting period: 01/01/04 - 06/30/04
Item 1 - Report to Stockholders
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MERRILL LYNCH VARIABLE
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SERIES FUNDS, INC.
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<Table>
<Caption>
PAGE
----
American Balanced V.I. Fund........... 1
Basic Value V.I. Fund................. 24
Core Bond V.I. Fund................... 40
Domestic Money Market V.I. Fund....... 64
Fundamental Growth V.I. Fund.......... 77
Global Allocation V.I. Fund........... 91
Global Growth V.I. Fund............... 126
Government Bond V.I. Fund............. 142
High Current Income V.I. Fund......... 157
Index 500 V.I. Fund................... 176
International Value V.I............... 197
Large Cap Core V.I. Fund.............. 213
Large Cap Growth V.I. Fund............ 228
Large Cap Value V.I. Fund............. 243
Small Cap Value V.I. Fund............. 257
Utilities and Telecommunications V.I.
Fund................................ 275
</Table>
Semi-Annual Report
June 30, 2004
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This report is only for distribution to shareholders of the Funds of Merrill
Lynch Variable Series Funds, Inc. Past performance results shown in this report
should not be considered a representation of future performance. Investment
return and principal value of non-money market fund shares will fluctuate so
that shares, when redeemed, may be worth more or less than their original cost.
An investment in the Domestic Money Market V.I. Fund is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency. Although the money market Funds seek to preserve the value of your
investment at $1.00 per share, it is possible to lose money by investing in
money market funds. Statements and other information herein are as dated and are
subject to change.
A description of the policies and procedures that the Funds use to determine
how to vote proxies relating to portfolio securities is available (1) without
charge, upon request, by calling toll-free 1-800-MER-FUND (1-800-637-3863); (2)
on www.mutualfunds.ml.com; and (3) on the Securities and Exchange Commission's
Web site at http://www.sec.gov. Information about how the Funds voted proxies
related to securities held in the Funds' portfolios during the most recent
12-month period ended June 30 is available (1) at www.mutualfunds.ml.com and (2)
on the Securities and Exchange Commission's Web site at http://www.sec.gov.
Merrill Lynch Variable Series Funds, Inc.
Box 9011
Princeton, NJ
08543-9011
#16897-6/04
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MERRILL LYNCH
VARIABLE SERIES FUNDS, INC.
- ---------------------------------------------------------
PRINCIPAL OFFICE OF THE FUNDS
Box 9011
Princeton, NJ 08543-9011
CUSTODIAN
For all Funds except International
Value V.I. Fund and Large Cap
Growth V.I. Fund:
The Bank of New York
100 Church Street
New York, NY 10286
For International Value V.I. Fund
and Large Cap Growth V.I. Fund:
Brown Brothers Harriman & Co.
40 Water Street
Boston, MA 02109-3661
TRANSFER AGENT
Financial Data Services, Inc.
4800 Deer Lake Drive East
Jacksonville, FL 32246-6484
800-637-3863
<Table>
DIRECTORS AND OFFICERS
Terry K. Glenn James A. Macmillan
President and Director Vice President
James H. Bodurtha Robert J. Martorelli
Director Vice President
Joe Grills Robert F. Murray
Director Vice President
Herbert I. London Thomas F. Musmanno
Director Vice President
Andre F. Perold James J. Pagano
Director Vice President
Roberta Cooper Ramo Kevin M. Rendino
Director Vice President
Robert S. Salomon, Jr. Jacqueline L. Rogers-
Director Ayoub
Vice President
Stephen B. Swensrud
Director Kurt Schansinger
Vice President
Robert C. Doll, Jr.
Senior Vice President Dennis W. Stattman
Vice President
Kevin J. McKenna
Senior Vice President Richard J. Vella
Vice President
Kathleen M. Anderson
Vice President Frank Viola
Vice President
R. Elise Baum
Vice President Donald C. Burke
Vice President and
Lawrence R. Fuller Treasurer
Vice President
Phillip S. Gillespie
Debbie L. Jelilian Secretary
Vice President
Patrick Maldari
Vice President
</Table>
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
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DEAR SHAREHOLDER:
The direction of U.S. financial markets in the first half of 2004 was driven
by changing assessments of the pace and sustainability of economic growth,
inflation trends, Federal Reserve Board policy, energy prices and geopolitical
events. During the initial months of the period, accelerating economic growth,
benign inflation, accommodative monetary and fiscal policies and powerful
corporate profit gains drove stock prices higher. In March and April, however,
stock prices experienced a sharp correction as the prospect of rising interest
rates in the United States, slowing economic growth in China, $40 per barrel oil
prices and continued instability in Iraq raised investor concerns over the pace
of future economic and earnings growth. Stock prices recovered handsomely in the
latter months of the period as forecasts for economic growth continued to
increase, interest rates stabilized, commodity prices (including oil) moderated,
and equity valuations became more attractive.
For the six-month period ended June 30, 2004, the benchmark Standard & Poor's
500 (S&P 500) Index returned +3.44%. Value comfortably outpaced growth over the
period as the S&P 500 Barra Value Index gained 4.17%, while the S&P 500 Barra
Growth Index gained a more modest 2.72%. Nevertheless, all major indexes,
investment strategies and market capitalization categories showed positive
returns for the six-month period. The bond market has struggled this year as
rising oil prices, accelerating inflationary pressures and tightening Federal
Reserve Board policy initiatives continued to inhibit fixed income investors.
Amid these conditions, the benchmark Lehman Brothers Aggregate Bond Index
returned +.15% for the past six months.
FUND PERFORMANCE
For the six-month period ended June 30, 2004, American Balanced V.I. Fund
generated a total return of +2.41%. Asset allocation remained favorable, and
equities substantially outpaced their benchmark while bonds underperformed
slightly. Within the equity portfolio, favorable stock selection in the consumer
staples sector was a significant contributor to the outperformance, driven by
strong gains in Avon Products, Inc. and Kimberly-Clark Corporation and the
benefit of not owning Altria Group, which declined approximately 9% during the
period. Our overweight position and good stock selection in the energy sector
furthered our outperformance, led by strong gains in Devon Energy Corporation
and Murphy Oil Corporation. Good stock selection in the healthcare sector also
contributed favorably, with solid advances in Aetna Inc. and Baxter
International Inc. Our overweight position and good stock selection in the
industrial sector proved beneficial thanks to double-digit returns from Raytheon
Company and Tyco International Ltd. These factors more than offset weakness in
the consumer discretionary sector where poor performance from media holdings
Clear Channel Communications, Inc., Viacom, Inc. and Interpublic Group of
Companies, Inc. detracted from results. Our overweight position in the weak
materials sector also extracted a performance penalty, driven by weakness in
United States Steel Corporation, Weyerhaeuser Company and Alcoa Inc.
Within the fixed income portfolio, our concentration in those areas of the
market with a lower correlation to U.S. Treasury issues enabled us to avoid a
great deal of interest rate volatility while also achieving attractive total
returns. Fixed income performance further benefited from a relatively short
portfolio duration, which served to better protect our fixed income assets as
interest rates rose in the latter half of the period.
PORTFOLIO ACTIVITY
We continued to adjust our holdings during the period in response to ongoing
market volatility. Within the equity portfolio, we increased positions in a
number of holdings where improving fundamentals and declining stock prices
offered attractive buying opportunities. Railroad companies, such as Burlington
Northern Santa Fe Corporation, are reporting accelerating traffic trends and
improved pricing while the stocks continue to languish at low valuation levels.
Aerospace-related companies such as United Technologies Corporation are
benefiting from a return of commercial airline capacity and growing flight
hours, yet their stocks remain depressed. The advertising market appears to be
recovering nicely, benefiting companies such as The Interpublic Group of
Companies, Inc. whose stock remains near 52-week lows. We added a number of new
names to the portfolio such as Comcast Corporation. Fundamentals are strong with
steady subscriber growth, improving margins and rapidly accelerating free cash
flow while the stock sells at near-record-low valuation levels due to concerns
over the company's aborted bid for The Walt Disney Company and intensifying
competitive pressures. At Office Depot, Inc. solid economic growth and rising
employment trends bode well for the office products business. Complemented by an
improved competitive position and internal product mix enhancements, we believe
this company is poised for a strong earnings recovery while its stock sells at a
modest valuation.
We began to increase our healthcare exposure, introducing positions in
pharmaceutical manufacturers GlaxoSmithKline PLC and drug distributor
AmerisourceBergen Corporation to the portfolio. Our underweight position in this
sector has been beneficial, and we currently find
1
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several interesting values emerging in this group. Glaxo is among the cheapest
of the global pharmaceutical companies, selling at a low multiple of earnings
and offering a near 5% dividend yield. The company is financially strong,
generates substantial free cash flow, is actively repurchasing shares and offers
superior growth prospects in 2005 and beyond as patent expiry pressures abate.
AmeriSourceBergen declined sharply after losing a large government contract,
affording us an attractive opportunity to buy shares. AmeriSourceBergen should
benefit from increased drug consumption and the Medicare drug benefit plan,
which are expected to drive double-digit revenue and earnings growth and stock
price appreciation.
We reconfigured our energy holdings, selling both Anadarko Petroleum
Corporation and Royal Dutch Petroleum Company, increasing our existing position
in EnCana Corporation and introducing Total SA to the portfolio. We were
underwhelmed with the initiatives articulated by Anadarko's new management team
and disturbed by the negative oil reserve revisions at Royal Dutch, prompting us
to eliminate these holdings. Total, by contrast, has consistently delivered
superior growth, returns and free cash flow while selling at a discount to its
global oil peers. We reduced positions in a number of economically sensitive
investments such as Carnival Corporation, ITT Industries, Inc. and Tyco
International Ltd., and eliminated Nucor Corporation from the portfolio as these
stocks have performed well in response to favorable economic developments. We
also eliminated two insurance stocks, Cigna Corporation and XL Capital Limited,
from the portfolio. Cigna's price has recovered sharply from its
earnings-related decline in 2003, while XL Capital is confronting an
increasingly price-competitive commercial insurance market.
In the fixed income portion of the portfolio, we maintained overweight
positions in both investment grade and high yield corporate bonds and in
commercial mortgage-backed securities. During the six-month period, we modestly
increased our exposure to high yield securities and initiated positions in a
number of crossover credits, which have a split rating--half investment grade
and half non-investment grade. We reduced our weighting in high-quality sectors,
such as banks, finance companies and broker/dealers, as we believe these sectors
were both overvalued and particularly sensitive to an anticipated widening in
quality spreads. In February, we shifted to a shorter duration profile in an
effort to cushion the fixed income portfolio from the negative effects of an
expected rise in interest rates.
INVESTMENT OUTLOOK
Our asset allocation position at period-end showed 67.0% of portfolio net
assets invested in equities and 33.0% in debt securities (including short-term
investments). This compares to 66.1% in equities and 33.9% in debt securities,
which includes short-term investments at the end of December. After reducing our
equity allocation and the procyclical bias of the portfolio earlier in the year
in light of the magnitude of the stock market's gain, associated increase in
valuation and increased difficulty in finding undervalued securities, we began
to reverse this decision and redeploy cash to equities as the market
consolidation of March and April presented more attractive investment
opportunities. This proved to be a fortuitous decision given the market's
subsequent advance.
We continue to anticipate a constructive environment for equities as we move
through the remainder of 2004, driven by solid economic growth, stable interest
rates and inflation, improved corporate and consumer confidence, and sharply
rising corporate earnings. We believe bonds look fairly valued with inflation-
adjusted interest rates approaching long-term historical averages. We believe
profit-making opportunities in the fixed income markets will be limited,
however, as the Federal Reserve Board continues to reverse its long-standing
accommodative monetary policy position by increasing short-term interest rates.
Finally, we expect these developments to be accompanied by continued volatility
as economic and political events affect short-term investor sentiment and will
look to be opportunistic in our asset allocation decisions, taking advantage of
the Fund's flexibility.
IN CONCLUSION
We thank you for your continued investment in American Balanced V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Kurt Schansinger
Kurt Schansinger
Vice President and Senior Portfolio Manager
- -s- Patrick Maldari
Patrick Maldari
Fixed Income Portfolio Manager
July 12, 2004
2
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
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<Table>
<Caption>
PERIOD COVERED RETURN
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One Year Ended 6/30/04 +13.96%
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Five Years Ended 6/30/04 + 0.34
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Ten Years Ended 6/30/04 + 6.61
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</Table>
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
RECENT PERFORMANCE RESULTS
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<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +2.41% +13.96%
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S&P 500(R) Index** +3.44 +19.11
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Lehman Brothers Aggregate Bond Index*** +0.15 + 0.32
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</Table>
* Average annual and total investment returns are based on changes in net
asset values for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
** This unmanaged Index covers 500 industrial, utility, transportation and
financial companies of the U.S. markets (mostly NYSE issues), representing
about 75% of NYSE market capitalization and 30% of NYSE issues.
*** This unmanaged market-weighted Index is comprised of U.S. government and
agency securities, mortgage-backed securities issued by the Government
National Mortgage Association, Freddie Mac or Fannie Mae and investment
grade (rated BBB or better) corporate bonds.
Past results shown should not be considered a representation of future
performance.
S&P 500 is a registered trademark of the McGraw-Hill Companies.
3
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (IN U.S. DOLLARS)
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<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY ++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE 29,000 Honeywell International Inc. ............... $ 1,062,270 1.2%
11,500 Northrop Grumman Corporation................ 617,550 0.7
29,000 Raytheon Company............................ 1,037,330 1.2
13,500 United Technologies Corporation............. 1,234,980 1.5
----------- -----
3,952,130 4.6
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BEVERAGES 19,500 Anheuser-Busch Companies, Inc. ............. 1,053,000 1.2
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BUILDING PRODUCTS 31,500 Masco Corporation........................... 982,170 1.1
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CAPITAL MARKETS 19,500 J.P. Morgan Chase & Co. .................... 756,015 0.9
19,500 Janus Capital Group Inc. ................... 321,555 0.4
34,000 Mellon Financial Corporation................ 997,220 1.1
17,500 Morgan Stanley.............................. 923,475 1.1
----------- -----
2,998,265 3.5
- ----------------------------------------------------------------------------------------------------------------------
CHEMICALS 12,500 E.I. du Pont de Nemours and Company......... 555,250 0.7
- ----------------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 10,000 PNC Bank Corp. ............................. 530,800 0.6
22,000 Wells Fargo & Company....................... 1,259,060 1.5
----------- -----
1,789,860 2.1
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COMMUNICATIONS EQUIPMENT 49,000 +CommScope, Inc. ........................... 1,051,050 1.2
- ----------------------------------------------------------------------------------------------------------------------
COMPUTERS & PERIPHERALS 29,000 Hewlett-Packard Company..................... 611,900 0.7
13,500 International Business Machines
Corporation............................... 1,190,025 1.4
----------- -----
1,801,925 2.1
- ----------------------------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 26,500 Citigroup Inc. ............................. 1,232,250 1.4
SERVICES
- ----------------------------------------------------------------------------------------------------------------------
DIVERSIFIED 29,000 Verizon Communications...................... 1,049,510 1.2
TELECOMMUNICATION SERVICES
- ----------------------------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 22,000 +Agilent Technologies, Inc. ................ 644,160 0.8
INSTRUMENTS
- ----------------------------------------------------------------------------------------------------------------------
ENERGY EQUIPMENT & SERVICE 17,000 GlobalSantaFe Corporation................... 450,500 0.5
4,500 Schlumberger Limited........................ 285,795 0.4
9,500 +Weatherford International Ltd. ............ 427,310 0.5
----------- -----
1,163,605 1.4
- ----------------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS 8,500 General Mills, Inc. ........................ 404,005 0.5
4,500 Nestle SA (Registered Shares)............... 1,200,096 1.4
15,000 Unilever NV (NY Registered Shares).......... 1,027,650 1.2
----------- -----
2,631,751 3.1
- ----------------------------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT & 26,500 Baxter International Inc. .................. 914,515 1.1
SUPPLIES
- ----------------------------------------------------------------------------------------------------------------------
HEALTH CARE PROVIDERS & 7,000 Aetna Inc. (New Shares)..................... 595,000 0.7
SERVICES
7,500 AmerisourceBergen Corporation............... 448,350 0.5
22,000 HCA Inc. ................................... 914,980 1.1
----------- -----
1,958,330 2.3
- ----------------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 7,500 Carnival Corporation........................ 352,500 0.4
LEISURE
34,000 McDonald's Corporation...................... 884,000 1.0
----------- -----
1,236,500 1.4
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HOUSEHOLD PRODUCTS 19,500 Kimberly-Clark Corporation.................. 1,284,660 1.5
- ----------------------------------------------------------------------------------------------------------------------
IT SERVICES 24,000 +Accenture Ltd. (Class A)................... 659,520 0.8
9,500 +Computer Sciences Corporation.............. 441,085 0.5
----------- -----
1,100,605 1.3
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INDUSTRIAL CONGLOMERATES 34,000 General Electric Company.................... 1,101,600 1.3
30,000 Tyco International Ltd. .................... 994,200 1.1
----------- -----
2,095,800 2.4
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</Table>
4
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY ++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
INSURANCE 26,500 ACE Limited................................. $ 1,120,420 1.3%
14,500 American International Group, Inc. ......... 1,033,560 1.2
26,500 Prudential Financial, Inc. ................. 1,231,455 1.4
----------- -----
3,385,435 3.9
- ----------------------------------------------------------------------------------------------------------------------
MACHINERY 26,500 Dover Corporation........................... 1,115,650 1.3
1,500 ITT Industries, Inc. ....................... 124,500 0.1
5,000 SPX Corporation............................. 232,200 0.3
----------- -----
1,472,350 1.7
- ----------------------------------------------------------------------------------------------------------------------
MEDIA 22,000 Clear Channel Communications, Inc. ......... 812,900 1.0
14,000 +Comcast Corporation (Special Class A)...... 386,540 0.5
41,500 +The Interpublic Group of Companies,
Inc. ..................................... 569,795 0.7
12,500 +Liberty Media Corporation (Class A)........ 112,375 0.1
27,500 Viacom, Inc. (Class B)...................... 982,300 1.1
14,500 The Walt Disney Company..................... 369,605 0.4
----------- -----
3,233,515 3.8
- ----------------------------------------------------------------------------------------------------------------------
METALS & MINING 19,500 Alcoa Inc. ................................. 644,085 0.8
30,000 United States Steel Corporation............. 1,053,600 1.2
----------- -----
1,697,685 2.0
- ----------------------------------------------------------------------------------------------------------------------
OIL & GAS 17,500 Devon Energy Corporation.................... 1,155,000 1.4
19,500 EnCana Corporation.......................... 841,620 1.0
19,500 Exxon Mobil Corporation..................... 865,995 1.0
16,500 Murphy Oil Corporation...................... 1,216,050 1.4
5,500 Total SA (ADR)(a)........................... 528,440 0.6
----------- -----
4,607,105 5.4
- ----------------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCTS 26,500 International Paper Company................. 1,184,550 1.4
15,000 Weyerhaeuser Company........................ 946,800 1.1
----------- -----
2,131,350 2.5
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PERSONAL PRODUCTS 5,000 Avon Products, Inc. ........................ 230,700 0.3
- ----------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 10,000 GlaxoSmithKline PLC (ADR)(a)................ 414,600 0.5
34,000 Pfizer, Inc. ............................... 1,165,520 1.4
29,000 Schering-Plough Corporation................. 535,920 0.6
24,500 Wyeth....................................... 885,920 1.0
----------- -----
3,001,960 3.5
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ROAD & RAIL 16,500 Burlington Northern Santa Fe Corporation.... 578,655 0.7
30,000 CSX Corporation............................. 983,100 1.1
----------- -----
1,561,755 1.8
- ----------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 72,500 +Agere Systems Inc. (Class A)............... 166,750 0.2
SEMICONDUCTOR EQUIPMENT
34,000 +Applied Materials, Inc. ................... 667,080 0.8
15,000 Intel Corporation........................... 414,000 0.5
19,500 Intersil Holding Corporation (Class A)...... 422,370 0.5
15,000 +Micron Technology, Inc. ................... 229,650 0.2
5,000 Texas Instruments Incorporated.............. 120,900 0.1
----------- -----
2,020,750 2.3
- ----------------------------------------------------------------------------------------------------------------------
SOFTWARE 6,000 +Citrix Systems, Inc. ...................... 122,160 0.2
48,500 Microsoft Corporation....................... 1,385,160 1.6
35,000 +Siebel Systems, Inc. ...................... 373,800 0.4
----------- -----
1,881,120 2.2
- ----------------------------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 48,500 Limited Brands, Inc. ....................... 906,950 1.1
25,000 +Office Depot, Inc. ........................ 447,750 0.5
14,500 The TJX Companies, Inc. .................... 350,030 0.4
----------- -----
1,704,730 2.0
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</Table>
5
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY ++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
THRIFTS & MORTGAGE FINANCE 14,500 Fannie Mae.................................. $ 1,034,720 1.2%
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN COMMON STOCKS
(COST--$54,215,537)......................... 57,458,511 67.0
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
PREFERRED SECURITIES
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
FACE
AMOUNT CAPITAL TRUSTS
- ----------------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS US$ 55,000 Chase Capital III, 1.86% due 3/01/2027(c)... 52,299 0.1
40,000 First Chicago NBD Capital I, 1.729% due
2/01/2027(c).............................. 38,317 0.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CAPITAL TRUSTS
(COST--$89,712)............................. 90,616 0.1
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
SHARES
HELD PREFERRED STOCKS
- ----------------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 5 DG Funding Trust(b)......................... 54,503 0.1
- ----------------------------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 500 Duquesne Light Company...................... 24,875 0.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN PREFERRED STOCKS
(COST--$80,018)............................. 79,378 0.1
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
FACE
AMOUNT TRUST PREFERRED
- ----------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE US$ 150,000 RC Trust I, 7% due 5/15/2006................ 159,375 0.2
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN TRUST PREFERRED
(COST--$158,848)............................ 159,375 0.2
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN PREFERRED SECURITIES
(COST--$328,578)............................ 329,369 0.4
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
CORPORATE BONDS
- ----------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE
Raytheon Company:
185,000 6.15% due 11/01/2008...................... 197,344 0.2
5,000 8.30% due 3/01/2010....................... 5,865 0.0
----------- -----
203,209 0.2
- ----------------------------------------------------------------------------------------------------------------------
AIRLINES 29,309 American Airlines, Inc., 3.857% due
7/09/2010................................. 28,308 0.0
60,000 Continental Airlines, Inc., 7.875% due
7/02/2018................................. 56,380 0.1
33,361 Delta Air Lines, Inc., 7.379% due
11/18/2011................................ 31,559 0.0
----------- -----
116,247 0.1
- ----------------------------------------------------------------------------------------------------------------------
AUTO COMPONENTS 50,000 Lear Corporation, 8.11% due 5/15/2009....... 56,952 0.1
- ----------------------------------------------------------------------------------------------------------------------
AUTOMOBILES
DaimlerChrysler NA Holding Corporation:
30,000 4.75% due 1/15/2008....................... 30,249 0.1
20,000 7.75% due 1/18/2011....................... 22,352 0.0
25,000 General Motors Corporation, 7.125% due
7/15/2013................................. 25,676 0.0
30,000 Hyundai Motor Manufacturing Alabama, LLC,
5.30% due 12/19/2008(b)................... 29,523 0.0
----------- -----
107,800 0.1
- ----------------------------------------------------------------------------------------------------------------------
BEVERAGES 65,000 Cia Brasileira de Bebida, 8.75% due
9/15/2013(b).............................. 68,575 0.1
- ----------------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS
The Bear Stearns Companies Inc.:
50,000 1.47% due 1/30/2009(c).................... 50,087 0.0
40,000 5.70% due 11/15/2014...................... 40,125 0.0
50,000 Corporacion Andina de Fomento, 6.875% due
3/15/2012................................. 53,750 0.1
70,000 Credit Suisse First Boston (USA) Inc., 4.70%
due 6/01/2009............................. 70,206 0.1
</Table>
6
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE PERCENT OF
INDUSTRY++ AMOUNT CORPORATE BONDS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS (CONCLUDED)
The Goldman Sachs Group, Inc.:
US$ 120,000 5.70% due 9/01/2012....................... $ 121,726 0.1%
65,000 5.25% due 10/15/2013...................... 63,114 0.1
J.P. Morgan Chase & Co.:
90,000 3.50% due 3/15/2009....................... 86,361 0.1
60,000 5.75% due 1/02/2013....................... 60,982 0.1
Lehman Brothers Holdings, Inc.:
5,000 4% due 1/22/2008.......................... 4,990 0.0
80,000 3.50% due 8/07/2008....................... 77,567 0.1
500,000 Sigma Finance Incorporated, 2.38% due
3/31/2014(c).............................. 499,769 0.6
----------- -----
1,128,677 1.3
- ----------------------------------------------------------------------------------------------------------------------
CHEMICALS 60,000 IMC Global Inc., 10.875% due 8/01/2013...... 71,550 0.1
- ----------------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 100,000 Bank of America Corporation, 4.875% due
9/15/2012................................. 97,436 0.1
10,000 FirstBank Puerto Rico, 7.625% due
12/20/2005................................ 10,475 0.0
15,000 FleetBoston Financial Corporation, 6.375%
due 5/15/2008............................. 16,186 0.0
15,000 Hudson United Bancorp, 8.20% due
9/15/2006................................. 16,310 0.0
Y 29,800,000 International Bank for Reconstruction &
Development, 4.75% due 12/20/2004......... 278,952 0.3
US$ 45,000 PNC Funding Corporation, 6.125% due
2/15/2009................................. 47,991 0.1
25,000 Popular North America, Inc., 3.875% due
10/01/2008................................ 24,475 0.0
70,000 Sovereign Bank, 5.125% due 3/15/2013........ 66,542 0.1
Wells Fargo & Company:
50,000 5.125% due 2/15/2007........................ 52,106 0.1
45,000 5% due 11/15/2014........................... 43,491 0.1
----------- -----
653,964 0.8
- ----------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 5,000 ARAMARK Services, Inc., 6.75% due
SUPPLIES 8/01/2004................................. 5,016 0.0
Cendant Corporation:
30,000 6.875% due 8/15/2006...................... 32,055 0.0
125,000 6.25% due 1/15/2008....................... 133,302 0.2
45,000 Certegy Inc., 4.75% due 9/15/2008........... 45,461 0.1
25,000 PHH Corporation, 6% due 3/01/2008........... 26,413 0.0
20,000 Waste Management, Inc., 7.375% due
8/01/2010................................. 22,471 0.0
----------- -----
264,718 0.3
- ----------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS EQUIPMENT 60,000 Harris Corporation, 6.35% due 2/01/2028..... 62,971 0.1
- ----------------------------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 55,000 Celulosa Arauco y Constitucion SA, 8.625%
due 8/15/2010............................. 63,912 0.1
25,000 Hanson PLC, 7.875% due 9/27/2010............ 28,488 0.0
----------- -----
92,400 0.1
- ----------------------------------------------------------------------------------------------------------------------
CONSUMER FINANCE 40,000 Capital One Bank, 4.875% due 5/15/2008...... 40,430 0.1
30,000 MBNA Corporation, 4.625% due 9/15/2008...... 30,096 0.0
----------- -----
70,526 0.1
- ----------------------------------------------------------------------------------------------------------------------
CONTAINERS & PACKAGING
Sealed Air Corporation:
55,000 5.375% due 4/15/2008...................... 56,878 0.1
25,000 6.95% due 5/15/2009(b).................... 27,291 0.0
----------- -----
84,169 0.1
- ----------------------------------------------------------------------------------------------------------------------
</Table>
7
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE PERCENT OF
INDUSTRY++ AMOUNT CORPORATE BONDS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL US$ 20,000 Brascan Corporation, 5.75% due 3/01/2010.... $ 20,570 0.0%
SERVICES
Citigroup Inc.:
30,000 5.75% due 5/10/2006....................... 31,430 0.0
90,000 5.625% due 8/27/2012...................... 92,512 0.1
35,000 6.625% due 6/15/2032...................... 36,250 0.1
95,000 ERAC USA Finance Company, 6.70% due
6/01/2034(b).............................. 95,134 0.1
Ford Motor Credit Company:
250,000 2.036% due 6/30/2005(c)................... 249,805 0.3
85,000 7.375% due 2/01/2011...................... 89,655 0.1
185,000 7% due 10/01/2013......................... 186,751 0.2
235,000 General Electric Capital Corporation, 6% due
6/15/2012................................. 247,993 0.3
General Motors Acceptance Corporation:
80,000 6.875% due 8/28/2012...................... 81,381 0.1
40,000 8% due 11/01/2031......................... 40,983 0.1
165,000 Household Finance Corporation, 6.50% due
11/15/2008................................ 178,275 0.2
30,000 International Lease Finance Corporation,
2.95% due 5/23/2006....................... 29,801 0.0
100,000 Textron Financial Corporation, 2.75% due
6/01/2006................................. 99,148 0.1
----------- -----
1,479,688 1.7
- ----------------------------------------------------------------------------------------------------------------------
DIVERSIFIED 20,000 AT&T Corporation, 8.05% due 11/15/2011...... 20,534 0.0
TELECOMMUNICATION SERVICES
Deutsche Telekom International Finance BV:
60,000 8.50% due 6/15/2010....................... 70,113 0.1
15,000 8.75% due 6/15/2030....................... 18,257 0.0
France Telecom:
140,000 8.75% due 3/01/2011....................... 162,235 0.2
25,000 9.50% due 3/01/2031....................... 31,376 0.0
50,000 GTE Corporation, 6.84% due 4/15/2018........ 52,753 0.1
35,000 Koninklijke (KPN) NV, 8% due 10/01/2010..... 40,526 0.0
Sprint Capital Corporation:
100,000 6.90% due 5/01/2019....................... 100,596 0.1
5,000 8.75% due 3/15/2032....................... 5,826 0.0
50,000 TELUS Corporation, 7.50% due 6/01/2007...... 54,456 0.1
40,000 Verizon New York Inc., 6.875% due
4/01/2012................................. 42,885 0.1
----------- -----
599,557 0.7
- ----------------------------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 37,000 AEP Texas Central Company, 6.65% due
2/15/2033................................. 37,549 0.0
60,000 Arizona Public Service Company, 5.80% due
6/30/2014................................. 60,058 0.1
65,000 Cincinnati Gas & Electric Company, 5.70% due
9/15/2012................................. 66,457 0.1
Dominion Resources, Inc.:
25,000 7.625% due 7/15/2005...................... 26,262 0.0
30,000 1.55% due 5/15/2006(c).................... 30,044 0.0
15,000 Exelon Corporation, 6.75% due 5/01/2011..... 16,313 0.0
60,000 Exelon Generation Company, LLC, 5.35% due
1/15/2014................................. 58,185 0.1
80,000 FPL Group Capital Inc., 1.886% due
3/30/2005(c).............................. 80,152 0.1
150,000 PPL Capital Funding, Inc., 2.31% due
5/18/2006(c).............................. 149,963 0.2
30,000 Pepco Holdings, Inc., 4% due 5/15/2010...... 27,897 0.0
40,000 Public Service Company of New Mexico, 4.40%
due 9/15/2008............................. 39,877 0.0
Southern California Edison Company:
9,000 1.44% due 1/13/2006(c).................... 9,012 0.0
50,000 8% due 2/15/2007.......................... 55,233 0.1
35,000 6% due 1/15/2034.......................... 33,536 0.0
</Table>
8
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE PERCENT OF
INDUSTRY++ AMOUNT CORPORATE BONDS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES
(CONCLUDED)
US$ 45,000 Southern Power Company, 6.25% due
7/15/2012................................. $ 47,263 0.1%
40,000 TXU Australia Holdings Partnership LP, 6.15%
due 11/15/2013(b)......................... 41,671 0.1
Westar Energy, Inc.:
45,000 9.75% due 5/01/2007....................... 51,259 0.1
30,000 6% due 7/01/2014.......................... 30,479 0.0
----------- -----
861,210 1.0
- ----------------------------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 200,000 Celestica Inc., 3.69%* due 8/01/2020
INSTRUMENTS (Convertible)............................. 110,000 0.1
40,000 Jabil Circuit, Inc., 5.875% due 7/15/2010... 41,320 0.1
----------- -----
151,320 0.2
- ----------------------------------------------------------------------------------------------------------------------
ENERGY EQUIPMENT & SERVICE 55,000 Halliburton Company, 5.50% due 10/15/2010... 55,643 0.1
- ----------------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS 55,000 Cadbury Schweppes US Finance LLC, 3.875% due
10/01/2008(b)............................. 53,955 0.1
- ----------------------------------------------------------------------------------------------------------------------
FOREIGN GOVERNMENT E 131,000 Bundesobligation, 3.50% due 10/10/2008...... 159,575 0.2
OBLIGATIONS
US$ 20,000 Republic of Chile, 5.50% due 1/15/2013...... 20,052 0.0
55,000 Republic of South Africa, 6.50% due
6/02/2014................................. 55,550 0.1
United Mexican States:
65,000 9.875% due 2/01/2010...................... 78,098 0.1
25,000 6.375% due 1/16/2013...................... 24,950 0.0
25,000 5.875% due 1/15/2014...................... 24,025 0.0
----------- -----
362,250 0.4
- ----------------------------------------------------------------------------------------------------------------------
GAS UTILITIES 94,975 Kern River Funding Corporation, 4.893% due
4/30/2018(b).............................. 92,045 0.1
90,000 Plains All American Pipeline LP, 5.625% due
12/15/2013(b)............................. 85,433 0.1
50,000 Texas Gas Transmission, LLC, 4.60% due
6/01/2015................................. 46,074 0.0
50,000 Vectren Utility Holdings, Inc., 5.25% due
8/01/2013................................. 49,284 0.1
----------- -----
272,836 0.3
- ----------------------------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT & 55,000 Boston Scientific Corporation, 5.45% due
SUPPLIES 6/15/2014................................. 55,335 0.1
- ----------------------------------------------------------------------------------------------------------------------
HEALTH CARE PROVIDERS &
SERVICES
HCA Inc.:
30,000 6.95% due 5/01/2012....................... 31,300 0.1
20,000 6.30% due 10/01/2012...................... 20,010 0.0
20,000 5.75% due 3/15/2014....................... 19,014 0.0
Manor Care, Inc.:
50,000 7.50% due 6/15/2006....................... 53,250 0.1
15,000 6.25% due 5/01/2013....................... 15,281 0.0
----------- -----
138,855 0.2
- ----------------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 80,000 MGM Mirage Inc., 6% due 10/01/2009.......... 78,400 0.1
LEISURE
50,000 Yum! Brands, Inc., 8.875% due 4/15/2011..... 60,336 0.1
----------- -----
138,736 0.2
- ----------------------------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 60,000 D.R. Horton, Inc., 5% due 1/15/2009......... 58,875 0.1
- ----------------------------------------------------------------------------------------------------------------------
IT SERVICES 30,000 Electronic Data Systems Corporation, 7.125%
due 10/15/2009............................ 31,394 0.0
- ----------------------------------------------------------------------------------------------------------------------
INDUSTRIAL CONGLOMERATES 5,000 General Electric Company, 5% due
2/01/2013................................. 4,921 0.0
30,000 Hutchison Whampoa International Ltd., 5.45%
due 11/24/2010............................ 29,446 0.1
95,000 Tyco International Group SA, 6.75% due
2/15/2011................................. 103,225 0.1
----------- -----
137,592 0.2
- ----------------------------------------------------------------------------------------------------------------------
</Table>
9
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE PERCENT OF
INDUSTRY++ AMOUNT CORPORATE BONDS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
INSURANCE US$ 45,000 Aon Corporation, 6.70% due 1/15/2007........ $ 48,087 0.1%
35,000 Infinity Property and Casualty Corporation,
5.50% due 2/18/2014(b).................... 33,671 0.0
25,000 Kingsway America, Inc., 7.50% due
2/01/2014(b).............................. 24,570 0.0
60,000 NLV Financial Corporation, 7.50% due
8/15/2033(b).............................. 60,571 0.1
140,000 Prudential Holdings LLC, 8.695% due
12/18/2023(b)............................. 168,067 0.2
45,000 RLI Corp., 5.95% due 1/15/2014.............. 43,887 0.1
90,000 Security Benefit Life Insurance Company,
7.45% due 10/01/2033(b)................... 89,307 0.1
30,000 Travelers Property Casualty Corp., 6.375%
due 3/15/2033............................. 29,550 0.0
----------- -----
497,710 0.6
- ----------------------------------------------------------------------------------------------------------------------
MARINE 65,000 MISC Capital (L) Limited, 5% due
7/01/2009(b).............................. 65,087 0.1
- ----------------------------------------------------------------------------------------------------------------------
MEDIA 15,000 Clear Channel Communications, Inc., 4.25%
due 5/15/2009............................. 14,640 0.0
137,000 Comcast Cable Communications Holdings, Inc.,
8.375% due 3/15/2013...................... 160,830 0.2
50,000 Comcast Corporation, 5.85% due 1/15/2010.... 52,173 0.1
5,000 Cox Communications, Inc., 7.125% due
10/01/2012................................ 5,480 0.0
65,000 EchoStar DBS Corporation, 5.75% due
10/01/2008................................ 64,106 0.1
25,000 InterActiveCorp, 7% due 1/15/2013........... 26,960 0.0
Liberty Media Corporation:
20,000 3.02% due 9/17/2006(c).................... 20,371 0.0
60,000 5.70% due 5/15/2013....................... 59,107 0.1
85,000 News America Incorporated, 6.75% due
1/09/2038................................. 92,935 0.1
30,000 Tele-Communications Inc., 9.80% due
2/01/2012................................. 37,611 0.0
190,000 Time Warner Inc., 6.875% due 5/01/2012...... 205,313 0.2
60,000 Univision Communications Inc., 7.85% due
7/15/2011................................. 69,192 0.1
----------- -----
808,718 0.9
- ----------------------------------------------------------------------------------------------------------------------
METALS & MINING
Corporacion Nacional del Cobre de Chile
(Codelco)(b):
35,000 6.375% due 11/30/2012..................... 37,043 0.1
35,000 5.50% due 10/15/2013...................... 34,754 0.0
----------- -----
71,797 0.1
- ----------------------------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 35,000 PSE&G Power LLC, 6.95% due 6/01/2012........ 38,058 0.0
UNREGULATED POWER
150,000 Pacific Gas & Electric Company, 6.05% due
3/01/2034................................. 141,083 0.2
30,000 Sempra Energy, 4.75% due 5/15/2009.......... 30,181 0.0
----------- -----
209,322 0.2
- ----------------------------------------------------------------------------------------------------------------------
OIL & GAS 30,000 Amerada Hess Corporation, 7.125% due
3/15/2033................................. 29,905 0.0
Anadarko Finance Company:
21,000 6.75% due 5/01/2011....................... 23,097 0.0
10,000 7.50% due 5/01/2031....................... 11,386 0.0
25,000 Colonial Pipeline Company, 7.63% due
4/15/2032(b).............................. 29,465 0.0
20,000 EnCana Corporation, 4.75% due 10/15/2013.... 18,910 0.0
110,000 Kerr-McGee Corporation, 6.95% due
7/01/2024................................. 109,645 0.1
60,000 Motiva Enterprises LLC, 5.20% due
9/15/2012(b).............................. 59,536 0.1
</Table>
10
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE PERCENT OF
INDUSTRY++ AMOUNT CORPORATE BONDS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
OIL & GAS (CONCLUDED) US$ 40,000 Panhandle Eastern Pipe Line Company, LLC,
2.75% due 3/15/2007....................... $ 38,384 0.1%
Pemex Project Funding Master Trust:
50,000 2.64% due 1/07/2005(b)(c)................. 50,400 0.1
150,000 2.82% due 6/15/2010(b)(c)................. 150,675 0.2
180,000 9.125% due 10/13/2010..................... 206,100 0.2
55,000 XTO Energy, Inc., 7.50% due 4/15/2012....... 62,060 0.1
----------- -----
789,563 0.9
- ----------------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCTS 6,000 Abitibi-Consolidated Inc., 8.55% due
8/01/2010................................. 6,327 0.0
20,000 Champion International Corporation, 6.65%
due 12/15/2037............................ 21,675 0.0
30,000 Inversiones CMPC SA, 4.875% due
6/18/2013(b).............................. 27,851 0.0
15,000 Rock-Tenn Company, 5.625% due 3/15/2013..... 14,751 0.0
30,000 Sappi Papier Holding AG, 6.75% due
6/15/2012(b).............................. 32,014 0.1
90,000 Weyerhaeuser Company, 6.75% due 3/15/2012... 97,466 0.1
----------- -----
200,084 0.2
- ----------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 5,000 Eli Lilly and Company, 7.125% due
6/01/2025................................. 5,722 0.0
200,000 Valeant Pharmaceuticals International, 6.50%
due 7/15/2008 (Convertible)............... 206,750 0.2
----------- -----
212,472 0.2
- ----------------------------------------------------------------------------------------------------------------------
REAL ESTATE 30,000 CarrAmerica Realty Corporation, 3.625% due
4/01/2009................................. 28,414 0.0
20,000 Colonial Realty LP, 4.80% due 4/01/2011..... 19,215 0.0
20,000 Developers Diversified Realty Corporation,
6.625% due 1/15/2008...................... 21,347 0.0
40,000 HRPT Properties Trust, 5.75% due 2/15/2014.. 39,160 0.1
30,000 Health Care REIT, Inc., 6% due 11/15/2013... 29,545 0.0
40,000 Highwoods Realty LP, 7% due 12/01/2006...... 42,201 0.1
95,000 iStar Financial Inc., 5.125% due
4/01/2011(b).............................. 90,349 0.1
30,000 United Dominion Realty Trust, Inc., 6.50%
due 6/15/2009............................. 32,320 0.0
----------- -----
302,551 0.3
- ----------------------------------------------------------------------------------------------------------------------
ROAD & RAIL 30,000 Norfolk Southern Corporation, 7.25% due
2/15/2031................................. 32,924 0.1
Union Pacific Corporation:
25,000 7.25% due 11/01/2008...................... 27,597 0.0
20,000 5.375% due 5/01/2014...................... 19,707 0.0
----------- -----
80,228 0.1
- ----------------------------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 105,000 Boise Cascade Corporation, 7.66% due
5/27/2005................................. 108,412 0.1
- ----------------------------------------------------------------------------------------------------------------------
THRIFTS & MORTGAGE FINANCE 45,000 Countrywide Home Loans, Inc., 5.625% due
7/15/2009................................. 46,884 0.1
- ----------------------------------------------------------------------------------------------------------------------
WIRELESS TELECOMMUNICATIONS 5,000 AT&T Wireless Services, Inc., 8.75% due
SERVICES 3/01/2031................................. 6,096 0.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CORPORATE BONDS
(COST--$10,790,759)......................... 10,777,928 12.6
- ----------------------------------------------------------------------------------------------------------------------
</Table>
11
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE PERCENT OF
AMOUNT COLLATERALIZED MORTGAGE OBLIGATIONS++ VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
US$ 205,000 Bear Stearns Adjustable Rate Mortgage Trust,
Series 2004-4, Class A4, 3.517% due
6/25/2034(c).............................. $ 199,176 0.2%
231,975 CIT Group Home Equity Loan Trust, Series
2003-1, Class A2, 2.35% due 4/20/2027..... 231,664 0.3
Federal Home Loan Mortgage Corporation:
200,000 5% due 7/15/2019.......................... 200,062 0.2
491,649 5.50% due 12/01/2017-1/01/2018............ 503,597 0.6
292,692 6% due 4/01/2016-12/01/2017............... 305,467 0.4
110,904 6.50% due 6/01/2017....................... 117,160 0.1
283,162 5% due 7/15/2034.......................... 273,251 0.3
1,625,000 5.50% due 7/15/2034....................... 1,617,382 1.9
1,094,753 6% due 5/01/2034-7/15/2034................ 1,117,758 1.3
431,529 7% due 10/01/2031-7/01/2032............... 456,487 0.5
Federal National Mortgage Association:
235,656 5% due 7/15/2019.......................... 235,877 0.3
684,512 6.50% due 12/01/2031-7/15/2034............ 713,355 0.8
220,000 7.125% due 1/15/2030...................... 256,294 0.3
199,754 7.50% due 12/01/2031-9/01/2032............ 214,088 0.2
162,437 Whole Loan, Series 2003-W19, Class 1A1,
2.01% due 11/25/2033...................... 161,542 0.2
139,389 First Franklin Mortgage Loan Trust, Series
2003-FF5, Class A2, 2.82% due
3/25/2034(c).............................. 140,559 0.2
183,986 GMAC Mortgage Corporation Loan Trust, Series
2003-J7, Class A10, 5.50% due
11/25/2033................................ 182,686 0.2
150,000 Government National Mortgage Association,
Series 2004-6, Class C, 4.66% due
7/16/2033................................. 145,603 0.2
170,000 Greenwich Capital Commercial Funding
Corporation, Series 2004-GG1, Class A4,
4.755% due 6/10/2036...................... 169,425 0.2
159,488 MASTR Asset Securitization Trust, Series
2003-10, Class 3A1, 5.50% due
11/25/2033................................ 157,786 0.2
300,000 MBNA Credit Card Master Note Trust, Series
2001-C3, Class C3, 6.55% due 12/15/2008... 316,496 0.4
Morgan Stanley ABS Capital I:
336,207 Series 2004-NC1, Class A2, 1.67% due
12/27/2033(c)............................. 337,350 0.4
250,000 Series 2004 WMC1, Class A3, 1.65% due
6/25/2034................................. 250,000 0.3
100,000 Nationslink Funding Corporation, Series
1999-2, Class A3, 7.181% due 6/20/2031.... 105,936 0.1
300,000 New Century Home Equity Loan Trust, Series
2004-2, Class A3, 1.57% due
4/25/2034(c).............................. 300,000 0.3
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN COLLATERALIZED MORTGAGE
OBLIGATIONS
(COST--$8,680,868).......................... 8,709,001 10.1
- ----------------------------------------------------------------------------------------------------------------------
</Table>
12
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE PERCENT OF
AMOUNT U.S. GOVERNMENT OBLIGATIONS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
U.S. Treasury Bonds:
US$ 120,000 7.50% due 11/15/2016...................... $ 147,933 0.2%
70,000 8.125% due 8/15/2019...................... 91,678 0.1
260,000 7.25% due 8/15/2022....................... 318,581 0.4
50,000 6.25% due 8/15/2023....................... 55,367 0.0
50,000 6.625% due 2/15/2027...................... 58,018 0.1
U.S. Treasury Inflation Indexed Notes:
152,447 3.875% due 1/15/2009...................... 169,955 0.2
135,008 3.50% due 1/15/2011....................... 149,900 0.2
U.S. Treasury Notes:
670,000 7% due 7/15/2006(e)....................... 725,930 0.8
70,000 6.50% due 2/15/2010....................... 78,876 0.1
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN U.S. GOVERNMENT
OBLIGATIONS
(COST--$1,793,970).......................... 1,796,238 2.1
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
STATE MUNICIPAL BONDS
- ----------------------------------------------------------------------------------------------------------------------
TEXAS 20,000 Harris County, Texas, Industrial Development
Corporation, Solid Waste Disposal Revenue
Bonds (Deer Park Refining LP), 5.683% due
3/01/2023(c).............................. 20,001 0.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN MUNICIPAL BONDS
(COST--$20,000)............................. 20,001 0.0
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL
INTEREST SHORT-TERM SECURITIES
- ----------------------------------------------------------------------------------------------------------------------
US$10,296,612 Merrill Lynch Liquidity Series, LLC Cash
Sweep Series I(d)......................... 10,296,612 12.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$10,296,612)......................... 10,296,612 12.0
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
NUMBER OF
CONTRACTS OPTIONS PURCHASED
- ----------------------------------------------------------------------------------------------------------------------
CALL OPTIONS PURCHASED 73 Euro-Dollar Future, expiring July 2004 at
USD 98.25, Broker Credit Suisse First
Boston.................................... 456 0.0
73 Euro-Dollar Future, expiring July 2004 at
USD 98.5, Broker Credit Suisse First
Boston.................................... 456 0.0
2++++ London InterBank Offered Rate (LIBOR) Linked
Floor, expiring April 2005 at USD 1.5,
Broker J.P. Morgan Chase Bank............. 34 0.0
- ----------------------------------------------------------------------------------------------------------------------
PUT OPTIONS PURCHASED 8 Ten-Year U.S. Treasury Note Future, expiring
July 2004 at USD 107, Broker Credit Suisse
First Boston.............................. 1,000 0.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL OPTIONS PURCHASED
(PREMIUMS PAID--$16,515).................... 1,946 0.0
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
OPTIONS WRITTEN
- ----------------------------------------------------------------------------------------------------------------------
CALL OPTIONS WRITTEN 146 Euro-Dollar Future, expiring July 2004 at
USD 98.38, Broker Credit Suisse First
Boston.................................... (913) 0.0
8 Ten-Year U.S. Treasury Note Future, expiring
July 2004 at USD 110, Broker Credit Suisse
First Boston.............................. (3,625) 0.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL OPTIONS WRITTEN
(PREMIUMS RECEIVED--$11,548)................ (4,538) 0.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS, NET OF OPTIONS WRITTEN
(COST--$86,131,291)......................... 89,385,068 104.2
LIABILITIES IN EXCESS OF OTHER ASSETS....... (3,568,487) (4.2)
----------- -----
NET ASSETS.................................. $85,816,581 100.0%
=========== =====
- ----------------------------------------------------------------------------------------------------------------------
</Table>
13
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
* Represents a zero coupon bond; the interest rate shown reflects the
effective yield at the time of purchase by the Fund.
+ Non-income producing security.
++ Mortgage-Backed Securities are subject to principal paydowns as a result of
prepayments or refinancing of the underlying mortgage instruments. As a
result, the average life may be substantially less than the original
maturity.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management.
This definition may not apply for purposes of this report, which may
combine such industry sub-classifications for reporting ease.
++++ One contract represents a notional amount of $1,000,000.
(a) American Depositary Receipts (ADR).
(b) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(c) Floating rate note.
(d) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
NET INTEREST/DIVIDEND
AFFILIATE ACTIVITY INCOME
- -----------------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $(2,293,858) $62,518
Merrill Lynch Liquidity Series, LLC Money Market Series..... $ (316,799) $ 29
Merrill Lynch Premier Institutional Fund.................... (105,601) $ 8
- -----------------------------------------------------------------------------------------------
</Table>
(e) All or a portion of security held as collateral in connection with open
financial futures contracts.
Financial futures contracts sold as of June 30, 2004 were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------
NUMBER OF EXPIRATION FACE UNREALIZED
CONTRACTS ISSUE DATE VALUE DEPRECIATION
- -------------------------------------------------------------------------------
5 Ten-Year U.S. Treasury Note September 2004 $545,924 $(717)
- -------------------------------------------------------------------------------
TOTAL UNREALIZED DEPRECIATION--NET $(717)
=====
- -------------------------------------------------------------------------------
</Table>
Swap contracts outstanding as of June 30, 2004 were as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------------------------
UNREALIZED
NOTIONAL APPRECIATION/
AMOUNT DEPRECIATION
- ----------------------------------------------------------------------------------------
Receive a variable return equal to CMBS Investment Grade
Index Total Return and pay a floating rate based on 1-month
USD LIBOR, minus .60%
Broker, J.P. Morgan Chase Bank
Expires September 2004...................................... $1,050,000 --
Receive a variable return equal to Lehman Brothers U.S. High
Yield Index Total Return and pay a floating rate based on
1-month USD LIBOR, minus .40%
Broker, Lehman Brothers Special Finance
Expires July 2004........................................... $ 300,000 --
Receive a variable return based on 3-month USD LIBOR, plus
..42%, which is capped at a fixed coupon of 8% and callable
quarterly beginning September 2004 and pay a floating rate
based on 3-month USD LIBOR
Broker, J.P. Morgan Chase Bank
Expires March 2010.......................................... $ 650,000 $ (60)
Receive a variable return based on 3-month USD LIBOR, plus
..56%, which is capped at a fixed coupon of 8% and callable
quarterly beginning December 2004 and pay a floating rate
based on 3-month USD LIBOR
Broker, J.P. Morgan Chase Bank
Expires June 2010........................................... $ 650,000 771
Receive a variable return equal to MBS Fixed Rate Index
Total Return and pay a floating rate based on 1-month USD
LIBOR, minus .15%
Broker, Lehman Brothers Special Finance
Expires September 2004...................................... $ 250,000 --
Receive a variable return equal to MBS Fixed Rate Index
Total Return and pay a floating rate based on 1-month USD
LIBOR, minus .16%
Broker, UBS Warburg
Expires August 2004......................................... $1,800,000 --
</Table>
14
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ----------------------------------------------------------------------------------------
UNREALIZED
NOTIONAL APPRECIATION/
AMOUNT DEPRECIATION
- ----------------------------------------------------------------------------------------
Receive a variable return equal to MBS Fixed Rate Index
Total Return and pay a floating rate based on 1-month USD
LIBOR, minus .17%
Broker, UBS Warburg
Expires November 2004....................................... $ 250,000 --
Bought credit default protection on Boeing Capital Corp. and
pay .48%
Broker, J.P. Morgan Chase Bank
Expires March 2009.......................................... $ 30,000 $ (121)
Pay 3.875% on TIPS adjusted principal and receive a fixed
rate of 3.401%
Broker, J.P. Morgan Chase Bank
Expires January 2009........................................ $ 171,000 3,244
Pay 3.50% on TIPS adjusted principal and receive a fixed
rate of 4.17%
Broker, Morgan Stanley Capital Services, Inc.
Expires January 2011........................................ $ 150,000 2,011
Receive a variable return equal to U.S. Treasury Index Total
Return and pay a floating rate based on 1-month USD LIBOR,
minus .20%
Broker, Lehman Brothers Special Finance
Expires December 2004....................................... $1,500,000 --
Receive a variable return equal to U.S. Treasury Index Total
Return and pay a floating rate based on 1-month USD LIBOR,
minus .20%
Broker, Lehman Brothers Special Finance
Expires March 2005.......................................... $1,100,000 --
Bought credit default protection on AON Corp. and pay .37%
Broker, Morgan Stanley Capital Services, Inc.
Expires January 2007........................................ $ 50,000 (10)
Bought credit default protection on AT&T Corporation and pay
2.28%
Broker, Morgan Stanley Capital Services, Inc.
Expires June 2009........................................... $ 30,000 1,272
Sold credit default protection on Raytheon Company and
receive .73%
Broker, J.P. Morgan Chase Bank
Expires March 2009.......................................... $ 30,000 (81)
Receive a variable return based on 3-month USD LIBOR and pay
2.8025%
Broker, J.P. Morgan Chase Bank
Expires January 2007........................................ $ 50,000 146
------
Total....................................................... $7,172
======
- ----------------------------------------------------------------------------------------
</Table>
Forward foreign exchange contracts as of June 30, 2004 were as follows:
<Table>
<Caption>
- --------------------------------------------
FOREIGN CURRENCY SETTLEMENT UNREALIZED
SOLD DATE APPRECIATION
- --------------------------------------------
Y31,194,080 August 2004 $4,689
- --------------------------------------------
TOTAL UNREALIZED APPRECIATION
ON FORWARD FOREIGN EXCHANGE
CONTRACTS--NET (US$
COMMITMENT--$291,261) $4,689
======
- --------------------------------------------
</Table>
See Notes to Financial Statements.
15
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (identified
cost--$75,829,712)........................................ $ 79,091,048
Investments in affiliated securities, at value (identified
cost--$10,296,612)........................................ 10,296,612
Options purchased, at value (premiums paid--$16,515)........ 1,946
Cash........................................................ 3,405
Unrealized appreciation on swaps--net....................... 7,172
Unrealized appreciation on forward foreign exchange
contracts................................................. 4,689
Receivables:
Interest (including $326 from affiliates)................. $ 232,153
Dividends................................................. 51,329
Securities sold........................................... 32,556 316,038
------------
Prepaid expenses and other assets........................... 37,671
------------
Total assets................................................ 89,758,581
------------
- -----------------------------------------------------------------------------------------
LIABILITIES:
Options written, at value (premiums received--$11,548)...... 4,538
Payables:
Securities purchased...................................... 3,884,415
Capital shares redeemed................................... 20,972
Swaps..................................................... 11,563
Investment adviser........................................ 6,413
Variation margin.......................................... 3,758
Other affiliates.......................................... 1,774 3,928,895
------------
Accrued expenses and other liabilities...................... 8,567
------------
Total liabilities........................................... 3,942,000
------------
- -----------------------------------------------------------------------------------------
NET ASSETS.................................................. $ 85,816,581
============
- -----------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized+........................................ $ 747,188
Paid-in capital in excess of par............................ 95,104,313
Undistributed investment income--net........................ $ 594,896
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (13,895,734)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 3,265,918
------------
Total accumulated losses--net............................... (10,034,920)
------------
NET ASSETS.................................................. $ 85,816,581
============
- -----------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $85,816,581 and 7,471,876
shares outstanding........................................ $ 11.49
============
- -----------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II or Class III as of June 30,
2004.
See Notes to Financial Statements.
16
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Interest (including $62,518 from affiliates)................ $ 478,896
Dividends (net of $9,047 foreign withholding tax)........... 448,386
Securities lending--net..................................... 37
-----------
Total income................................................ 927,319
-----------
- ---------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $ 243,048
Professional fees........................................... 14,123
Accounting services......................................... 13,481
Pricing services............................................ 12,945
Custodian fees.............................................. 10,800
Printing and shareholder reports............................ 3,937
Directors' fees and expenses................................ 2,621
Transfer agent fees......................................... 2,392
Other....................................................... 10,967
-----------
Total expenses.............................................. 314,314
-----------
Investment income--net...................................... 613,005
-----------
- ---------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS AND FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain (loss) on:
Investments--net.......................................... 2,377,462
Foreign currency transactions--net........................ (4,878) 2,372,584
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (922,006)
Foreign currency transactions--net........................ 8,833 (913,173)
----------- -----------
Total realized and unrealized gain on investments and
foreign currency transactions--net........................ 1,459,411
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 2,072,416
===========
- ---------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
17
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- -----------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 613,005 $ 1,792,973
Realized gain (loss) on investments and foreign currency
transactions--net......................................... 2,372,584 (2,564,700)
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (913,173) 18,263,997
----------- ------------
Net increase in net assets resulting from operations........ 2,072,416 17,492,270
----------- ------------
- -----------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... -- (1,950,006)
----------- ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. -- (1,950,006)
----------- ------------
- -----------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (8,694,116) (14,608,152)
----------- ------------
- -----------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (6,621,700) 934,112
Beginning of period......................................... 92,438,281 91,504,169
----------- ------------
End of period*.............................................. $85,816,581 $ 92,438,281
=========== ============
- -----------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess of)
investment income--net.................................... $ 594,896 $ (18,109)
=========== ============
- -----------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
18
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE
BEEN DERIVED FROM INFORMATION PROVIDED IN THE CLASS I
FINANCIAL STATEMENTS. FOR THE SIX --------------------------------------------
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,++
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............. $ 11.22 $ 9.43 $ 11.27 $ 12.49 $ 14.80
-------- -------- -------- -------- --------
Investment income--net***......................... .08 .20 .27 .28 .34
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net.......... .19 1.83 (1.81) (1.20) (.58)
-------- -------- -------- -------- --------
Total from investment operations.................. .27 2.03 (1.54) (.92) (.24)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.......................... -- (.24) (.30) (.30) (.38)
In excess of investment income--net............. -- -- -- -- --+
Realized gain on investments--net............... -- -- -- -- (1.33)
In excess of realized gain on
investments--net.............................. -- -- -- -- (.36)
-------- -------- -------- -------- --------
Total dividends and distributions................. -- (.24) (.30) (.30) (2.07)
-------- -------- -------- -------- --------
Net asset value, end of period.................... $ 11.49 $ 11.22 $ 9.43 $ 11.27 $ 12.49
======== ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share................ 2.41%++++ 21.55% (13.68%) (7.39%) (1.68%)
======== ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.......................................... .71%* .68% .66% .68% .62%
======== ======== ======== ======== ========
Investment income--net............................ 1.38%* 2.00% 2.55% 2.42% 2.32%
======== ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).......... $ 85,817 $ 92,438 $ 91,504 $130,504 $133,090
======== ======== ======== ======== ========
Portfolio turnover................................ 48.56% 109.21% 32.00% 134.43% 85.30%
======== ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Amount is less than $(.01) per share.
++ Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
++++ Aggregate total investment return.
See Notes to Financial Statements.
19
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--AMERICAN BALANCED V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. American
Balanced V.I. Fund (the "Fund") is classified as "diversified," as defined in
the Investment Company Act of 1940, as amended. Class I Shares, Class II Shares
and Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
20
- --------------------------------------------------------------------------------
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good faith by the Company's Board of
Directors or by the Investment Adviser using a pricing service and/or procedures
approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- - Options--The Fund may purchase and write 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 loss or gain to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Swaps--The Fund may enter into swap agreements, which are over-the-counter
contracts in which the Fund and a counterparty agree to make periodic net
payments on a specified notional amount. The net payments can be made for a set
period of time or may be triggered by a predetermined credit event. The net
periodic payments may be based on a fixed or variable interest rate; the change
in market value of a specified security, basket of securities, or index; or the
return generated by a security.
- - Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
(c) 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 U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis. The Fund amortizes all
premiums and discounts on debt securities.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective
21
- --------------------------------------------------------------------------------
aggregate net asset value of each fund included in the Company.
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it receives a fee from the borrower. Where the Fund receives cash collateral, it
may invest such collateral and retain the amount earned on such investment, net
of any amount rebated to the borrower. The Fund typically receives the income on
the loaned securities but does not receive the income on the collateral. Loans
of securities are terminable at any time and the borrower, after notice, is
required to return borrowed securities within five business days. The Fund may
pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .55% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Fund. There is no increase in the aggregate fees paid by the Fund for these
services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated, ("MLPF&S") a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $12 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, MLPF&S earned $3,487 in commissions in
the execution of portfolio security transactions.
In addition, the Fund reimbursed MLIM $880 for certain accounting services for
the six months ended June 30, 2004.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $39,315,975 and $45,428,092, respectively.
Net realized gains (losses) for the six months ended June 30, 2004 and net
unrealized appre-
22
- --------------------------------------------------------------------------------
ciation/depreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------
Unrealized
Realized Appreciation/
Gains (Losses) Depreciation
- ----------------------------------------------------------------------
Long-term investments................. $2,437,017 $3,261,336
Short-term investments................ 232 --
Options purchased..................... 3,497 (14,569)
Options written....................... (282) 7,010
Swaps................................. (37,741) 7,172
Financial futures contracts........... (25,261) (717)
Forward foreign exchange contracts.... (5,785) 4,689
Foreign currency transactions......... 907 997
---------- ----------
Total................................. $2,372,584 $3,265,918
========== ==========
- ----------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $2,625,665, of which $7,827,316 related to appreciated securities and
$5,201,651 related to depreciated securities. At June 30, 2004, the aggregate
cost of investments, net of options written, for federal income tax purposes was
$86,759,403.
Transactions in options written for the six months ended June 30, 2004 were as
follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Number of Premiums
Call Options Written Contracts Received
- ------------------------------------------------------------------
Outstanding call options written, beginning
of period................................. -- --
Options written............................ 154 $11,548
--- -------
Outstanding call options written, end of
period.................................... 154 $11,548
=== =======
- ------------------------------------------------------------------
</Table>
<Table>
<Caption>
- ------------------------------------------------------------------
Number of Premiums
Put Options Written Contracts Received
- ------------------------------------------------------------------
Outstanding put options written, beginning
of period................................. -- --
Options written............................ 10 $ 6,525
Options expired............................ (10) (6,525)
--- -------
Outstanding put options written, end of
period.................................... -- $ --
=== =======
- ------------------------------------------------------------------
</Table>
4. CAPITAL SHARE TRANSACTIONS:
Transactions in capital shares were as follows:
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -----------------------------------------------------------------
Shares sold............................. 2,317 $ 26,188
Shares redeemed......................... (767,844) (8,720,304)
-------- -----------
Net decrease............................ (765,527) $(8,694,116)
======== ===========
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares For the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold.......................... 14,857 $ 149,056
Shares issued to shareholders in
reinvestment of dividends........... 173,952 1,950,006
---------- ------------
Total issued......................... 188,809 2,099,062
Shares redeemed...................... (1,651,599) (16,707,214)
---------- ------------
Net decrease......................... (1,462,790) $(14,608,152)
========== ============
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$15,643,663, of which $593,021 expires in 2007; $3,283,129 expires in 2009;
$9,064,537 expires in 2010 and $2,702,976 expires in 2011. This amount will be
available to offset like amounts of any future taxable gains.
23
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
The Fund's returns for the recent period exceeded that of its benchmark and
its comparable Lipper category. For the six-month period ended June 30, 2004,
Basic Value V.I. Fund's Class I and Class II Shares had total returns of +5.10%
and +5.05%, respectively. For the same period, the Standard & Poor's 500 (S&P
500) Barra Value Index returned +4.17% and the Lipper Large Cap Value Funds
category had an average return of +3.25%. (Funds in this Lipper category invest
in companies considered to be undervalued relative to a major unmanaged stock
index.) The Fund's Class III Shares commenced operations on May 25, 2004. Since
that date through June 30, 2004, the Class III Shares returned +5.18%.
The past six months have been a transitional period for equity markets.
Whereas our cyclical bias had benefited performance in 2003, this period was
characterized by a move to more defensive names, with no clear leadership in
terms of industry sectors or market capitalization size. We found that those
areas that hurt performance most in 2003 have been benefiting performance in the
first six months of 2004. Not only did the stocks in these sectors perform well,
but we also increased our exposure to these areas at the end of last year,
simultaneously reducing exposure to the more cyclical sectors, in anticipation
of this market transition.
Over the past six months, our investments in the consumer staples and energy
sectors contributed most to the Fund's relative returns. Top performers in these
sectors included: Coca-Cola Enterprises Inc., Grant Prideco, Inc., The Gillette
Company, Diamond Offshore Drilling, Inc., Kimberly-Clark Corporation and
Anadarko Petroleum Corporation. Areas that hindered Fund results were health
care and information technology. Specific stocks that disappointed included
Bristol-Myers Squibb Company, LSI Logic Corporation, 3Com Corporation and
Borland Software Corporation.
PORTFOLIO MATTERS
Based on our belief that 2004 would be a transition year for the market, we
began making changes to the portfolio that reflected this view. In 2003, fiscal
and monetary stimulus were working on behalf of the market. Clearly, 2004 would
not be the same in that regard. We will not see a new tax rebate, the once
accommodative Federal Reserve Board has begun raising interest rates,
geopolitical uncertainties persist and we have a presidential election in
November, which historically causes consternation and debate.
In anticipation of this transition, we began to trim from the portfolio some
of the economically sensitive stocks that had performed so well in favor of some
of the safe-haven names. We started making these types of changes in 2003,
reducing our weightings in information technology, materials, industrials and
consumer discretionary while increasing exposure to the defensive areas that
underperformed in 2003--staples, energy, utilities and financials. This shift
also involved taking down the Fund's beta (that is, reducing risk), increasing
large cap exposure and building a more diversified portfolio.
Specific changes in the past six months included increasing the Fund's
exposure to consumer staples from 8.1% of net assets to 9.5%. This involved
purchasing Coca-Cola Enterprises Inc., Albertson's, Inc., ConAgra Foods, Inc.,
Kraft Foods Inc. and General Mills, Inc. At the same time, we reduced our
weighting in the consumer discretionary sector from 15.9% of net assets to
11.2%. The U.S. consumer has been spending consistently over the past few years,
even in uncertain economic times, and borrowing heavily as interest rates
declined. It seems rational to imagine that 2004 could bring some sort of
slowdown. In trimming our exposure to consumer discretionary, we eliminated Fox
Entertainment Group, Inc., DaimlerChrysler Corporation, Tribune Company and The
Gap Inc., and reduced our positions in Koninklijke Philips Electronics NV and
McDonald's Corporation.
Our weightings in the remaining sectors looked much the same as they did six
months ago. Technology, for example, held steady at 18% of net assets. We have
been taking profits in technology; however, the group was up 40%- 50% on average
and has remained a large position due to its substantial appreciation. We
reduced our positions in Lucent Technologies Inc., Motorola, Inc., Agilent
Technologies Inc. and Advanced Micro Devices, Inc. Most of the sales were based
on strength. As the group rallied, we sold our positions to fund purchases in
consumer staples.
We were not shaken by the underperformance of the energy sector last year and,
in fact, we have added to the group. Specifically, we initiated positions in
Transocean Inc. and Anadarko Petroleum Corporation and increased our weighting
in GlobalSantaFe Corporation. Our commitment to the sector benefited performance
in the past six months. We continue to overweight energy based on our belief
that oil prices
24
- --------------------------------------------------------------------------------
could remain stubbornly high; supply issues persist and, ultimately, the stock
prices will need to fully reflect this scenario.
We maintained our view on the financials sector. The generally accepted
philosophy is to overweight financials when interest rates seem poised to
decline and underweight financials when interest rates appear ready to increase.
Given our expectation for rising rates, we remained underweight in financials.
Nevertheless, the Fund benefited from our position in Bank One Corporation,
which was taken over by J.P. Morgan Chase & Co. on July 1, 2004. We accepted the
J.P. Morgan paper and, based on our constructive outlook, will continue to own
it.
LOOKING AHEAD
At the close of the period, the portfolio was overweight versus the S&P 500
Barra Value Index in energy, materials and information technology. We had
underweights in consumer discretionary, financials and utilities. We were
slightly underweight in industrials, due to profit taking, and maintained a
market weighting in health care.
We continue to believe the economy and the markets are in a transition period.
The hope is for a "Goldilocks" economy--not too hot, not too cold--with decent
growth and relatively low interest rates. While it is unclear exactly what is
down the road, the market will almost certainly continue to be rocky with no
obvious leadership in terms of sectors or market-cap size. In this environment,
we believe proper diversification makes sense, and we are positioning the
portfolio with that view in mind.
As always, we will continue our search for what we believe are very good
companies that are temporarily underpriced as a result of negative investor
sentiment or short-term circumstances, and that we believe have the potential to
offer shareholders significant value over a three-year time horizon.
IN CONCLUSION
We thank you for your continued investment in Basic Value V.I. Fund of Merrill
Lynch Variable Series Funds, Inc., and we look forward to serving your future
investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Kevin M. Rendino
Kevin M. Rendino
Vice President and Co-Portfolio Manager
- -s- Robert J. Martorelli
Robert J. Martorelli
Vice President and Co-Portfolio Manager
July 12, 2004
25
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +26.91%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 + 6.04
- --------------------------------------------------------------------------
Ten Years Ended 6/30/04 +13.25
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS II SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +26.75%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 + 5.87
- --------------------------------------------------------------------------
Inception (11/03/97) through 6/30/04 + 8.96
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
AGGREGATE TOTAL RETURN--CLASS III SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
Inception (5/25/04) through 6/30/04 + 5.18%
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +5.10% +26.91%
- -----------------------------------------------------------------------------------------
Class II Shares* +5.05 +26.75
- -----------------------------------------------------------------------------------------
Class III Shares* -- --
- -----------------------------------------------------------------------------------------
S&P 500(R) Index** +3.44 +19.11
- -----------------------------------------------------------------------------------------
S&P 500 Barra Value Index*** +4.17 +22.25
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset values for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A and Class B Shares were redesignated
Class I and Class II Shares. Class III Shares commenced operations on
5/25/2004.
** This unmanaged Index covers 500 industrial, utility, transportation and
financial companies of the U.S. markets (mostly NYSE issues), representing
about 75% of NYSE market capitalization and 25% of NYSE issues.
*** This unmanaged Index is a capitalization-weighted index of those stocks in
the S&P 500 Index that have lower price-to-book ratios.
Past results shown should not be considered a representation of future
performance.
S&P 500 is a registered trademark of the McGraw-Hill Companies.
26
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
ABOVE-AVERAGE YIELD
- -----------------------------------------------------------------------------------------------------------------------
METALS & MINING 410,300 Alcoa Inc. ............................... $ 13,552,209 1.0%
CAPITAL MARKETS 623,800 The Bank of New York Company, Inc. ....... 18,389,624 1.4
FOOD PRODUCTS 664,300 ConAgra Foods, Inc. ...................... 17,989,244 1.4
CHEMICALS 539,800 E.I. du Pont de Nemours and Company....... 23,977,916 1.8
OIL & GAS 965,100 Exxon Mobil Corporation................... 42,860,091 3.2
INDUSTRIAL CONGLOMERATES 631,600 General Electric Company.................. 20,463,840 1.5
FOOD PRODUCTS 143,000 General Mills, Inc. ...................... 6,796,790 0.5
PERSONAL PRODUCTS 455,500 The Gillette Company...................... 19,313,200 1.5
AEROSPACE & DEFENSE 341,000 Goodrich Corporation...................... 11,024,530 0.8
AEROSPACE & DEFENSE 615,900 Honeywell International Inc. ............. 22,560,417 1.7
OIL & GAS 262,700 Kerr-McGee Corporation.................... 14,125,379 1.1
INSURANCE 123,700 Marsh & McLennan Companies, Inc. ......... 5,613,506 0.4
CAPITAL MARKETS 671,500 Mellon Financial Corporation.............. 19,695,095 1.5
OIL & GAS 418,400 Royal Dutch Petroleum Company (NY
Registered Shares)...................... 21,618,728 1.6
DIVERSIFIED 584,900 SBC Communications Inc. .................. 14,183,825 1.1
TELECOMMUNICATION SERVICES
FOOD PRODUCTS 784,300 Sara Lee Corporation...................... 18,031,057 1.4
COMMERCIAL BANKS 314,800 U.S. Bancorp.............................. 8,675,888 0.7
DIVERSIFIED 398,100 Verizon Communications.................... 14,407,239 1.1
TELECOMMUNICATION SERVICES
COMMERCIAL BANKS 366,000 Wachovia Corporation...................... 16,287,000 1.2
-------------- -----
329,565,578 24.9
- -----------------------------------------------------------------------------------------------------------------------
BELOW-AVERAGE PRICE EARNINGS/RATIO
- -----------------------------------------------------------------------------------------------------------------------
INSURANCE 406,100 ACE Limited............................... 17,169,908 1.3
INSURANCE 362,100 The Allstate Corporation.................. 16,855,755 1.3
INSURANCE 430,400 American International Group, Inc. ....... 30,678,912 2.3
HEALTH CARE PROVIDERS & 126,300 AmerisourceBergen Corporation............. 7,550,214 0.6
SERVICES
INSURANCE 514,600 Aon Corporation........................... 14,650,662 1.1
INSURANCE 149,700 Assurant, Inc. ........................... 3,949,086 0.3
COMMERCIAL BANKS 256,000 Bank of America Corporation............... 21,662,720 1.6
COMMERCIAL BANKS 464,300 Bank One Corporation...................... 23,679,300 1.8
HEALTH CARE EQUIPMENT & 501,400 Baxter International Inc. ................ 17,303,314 1.3
SUPPLIES
MACHINERY 106,800 Caterpillar Inc. ......................... 8,484,192 0.6
DIVERSIFIED FINANCIAL 856,920 Citigroup Inc. ........................... 39,846,780 3.0
SERVICES
BEVERAGES 419,600 Coca-Cola Enterprises Inc. ............... 12,164,204 0.9
SPECIALTY RETAIL 1,071,700 Foot Locker, Inc. ........................ 26,085,178 2.0
ENERGY EQUIPMENT & SERVICE 1,536,900 +Grant Prideco, Inc. ..................... 28,371,174 2.1
COMPUTERS & PERIPHERALS 1,393,331 Hewlett-Packard Company................... 29,399,284 2.2
HOUSEHOLD DURABLES 470,800 Koninklijke (Royal) Philips Electronics NV
(NY Registered Shares).................. 12,805,760 1.0
HOTELS, RESTAURANTS & 634,800 McDonald's Corporation.................... 16,504,800 1.2
LEISURE
PHARMACEUTICALS 244,600 Merck & Co., Inc. ........................ 11,618,500 0.9
CAPITAL MARKETS 379,000 Morgan Stanley............................ 19,999,830 1.5
PHARMACEUTICALS 828,500 Schering-Plough Corporation............... 15,310,680 1.2
ELECTRICAL EQUIPMENT 158,600 +Thomas & Betts Corporation............... 4,318,678 0.3
FOOD PRODUCTS 278,100 Unilever NV (NY Registered Shares)........ 19,052,631 1.4
INFORMATION TECHNOLOGY 2,466,800 +Unisys Corporation....................... 34,239,184 2.6
SERVICES
OIL & GAS 539,800 Unocal Corporation........................ 20,512,400 1.5
-------------- -----
452,213,146 34.0
- -----------------------------------------------------------------------------------------------------------------------
LOW PRICE TO BOOK VALUE
- -----------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS EQUIPMENT 3,334,700 +3Com Corporation......................... 20,841,875 1.6
SEMICONDUCTORS & 1,137,000 +Advanced Micro Devices, Inc. ............ 18,078,300 1.4
SEMICONDUCTOR EQUIPMENT
ELECTRONIC EQUIPMENT & 288,400 +Agilent Technologies, Inc. .............. 8,444,352 0.6
INSTRUMENTS
</Table>
27
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------
LOW PRICE TO BOOK VALUE (CONCLUDED)
- -----------------------------------------------------------------------------------------------------------------------
FOOD & STAPLES RETAILING 451,500 Albertson's, Inc. ........................ $ 11,982,809 0.9%
OIL & GAS 278,700 Anadarko Petroleum Corporation............ 16,331,820 1.2
METALS & MINING 207,700 Arch Coal, Inc. .......................... 7,599,743 0.6
AEROSPACE & DEFENSE 255,100 The Boeing Company........................ 13,033,059 1.0
SOFTWARE 1,510,200 +Borland Software Corporation............. 12,821,598 1.0
MEDIA 791,400 +Comcast Corporation (Special Class A).... 21,850,554 1.7
MACHINERY 366,700 Deere & Company........................... 25,720,338 1.9
ENERGY EQUIPMENT & SERVICE 551,200 Diamond Offshore Drilling, Inc. .......... 13,135,096 1.0
ENERGY EQUIPMENT & SERVICE 768,800 GlobalSantaFe Corporation................. 20,373,200 1.5
INSURANCE 197,700 The Hartford Financial Services Group,
Inc. ................................... 13,589,898 1.0
PAPER & FOREST PRODUCTS 555,000 International Paper Company............... 24,808,500 1.9
HOUSEHOLD PRODUCTS 478,900 Kimberly-Clark Corporation................ 31,549,932 2.4
SEMICONDUCTORS & 2,721,800 +LSI Logic Corporation.................... 20,740,116 1.6
SEMICONDUCTOR EQUIPMENT
MEDIA 2,096,828 +Liberty Media Corporation (Class A)...... 18,850,484 1.4
COMMUNICATIONS EQUIPMENT 2,068,580 +Lucent Technologies Inc. ................ 7,819,232 0.6
COMMUNICATIONS EQUIPMENT 732,570 Motorola, Inc. ........................... 13,369,403 1.0
ROAD & RAIL 920,800 Norfolk Southern Corporation.............. 24,419,616 1.8
AEROSPACE & DEFENSE 1,237,500 Raytheon Company.......................... 44,265,375 3.3
INSURANCE 481,308 The St. Paul Companies, Inc. ............. 19,512,226 1.5
MEDIA 1,393,500 +Time Warner Inc. ........................ 24,497,730 1.8
SPECIALTY RETAIL 1,132,500 +Toys 'R' Us, Inc. ....................... 18,040,725 1.4
MEDIA 730,000 Viacom, Inc. (Class B).................... 26,075,600 2.0
MEDIA 574,800 The Walt Disney Company................... 14,651,652 1.1
PAPER & FOREST PRODUCTS 228,900 Weyerhaeuser Company...................... 14,448,168 1.1
-------------- -----
506,851,401 38.3
- -----------------------------------------------------------------------------------------------------------------------
SPECIAL SITUATIONS
- -----------------------------------------------------------------------------------------------------------------------
SOFTWARE 406,900 Computer Associates International,
Inc. ................................... 11,417,614 0.9
COMPUTERS & PERIPHERALS 215,810 International Business Machines
Corporation............................. 19,023,652 1.4
-------------- -----
30,441,266 2.3
- -----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST--$1,134,255,358).................... 1,319,071,391 99.5
- -----------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL
INTEREST SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------
$ 21,418,489 Merrill Lynch Liquidity Series, LLC Cash
Sweep Series I(a)....................... 21,418,489 1.6
144,308,650 Merrill Lynch Liquidity Series, LLC Money
Market Series(a)(b)..................... 144,308,650 10.9
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$165,727,139)...................... 165,727,139 12.5
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$1,299,982,497).................... 1,484,798,530 112.0
LIABILITIES IN EXCESS OF OTHER ASSETS..... (159,430,148) (12.0)
-------------- -----
NET ASSETS................................ $1,325,368,382 100.0%
============== =====
- -----------------------------------------------------------------------------------------------------------------------
</Table>
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management.
This definition may not apply for purposes of this report, which may
combine such industry sub-classifications for reporting ease.
28
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
(a) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------------
INTEREST/
DIVIDEND
AFFILIATE NET ACTIVITY INCOME
- -------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $(42,822,111) $275,130
Merrill Lynch Liquidity Series, LLC Money Market Series..... $ (4,620,875) $ 62,522
Merrill Lynch Premier Institutional Fund.................... (49,643,175) $ 18,110
- -------------------------------------------------------------------------------------
</Table>
(b) Security was purchased with the cash proceeds from securities loans.
See Notes to Financial Statements.
29
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (including
securities loaned of $140,461,660) (identified
cost--$1,134,255,358)..................................... $1,319,071,391
Investments in affiliated securities, at value (identified
cost--$165,727,139)....................................... 165,727,139
Receivables:
Securities sold........................................... $ 2,606,012
Dividends................................................. 1,451,127
Capital shares sold....................................... 187,073
Interest from affiliates.................................. 10,780
Securities lending--net................................... 8,731 4,263,723
------------
Prepaid expenses and other assets........................... 4,914
--------------
Total assets................................................ 1,489,067,167
--------------
- --------------------------------------------------------------------------------------------
LIABILITIES:
Collateral on securities loaned, at value................... 144,308,650
Payables:
Capital shares redeemed................................... 16,919,330
Securities purchased...................................... 2,233,814
Investment adviser........................................ 109,453
Custodian bank............................................ 72,188
Other affiliates.......................................... 14,778
Distributor............................................... 5,097 19,354,660
------------
Accrued expenses............................................ 35,475
--------------
Total liabilities........................................... 163,698,785
--------------
- --------------------------------------------------------------------------------------------
NET ASSETS.................................................. $1,325,368,382
==============
- --------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 300,000,000
shares authorized......................................... $ 8,559,663
Class II Shares of Common Stock, $.10 par value, 100,000,000
shares authorized......................................... 249,152
Class III Shares of Common Stock, $.10 par value,
100,000,000 shares authorized............................. 3,310
Paid-in capital in excess of par............................ 1,168,683,844
Undistributed investment income--net........................ $ 6,411,127
Accumulated realized capital losses on investments--net..... (43,354,747)
Unrealized appreciation on investments--net................. 184,816,033
------------
Total accumulated earnings--net............................. 147,872,413
--------------
NET ASSETS.................................................. $1,325,368,382
==============
- --------------------------------------------------------------------------------------------
NET ASSET VALUE:
Class I--Based on net assets of $1,287,517,084 and
85,596,632 shares outstanding............................. $ 15.04
==============
Class II--Based on net assets of $37,353,702 and 2,491,522
shares outstanding........................................ $ 14.99
==============
Class III--Based on net assets of $497,596 and 33,097 shares
outstanding............................................... $ 15.03
==============
- --------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
30
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends (net of $214,141 foreign withholding tax)......... $10,545,161
Interest from affiliates.................................... 275,130
Securities lending--net..................................... 80,632
-----------
Total income................................................ 10,900,923
-----------
- ----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $4,031,514
Accounting services......................................... 213,763
Printing and shareholder reports............................ 61,185
Custodian fees.............................................. 41,643
Directors' fees and expenses................................ 38,987
Professional fees........................................... 34,125
Distribution fees--Class II................................. 28,339
Transfer agent fees--Class I................................ 2,370
Pricing services............................................ 612
Distribution fees--Class III................................ 89
Transfer agent fees--Class II............................... 68
Other....................................................... 21,795
----------
Total expenses.............................................. 4,474,490
-----------
Investment income--net...................................... 6,426,433
-----------
- ----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN ON INVESTMENTS--NET:
Realized gain from investments--net......................... 30,560,705
Change in unrealized appreciation on investments--net....... 30,196,721
-----------
Total realized and unrealized gain on investments--net...... 60,757,426
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $67,183,859
===========
- ----------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
31
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- ----------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 6,426,433 $ 13,292,683
Realized gain (loss) on investments--net.................... 30,560,705 (32,094,141)
Change in unrealized appreciation on investments--net....... 30,196,721 358,414,414
-------------- --------------
Net increase in net assets resulting from operations........ 67,183,859 339,612,956
-------------- --------------
- ----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... -- (13,094,662)
Class II.................................................. -- (333,589)
-------------- --------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. -- (13,428,251)
-------------- --------------
- ----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (86,396,107) (66,202,415)
-------------- --------------
- ----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (19,212,248) 259,982,290
Beginning of period......................................... 1,344,580,630 1,084,598,340
-------------- --------------
End of period*.............................................. $1,325,368,382 $1,344,580,630
============== ==============
- ----------------------------------------------------------------------------------------------
*
Undistributed (accumulated distributions in excess of)
investment income--net $ 6,411,127 $ (15,306)
============== ==============
- ----------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
32
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -------------------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,++
JUNE 30, ----------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........... $ 14.31 $ 10.85 $ 13.47 $ 13.71 $ 13.60
---------- ---------- ---------- ---------- ----------
Investment income--net***...................... .07 .14 .12 .14 .24
Realized and unrealized gain (loss) on
investments and foreign currency
transactions--net............................ .66 3.47 (2.48) .44 1.41
---------- ---------- ---------- ---------- ----------
Total from investment operations............... .73 3.61 (2.36) .58 1.65
---------- ---------- ---------- ---------- ----------
Less dividends and distributions:
Investment income--net....................... -- (.15) (.13) (.13) (.24)
Realized gain on investments--net............ -- -- (.13) (.69) (1.30)
---------- ---------- ---------- ---------- ----------
Total dividends and distributions.............. -- (.15) (.26) (.82) (1.54)
---------- ---------- ---------- ---------- ----------
Net asset value, end of period................. $ 15.04 $ 14.31 $ 10.85 $ 13.47 $ 13.71
========== ========== ========== ========== ==========
- --------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share............. 5.10%+ 33.23% (17.77%) 4.26% 12.65%
========== ========== ========== ========== ==========
- --------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses....................................... .66%* .67% .67% .68% .65%
========== ========== ========== ========== ==========
Investment income--net......................... .96%* 1.17% 1.02% 1.00% 1.75%
========== ========== ========== ========== ==========
- --------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)....... $1,287,517 $1,306,427 $1,051,063 $1,310,134 $1,179,853
========== ========== ========== ========== ==========
Portfolio turnover............................. 29.71% 24.57% 41.31% 61.04% 67.31%
========== ========== ========== ========== ==========
- --------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Aggregate total investment return.
++ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
See Notes to Financial Statements.
33
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
FINANCIAL HIGHLIGHTS (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS II
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,++
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 14.27 $ 10.82 $ 13.43 $ 13.68 $ 13.58
-------- -------- -------- -------- --------
Investment income--net***............................. .06 .12 .11 .11 .22
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net.................. .66 3.46 (2.48) .45 1.40
-------- -------- -------- -------- --------
Total from investment operations...................... .72 3.58 (2.37) .56 1.62
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.............................. -- (.13) (.11) (.12) (.22)
Realized gain on investments--net................... -- -- (.13) (.69) (1.30)
-------- -------- -------- -------- --------
Total dividends and distributions..................... -- (.13) (.24) (.81) (1.52)
-------- -------- -------- -------- --------
Net asset value, end of period........................ $ 14.99 $ 14.27 $ 10.82 $ 13.43 $ 13.68
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................... 5.05%+ 33.05% (17.89%) 4.05% 12.46%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................. .81%* .82% .82% .83% .80%
======== ======== ======== ======== ========
Investment income--net................................ .81%* 1.02% .87% .85% 1.60%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).............. $ 37,354 $ 38,154 $ 33,535 $ 46,031 $ 34,587
======== ======== ======== ======== ========
Portfolio turnover.................................... 29.71% 24.57% 41.31% 61.04% 67.31%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Aggregate total investment return.
++ Effective September 2, 2003, Class B Shares were redesignated Class II
Shares.
See Notes to Financial Statements.
34
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS III
--------------
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE FOR THE PERIOD
BEEN DERIVED FROM INFORMATION PROVIDED IN THE MAY 25, 2004++
FINANCIAL STATEMENTS. TO JUNE 30,
INCREASE IN NET ASSET VALUE: 2004
- ----------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 14.29
--------
Investment income--net***................................... --++
Realized and unrealized gain on investments and foreign
currency transactions--net................................ .74
--------
Total from investment operations............................ .74
--------
Net asset value, end of period.............................. $ 15.03
========
- ----------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... 5.18%+
========
- ----------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... .91%*
========
Investment income--net...................................... .71%*
========
- ----------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 498
========
Portfolio turnover.......................................... 29.71%
========
- ----------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Aggregate total investment return.
++ Amount is less than $.01 per share.
++ Commencement of Operations.
See Notes to Financial Statements.
35
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--BASIC VALUE V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Basic Value V.I.
Fund (the "Fund") is classified as "diversified," as defined in the Investment
Company Act of 1940, as amended. Class I Shares, Class II Shares and Class III
Shares have equal voting, dividend, liquidation and other rights, except that
only shares of the respective classes are entitled to vote on matters concerning
only that class. In addition, Class II Shares and Class III Shares bear certain
expenses related to the distribution of such shares. The Fund's financial
statements are prepared in conformity with U.S. generally accepted accounting
principles, which may require the use of management accruals and estimates.
Actual results may differ from these estimates. These unaudited financial
statements reflect all adjustments, which are, in the opinion of management,
necessary to present a fair statement of the results for the interim period. All
such adjustments are of a normal, recurring nature. The following is a summary
of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
36
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- - Options--The Fund may write 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 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 gain or loss to the extent the cost of the closing
transaction exceeds the premium received).
Written options are non-income producing investments.
(c) 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.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis.
(e) Dividends and distributions to shareholders--Dividends and distributions
paid by the Fund are recorded on the ex-dividend dates.
(f) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(g) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
(h) Custodian bank--The Fund recorded an amount payable to the custodian bank
reflecting an overnight overdraft, which resulted from an unprojected payment of
redemptions.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with FAM Distributors, Inc. ("FAMD" or the
"Distributor"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .60% of the
37
- --------------------------------------------------------------------------------
average daily value of the Fund's net assets. MLIM has entered into a
Sub-Advisory Agreement with Merrill Lynch Asset Management, Ltd. ("MLAM U.K."),
an affiliate of MLIM, pursuant to which MLAM U.K. provides investment advisory
services to MLIM with respect to the Fund. There is no increase in the aggregate
fees paid by the Fund for these services.
Pursuant to the Distribution Plan adopted by the Company pursuant to Rule
12b-1 under the Investment Company Act of 1940, the Fund pays the Distributor an
ongoing distribution fee each month at the annual rate of .15% and .25% of the
average daily value of the Fund's Class II and Class III net assets,
respectively.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. As of June 30, 2004, the Fund lent securities
with a value of $26,874,689 to MLPF&S or its affiliates. For the six months
ended June 30, 2004, MLIM, LLC received $34,477 in securities lending agent fees
from the Fund.
In addition, MLPF&S earned $165,089 in commissions on the execution of
portfolio security transactions for the six months ended June 30, 2004.
In addition, the Fund reimbursed MLIM $13,492 for certain accounting services
for the six months ended June 30, 2004.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $383,160,234 and $397,096,025, respectively.
Net realized gains for the six months ended June 30, 2004 and net unrealized
appreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Realized Unrealized
Gains Appreciation
- ------------------------------------------------------------------
Long-term investments................. $30,560,705 $184,816,033
----------- ------------
Total................................. $30,560,705 $184,816,033
=========== ============
- ------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $169,647,292, of which $205,708,915 related to appreciated securities
and $36,061,623 related to depreciated securities. At June 30, 2004, the
aggregate cost of investments for federal income tax purposes was
$1,315,151,238.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions was
$86,396,107 and $66,202,415 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares for each class were as follows:
<Table>
<Caption>
- --------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- --------------------------------------------------------------------
Shares sold.......................... 2,122,301 $ 31,343,846
Shares redeemed...................... (7,844,961) (115,566,835)
---------- -------------
Net decrease......................... (5,722,660) $ (84,222,989)
========== =============
- --------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold........................ 4,319,589 $ 51,652,267
Shares issued to shareholders in
reinvestment of dividends......... 918,683 13,094,662
----------- -------------
Total issued....................... 5,238,272 64,746,929
Shares redeemed.................... (10,790,122) (125,796,320)
----------- -------------
Net decrease....................... (5,551,850) $ (61,049,391)
=========== =============
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class II Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -----------------------------------------------------------------
Shares sold............................. 7,693 $ 113,142
Shares redeemed......................... (189,921) (2,772,315)
-------- -----------
Net decrease............................ (182,228) $(2,659,173)
======== ===========
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class II Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold............................. 45,421 $ 536,990
Shares issued to shareholders in
reinvestment of dividends.............. 23,472 333,589
-------- -----------
Total issued............................ 68,893 870,579
Shares redeemed......................... (493,165) (6,023,603)
-------- -----------
Net decrease............................ (424,272) $(5,153,024)
======== ===========
- -----------------------------------------------------------------
</Table>
38
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -----------------------------------------------------------------
Class III Shares for the Period Dollar
May 25, 2004+ to June 30, 2004 Shares Amount
- -----------------------------------------------------------------
Shares sold.................................. 33,124 $486,459
Shares redeemed.............................. (27) (404)
------ --------
Net increase................................. 33,097 $486,055
====== ========
- -----------------------------------------------------------------
</Table>
+ Commencement of operations.
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$58,746,711, of which $31,503,949 expires in 2010 and $27,242,762 expires in
2011. This amount will be available to offset like amounts of any future taxable
gains.
39
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
The first six months of the year can be described as a tale of two quarters.
At the beginning of the year, the yield on the ten-year Treasury bond stood at
4.25%. In the three months that followed, interest rates bottomed at 3.84% on
fears that the economy was not growing and concerns over the relatively weak
employment picture.
In the second quarter, a surge in job creation led to a dramatic rise in
interest rates, with the 10-year Treasury bond closing at a yield of 4.58% by
the end of June. The improvement in employment, along with an up-tick in
inflation, led the Federal Reserve Board to raise short-term interest rates for
the first time in more than four years on June 30. We also saw the spread
between short-term and long-term interest rates--as measured by two-year and
10-year rates--flatten by more than 50 basis points (.50%).
In addition, the overall environment continued to reward investors for taking
on risk, as spread sectors continued to outperform the Treasury sector. For
example, excess returns for the high yield and crossover credit sectors were 135
basis points and 96 basis points, respectively. The asset-backed and mortgage
sectors also had positive excess returns.
PORTFOLIO MATTERS
For the six-month period ended June 30, 2004, Core Bond V.I. Fund's Class I
Shares had a total return of +.14%. This compared to a return of +.15% for the
benchmark Lehman Brothers Aggregate Bond Index for the same period.
Fund returns were competitive with the benchmark, and we attribute this
primarily to our focus on higher-beta credits, which continued to perform well
throughout the period. By maintaining our focus on spread sectors--those areas
of the market with a lower correlation to Treasury issues--we were able to avoid
a great deal of interest rate volatility while also achieving more attractive
total returns. In general, we maintained a 13%--15% overweight to spread sectors
throughout the period. This included overweight positions in both investment
grade and high yield corporate bonds and in commercial mortgage-backed
securities (CMBS).
We also maintained a duration profile shorter than that of our benchmark in an
effort to cushion the portfolio from the price impact associated with a rise in
interest rates. This positioning was established in late February 2004 and,
although it hurt performance early in the period as interest rates declined, it
aided performance later in the period as interest rates began to rise. In
general, we maintained a duration profile 3%--10% below our benchmark.
PORTFOLIO ACTIVITY
Changes made during the past six months were generally tactical. Although the
portfolio remained overweight in spread sectors, we reduced our overweighting
from 15%--17% above the benchmark to approximately 13%--15% above benchmark. We
maintained an aggressive overweight to the BBB-rated corporate sector during the
period and consistently maintained an overweight of about 5% to investment grade
corporates. In the high yield space, we increased our exposure modestly from 3%
of net assets to 4%. Primarily, we moved from a broad market exposure to the
high yield asset class to individual security selection in crossover credits. We
had zero exposure to crossover credits at the beginning of the period, and
currently have 2% of net assets invested in these types of issues. (As their
name implies, crossover credits have a split rating--half investment grade and
half non-investment grade.) In our view, the easy money had already been
extracted from the high yield market. Rather than benefiting from the general
outperformance of the high yield asset class, we began to focus more on
individual bond selection.
While increasing our high yield exposure, we reduced our weighting in
high-quality sectors, such as banks, finance and broker/dealer paper, based on
our belief that these sectors were overvalued and would be particularly
sensitive to a widening in quality spreads. Overall, we reduced exposure to this
sector by 3%. We continued to maintain a 4% overweighting to CMBS throughout the
period.
Another broad change during the period involved the previously mentioned shift
in the Fund's duration profile. Our shift from a neutral to a relatively short
duration stance was based on our belief that several important factors would
fuel economic growth in the first half of 2004, thereby forcing interest rates
higher. The final change also had to do with our view on interest rates. We
expected that interest rates would be less volatile than was priced into the
market and, for that reason, we set out to sell volatility. This was
accomplished by selling options on the 10-year Treasury note. We executed these
types of transactions on two
40
- --------------------------------------------------------------------------------
occasions during the period at a profit to the Fund.
LOOKING AHEAD
At period-end, the portfolio's duration remained short relative to the
benchmark. We also maintained a 13% overweight to spread sectors, broken down as
follows: 3% overweight corporates, 4% CMBS, 4% high yield and 2% crossover
credits. In general, we believe improving economic conditions should continue to
support the high yield and investment grade corporate bond sectors. We believe
the overall economic environment is still conducive to corporate profitability,
corporate deleveraging and improving free cash flows, all of which should
continue to benefit corporate bonds. In the high yield space, we are at the
higher end of the quality spectrum -BB and BBB.
Broadly speaking, we would look to reduce exposure to higher-beta sectors and
to spread sectors in general as spreads (versus 10-year Treasury issues)
continue to contract. Having said that, we believe there is still an opportunity
to extract value out of those sectors that we find to be inexpensive relative to
their underlying fundamentals. As far as duration is concerned, we believe the
bond market starts to represent value when the 10-year Treasury yield approaches
5%. At that point, we would look to reduce our duration-short profile.
While the Federal Reserve Board has begun raising short-term interest rates,
we believe the Fed seems more inclined to be slow and steady in adjusting
monetary policy so as to avoid derailing the sustainability of the current
economic recovery.
IN CONCLUSION
We thank you for your investment in Core Bond V.I. Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to serving your future
investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Patrick Maldari
Patrick Maldari
Vice President and Co-Portfolio Manager
- -s- James J. Pagano
James J. Pagano
Vice President and Co-Portfolio Manager
July 12, 2004
41
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +0.72%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 +6.20
- --------------------------------------------------------------------------
Ten Years Ended 6/30/04 +6.66
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH STANDARDIZED
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN 30-DAY YIELD
- --------------------------------------------------------------------------------------------------------
Class I Shares* +0.14% +0.72% 2.75%
- --------------------------------------------------------------------------------------------------------
Lehman Brothers Aggregate Bond Index** +0.15 +0.32 --
- --------------------------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset values for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the payable date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
** This unmanaged market-weighted Index is comprised of U.S. government and
agency securities, mortgage-backed securities issued by the Government
National Mortgage Association, Freddie Mac or Fannie Mae and investment
grade (rated BBB or better) corporate bonds.
Past results shown should not be considered a representation of future
performance.
42
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
RATINGS RATINGS AMOUNT ASSET-BACKED SECURITIES+ VALUE
- -------------------------------------------------------------------------------------------------------------------------
AAA Aaa US$ 4,804,932 Ace Securities Corp., Series 2003-OP1,
Class A2, 1.66% due 12/25/2033(b)... $ 4,816,216
AAA Aaa 1,565,920 Advanta Mortgage Loan Trust, Series
1999-3, Class A4, 7.75% due
10/25/2026.......................... 1,636,595
AAA Aaa 5,884,300 Aegis Asset Backed Securities Trust,
Series 2004-1, Class A, 1.65% due
4/25/2034(b)........................ 5,885,451
AAA Aaa 5,200,000 Banc of America Large Loan, Series
2003-BBA2, Class A3, 1.559% due
10/15/2006(b)....................... 5,199,874
AAA Aaa 4,128,000 Bear Stearns Adjustable Rate Mortgage
Trust, Series 2004-4, Class A4,
3.517% due 6/25/2034(b)............. 4,010,715
AAA Aaa 4,900,000 CIT Equipment Collateral, Series
2003-VT1, Class A3A, 1.23% due
4/20/2007(b)........................ 4,905,789
AAA Aaa 5,474,611 CIT Group Home Equity Loan Trust,
Series 2003-1, Class A2, 2.35% due
4/20/2027........................... 5,467,279
California Infrastructure, Series
1997-1:
AAA Aaa 1,501,918 PG&E-1, Class A7, 6.42% due
9/25/2008........................... 1,567,299
AAA Aaa 1,086,956 SCE-1, Class A6, 6.38% due
9/25/2008........................... 1,135,635
A+ Aa3 1,331,910 Capital Auto Receivables Asset Trust,
Series 2003-2, Class B, 1.38% due
1/15/2009(b)........................ 1,334,706
NR* NR* 6,500,000 Capital One Master Trust, Series
2000-4, Class C, 2.039% due
8/15/2008(a)(b)..................... 6,512,188
AAA Aaa 3,566,527 Centex Home Equity, Series 2003-B,
Class AV, 1.58% due 6/25/2033(b).... 3,569,239
Chase Credit Card Master Trust, Class
C(b):
BBB Baa2 3,550,000 Series 2000-3, 1.94% due 1/15/2008.. 3,569,748
BBB Baa2 6,500,000 Series 2003-1, 2.339% due
4/15/2008........................... 6,566,246
AAA NR* 5,150,000 CountryWide Asset-Backed Certificates,
Series 2003-BC3, Class A2, 1.61% due
9/25/2033(b)........................ 5,155,506
AAA Aaa 3,717,036 First Franklin Mortgage Loan Trust,
Series 2003-FF5, Class A2, 2.82% due
3/25/2034(b)........................ 3,748,249
AAA NR* 4,875,634 GMAC Mortgage Corporation Loan Trust,
Series 2003-J7, Class A10, 5.50% due
11/25/2033.......................... 4,841,168
AAA Aaa 3,200,000 Household Automotive Trust, Series
2002-3, Class A3A, 2.75% due
6/18/2007........................... 3,212,940
AAA Aaa 1,474,348 Household Home Equity Loan Trust,
Series 2002-2, Class A, 1.58% due
4/20/2032(b)........................ 1,477,023
Long Beach Mortgage Loan Trust(b):
AAA Aaa 2,759,703 Series 2002-4, Class 2A, 1.76% due
11/26/2032.......................... 2,772,778
AAA Aaa 6,811,005 Series 2004-1, Class A3, 1.60% due
2/25/2034........................... 6,816,174
AAA Aaa 4,556,809 MASTR Asset Securitization Trust,
Series 2003-10, Class 3A1, 5.50% due
11/25/2033.......................... 4,508,166
A+ A2 2,222,200 MBNA Master Credit Card Trust, Series
1999-F, Class B, 1.64% due
1/16/2007(b)........................ 2,221,096
Morgan Stanley ABS Capital I(b):
AAA Aaa 5,463,362 Series 2004-NC1, Class A2, 1.67% due
12/27/2033.......................... 5,481,932
AAA Aaa 5,657,140 Series 2004-NC2, Class A2, 1.60% due
12/25/2033.......................... 5,661,096
AAA Aaa 5,300,000 Series 2004-WMC1, Class A3, 1.61%
due 6/25/2034....................... 5,300,000
</Table>
43
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
RATINGS RATINGS AMOUNT ASSET-BACKED SECURITIES+ VALUE
- -------------------------------------------------------------------------------------------------------------------------
AAA Aaa US$ 6,600,000 New Century Home Equity Loan Trust,
Series 2004-2, Class A3, 1.57% due
4/25/2034(b)........................ $ 6,600,000
Option One Mortgage Loan Trust(b):
AAA Aaa 1,162,234 Series 2002-4, Class A, 1.56% due
7/25/2032........................... 1,162,873
AAA Aaa 4,589,566 Series 2003-4, Class A2, 1.62% due
7/25/2033........................... 4,595,629
AAA Aaa 2,842,588 Residential Asset Mortgage Products,
Inc., Series 2003-RS7, Class AI1,
1.43% due 6/25/2018(b).............. 2,842,810
Residential Asset Securities
Corporation:
AAA Aaa 1,965,701 Series 2002-KS8, Class A2, 3.04% due
5/25/2023........................... 1,965,864
AAA Aaa 5,503,503 Series 2003-KS5, Class AIIB, 1.59%
due 7/25/2033(b).................... 5,507,219
AAA Aaa 4,060,905 Saxon Asset Securities Trust, Series
2002-3, Class AV, 1.70% due
12/25/2032(b)....................... 4,069,658
- -------------------------------------------------------------------------------------------------------------------------
TOTAL ASSET-BACKED SECURITIES
(COST--$133,996,099)--22.3%........... 134,117,161
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
GOVERNMENT & AGENCY OBLIGATIONS
- -------------------------------------------------------------------------------------------------------------------------
AAA Aaa 4,840,000 Federal National Mortgage Association,
7.125% due 1/15/2030................ 5,638,474
U.S. Treasury Bonds:
AAA Aaa 2,280,000 7.50% due 11/15/2016................ 2,810,722
AAA Aaa 1,390,000 8.125% due 8/15/2019................ 1,820,466
AAA Aaa 4,820,000 7.25% due 8/15/2022................. 5,906,004
AAA Aaa 1,010,000 6.25% due 8/15/2023(c).............. 1,118,417
AAA Aaa 1,010,000 6.625% due 2/15/2027(c)............. 1,171,956
U.S. Treasury Inflation Indexed Notes:
AAA Aaa 3,603,716 3.875% due 1/15/2009................ 4,017,581
AAA Aaa 3,149,455 3.50% due 1/15/2011................. 3,496,878
U.S. Treasury Notes:
AAA Aaa 12,580,000 7% due 7/15/2006(c)................. 13,630,141
AAA Aaa 1,390,000 6.50% due 2/15/2010................. 1,566,248
- -------------------------------------------------------------------------------------------------------------------------
TOTAL GOVERNMENT & AGENCY OBLIGATIONS
(COST--$41,045,425)--6.9%............. 41,176,887
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
GOVERNMENT AGENCY
MORTGAGE-BACKED SECURITIES+
- -------------------------------------------------------------------------------------------------------------------------
Federal Home Loan Mortgage
Corporation:
AAA Aaa 6,195,546 4.50% due 8/01/2018-9/01/2018....... 6,067,863
AAA Aaa 11,428,535 5% due 7/01/2018-7/15/2019.......... 11,463,746
AAA Aaa 15,106,823 5% due 7/15/2034.................... 14,578,083
AAA Aaa 24,900,000 5.50% due 7/15/2034................. 24,783,269
AAA Aaa 4,906,220 6% due 6/01/2016-9/01/2017.......... 5,119,808
AAA Aaa 20,123,361 6% due 7/15/2034.................... 20,544,704
AAA Aaa 1,719,597 6.50% due 5/01/2016-6/01/2016....... 1,817,134
AAA Aaa 2,122,396 7% due 10/01/2031-9/01/2032......... 2,242,978
AAA Aaa 1,618,763 7.50% due 11/01/2029-5/01/2032 1,742,617
Federal National Mortgage Association:
AAA Aaa 3,898,484 2.01% due 11/25/2033................ 3,877,005
AAA Aaa 4,540,938 5% due 7/15/2019.................... 4,545,197
AAA Aaa 2,889,513 6% due 2/01/2017.................... 3,015,100
AAA Aaa 16,368,122 6.50% due 5/01/2031-7/15/2034....... 17,059,522
AAA Aaa 3,495,507 7% due 5/01/2031-3/01/2032.......... 3,695,162
AAA Aaa 2,858,859 7.50% due 2/01/2026-10/01/2032...... 3,064,139
AAA Aaa 3,185,328 8% due 9/01/2030-4/01/2032.......... 3,447,575
</Table>
44
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE GOVERNMENT AGENCY
RATINGS RATINGS AMOUNT MORTGAGE-BACKED SECURITIES+ VALUE
- -------------------------------------------------------------------------------------------------------------------------
Government National Mortgage
Association:
AAA Aaa US$ 4,600,000 4.66% due 7/16/2033................. $ 4,465,166
AAA Aaa 3,120,964 6.50% due 5/15/2031-4/15/2032....... 3,265,048
- -------------------------------------------------------------------------------------------------------------------------
TOTAL GOVERNMENT AGENCY
MORTGAGE-BACKED SECURITIES
(COST--$133,628,007)--22.5%........... 134,794,116
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
NON-GOVERNMENT AGENCY
MORTGAGE-BACKED SECURITIES+
- -------------------------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE
OBLIGATIONS--2.6%
AAA Aaa 5,594,589 Countrywide Home Loans, Inc., Series
2003-R4, Class 1A1A, 2.216% due
7/25/2019........................... $ 5,561,843
AAA NR* 643,337 Deutsche Mortgage Securities, Inc.,
Series 2003-1, Class 1A1, 4.50% due
4/25/2033........................... 643,629
AAA Aaa 6,700,000 RMAC, Series 2003-NS2A, Class A2C,
1.92% due 9/12/2035(b).............. 6,733,500
AAA Aaa 2,194,103 Structured Asset Securities
Corporation, Series 2002-9, Class
A2, 1.60% due 10/25/2027(b)......... 2,191,792
AAA Aaa 306,632 Washington Mutual, Inc., Series 2002-
AR4, Class A7, 5.50% due
4/26/2032(b)........................ 308,640
------------
15,439,404
- -------------------------------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE- Commercial Mortgage Pass-Through
BACKED SECURITIES--5.3% Certificates(b):
AAA Aaa 3,950,000 Series 2003-FL8, Class A2, 1.44% due
7/15/2015(a)........................ 3,951,089
AAA Aaa 7,450,000 Series 2003-FL9, Class A3, 1.56% due
11/15/2015.......................... 7,452,479
Greenwich Capital Commercial Funding
Corporation:
AAA Aaa 5,572,762 Series 2003-FL1, Class A, 1.68% due
1/05/2006(b)........................ 5,573,570
AAA Aaa 4,180,000 Series 2004-GG1, Class A4, 4.755%
due 6/10/2036....................... 4,165,872
AAA NR* 3,100,000 Nationslink Funding Corporation,
Series 1999-2, Class A3, 7.181% due
6/20/2031........................... 3,284,012
AAA Aaa 7,250,000 Wachovia Bank Commercial Mortgage
Trust, Series 2003-WHL2, Class A3,
1.559% due 6/15/2013(b)............. 7,251,439
------------
31,678,461
- -------------------------------------------------------------------------------------------------------------------------
TOTAL NON-GOVERNMENT AGENCY
MORTGAGE-BACKED SECURITIES
(COST--$46,917,120)--7.9%............. 47,117,865
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
INDUSTRY++ CORPORATE BONDS
- -------------------------------------------------------------------------------------------------------------------------
BUILDING PRODUCTS--0.4% BB+ Ba1 1,545,000 D.R. Horton, Inc., 5% due 1/15/2009... 1,516,031
BBB+ Baa1 775,000 Hanson PLC, 7.875% due 9/27/2010...... 883,116
------------
2,399,147
- -------------------------------------------------------------------------------------------------------------------------
CABLE--U.S.--0.5% BBB Baa3 1,270,000..... Comcast Cable Communications Holdings,
Inc., 8.375% due 3/15/2013.......... 1,490,910
BB- Ba3 1,380,000 EchoStar DBS Corporation, 5.75% due
10/01/2008.......................... 1,361,025
------------
2,851,935
- -------------------------------------------------------------------------------------------------------------------------
CANADIAN BB Ba2 230,000 Abitibi-Consolidated Inc., 8.55% due
CORPORATES**--0.0% 8/01/2010(3)........................ 242,519
- -------------------------------------------------------------------------------------------------------------------------
CHEMICALS--0.3% B+ B1 1,750,000 IMC Global Inc., 10.875% due
8/01/2013........................... 2,086,875
- -------------------------------------------------------------------------------------------------------------------------
</Table>
45
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY++ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- -------------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & BBB Baa3 US$ 715,000 Waste Management, Inc., 7.375% due
SUPPLIES--0.1% 8/01/2010........................... $ 803,325
- -------------------------------------------------------------------------------------------------------------------------
COMPUTER SERVICES--0.1% BBB-.. Baa3 650,000 Electronic Data Systems Corporation,
7.125% due 10/15/2009............... 680,208
- -------------------------------------------------------------------------------------------------------------------------
CONTAINERS--0.0% BBB Baa3 225,000 Sealed Air Corporation, 5.375% due
4/15/2008........................... 232,681
- -------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED--0.1% A- Baa3 725,000 Brascan Corporation, 5.75% due
3/01/2010........................... 745,651
- -------------------------------------------------------------------------------------------------------------------------
FINANCE--2.1% Household Finance Corporation:
A A1 905,000 6.50% due 11/15/2008................ 977,811
A A1 955,000 5.875% due 2/01/2009................ 1,008,118
A A1 1,785,000 6.75% due 5/15/2011................. 1,950,652
Sigma Finance Incorporated:
AAA Aaa 4,850,000 1.12% due 8/15/2011................. 4,850,000
AAA Aaa 2,400,000 2.38% due 3/31/2014(b).............. 2,398,889
AA Aa3 395,000 Texaco Capital Inc., 8.625% due
6/30/2010........................... 484,058
A- A3 965,000 Textron Financial Corporation, 2.75%
due 6/01/2006....................... 956,774
------------
12,626,302
- -------------------------------------------------------------------------------------------------------------------------
FINANCE--BANKS--2.5% Bank of America Corporation:
A+ Aa2 1,085,000 5.875% due 2/15/2009................ 1,153,021
A+ Aa2 1,050,000 4.875% due 9/15/2012................ 1,023,079
A A1 580,000 Bank One Corporation, 8% due
4/29/2027........................... 687,324
BBB- Baa2 975,000 Capital One Bank, 4.875% due
5/15/2008........................... 985,484
Citigroup Inc.:
A+ Aa2 1,910,000 5.625% due 8/27/2012................ 1,963,308
A+ Aa2 1,140,000 6.625% due 6/15/2032................ 1,180,703
BB+ Baa3 725,000 FirstBank Puerto Rico, 7.625% due
12/20/2005.......................... 759,426
FleetBoston Financial Corporation:
A+ Aa2 410,000 3.85% due 2/15/2008................. 408,397
A Aa3 395,000 6.375% due 5/15/2008................ 426,239
BB+ NR* 425,000 Hudson United Bancorp, 8.20% due
9/15/2006........................... 462,117
BBB+ A3 895,000 PNC Funding Corporation, 6.125% due
2/15/2009........................... 954,490
BBB+ A3 525,000 Popular North America, Inc., 3.875%
due 10/01/2008...................... 513,970
BBB- Baa3 1,535,000 Sovereign Bank, 5.125% due 3/15/2013.. 1,459,177
A+ Aa3 655,000 U.S. Bancorp, 1.691% due
9/16/2005(b)........................ 655,790
A- A3 900,000 Washington Mutual, Inc., 7.50% due
8/15/2006........................... 975,425
Wells Fargo & Company:
AA- Aa1 236,000 5.125% due 2/15/2007................ 245,938
A+ Aa2 950,000 5% due 11/15/2014................... 918,152
------------
14,772,040
- -------------------------------------------------------------------------------------------------------------------------
FINANCE--OTHER--8.1% A+ A1 1,110,000 American Honda Finance Corporation,
1.87% due 10/03/2005(a)(b).......... 1,113,806
The Bear Stearns Companies Inc.:
A A1 1,290,000 1.47% due 1/30/2009(b).............. 1,292,247
A A1 1,030,000 5.70% due 11/15/2014................ 1,033,207
BBB Baa2 930,000 Certegy Inc., 4.75% due 9/15/2008..... 939,533
A A3 1,600,000 Countrywide Home Loans, Inc., 5.625%
due 7/15/2009....................... 1,666,981
A+ Aa3 1,430,000 Credit Suisse First Boston (USA) Inc.,
4.70% due 6/01/2009................. 1,434,200
</Table>
46
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY++ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- -------------------------------------------------------------------------------------------------------------------------
FINANCE--OTHER
(CONCLUDED)
Deutsche Telekom International Finance
BV:
BBB+ Baa2 US$ 875,000 8.50% due 6/15/2010................. $ 1,022,488
BBB+ Baa2 800,000 8.75% due 6/15/2030................. 973,709
BBB+ Baa1 2,000,000 ERAC USA Finance Company, 6.70% due
6/01/2034(a)........................ 2,002,826
Ford Motor Credit Company:
BBB- A3 4,500,000 2.036% due 6/30/2005(b)............. 4,496,495
BBB- A3 1,125,000 7.375% due 10/28/2009............... 1,200,629
BBB- A3 1,735,000 7.375% due 2/01/2011................ 1,830,021
BBB- A3 3,560,000 7% due 10/01/2013................... 3,593,699
General Motors Acceptance Corporation:
BBB A3 4,000,000 2.40% due 10/20/2005(b)............. 4,032,472
BBB A3 4,000,000 2.042% due 1/16/2007(b)............. 4,011,192
BBB A3 645,000 6.875% due 8/28/2012................ 656,131
BBB A3 1,704,000 8% due 11/01/2031................... 1,745,896
The Goldman Sachs Group, Inc.:
A+ Aa3 2,545,000 5.70% due 9/01/2012................. 2,581,612
A+ Aa3 1,355,000 5.25% due 10/15/2013................ 1,315,682
AA- A1 710,000 International Lease Finance
Corporation, 2.95% due 5/23/2006.... 705,302
J.P. Morgan Chase & Co.:
A+ Aa3 2,035,000 3.50% due 3/15/2009................. 1,952,715
A A1 1,270,000 5.75% due 1/02/2013................. 1,290,777
A A1 1,605,000 Lehman Brothers Holdings, Inc., 3.50%
due 8/07/2008....................... 1,556,190
BBB+ Baa1 1,000,000 MBNA America Bank NA, 6.875% due
7/15/2004(a)........................ 1,001,197
MBNA Corporation:
BBB Baa2 405,000 6.25% due 1/17/2007................. 429,107
BBB Baa2 250,000 5.625% due 11/30/2007............... 261,234
BBB Baa2 650,000 4.625% due 9/15/2008................ 652,086
A A2 285,000 Mellon Funding Corporation, 6.40% due
5/14/2011........................... 309,837
A A3 3,080,000 Prudential Holdings LLC, 8.695% due
12/18/2023(a)....................... 3,697,478
------------
48,798,749
- -------------------------------------------------------------------------------------------------------------------------
FOREIGN AAA Aaa Y 713,900,000 International Bank for Reconstruction
OBLIGATIONS**--1.1% & Development, 4.75% due
12/20/2004(1)....................... 6,682,684
- -------------------------------------------------------------------------------------------------------------------------
GAMING--0.3% BB+ Ba1 US$ 1,595,000 MGM Mirage Inc., 6% due 10/01/2009.... 1,563,100
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL--CONSUMER BBB- Ba1 1,600,000 American Greetings Corporation, 6.10%
GOODS--1.2% due 8/01/2028....................... 1,636,000
BBB Baa2 635,000 Cadbury Schweppes US Finance LLC,
3.875% due 10/01/2008(a)............ 622,931
B NR* 3,600,000 Valeant Pharmaceuticals International,
6.50% due 7/15/2008 (Convertible)... 3,721,500
BBB- Baa3 1,195,000 Yum! Brands, Inc., 8.875% due
4/15/2011........................... 1,442,039
------------
7,422,470
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL--ENERGY--1.5% Anadarko Finance Company:
BBB+ Baa1 165,000 6.75% due 5/01/2011................. 181,479
BBB+ Baa1 240,000 7.50% due 5/01/2031................. 273,264
BBB+ Baa1 400,000 Anadarko Petroleum Corporation, 5.375%
due 3/01/2007....................... 417,791
BBB Baa2 1,250,000 Halliburton Company, 5.50% due
10/15/2010.......................... 1,264,613
A- A3 949,750 Kern River Funding Corporation, 4.893%
due 4/30/2018(a).................... 920,450
BBB+ Baa1 755,000 Kinder Morgan Energy Partners, LP,
5.35% due 8/15/2007................. 785,667
</Table>
47
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY++ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL--ENERGY
(CONCLUDED)
BBB- Baa3 US$ 785,000 MidAmerican Energy Holdings Company,
5.875% due 10/01/2012............... $ 797,095
NR* A1 695,000 Motiva Enterprises LLC, 5.20% due
9/15/2012(a)........................ 689,631
BBB Baa3 945,000 Panhandle Eastern Pipe Line Company,
LLC, 2.75% due 3/15/2007............ 906,819
BBB- Ba1 1,340,000 Plains All American Pipeline LP,
5.625% due 12/15/2013(a)............ 1,272,010
BBB- Baa3 1,565,000 XTO Energy, Inc., 7.50% due
4/15/2012........................... 1,765,887
------------
9,274,706
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- A- A2 900,000 Alcoa Inc., 1.64% due 12/06/2004(b)... 900,687
MANUFACTURING--3.7%
BBB- Ba1 615,000 Amerada Hess Corporation, 7.125% due
3/15/2033........................... 613,045
B+ Ba3 2,900,000 Celestica Inc., 3.691%*** due
8/01/2020 (Convertible)............. 1,595,000
BBB- Baa3 595,000 Cia Brasileira de Bebida, 8.75% due
9/15/2013(a)........................ 627,725
DaimlerChrysler NA Holding
Corporation:
BBB A3 6,900,000 1.87% due 5/24/2006(b).............. 6,919,327
BBB A3 845,000 4.75% due 1/15/2008................. 852,003
BBB A3 600,000 7.75% due 1/18/2011................. 670,560
BBB Baa1 1,000,000 General Motors Corporation, 7.125% due
7/15/2013........................... 1,027,049
A- A3 695,000 Hutchison Whampoa International Ltd.,
5.45% due 11/24/2010................ 682,163
BB+ Ba1 770,000 Hyundai Motor Manufacturing Alabama,
LLC, 5.30% due 12/19/2008(a)........ 757,745
BB+ Baa3 840,000 Jabil Circuit, Inc., 5.875% due
7/15/2010........................... 867,717
BBB Baa3 2,270,000 Kerr-McGee Corporation, 6.95% due
7/01/2024........................... 2,262,684
BBB- Baa3 1,205,000 Lear Corporation, 8.11% due
5/15/2009........................... 1,372,553
BBB- Baa3 790,000 Raytheon Company, 8.30% due
3/01/2010........................... 926,672
BBB Baa3 2,075,000 Tyco International Group SA, 6.75% due
2/15/2011........................... 2,254,656
------------
22,329,586
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL--SERVICES--4.3% ARAMARK Services, Inc.:
BBB- Baa3 1,035,000 6.75% due 8/01/2004................. 1,038,312
BBB- Baa3 1,020,000 6.375% due 2/15/2008................ 1,083,416
A- Baa1 1,070,000 Boston Scientific Corporation, 5.45%
due 6/15/2014....................... 1,076,526
BBB Baa1 895,000 Cendant Corporation, 6.875% due
8/15/2006........................... 956,309
HCA Inc.:
BBB- Ba1 660,000 6.95% due 5/01/2012................. 688,595
BBB- Ba1 1,310,000 6.30% due 10/01/2012................ 1,310,672
BBB- Ba1 435,000 5.75% due 3/15/2014................. 413,555
BBB- Baa3 830,000 InterActiveCorp, 7% due 1/15/2013..... 895,073
BBB Ba1 1,650,000 Lenfest Communications, Inc., 10.50%
due 6/15/2006....................... 1,857,682
BBB- Baa3 7,675,000 Liberty Media Corporation, 3.02% due
9/17/2006(b)........................ 7,817,218
Manor Care, Inc.:
BBB Ba1 1,080,000 7.50% due 6/15/2006................. 1,150,200
BBB Ba1 520,000 6.25% due 5/01/2013................. 529,750
News America Incorporated:
BBB- Baa3 1,000,000 7.30% due 4/30/2028................. 1,084,389
BBB- Baa3 555,000 6.75% due 1/09/2038................. 606,811
BBB+ Baa1 465,000 PHH Corporation, 6% due 3/01/2008..... 491,284
BBB Baa3 210,000 SUPERVALU Inc., 7.50% due 5/15/2012... 235,432
</Table>
48
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY++ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL--SERVICES
(CONCLUDED)
BBB Baa3 US$ 1,032,000 Tele-Communications Inc., 9.80% due
2/01/2012........................... $ 1,293,820
BBB+ Baa1 3,157,000 Time Warner Inc., 6.875% due
5/01/2012........................... 3,411,432
------------
25,940,476
- -------------------------------------------------------------------------------------------------------------------------
INDUSTRIAL-- AAA Aaa 703,405 American Airlines, Inc., 3.857% due
TRANSPORTATION--1.3% 7/09/2010........................... 679,392
Continental Airlines, Inc.:
AAA Aaa 600,000 6.563% due 2/15/2012................ 624,003
BBB Ba3 1,475,000 7.875% due 7/02/2018................ 1,386,013
A- Ba1 954,126 Delta Air Lines, Inc., 7.379% due
11/18/2011.......................... 902,585
BBB+ Baa1 1,315,000 MISC Capital (L) Limited, 5% due
7/01/2009(a)........................ 1,316,770
BBB Baa1 815,000 Norfolk Southern Corporation, 7.25%
due 2/15/2031....................... 894,427
Southwest Airlines Co.:
A Baa1 190,000 8% due 3/01/2005.................... 196,019
A Baa1 940,000 7.875% due 9/01/2007................ 1,041,885
Union Pacific Corporation:
BBB Baa2 490,000 7.25% due 11/01/2008................ 540,908
BBB Baa2 460,000 5.375% due 5/01/2014................ 453,250
------------
8,035,252
- -------------------------------------------------------------------------------------------------------------------------
INSURANCE--1.4% A- Baa2 1,225,000 Aon Corporation, 6.70% due 1/15/2007.. 1,309,046
BBB Baa3 870,000 Infinity Property and Casualty
Corporation, 5.50% due 2/18/2014.... 836,974
BBB- NR* 735,000 Kingsway America, Inc., 7.50% due
2/01/2014(a)........................ 722,357
AA- A2 355,000 Marsh & McLennan Companies, Inc.,
3.625% due 2/15/2008................ 350,136
BBB+ Baa3 1,260,000 NLV Financial Corporation, 7.50% due
8/15/2033(a)........................ 1,271,998
BBB+ Baa3 1,035,000 RLI Corp., 5.95% due 1/15/2014........ 1,009,390
A- Baa1 1,930,000 Security Benefit Life Insurance
Company, 7.45% due 10/01/2033(a).... 1,915,133
BBB+ A3 775,000 Travelers Property Casualty Corp.,
6.375% due 3/15/2033................ 763,371
------------
8,178,405
- -------------------------------------------------------------------------------------------------------------------------
OIL REFINERIES--0.5% A- Baa1 480,000 EnCana Corporation, 4.75% due
10/15/2013.......................... 453,845
BBB Baa3 2,110,000 Ultramar Diamond Shamrock Corporation,
6.75% due 10/15/2037................ 2,292,293
------------
2,746,138
- -------------------------------------------------------------------------------------------------------------------------
PAPER--1.4% BB Ba2 2,265,000 Boise Cascade Corporation, 7.66% due
5/27/2005........................... 2,338,613
BBB+ Baa2 1,260,000 Celulosa Arauco y Constitucion SA,
8.625% due 8/15/2010................ 1,464,170
BBB Baa2 2,205,000 Champion International Corporation,
6.65% due 12/15/2037................ 2,389,645
A- Baa2 720,000 Inversiones CMPC SA, 4.875% due
6/18/2013(a)........................ 668,422
BBB- Baa3 710,000 Rock-Tenn Company, 5.625% due
3/15/2013........................... 698,220
BBB Baa2 695,000 Sappi Papier Holding AG, 6.75% due
6/15/2012(a)........................ 741,654
------------
8,300,724
- -------------------------------------------------------------------------------------------------------------------------
PAPER & FOREST BBB Baa2 2,560,000..... Weyerhaeuser Company, 6.75% due
PRODUCTS--0.5% 3/15/2012........................... 2,772,357
- -------------------------------------------------------------------------------------------------------------------------
REAL ESTATE INVESTMENT BBB Baa2 690,000 CarrAmerica Realty Corporation, 3.625%
TRUST--1.3% due 4/01/2009....................... 653,516
BBB- Baa3 415,000 Colonial Realty LP, 4.80% due
4/01/2011........................... 398,719
</Table>
49
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY++ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- -------------------------------------------------------------------------------------------------------------------------
REAL ESTATE INVESTMENT
TRUST (CONCLUDED)
BBB Baa3 US$ 575,000 Developers Diversified Realty
Corporation, 6.625% due 1/15/2008... $ 613,730
BBB Baa2 955,000 HRPT Properties Trust, 5.75% due
2/15/2014........................... 934,947
BBB+ Baa2 700,000 Health Care Property Investors, Inc.,
6.50% due 2/15/2006................. 729,916
BBB- Baa3 640,000 Health Care REIT, Inc., 6% due
11/15/2013.......................... 630,283
BB+ Ba1 2,165,000 iStar Financial Inc., 5.125% due
4/01/2011(a)........................ 2,059,010
BBB- Baa3 775,000 Nationwide Health Properties, Inc.,
6.59% due 7/07/2038................. 782,543
BBB Baa3 670,000 United Dominion Realty Trust, Inc.,
6.50% due 6/15/2009................. 721,819
------------
7,524,483
- -------------------------------------------------------------------------------------------------------------------------
RETAIL--STORES--0.1% BBB+ Baa1 285,000 Limited Brands, Inc., 6.125% due
12/01/2012.......................... 298,792
- -------------------------------------------------------------------------------------------------------------------------
SUPRANATIONAL--0.1% A A2 810,000 Corporacion Andina de Fomento, 6.875%
due 3/15/2012....................... 870,755
- -------------------------------------------------------------------------------------------------------------------------
UTILITIES-- BBB Baa2 515,000 AT&T Corporation, 8.05% due
COMMUNICATION--1.3% 11/15/2011.......................... 528,763
BBB Baa2 706,000 AT&T Wireless Services, Inc., 8.75%
due 3/01/2031....................... 860,733
A+ A3 1,620,000 GTE Corporation, 6.84% due 4/15/2018.. 1,709,204
BBB Baa2 1,090,000 Harris Corporation, 6.35% due
2/01/2028........................... 1,143,982
BB- Ba3 1,077,000 Qwest Corporation, 7.20% due
11/01/2004.......................... 1,085,078
BBB- Baa3 1,110,000 Sprint Capital Corporation, 6.90% due
5/01/2019........................... 1,116,611
BBB Baa3 1,105,000 TELUS Corporation, 7.50% due
6/01/2007........................... 1,203,488
------------
7,647,859
- -------------------------------------------------------------------------------------------------------------------------
UTILITIES-- ELECTRIC & NR* Baa2 1,185,000 AEP Texas Central Company, 6.65% due
GAS--4.3% 2/15/2033........................... 1,202,587
BBB Baa1 1,280,000 Arizona Public Service Company, 5.80%
due 6/30/2014....................... 1,281,231
BBB Baa1 1,050,000 Cincinnati Gas & Electric Company,
5.70% due 9/15/2012................. 1,073,536
Dominion Resources, Inc.:
BBB+ Baa1 1,051,000 7.625% due 7/15/2005................ 1,104,066
BBB+ Baa1 860,000 1.55% due 5/15/2006(b).............. 861,258
A- Baa1 1,530,000 Exelon Generation Company, LLC, 5.35%
due 1/15/2014....................... 1,483,713
A- A2 1,745,000 FPL Group Capital Inc., 1.886% due
3/30/2005(b)........................ 1,748,316
BBB- Baa3 3,350,000 PPL Capital Funding, Inc., 2.31% due
5/18/2006(b)........................ 3,349,183
BBB Baa1 975,000 PSE&G Power LLC, 6.95% due
6/01/2012........................... 1,060,199
Pacific Gas & Electric Company:
BBB Baa2 3,100,000 1.81% due 4/03/2006(b).............. 3,101,869
BBB Baa2 1,325,000 6.05% due 3/01/2034................. 1,246,237
BBB Baa2 730,000 Pepco Holdings, Inc., 4% due
5/15/2010........................... 678,832
BBB Baa2 860,000 Public Service Company of New Mexico,
4.40% due 9/15/2008................. 857,348
BBB+ Baa1 645,000 Sempra Energy, 4.75% due 5/15/2009.... 648,883
Southern California Edison Company:
NR* Baa2 235,000 1.44% due 1/13/2006(b).............. 235,306
NR* Baa2 830,000 6% due 1/15/2034.................... 795,291
BBB+ Baa1 650,000 Southern Power Company, 6.25% due
7/15/2012........................... 682,694
</Table>
50
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY++ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- -------------------------------------------------------------------------------------------------------------------------
UTILITIES-- ELECTRIC &
GAS (CONCLUDED)
BBB Baa2 US$ 1,010,000 TXU Australia Holdings Partnership LP,
6.15% due 11/15/2013(a)............. $ 1,052,190
A- Baa1 1,035,000 Vectren Utility Holdings, Inc., 5.25%
due 8/01/2013....................... 1,020,172
Westar Energy, Inc.:
BB- Ba2 1,196,000 9.75% due 5/01/2007................. 1,362,358
NR* Ba1 620,000 6% due 7/01/2014.................... 629,904
------------
25,475,173
- -------------------------------------------------------------------------------------------------------------------------
YANKEE CORPORATES**--1.7% Corporacion Nacional del Cobre de
Chile (Codelco)(3)(a):
A A2 145,000 6.375% due 11/30/2012............... 153,464
A A2 730,000 5.50% due 10/15/2013................ 724,861
France Telecom(4):
BBB+ Baa2 1,780,000 8.75% due 3/01/2011................. 2,062,701
BBB+ Baa2 555,000 9.50% due 3/01/2031................. 696,536
A- Baa1 840,000 Koninklijke (KPN) NV, 8% due
10/01/2010(3)....................... 972,612
Pemex Project Funding Master Trust(1):
BBB- Baa1 1,110,000 2.64% due 1/07/2005(a)(b)........... 1,118,880
BBB- Baa1 3,350,000 2.82% due 6/15/2010(a)(b)........... 3,365,075
BBB- Baa1 1,000,000 9.125% due 10/13/2010............... 1,145,000
------------
10,239,129
- -------------------------------------------------------------------------------------------------------------------------
YANKEE AAA Aaa E 3,190,000 Bundesobligation, 3.50% due
SOVEREIGNS**--1.6% 10/10/2008(2)....................... 3,885,833
A Baa1 US$ 735,000 Republic of Chile, 5.50% due
1/15/2013(2)........................ 736,911
BBB Baa2 1,170,000 Republic of South Africa, 6.50% due
6/02/2014(2)........................ 1,181,700
United Mexican States(2):
BBB- Baa2 1,870,000 9.875% due 2/01/2010................ 2,246,805
BBB- Baa2 1,010,000 6.375% due 1/16/2013................ 1,007,980
BBB- Baa2 565,000 5.875% due 1/15/2014................ 542,965
------------
9,602,194
- -------------------------------------------------------------------------------------------------------------------------
TOTAL CORPORATE BONDS
(COST--$250,142,130)--41.8%........... 251,143,715
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
STATE MUNICIPAL BONDS
- -------------------------------------------------------------------------------------------------------------------------
TEXAS--0.1% NR* A1 515,000 Harris County, Texas, Industrial
Development Corporation, Solid Waste
Disposal Revenue Bonds (Deer Park
Refining LP), 5.683% due
3/01/2023(b)........................ 515,026
- -------------------------------------------------------------------------------------------------------------------------
TOTAL MUNICIPAL BONDS
(COST--$515,000)--0.1%................ 515,026
- -------------------------------------------------------------------------------------------------------------------------
PREFERRED SECURITIES
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
INDUSTRY++ CAPITAL TRUSTS
- -------------------------------------------------------------------------------------------------------------------------
FINANCE--BANKS--0.4% A- A1 1,480,000 Chase Capital III, 1.86% due
3/01/2027(b)........................ 1,407,310
A- A1 1,160,000 First Chicago NBD Capital I, 1.729%
due 2/01/2027(b).................... 1,111,187
------------
2,518,497
- -------------------------------------------------------------------------------------------------------------------------
UTILITIES--ELECTRIC & BBB+ A3 585,000 Alabama Power Capital Trust V, 5.50%
GAS--0.1% due 10/01/2042(b)................... 603,060
- -------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITAL TRUSTS
(COST--$3,077,268)--0.5%.............. 3,121,557
- -------------------------------------------------------------------------------------------------------------------------
</Table>
51
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
PREFERRED SECURITIES
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
SHARES
INDUSTRY++ HELD PREFERRED STOCKS VALUE
- -------------------------------------------------------------------------------------------------------------------------
FINANCE--OTHER--0.3% 175 DG Funding Trust(a)................... $ 1,907,588
- -------------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS
(COST--$1,925,630)--0.3%.............. 1,907,588
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
S&P MOODY'S FACE
RATINGS RATINGS AMOUNT TRUST PREFERRED
- -------------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE--0.7% NR* NR* US$ 3,685,000 RC Trust I, 7% due 5/15/2006.......... 3,915,312
- -------------------------------------------------------------------------------------------------------------------------
TOTAL TRUST PREFERRED
(COST--$3,902,368)--0.7%.............. 3,915,312
- -------------------------------------------------------------------------------------------------------------------------
TOTAL PREFERRED SECURITIES
(COST--$8,905,266)--1.5%.............. 8,944,457
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
SHORT-TERM INVESTMENTS
- -------------------------------------------------------------------------------------------------------------------------
COMMERCIAL 3,548,000 General Electric Capital Corp., 1.48%
PAPER****--8.5% due 7/01/2004....................... 3,547,854
27,737,000 Grampian Funding Limited, 1.55% due
7/01/2004........................... 27,735,806
20,000,000 Old Line Funding Corporation, 1.15%
due 7/14/2004....................... 19,991,056
- -------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS
(COST--$51,274,716)--8.5%............. 51,274,716
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
NUMBER OF
CONTRACTS OPTIONS PURCHASED
- -------------------------------------------------------------------------------------------------------------------------
CALL OPTIONS PURCHASED--0.0% 1,529 Eurodollar Futures, expiring July 2004
at USD 98.25, Broker Credit Suisse
First Boston........................ 9,556
1,529 Eurodollar Futures, expiring July 2004
at USD 98.5, Broker Credit Suisse
First Boston........................ 9,556
46++++ London InterBank Offered Rate (LIBOR)
Linked Floor, expiring April 2005 at
USD 1.5, Broker J.P. Morgan Chase
Bank................................ 782
------------
19,894
- -------------------------------------------------------------------------------------------------------------------------
PUT OPTIONS PURCHASED--0.0% 169 U.S. Treasury Notes, expiring July
2004 at USD 107, Broker Credit
Suisse First Boston................. 21,125
- -------------------------------------------------------------------------------------------------------------------------
TOTAL OPTIONS PURCHASED (PREMIUMS
PAID--$348,898)--0.0%................. 41,019
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$666,772,661)--111.5%.......... 669,124,962
- -------------------------------------------------------------------------------------------------------------------------
<Caption>
OPTIONS WRITTEN
- -------------------------------------------------------------------------------------------------------------------------
CALL OPTIONS WRITTEN--0.0% 3,059 Eurodollar Futures, expiring July 2004
at USD 98.38, Broker Credit Suisse
First Boston........................ (19,119)
169 U.S. Treasury Notes, expiring July
2004 at USD 110, Broker Credit
Suisse First Boston................. (76,578)
- -------------------------------------------------------------------------------------------------------------------------
TOTAL OPTIONS WRITTEN (PREMIUMS
RECEIVED--$242,457)--0.0%............. (95,697)
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS, NET OF OPTIONS
WRITTEN
(COST--$666,530,204)--111.5%.......... 669,029,265
LIABILITIES IN EXCESS OF OTHER
ASSETS--(11.5%)....................... (68,823,462)
------------
NET ASSETS--100.0%.................... $600,205,803
============
- -------------------------------------------------------------------------------------------------------------------------
</Table>
52
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
* Not Rated.
** Corresponding industry groups for foreign securities:
(1) Financial Institution.
(2) Government Entity.
(3) Industrial.
(4) Telecommunications.
*** Represents a zero coupon bond; the interest rate shown reflects the
effective yield at the time of purchase by the Fund.
**** Commercial Paper is traded on a discount basis; the interest rates shown
reflect the discount rates paid at the time of purchase by the Fund.
+ Asset-Backed and Mortgage-Backed Obligations are subject to principal
paydowns as a result of prepayments or refinancings of the underlying
instruments. As a result, the average life may be substantially less than
the original maturity.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
++++ One contract represents a notional amount of $1,000,000.
(a) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(b) Floating rate note.
(c) All or a portion of security held as collateral in connection with open
financial futures contracts.
Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
INTEREST/DIVIDEND
AFFILIATE NET ACTIVITY INCOME
- -----------------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Money Market Series..... -- $ 569
Merrill Lynch Premier Institutional Fund.................... (48,089,225) $ 16,064
- -----------------------------------------------------------------------------------------------
</Table>
Financial futures contracts sold as of June 30, 2004 were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
NUMBER OF EXPIRATION FACE UNREALIZED
CONTRACTS ISSUE DATE VALUE DEPRECIATION
- -------------------------------------------------------------------------------------------
431... Ten-Year U.S. Treasury Notes September 2004 $46,646,225 $(474,197)
- -------------------------------------------------------------------------------------------
</Table>
Forward foreign exchange contracts as of June 30, 2004 were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------
FOREIGN CURRENCY SETTLEMENT UNREALIZED
SOLD DATE APPRECIATION
- -------------------------------------------------------------------------------
Y 747,298,489 August 2004 $112,327
- -------------------------------------------------------------------------------
TOTAL UNREALIZED APPRECIATION ON
FORWARD FOREIGN EXCHANGE
CONTRACTS--NET (US$
COMMITMENT--$6,977,577) $112,327
========
- -------------------------------------------------------------------------------
</Table>
Swap contracts outstanding as of June 30, 2004 were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
UNREALIZED
NOTIONAL APPRECIATION/
AMOUNT DEPRECIATION
- -------------------------------------------------------------------------------------------
Receive a variable rate return equal to Lehman Brothers U.S.
High Yield Index Total Return and pay a floating rate
based on 1-month USD LIBOR, minus .40%
Broker, Lehman Brothers Special Finance
Expires July 2004......................................... $ 7,300,000 --
Sold credit default protection on Sprint Capital Corporation
and receive 1.50% interest
Broker, Morgan Stanley Capital Services Inc.
Expires September 2008.................................... $ 1,980,000 $ 52,971
Sold credit default protection on Comcast Cable
Communications, Inc. and receive 1.15%
Broker, Morgan Stanley Capital Services Inc.
Expires September 2008.................................... $ 1,980,000 45,900
Pay 3.875% on TIPS adjusted principal and receive a fixed
rate of 3.401% interest
Broker, J.P. Morgan Chase Bank
Expires January 2009...................................... $ 4,062,000 (49,619)
Pay 3.50% on TIPS adjusted principal and receive a fixed
rate of 4.17% interest
Broker, Morgan Stanley Capital Services Inc.
Expires January 2011...................................... $ 3,500,000 (36,613)
</Table>
53
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
UNREALIZED
NOTIONAL APPRECIATION/
AMOUNT DEPRECIATION
- -------------------------------------------------------------------------------------------
Receive a variable rate return equal to Lehman Brothers CMBS
Investment Grade Index Total Return and pay a floating
rate based on 1-month USD LIBOR, minus .55%
Broker, Deutsche Bank AG, London
Expires January 2005...................................... $ 8,400,000 --
Receive a variable rate return equal to U.S. Treasury Index
Total Return and pay a floating rate based on 1-month USD
LIBOR, minus .20%
Broker, Lehman Brothers Special Finance
Expires December 2004..................................... $35,600,000 --
Bought credit default protection on Tyson Foods Inc. and pay
1.36% interest
Broker, Morgan Stanley Capital Services Inc.
Expires September 2008.................................... $ 1,980,000 $(29,609)
Bought credit default protection on Weyerhaeuser Co. and pay
.73% interest
Broker, Morgan Stanley Capital Services Inc.
Expires September 2008.................................... $ 1,980,000 (22,839)
Receive a variable rate return equal to MBS Fixed Rate Index
Total Return and pay a floating rate based on 1-month USD
LIBOR, minus .16%
Broker, UBS Warburg
Expires August 2004....................................... $32,700,000 --
Bought credit default protection on AON Corp. and pay
2.8025% interest
Broker, J.P. Morgan Chase Bank
Expires January 2007...................................... $ 1,345,000 (262)
Bought credit default protection on AON Corp. and pay .37%
interest
Broker, Morgan Stanley Capital Services Inc.
Expires January 2007...................................... $ 1,345,000 19,573
Bought credit default protection on Boeing Capital Corp. and
pay .48% interest
Broker, J.P. Morgan Chase Bank
Expires March 2009........................................ $ 770,000 (2,093)
Sold credit default protection on Raytheon Company and
receive .73% interest
Broker, J.P. Morgan Chase Bank
Expires March 2009........................................ $ 770,000 (3,117)
Receive a variable rate return equal to U.S. Treasury Index
Total Return and pay a floating rate based on 1-month USD
LIBOR, minus .20%
Broker, Lehman Brothers Special Finance
Expires March 2005........................................ $36,400,000 --
Receive a variable rate return equal to MBS Fixed Rate Index
Total Return and pay a floating rate based on 1-month USD
LIBOR, minus .15%
Broker, Lehman Brothers Special Finance
Expires September 2004.................................... $ 5,900,000 --
Receive a variable rate return equal to Lehman Brothers CMBS
Investment Grade Index Total Return and pay a floating
rate based on 1-month USD LIBOR, minus .60%
Broker, UBS Warburg
Expires October 2004...................................... $21,200,000 --
Receive a variable rate return equal to MBS Fixed Rate Index
Total Return and pay a floating rate based on 1-month USD
LIBOR, minus .17%
Broker, UBS Warburg
Expires November 2004..................................... $12,100,000 --
Receive a variable rate return based on 3-Month USD LIBOR,
plus .56% which is capped at a fixed coupon of 8% and
callable quarterly beginning September 2004 and pay a
floating rate based on 3-month USD LIBOR
Broker, J.P. Morgan Chase Bank
Expires June 2010......................................... $13,600,000 24,634
Bought credit default protection on AT&T Corp. and pay 2.28%
interest
Broker, Morgan Stanley Capital Services Inc.
Expires June 2009......................................... $ 680,000 28,839
Sold credit spreadlock protection on Dominion Resources,
Inc. and receive 7.82% interest
Broker, Morgan Stanley Capital Services Inc.
Expires September 2004.................................... $ 750,000 --
</Table>
54
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
UNREALIZED
NOTIONAL APPRECIATION/
AMOUNT DEPRECIATION
- -------------------------------------------------------------------------------------------
Receive a variable rate return based on 3-month USD LIBOR,
plus .42%, which is capped at a fixed coupon of 8% and
callable quarterly beginning September 2004 and pay a
floating rate based on 3-month USD LIBOR
Broker, J.P. Morgan Chase Bank
Expires March 2010........................................ $14,750,000 $ (1,352)
- -------------------------------------------------------------------------------------------
TOTAL $ 26,413
========
- -------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
55
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (identified
cost--$666,423,763)....................................... $669,083,943
Unrealized appreciation on forward foreign exchange
contracts................................................. 112,327
Options purchased, at value (premiums paid--$348,898)....... 41,019
Unrealized appreciation on swaps............................ 58,222
Foreign cash (cost--$156,232)............................... 155,388
Cash........................................................ 26,270
Receivables:
Interest.................................................. $ 4,973,191
Capital shares sold....................................... 1,955,432
Dividends................................................. 14,863
Securities lending--net................................... 1,150 6,944,636
-----------
Prepaid expenses and other assets........................... 921,036
------------
Total assets................................................ 677,342,841
------------
- ------------------------------------------------------------------------------------------
LIABILITIES:
Unrealized depreciation on swaps............................ 31,809
Options written, at value (premiums received--$242,457)..... 95,697
Payables:
Securities purchased...................................... 76,013,067
Variation margin.......................................... 312,668
Capital shares redeemed................................... 289,889
Investment adviser........................................ 233,219
Swaps..................................................... 104,071
Other affiliates.......................................... 16,723 76,969,637
-----------
Accrued expenses and other liabilities...................... 39,895
------------
Total liabilities........................................... 77,137,038
------------
- ------------------------------------------------------------------------------------------
NET ASSETS.................................................. $600,205,803
============
- ------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 600,000,000
shares authorized+........................................ $ 5,003,863
Paid-in capital in excess of par............................ 598,951,495
Undistributed investment income--net........................ $ 1,378,126
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (7,291,055)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 2,163,374
-----------
Total accumulated losses--net............................... (3,749,555)
------------
NET ASSETS.................................................. $600,205,803
============
- ------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $600,205,803 and 50,038,632
shares outstanding........................................ $ 11.99
============
- ------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II or Class III as of June 30,
2004.
See Notes to Financial Statements.
56
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Interest.................................................... $ 11,726,561
Dividends................................................... 24,847
Securities lending--net..................................... 16,633
------------
Total income................................................ 11,768,041
------------
- --------------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $ 1,380,030
Accounting services......................................... 109,843
Custodian fees.............................................. 36,979
Printing and shareholder reports............................ 33,199
Professional fees........................................... 21,540
Directors' fees and expenses................................ 20,132
Pricing services............................................ 17,988
Transfer agent fees......................................... 2,591
Other....................................................... 22,703
------------
Total expenses.............................................. 1,645,005
------------
Investment income--net...................................... 10,123,036
------------
- --------------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain (loss) on:
Investments--net.......................................... 3,084,046
Foreign currency transactions--net........................ (139,749) 2,944,297
------------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (11,088,984)
Foreign currency transactions--net........................ 263,328 (10,825,656)
------------ ------------
Total realized and unrealized loss on investments and
foreign currency transactions--net........................ (7,881,359)
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 2,241,677
============
- --------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
57
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- --------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 10,123,036 $ 25,026,137
Realized gain on investments and foreign currency
transactions--net......................................... 2,944,297 18,410,184
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (10,825,656) (12,114,639)
------------ ------------
Net increase in net assets resulting from operations........ 2,241,677 31,321,682
------------ ------------
- --------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... (12,902,575) (26,354,986)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (12,902,575) (26,354,986)
------------ ------------
- --------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net increase(decrease) in net assets derived from capital
share transactions........................................ (82,640,843) 16,235,506
------------ ------------
- --------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (93,301,741) 21,202,202
Beginning of period......................................... 693,507,544 672,305,342
------------ ------------
End of period*.............................................. $600,205,803 $693,507,544
============ ============
- --------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 1,378,126 $ 4,157,665
============ ============
- --------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
58
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE CLASS I
BEEN DERIVED FROM INFORMATION PROVIDED IN THE ------------------------------------------------------------
FINANCIAL STATEMENTS.
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31,++
MONTHS ENDED --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: JUNE 30, 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................ $ 12.21 $ 12.11 $ 11.59 $ 11.49 $ 11.14
-------- -------- -------- -------- --------
Investment income--net.............................. .19+ .44+ .56+ .63 .78
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net............ (.17) .13 .52 .12 .29
-------- -------- -------- -------- --------
Total from investment operations.................... .02 .57 1.08 .75 1.07
-------- -------- -------- -------- --------
Less dividends from investment income--net.......... (.24) (.47) (.56) (.65) (.72)
-------- -------- -------- -------- --------
Net asset value, end of period...................... $ 11.99 $ 12.21 $ 12.11 $ 11.59 $ 11.49
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................. .14%++ 4.76% 9.57% 6.68% 10.01%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................ .51%* .50% .50% .51% .49%
======== ======== ======== ======== ========
Investment income--net.............................. 3.12%* 3.62% 4.76% 5.50% 6.96%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)............ $600,206 $693,508 $672,305 $646,028 $507,248
======== ======== ======== ======== ========
Portfolio turnover.................................. 104.65% 254.01% 274.08% 277.86% 120.99%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
++ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
++ Aggregate total investment return.
See Notes to Financial Statements.
59
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--CORE BOND V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Core Bond V.I.
Fund (the "Fund") is classified as "diversified," as defined in the Investment
Company Act of 1940, as amended. Class I Shares, Class II Shares and Class III
Shares have equal voting, dividend, liquidation and other rights, except that
only shares of the respective classes are entitled to vote on matters concerning
only that class. In addition, Class II Shares and Class III Shares bear certain
expenses related to the distribution of such shares. The Fund's financial
statements are prepared in conformity with U.S. generally accepted accounting
principles, which may require the use of management accruals and estimates.
Actual results may differ from these estimates. These unaudited financial
statements reflect all adjustments, which are, in the opinion of management,
necessary to present a fair statement of the results for the interim period. All
such adjustments are of a normal, recurring nature. The following is a summary
of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be
60
- --------------------------------------------------------------------------------
valued at their fair value as determined in good faith by the Company's Board of
Directors or by the Investment Adviser using a pricing service and/or procedures
approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- - Options--The Fund may write 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 loss or gain to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- - Swaps--The Fund may enter into swap agreements, which are over-the-counter
contracts in which the Fund and a counterparty agree to make periodic net
payments on a specified notional amount. The net payments can be made for a set
period of time or may be triggered by a predetermined credit event. The net
periodic payments may be based on a fixed or variable interest rate; the change
in market value of a specified security, basket of securities, or index; or the
return generated by a security.
(c) Repurchase agreements--The Fund may invest in U.S. government securities
pursuant to repurchase agreements. Under such agreements, the counterparty
agrees to repurchase the security at a mutually agreed upon time and price. The
Fund takes possession of the underlying securities, marks to market such
securities and, if necessary, receives additional securities daily to ensure
that the contract is fully collateralized. If the seller defaults and the fair
value of the collateral declines, liquidation of the collateral by the Fund may
be delayed or limited.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Interest income is recognized on the accrual basis. The
Fund amortizes all premiums and discounts on debt securities.
(f) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend date.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the
61
- --------------------------------------------------------------------------------
U.S. government as collateral, which will be maintained at all times in an
amount equal to at least 100% of the current market value of the loaned
securities. The market value of the loaned securities is determined at the close
of business of the Fund and any additional required collateral is delivered to
the Fund on the next business day. Where the Fund receives securities as
collateral for the loaned securities, it collects a fee from the borrower. The
Fund typically receives the income on the loaned securities but does not receive
the income on the collateral. Where the Fund receives cash collateral, it may
invest such collateral and retain the amount earned on such investment, net of
any amount rebated to the borrower. Loans of securities are terminable at any
time and the borrower, after notice, is required to return borrowed securities
within five business days. The Fund may pay reasonable finder's, lending agent,
administrative and custodial fees in connection with its loans. In the event
that the borrower defaults on its obligation to return borrowed securities
because of insolvency or for any other reason, the Fund could experience delays
and costs in gaining access to the collateral. The Fund also could suffer a loss
where the value of the collateral falls below the market value of the borrowed
securities, in the event of borrower default or in the event of losses on
investments made with cash collateral.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee
based upon the aggregate daily value of net assets of the Fund and the Company's
High Current Income Fund at the following annual rates: .50% of average daily
net assets not exceeding $250 million; .45% of average daily net assets in
excess of $250 million but not exceeding $500 million; .40% of average daily net
assets in excess of $500 million but not exceeding $750 million; and .35% of
average daily net assets in excess of $750 million. For the six months ended
June 30, 2004, the aggregate average daily net assets of the Fund and the
Company's High Current Income Fund was approximately $978,834,000. MLIM has
entered into a Sub-Advisory Agreement with Merrill Lynch Asset Management U.K.
Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which MLAM U.K.
provides investment advisory services to MLIM with respect to the Fund. There is
no increase in the aggregate fees paid by the Fund for these services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $6,949 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, the Fund reimbursed MLIM $7,155 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $718,302,044 and $840,044,080, respectively.
Net realized gains (losses) for the six months ended June 30, 2004 and net
unrealized appre-
62
- --------------------------------------------------------------------------------
ciation/depreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------
Unrealized
Realized Appreciation/
Gains (Losses) Depreciation
- ----------------------------------------------------------------------
Long-term investments................. $4,398,290 $ 2,660,180
Short-term investments................ 5,224 --
Options purchased..................... 70,435 (307,879)
Options written....................... 64,253 146,760
Swaps................................. (978,714) 26,413
Financial futures contracts........... (475,442) (474,197)
Forward foreign exchange contracts.... (139,460) 112,327
Foreign currency transactions......... (289) (230)
---------- -----------
Total................................. $2,944,297 $ 2,163,374
========== ===========
- ----------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $2,120,346, of which $6,078,175 related to appreciated securities and
$3,957,829 related to depreciated securities. At June 30, 2004, the aggregate
cost of investments for federal income tax purposes was $666,908,919.
Transactions in call options written for the six months ended June 30, 2004
were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Number of Premiums
Contracts Received
- -------------------------------------------------------------------
Outstanding call options written,
beginning of period........................ -- --
Options written............................. 11,945 $ 532,405
Options exercised........................... (105) (30,799)
Options closed.............................. (12) (238,992)
Options expired............................. (8,600) (20,157)
------ ---------
Outstanding call options written,
end of period.............................. 3,228 $ 242,457
====== =========
- -------------------------------------------------------------------
</Table>
Transactions in put options written for the six months ended June 30, 2004
were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Number of Premiums
Contracts Received
- -------------------------------------------------------------------
Outstanding put options written,
beginning of period........................ -- --
Options written............................. 347 $ 160,058
Options expired............................. (347) (160,058)
---- ---------
Outstanding put options written,
end of period.............................. -- $ --
==== =========
- -------------------------------------------------------------------
</Table>
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets resulting from capital share transactions
were $(82,640,843) and $16,235,506 for the six months ended June 30, 2004 and
the year ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- --------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- --------------------------------------------------------------------
Shares sold.......................... 524,267 $ 6,359,063
Shares issued to shareholders in
reinvestment of dividends........... 1,063,881 12,902,575
---------- -------------
Total issued......................... 1,588,148 19,261,638
Shares redeemed...................... (8,334,386) (101,902,481)
---------- -------------
Net decrease......................... (6,746,238) $ (82,640,843)
========== =============
- --------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold........................ 10,172,951 $ 124,326,980
Shares issued to shareholders in
reinvestment of dividends......... 2,178,222 26,354,986
----------- -------------
Total issued....................... 12,351,173 150,681,966
Shares redeemed.................... (11,064,573) (134,446,460)
----------- -------------
Net increase....................... 1,286,600 $ 16,235,506
=========== =============
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$9,217,912, all of which expires in 2008. This amount will be available to
offset like amounts of any future taxable gains.
7. DISTRIBUTION TO SHAREHOLDERS:
The Fund paid an ordinary income dividend in the amount of $.379721 per share on
July 1, 2004 to shareholders of record on June 30, 2004.
63
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the six-month period ended June 30, 2004, Domestic Money Market V.I.
Fund's Class I Shares had a net annualized yield of .62%. Since inception
(February 13, 2004) through June 30, 2004, the Fund's Class II Shares had a net
annualized yield of .47%. As of June 30, 2004, the Fund's Class I and Class II
Shares had seven-day yields of .74% and .58%, respectively. The Fund's average
portfolio maturity was 64 days at June 30, 2004, compared to 70 days at December
31, 2003. During the six-month period, the Fund maintained an average life
ranging from a low of 59 days to a high of 71 days.
THE ENVIRONMENT
During the first quarter of 2004, U.S. gross domestic product (GDP) growth
slowed slightly to 3.9%, down from 4.1% in the previous quarter. Expectations
are for growth to remain at roughly the same pace or to slow slightly into the
second half of 2004. While economic growth was relatively strong during the
first quarter, the lack of job growth and benign inflation kept the Federal
Reserve Board (the Fed) on the sidelines. However, a surge in the March
employment numbers, as well as a sharp rise in core prices in the first quarter,
resulted in a change in attitude on the part of the Fed. While the Federal Open
Market Committee (FOMC) left its target for its benchmark rate unchanged at 1%
at the May meeting, the FOMC issued a statement signaling that it was prepared
to raise interest rates sooner than previously expected. On June 30, the Fed
raised interest rates 25 basis points (.25%) to 1.25%. Although inflation was a
key factor in raising the Federal Funds rate, the Fed indicated that it felt the
rise in inflation was temporary and underlying inflation remained relatively
low.
Economic news going into the second half of 2004 has been mixed. Job growth
and consumer spending in June fell below expectations, and while home sales
continue to post healthy gains, going forward, rising interest rates could
dampen sales. The key to economic growth in the future may depend on consumer
spending. However, higher energy prices and a decline in mortgage-refinancing
activity may negatively influence spending. Given these factors, we feel the Fed
is likely to tighten monetary policy at a measured rate into 2005.
PORTFOLIO MATTERS
Early in the period, we believed the Fed would leave short-term interest rates
unchanged as long as the employment situation was weak and inflation remained
low. With that in mind, we added some longer-dated callable U.S. agency
securities to the portfolio in order to enhance yield. Yield spreads on callable
agency securities relative to straight bullet issues were wide, as interest rate
volatility remained at the higher end of the historical range.
We continued to position the Fund in a barbelled manner through April.
Investments were split in the longer-dated callable U.S. agency securities and
the three-month and under sector. We employed this strategy because there was no
pickup in yield in the three-month--one-year sectors. The yield curve was flat
in this area, with no increase in yield until the 15-month--two-year sector.
Floating rate securities, which represent approximately 35% of the Fund's
assets, serve as part of the barbell trade and help to protect the portfolio
from rising interest rates.
After the May FOMC meeting, we changed our investment strategy since it was
apparent that the Fed was moving toward a monetary tightening cycle. We
restricted our investments to those that would mature before the June 30 FOMC
meeting or to securities that had already priced in interest rate increases. We
remain cautious in our investments, but will purchase longer securities when the
market appears to be overdone.
The Fund's composition at the end of June and as of our last report to
shareholders is detailed below:
<Table>
<Caption>
- --------------------------------------------------------
6/30/04 12/31/03
- --------------------------------------------------------
Bank Notes.......................... --% 1.4%
Commercial Paper.................... 47.8 35.9
Funding Agreements.................. 9.6 8.5
Medium-Term Notes................... 9.6 11.4
Promissory Notes.................... -- 0.6
Repurchase Agreements............... 3.2 2.8
U.S. Government, Agency &
Instrumentality
Obligations--Discount............. 0.4 0.4
U.S. Government, Agency &
Instrumentality
Obligations--Non-Discount......... 30.7 39.7
Liabilities in Excess of Other
Assets............................ (1.3) (0.7)
----- -----
TOTAL............................... 100.0% 100.0%
===== =====
- --------------------------------------------------------
</Table>
64
- --------------------------------------------------------------------------------
IN CONCLUSION
We thank you for your investment in Domestic Money Market V.I. Fund of Merrill
Lynch Variable Series Funds, Inc., and we look forward to serving your future
investment needs.
Sincerely,
- -s- TERRY K. GLENN
Terry K. Glenn
President and Director
- -s- Jacqueline Rogers
Jacqueline Rogers
Vice President and Portfolio Manager
July 12, 2004
65
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE INTEREST MATURITY
AMOUNT ISSUE RATE* DATE VALUE
- ------------------------------------------------------------------------------------------------------------------------
COMMERCIAL PAPER--47.8% $ 5,000,000 Blue Ridge Asset Funding
Corporation........................ 1.25 % 7/26/2004 $ 4,995,660
10,000,000 CAFCO, LLC........................... 1.20 8/06/2004 9,987,300
760,000 CC (USA) Inc. (Centauri)............. 1.23 8/16/2004 758,738
3,100,000 CC (USA) Inc. (Centauri)............. 1.24 8/26/2004 3,093,229
10,000,000 CC (USA) Inc. (Centauri)............. 1.29 9/01/2004 9,975,520
4,000,000 CXC LLC.............................. 1.26 8/06/2004 3,994,960
10,000,000 CXC LLC.............................. 1.24 8/16/2004 9,983,389
12,000,000 Ciesco, LLC.......................... 1.08 7/12/2004 11,996,040
4,000,000 Ciesco, LLC.......................... 1.27 8/11/2004 3,994,214
17,560,000 Clipper Receivables Company, LLC..... 1.07 7/07/2004 17,556,869
16,000,000 Delaware Funding Corporation......... 1.09 7/08/2004 15,996,422
6,000,000 The E.W. Scripps Company............. 1.28 8/11/2004 5,991,253
6,109,000 Edison Asset Securitization, LLC..... 1.10 8/03/2004 6,102,280
3,000,000 Edison Asset Securitization, LLC..... 1.34 9/07/2004 2,991,813
9,000,000 Edison Asset Securitization, LLC..... 1.50 11/01/2004 8,949,906
200,000 General Electric Capital Corp. ...... 1.12 8/13/2004 199,693
5,500,000 General Electric Capital Corp. ...... 1.30 9/02/2004 5,486,283
2,000,000 Morgan Stanley+...................... 1.58 10/28/2004 2,000,000
10,000,000 New Center Asset Trust............... 1.49 9/09/2004 9,971,750
11,444,000 Park Avenue Receivables Corp. ....... 1.12 7/14/2004 11,439,372
11,000,000 Southern Company Funding Corp. ...... 1.09 7/07/2004 10,998,002
5,000,000 Southern Company Funding Corp. ...... 1.25 7/27/2004 4,995,486
16,000,000 White Pine Corporation............... 1.19 8/09/2004 15,978,203
- ------------------------------------------------------------------------------------------------------------------------
TOTAL COMMERCIAL PAPER
(COST--$177,445,722) 177,436,382
- ------------------------------------------------------------------------------------------------------------------------
FUNDING AGREEMENTS+--9.6% 5,000,000 Allstate Life Insurance Co........... 1.19 7/01/2004 5,000,000
5,000,000 Allstate Life Insurance Co........... 1.21 11/01/2004 5,000,000
5,000,000 ING USA Annuity and Life Insurance
Company............................ 1.33 7/18/2005 5,000,000
5,000,000 Metropolitan Life Insurance Company.. 1.22 4/01/2005 5,000,000
10,500,000 Monumental Life Insurance Company.... 1.27 5/23/2005 10,500,000
5,000,000 New York Life Insurance Company...... 1.42 5/27/2005 5,000,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL FUNDING AGREEMENTS
(COST--$35,500,000) 35,500,000
- ------------------------------------------------------------------------------------------------------------------------
MEDIUM-TERM NOTES+--9.6% 8,695,000 General Electric Capital Corp. ...... 1.359 7/15/2005 8,695,000
2,550,000 Household Finance Corporation........ 1.26 8/18/2004 2,549,336
1,750,000 Metropolitan Life Global Funding I... 1.249 7/15/2005 1,750,000
1,500,000 Morgan Stanley....................... 1.131 7/01/2005 1,500,000
5,800,000 Morgan Stanley....................... 1.359 7/15/2005 5,800,000
1,700,000 Morgan Stanley....................... 1.33 7/27/2005 1,700,000
7,750,000 Sigma Finance Inc. .................. 1.07 9/22/2004 7,749,822
6,000,000 Sigma Finance Inc. .................. 1.065 5/05/2005 5,999,238
- ------------------------------------------------------------------------------------------------------------------------
TOTAL MEDIUM-TERM NOTES
(COST--$35,743,975) 35,743,396
- ------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT AGENCY & 1,500,000 Federal National Mortgage
INSTRUMENTALITY Association........................ 7.00 7/15/2005 1,572,225
OBLIGATIONS--DISCOUNT--0.4%
- ------------------------------------------------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT AGENCY & INSTRUMENTALITY
OBLIGATIONS--DISCOUNT (COST--$1,580,072) 1,572,225
- ------------------------------------------------------------------------------------------------------------------------
</Table>
66
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE INTEREST MATURITY
AMOUNT ISSUE RATE* DATE VALUE
- ------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT AGENCY & $ 3,900,000 Federal Farm Credit Banks+........... 1.02 % 2/28/2005 $ 3,899,742
INSTRUMENTALITY 5,100,000 Federal Farm Credit Banks+........... 1.20 2/21/2006 5,098,325
OBLIGATIONS--
NON-DISCOUNT--30.7% 2,000,000 Federal Home Loan Banks+............. 1.23 8/05/2004 1,999,705
3,400,000 Federal Home Loan Banks+............. 1.01 8/19/2004 3,399,909
5,300,000 Federal Home Loan Banks.............. 2.00 11/15/2004 5,311,591
1,500,000 Federal Home Loan Banks.............. 1.875 2/15/2005 1,500,404
1,900,000 Federal Home Loan Banks.............. 4.375 2/15/2005 1,929,744
10,250,000 Federal Home Loan Banks+............. 1.511 3/30/2005 10,249,293
11,275,000 Federal Home Loan Banks.............. 1.625 4/15/2005 11,241,130
1,700,000 Federal Home Loan Banks.............. 1.42 6/30/2005 1,685,125
2,500,000 Federal Home Loan Banks.............. 1.75 8/15/2005 2,483,593
4,000,000 Federal Home Loan Banks.............. 1.50 8/26/2005 3,960,000
1,850,000 Federal Home Loan Mortgage Corp. .... 3.875 2/15/2005 1,873,267
55,000 Federal Home Loan Mortgage Corp. .... 1.75 5/15/2005 54,832
2,200,000 Federal Home Loan Mortgage Corp. .... 4.25 6/15/2005 2,242,394
1,300,000 Federal Home Loan Mortgage Corp. .... 2.29 10/28/2005 1,295,965
1,300,000 Federal Home Loan Mortgage Corp. .... 2.41 11/04/2005 1,297,773
11,000,000 Federal National Mortgage
Association+....................... 1.00 10/28/2004 10,998,924
10,250,000 Federal National Mortgage
Association+....................... 1.04 1/18/2005 10,247,109
10,000,000 Federal National Mortgage
Association+....................... 1.204 2/18/2005 9,998,750
10,200,000 Federal National Mortgage
Association+....................... 1.471 3/16/2005 10,199,296
3,000,000 Federal National Mortgage
Association........................ 1.61 5/13/2005 2,986,875
2,000,000 Federal National Mortgage
Association........................ 1.75 5/23/2005 1,993,124
4,050,000 Federal National Mortgage
Association........................ 1.875 9/15/2005 4,023,963
3,000,000 Student Loan Marketing Association... 3.375 7/15/2004 3,002,410
1,075,000 U.S. Treasury Notes.................. 2.125 8/31/2004 1,076,553
- ------------------------------------------------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT AGENCY & INSTRUMENTALITY
OBLIGATIONS--NON-DISCOUNT
(COST--$114,190,495) 114,049,796
- ------------------------------------------------------------------------------------------------------------------------
</Table>
67
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE
AMOUNT ISSUE VALUE
- ------------------------------------------------------------------------------------------------------------------------
REPURCHASE AGREEMENTS--3.2% $11,852,000 UBS Warburg Corp. LLC, purchased on 6/30/2004 to
yield 1.45% to 7/01/2004, repurchase price $11,852,211
collateralized by Resolution Funding STRIP, due 4/15/2009.. $ 11,852,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS
(COST--$11,852,000) 11,852,000
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$376,312,264)--101.3%......... 376,153,799
LIABILITIES IN EXCESS OF OTHER
ASSETS--(1.3%)....................... (4,968,813)
------------
NET ASSETS--100.0%................... $371,184,986
============
- ------------------------------------------------------------------------------------------------------------------------
</Table>
* Commercial Paper and certain U.S. Government & Agency Obligations are traded
on a discount basis; the interest rates shown reflect the discount rates paid
at the time of purchase by the Fund. Other securities bear interest at the
rates shown, payable at fixed dates or upon maturity. The interest rates on
variable rate securities are adjusted periodically based upon appropriate
indexes: the interest rates shown are the rates in effect at June 30, 2004.
+ Variable rate notes.
See Notes to Financial Statements.
68
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (identified
cost--$376,312,264*)...................................... $376,153,799
Receivables:
Capital shares sold....................................... $1,271,710
Interest.................................................. 467,899 1,739,609
----------
Prepaid expenses............................................ 2,981
------------
Total assets................................................ 377,896,389
------------
- -----------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Capital shares redeemed................................... 6,653,606
Custodian bank............................................ 16,847
Investment adviser........................................ 15,446
Other affiliates.......................................... 4,936
Distributor............................................... 97 6,690,932
----------
Accrued expenses and other liabilities...................... 20,471
------------
Total liabilities........................................... 6,711,403
------------
- -----------------------------------------------------------------------------------------
NET ASSETS.................................................. $371,184,986
============
- -----------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value,
3,300,000,000 shares authorized+.......................... $ 37,132,517
Class II Shares of Common Stock, $.10 par value,
1,300,000,000 shares authorized+.......................... 2,222
Paid-in capital in excess of par............................ 334,208,712
Unrealized depreciation on investments--net................. (158,465)
------------
NET ASSETS.................................................. $371,184,986
============
- -----------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $371,162,764 and 371,325,169
shares outstanding........................................ $ 1.00
============
Class II--Based on net assets of $22,222 and 22,214 shares
outstanding............................................... $ 1.00
============
- -----------------------------------------------------------------------------------------
</Table>
* Cost for federal income tax purposes. As of June 30, 2004, net unrealized
depreciation for federal income tax purposes amounted to $158,465, of which
$6,688 related to appreciated securities and $165,153 related to depreciated
securities.
+ The Fund is also authorized to issue 1,300,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class III as of June 30, 2004.
See Notes to Financial Statements.
69
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Interest and discount earned................................ $2,335,867
- -------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $974,771
Accounting services......................................... 67,074
Printing and shareholder reports............................ 19,599
Professional fees........................................... 17,762
Custodian fees.............................................. 14,878
Directors' fees and expenses................................ 11,929
Transfer agent fees--Class I................................ 2,492
Pricing services............................................ 1,146
Distribution fees--Class II................................. 97
Transfer agent fees--Class II............................... 1
Other....................................................... 11,225
--------
Total expenses.............................................. 1,120,974
----------
Investment income--net...................................... 1,214,893
----------
- -------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET:
Realized gain on investments--net........................... 22
Change in unrealized appreciation/depreciation on
investments--net.......................................... (302,312)
----------
Total realized and unrealized loss on investments--net...... (302,290)
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 912,603
==========
- -------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
70
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
DECREASE IN NET ASSETS: 2004 2003
- --------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 1,214,893 $ 3,651,621
Realized gain on investments--net........................... 22 21,313
Change in unrealized appreciation/depreciation on
investments--net.......................................... (302,312) (227,016)
------------- -------------
Net increase in net assets resulting from operations........ 912,603 3,445,918
------------- -------------
- --------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... (1,217,637) (3,652,671)
Class II.................................................. (304) --
Realized gain on investments--net:
Class I................................................... (22) (21,313)
------------- -------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (1,217,963) (3,673,984)
------------- -------------
- --------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (57,448,068) (116,463,036)
------------- -------------
- --------------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (57,753,428) (116,691,102)
Beginning of period......................................... 428,938,414 545,629,516
------------- -------------
End of period*.............................................. $371,184,986 $ 428,938,414
============= =============
- --------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
71
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS -----------------------------------------------------------
HAVE BEEN DERIVED FROM INFORMATION
PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,++
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
-------- -------- -------- -------- --------
Investment income--net................................ .0031 .0072 .0147 .0384 .0588
Realized and unrealized gain (loss) on
investments--net.................................... (.0008) (.0004) (.0007) .0015 .0008
-------- -------- -------- -------- --------
Total from investment operations...................... .0023 .0068 .0140 .0399 .0596
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.............................. (.0031) (.0072) (.0147) (.0384) (.0588)
Realized gain on investments--net................... --+ --+ --+ (.0002) --+
-------- -------- -------- -------- --------
Total dividends and distributions..................... (.0031) (.0072) (.0147) (.0386) (.0588)
-------- -------- -------- -------- --------
Net asset value, end of period........................ $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................... .62%* .73% 1.49% 3.89% 6.00%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................. .57%* .57% .57% .57% .55%
======== ======== ======== ======== ========
Investment income--net, and realized gain on
investments--net.................................... .62%* .73% 1.47% 3.69% 5.88%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).............. $371,163 $428,938 $545,630 $580,609 $455,259
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Amount is less than ($.0001) per share.
++ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
See Notes to Financial Statements.
72
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS II
-------------------
THE FOLLOWING PER SHARE DATA AND RATIOS FOR THE PERIOD
HAVE BEEN DERIVED FROM INFORMATION FEBRUARY 13, 2004++
PROVIDED IN THE FINANCIAL STATEMENTS. TO JUNE 30,
INCREASE (DECREASE) IN NET ASSET VALUE: 2004
- ---------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 1.00
-------
Investment income--net...................................... .0018
Realized and unrealized gain on investments--net............ --+
-------
Total from investment operations............................ .0018
-------
Less dividends and distributions:
Investment income--net.................................... (.0018)
Realized gain on investments--net......................... --***
-------
Total dividends and distributions........................... (.0018)
-------
Net asset value, end of period.............................. $ 1.00
=======
- ---------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... .47%*
=======
- ---------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... .72%*
=======
Investment income--net, and realized gain on
investments--net.......................................... .47%*
=======
- ---------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 22
=======
- ---------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Amount is less than ($.0001) per share.
+ Amount is less than $.0001 per share.
++ Commencement of operations.
See Notes to Financial Statements.
73
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--DOMESTIC MONEY MARKET V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Domestic Money
Market V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. Income expenses
(other than expenses attributable to a specific class) and realized and
unrealized gains and losses on investments and foreign currency transactions are
allocated daily to each class based on its relative net assets. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Portfolio securities with remaining maturities
of greater than sixty days, for which market quotations are readily available,
are valued at market value. As securities transition from 61 days--60 days to
maturity, the difference between the valuation existing on the sixty-first day
before maturity and maturity value is amortized on a straight-line basis to
maturity. Securities maturing 60 days or less from their date of acquisition are
valued at amortized cost, which approximates market value. For the purposes of
valuation, the maturity of a variable rate security is deemed to be the next
coupon date on which the interest rate is to be adjusted. Other investments for
which market quotations are not readily available are valued at their fair value
as determined in good faith by or under the direction of the Company's Board of
Directors.
(b) Repurchase agreements--The Fund may invest in U.S. government securities
pursuant to repurchase agreements. Under such agreements, the counterparty
agrees to repurchase the security at a mutually agreed upon time and price. The
Fund takes possession of the underlying securities, marks to market such
securities and, if necessary, receives additional securities daily to ensure
that the contract is fully collateralized. If the seller defaults and the fair
value of the collateral declines, liquidation of the collateral by the Fund may
be delayed or limited.
(c) 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.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Interest income is recognized on the accrual basis.
(e) Dividends and distributions to shareholders--The Fund declares dividends
daily and reinvests monthly such dividends (net of non-resident alien tax and
backup withholding tax withheld) in additional Fund shares at net asset value.
Dividends and distributions are declared from the total of net investment income
and net realized gain or loss on investments.
(f) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(g) Custodian bank--The Fund recorded an amount payable to the custodian bank
reflecting an overnight overdraft, which resulted from a failed interest
payment.
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on
74
- --------------------------------------------------------------------------------
the next business day. Where the Fund receives securities as collateral for the
loaned securities, it collects a fee from the borrower. The Fund typically
receives the income on the loaned securities but does not receive the income on
the collateral. Where the Fund receives cash collateral, it may invest such
collateral and retain the amount earned on such investment, net of any amount
rebated to the borrower. Loans of securities are terminable at any time and the
borrower, after notice, is required to return borrowed securities within five
business days. The Fund may pay reasonable finder's, lending agent,
administrative and custodial fees in connection with its loans. In the event
that the borrower defaults on its obligation to return borrowed securities
because of insolvency or for any other reason, the Fund could experience delays
and costs in gaining access to the collateral. The Fund also could suffer a loss
where the value of the collateral falls below the market value of the borrowed
securities, in the event of borrower default or in the event of losses on
investments made with cash collateral.
(i) Reclassification--U.S. generally accepted accounting principles require
that certain components of net assets be adjusted to reflect permanent
differences between financial and tax reporting. Accordingly, during the current
year, $3,048 has been reclassified between paid-in capital and accumulated
distributions in excess of net investment income as a result of permanent
differences attributable to nondeductible expenses. The reclassification has no
effect on net assets or net asset values per share.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with FAM Distributors, Inc. ("FAMD" or the
"Distributor"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .50% of the average daily value of the Fund's net assets.
Pursuant to the Distribution Plan adopted by the Company, in accordance with
Rule 12b-1 under the Investment Company Act of 1940, the Fund pays the
Distributor an ongoing distribution fee each month at the annual rate of .15% of
the average daily value of the Fund's Class II net assets and .25% of the
average daily value of the Fund's Class III net assets.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC, may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLLA or in registered money market funds advised
by MLIM or its affiliates.
For the six months ended June 30, 2004, the Fund reimbursed MLIM $4,021 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Certain officers and/or directors of the Fund are officers and/or directors of
MLIM, PSI, FDS, FAMD, and/or ML & Co.
3. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from beneficial interest transactions was
$57,448,068 and $116,463,036 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in shares of beneficial interest for each class were as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- ----------------------------------------------------------------------
Shares sold.......................... 78,253,158 $ 78,253,158
Shares issued to shareholders in
reinvestment of distributions....... 1,209,239 1,209,239
------------- -------------
Total issued......................... 79,462,397 79,462,397
Shares redeemed...................... (136,932,679) (136,932,679)
------------- -------------
Net decrease......................... (57,470,282) $ (57,470,282)
============= =============
- ----------------------------------------------------------------------
</Table>
75
- --------------------------------------------------------------------------------
<Table>
<Caption>
- ------------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- ------------------------------------------------------------------
Shares sold......................... 256,723,362 $ 256,723,362
Shares issued resulting from
reorganization..................... 10,391,621 10,391,621
Shares issued to shareholders in
reinvestment of dividends and
distributions...................... 3,675,136 3,675,136
------------ -------------
Total issued........................ 270,790,119 270,790,119
Shares redeemed..................... (387,253,155) (387,253,155)
------------ -------------
Net decrease........................ (116,463,036) $(116,463,036)
============ =============
- ------------------------------------------------------------------
</Table>
<Table>
<Caption>
- ------------------------------------------------------------------
Class II Shares for the Period
February 13, 2004+ to Dollar
June 30, 2004 Shares Amount
- ------------------------------------------------------------------
Shares sold............................. 1,464,531 $ 1,464,531
Shares issued to shareholders in
reinvestment of distributions.......... 39 39
---------- -----------
Total issued............................ 1,464,570 1,464,570
Shares redeemed......................... (1,442,356) (1,442,356)
---------- -----------
Net increase............................ 22,214 $ 22,214
========== ===========
- ------------------------------------------------------------------
</Table>
+ Commencement of operations.
76
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the six-month period ended June 30, 2004, Fundamental Growth V.I. Fund's
Class I Shares had a total return of +2.72%. The Fund's benchmark, the Standard
& Poor's 500 (S&P 500) Barra Growth Index, also returned +2.72% for the period.
The S&P 500 Index, which represents a broad-based, "core" investment style
rather than a growth style, had a total return of +3.44% for the same six-month
period.
Fund performance benefited from our focus on the largest of the
large-capitalization growth companies in the health care, energy, consumer
discretionary and industrial sectors. Individual stocks that contributed
meaningfully to performance included Alcon, Inc., Yahoo! Inc., Boston Scientific
Corporation, Gilead Sciences, Inc., DENTSPLY International Inc., Varian Medical
Systems, Inc., Devon Energy Corporation, Schlumberger Ltd., BJ Services Company,
Baker Hughes Incorporated, Apollo Group, Inc., Career Education Corp. (which we
have sold out of the portfolio), 3M Co., Rockwell Automation, Inc., eBay Inc.,
Starbucks Corporation, Coach, Inc., Nike, Inc. and Staples, Inc.
The Fund also benefited from our avoidance of certain large-capitalization
growth companies--those where we determined the growth prospects were not as
good as generally perceived. These companies included Wal-Mart Stores Inc., The
Coca-Cola Company, Fannie Mae, Pfizer Inc., Amgen Inc. and IBM Corp.
Fund performance was handicapped by its investment in several major
information technology companies. Information technology stocks that detracted
meaningfully from performance were EMC Corporation and SanDisk Corporation. In
our view, these companies are leaders in two of the major growth opportunities
for information storage in digital data, video and audio formats. Large
investment weightings in Intel Corporation and Texas Instruments Incorporated
also had a negative impact on performance.
PORTFOLIO ACTIVITY
The most significant change during the period involved the substantial
reduction of our overweight position in the consumer discretionary sector
relative to the S&P 500 Barra Growth Index. We liquidated our positions in
Krispy Kreme Doughnuts, Inc. and Ross Stores, Inc., in both cases due to a
change in the fundamental business outlook for the companies. We also
meaningfully reduced our investment weightings in Coach, Inc., eBay Inc., Lowe's
Companies, Inc. and Starbucks Corporation, as each of the stocks reached
relatively high valuations. Mandalay Resort Group was liquidated at a profit
after the management of MGM Mirage, Inc. announced its intention to pursue an
acquisition offer.
We increased our overweight position in the industrials sector, investing in
companies in the heavy-duty truck manufacturing industry, such as Cummins Inc.,
Eaton Corporation and PACCAR Inc. We also increased the Fund's information
technology weighting by re-introducing Microsoft Corporation into the portfolio.
We had liquidated our position in late March 2003 on concerns about competition
from Linux operating systems and application software. In our opinion, the
currently lower stock valuation within the context of a new operating system
upgrade cycle over the fiscal year make the stock an attractive investment.
Corning Incorporated was added to the portfolio given the emerging, and what we
believe are substantial growth opportunities, in the new flat panel, electronic
liquid crystal screen markets for computer and audio/visual device products.
Motorola, Inc. also was added to the portfolio after management reported a
surprising and sharp upturn in business fundamentals under the new chairman and
chief executive officer, Edward Zander.
LOOKING AHEAD
The best investment performance during the first half of 2004 came from value
stocks and companies in the mid-capitalization to small-capitalization sectors.
However, in the last months of the period, the larger-capitalization growth
companies started to produce better stock price returns, on a relative basis.
It appears that investors expect the current economic expansion to slow down
substantially, given that stocks in the consumer staples sector have produced
above-average investment returns during the first half of 2004. On the contrary,
we believe the economic expansion is continuing, with the impetus for real and
nominal growth shifting from consumer spending to spending on capital
investment. Approximately a year ago, federal legislators passed an accelerated
depreciation tax incentive for capital investment. The legislation requires that
the spending take place before the end of calendar year 2004. In our view, this
tax incentive may motivate corporate managements to spend on upgrading and
expanding the information technology infrastructure in 2004.
77
- --------------------------------------------------------------------------------
Currently, the Fund is positioned to benefit from increased capital investment
in the United States and in China over the next year. Compared to the S&P 500
Barra Growth Index, the Fund is overweight in the energy, information
technology, industrials and materials sectors. Investments in the energy and
industrials sectors have contributed to performance so far in 2004, whereas the
primary detractor has been investments in the major information technology
companies.
IN CONCLUSION
We appreciate your investment in Fundamental Growth V.I. Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to serving your future
investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Lawrence R. Fuller
Lawrence R. Fuller
Vice President and Portfolio Manager
July 12, 2004
78
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +21.66%
- --------------------------------------------------------------------------
Inception (4/03/00) through 6/30/04 - 7.34
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +2.72% +21.66%
- -----------------------------------------------------------------------------------------
S&P 500(R) Index** +3.44 +19.11
- -----------------------------------------------------------------------------------------
S&P 500 Barra Growth Index*** +2.72 +16.03
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset value for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
** This unmanaged Index covers 500 industrial, utility, transportation and
financial companies of the U.S. markets (mostly NYSE issues), representing
about 75% of the NYSE market capitalization and 30% of NYSE issues.
*** This unmanaged Index is a capitalization-weighted index of all the stocks in
the Standard & Poor's 500 Index that have higher price-to-book ratios.
Past results shown should not be considered a representation of future
performance.
S&P 500 is a registered trademark of the McGraw-Hill Companies.
79
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
BIOTECHNOLOGY 52,900 +Gilead Sciences, Inc. .................. $ 3,544,300 1.8%
- ---------------------------------------------------------------------------------------------------------------------
CHEMICALS 42,200 Air Products and Chemicals, Inc. ........ 2,213,390 1.1
55,900 Praxair, Inc. ........................... 2,230,969 1.1
------------ -----
4,444,359 2.2
- ---------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 20,800 +Apollo Group, Inc. (Class A)............ 1,836,432 0.9
SUPPLIES
70,700 +Monster Worldwide Inc. ................. 1,818,404 0.9
------------ -----
3,654,836 1.8
- ---------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS EQUIPMENT 394,300 +Cisco Systems, Inc. .................... 9,344,910 4.7
175,800 +Corning Incorporated.................... 2,295,948 1.1
660,600 +Lucent Technologies Inc. ............... 2,497,068 1.3
103,700 Motorola, Inc. .......................... 1,892,525 0.9
------------ -----
16,030,451 8.0
- ---------------------------------------------------------------------------------------------------------------------
COMPUTERS & PERIPHERALS 309,600 +EMC Corporation......................... 3,529,440 1.8
164,300 Hewlett-Packard Company.................. 3,466,730 1.7
73,800 +SanDisk Corporation..................... 1,600,722 0.8
------------ -----
8,596,892 4.3
- ---------------------------------------------------------------------------------------------------------------------
CONSUMER FINANCE 52,000 American Express Company................. 2,671,760 1.3
- ---------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 36,300 Emerson Electric Company................. 2,306,865 1.1
77,500 Rockwell Automation, Inc. ............... 2,907,025 1.5
------------ -----
5,213,890 2.6
- ---------------------------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 63,800 +Agilent Technologies, Inc. ............. 1,868,064 0.9
INSTRUMENTS
69,600 Tektronix, Inc. ......................... 2,367,792 1.2
------------ -----
4,235,856 2.1
- ---------------------------------------------------------------------------------------------------------------------
ENERGY EQUIPMENT & SERVICE 57,200 Baker Hughes Incorporated................ 2,153,580 1.1
82,700 Schlumberger Limited..................... 5,252,277 2.6
------------ -----
7,405,857 3.7
- ---------------------------------------------------------------------------------------------------------------------
FOOD & STAPLES RETAILING 75,200 SUPERVALU Inc. .......................... 2,301,872 1.2
67,800 SYSCO Corporation........................ 2,431,986 1.2
------------ -----
4,733,858 2.4
- ---------------------------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT & 63,000 Alcon, Inc. ............................. 4,954,950 2.5
SUPPLIES
113,900 +Boston Scientific Corporation........... 4,874,920 2.5
43,000 DENTSPLY International Inc. ............. 2,240,300 1.1
91,100 Medtronic, Inc. ......................... 4,438,392 2.2
25,400 +Varian Medical Systems, Inc. ........... 2,015,490 1.0
------------ -----
18,524,052 9.3
- ---------------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 20,000 Marriott International, Inc. (Class A)... 997,600 0.5
LEISURE
45,400 +Starbucks Corporation................... 1,973,992 1.0
43,600 Starwood Hotels & Resorts Worldwide,
Inc. .................................. 1,955,460 1.0
------------ -----
4,927,052 2.5
- ---------------------------------------------------------------------------------------------------------------------
IT SERVICES 70,300 First Data Corporation................... 3,129,756 1.6
22,400 +Hewitt Associates, Inc. (Class A)....... 616,000 0.3
69,600 Paychex, Inc. ........................... 2,358,048 1.2
------------ -----
6,103,804 3.1
- ---------------------------------------------------------------------------------------------------------------------
INDUSTRIAL CONGLOMERATES 104,700 3M Co. .................................. 9,424,047 4.7
364,400 General Electric Company................. 11,806,560 5.9
------------ -----
21,230,607 10.6
- ---------------------------------------------------------------------------------------------------------------------
INTERNET & CATALOG RETAIL 45,600 +eBay Inc. .............................. 4,192,920 2.1
72,400 +InterActiveCorp......................... 2,182,136 1.1
------------ -----
6,375,056 3.2
- ---------------------------------------------------------------------------------------------------------------------
INTERNET SOFTWARE & SERVICES 113,100 +Yahoo! Inc. ............................ 4,108,923 2.1
- ---------------------------------------------------------------------------------------------------------------------
</Table>
80
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
MACHINERY 30,700 Cummins Inc. ............................ $ 1,918,750 0.9%
33,800 Eaton Corporation........................ 2,188,212 1.1
43,800 PACCAR Inc. ............................. 2,539,962 1.3
------------ -----
6,646,924 3.3
- ---------------------------------------------------------------------------------------------------------------------
METALS & MINING 51,700 Freeport-McMoRan Copper & Gold, Inc.
(Class B).............................. 1,713,855 0.8
22,700 Phelps Dodge Corporation................. 1,759,477 0.9
------------ -----
3,473,332 1.7
- ---------------------------------------------------------------------------------------------------------------------
OFFICE ELECTRONICS 42,000 Canon, Inc. ............................. 2,213,261 1.1
- ---------------------------------------------------------------------------------------------------------------------
OIL & GAS 60,000 Apache Corporation....................... 2,613,000 1.3
47,900 Devon Energy Corporation................. 3,161,400 1.6
------------ -----
5,774,400 2.9
- ---------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 72,900 +Forest Laboratories, Inc. .............. 4,128,327 2.1
- ---------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 48,600 Analog Devices, Inc. .................... 2,288,088 1.1
SEMICONDUCTOR EQUIPMENT
351,100 Intel Corporation........................ 9,690,360 4.9
148,800 Texas Instruments Incorporated........... 3,597,984 1.8
------------ -----
15,576,432 7.8
- ---------------------------------------------------------------------------------------------------------------------
SOFTWARE 40,100 +Electronic Arts Inc. ................... 2,187,455 1.1
360,000 Microsoft Corporation.................... 10,281,600 5.2
336,300 +Oracle Corporation...................... 4,012,059 2.0
------------ -----
16,481,114 8.3
- ---------------------------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 66,300 Best Buy Co., Inc. ...................... 3,364,062 1.7
36,800 Lowe's Companies, Inc. .................. 1,933,840 1.0
56,300 +Rent A Center Inc. ..................... 1,685,059 0.9
90,400 Staples, Inc. ........................... 2,649,624 1.3
45,700 Tiffany & Co. ........................... 1,684,045 0.8
------------ -----
11,316,630 5.7
- ---------------------------------------------------------------------------------------------------------------------
TEXTILES, APPAREL & LUXURY 46,000 +Coach, Inc. ............................ 2,078,740 1.1
GOODS
61,400 Nike, Inc. (Class B)..................... 4,651,050 2.3
------------ -----
6,729,790 3.4
- ---------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST--$173,568,467) 194,141,763 97.3
- ---------------------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
BENEFICIAL INTEREST SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------
$3,606,287 Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I(a)............ 3,606,287 1.8
3,337,000 Merrill Lynch Liquidity Series, LLC
Money Market Series(a)(b)......... 3,337,000 1.7
- -----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$6,943,287) 6,943,287 3.5
- -----------------------------------------------------------------------------------------------------------------------
</Table>
<Table>
TOTAL INVESTMENTS (COST--$180,511,754)... 201,085,050 100.8
LIABILITIES IN EXCESS OF OTHER ASSETS.... (1,566,257) (0.8)
------------ -----
NET ASSETS............................... $199,518,793 100.0%
============ =====
- ---------------------------------------------------------------------------------------------------------------------
</Table>
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
81
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
(a) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------
INTEREST/
NET DIVIDEND
AFFILIATE ACTIVITY INCOME
- ---------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $(7,517,262) $42,653
Merrill Lynch Liquidity Series, LLC Money Market Series..... $(2,303,149) $ 3,613
Merrill Lynch Premier Institutional Fund.................... (1,880,051) $ 1,092
- ---------------------------------------------------------------------------------------
</Table>
(b) Security was purchased with the cash proceeds from securities loans.
See Notes to Financial Statements.
82
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (including
securities loaned of $3,194,780) (identified
cost--$173,568,467)....................................... $194,141,763
Investments in affiliated securities, at value (identified
cost--$6,943,287)......................................... 6,943,287
Receivables:
Securities sold........................................... $ 1,860,058
Dividends................................................. 175,576
Capital shares sold....................................... 43,011
Interest from affiliates.................................. 6,045
Securities lending--net................................... 279 2,084,969
------------
Prepaid expenses............................................ 884
------------
Total assets................................................ 203,170,903
------------
- -------------------------------------------------------------------------------------------
LIABILITIES:
Collateral on securities loaned, at value................... 3,337,000
Payables:
Capital shares redeemed................................... 286,641
Investment adviser........................................ 17,591
Other affiliates.......................................... 1,843 306,075
------------
Accrued expenses............................................ 9,035
------------
Total liabilities........................................... 3,652,110
------------
- -------------------------------------------------------------------------------------------
NET ASSETS.................................................. $199,518,793
============
- -------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized+........................................ $ 2,781,623
Paid-in capital in excess of par............................ 209,934,040
Undistributed investment income--net........................ $ 37,227
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (33,807,281)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 20,573,184
------------
Total accumulated losses--net............................... (13,196,870)
------------
NET ASSETS.................................................. $199,518,793
============
- -------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $199,518,793 and 27,816,229
shares outstanding........................................ $ 7.17
============
- -------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II or Class III as of June 30,
2004.
See Notes to Financial Statements.
83
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends (net of $14,354 foreign withholding tax).......... $ 723,320
Interest from affiliates.................................... 42,653
Securities lending--net..................................... 4,705
-----------
Total income................................................ 770,678
-----------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $ 643,932
Accounting services......................................... 30,932
Professional fees........................................... 15,434
Custodian fees.............................................. 14,283
Printing and shareholder reports............................ 8,820
Directors' fees and expenses................................ 5,952
Transfer agent fees......................................... 2,458
Pricing services............................................ 1,477
Other....................................................... 10,139
-----------
Total expenses.............................................. 733,427
-----------
Investment income--net...................................... 37,251
-----------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain from:
Investments--net.......................................... 13,231,364
Foreign currency transactions--net........................ 174 13,231,538
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (8,012,430)
Foreign currency transactions--net........................ (106) (8,012,536)
----------- -----------
Total realized and unrealized gain on investments and
foreign currency transactions--net........................ 5,219,002
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 5,256,253
===========
- -----------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
84
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- ------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 37,251 $ 231,435
Realized gain (loss) on investments and foreign currency
transactions--net......................................... 13,231,538 (12,981,295)
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (8,012,536) 53,661,567
------------ ------------
Net increase in net assets resulting from operations........ 5,256,253 40,911,707
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... (4,035) (220,023)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (4,035) (220,023)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (2,743,430) (44,206,000)
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... 2,508,788 (3,514,316)
Beginning of period......................................... 197,010,005 200,524,321
------------ ------------
End of period*.............................................. $199,518,793 $197,010,005
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 37,227 $ 4,011
============ ============
- ------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
85
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS -------------------------------------------------------------------------
HAVE BEEN DERIVED FROM INFORMATION
PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE SIX FOR THE YEAR ENDED FOR THE PERIOD
MONTHS ENDED DECEMBER 31,+++ APRIL 3, 2000+
JUNE 30, ------------------------------------ TO DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000+++
- -------------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........ $ 6.98 $ 5.46 $ 7.54 $ 9.23 $ 10.00
-------- -------- -------- -------- -------
Investment income--net...................... --++++*** .01++++ .01++++ .04++++ .03
Realized and unrealized gain (loss) on
investments and foreign currency
transactions--net......................... .19 1.52 (2.08) (1.71) (.76)
-------- -------- -------- -------- -------
Total from investment operations............ .19 1.53 (2.07) (1.67) (.73)
-------- -------- -------- -------- -------
Less dividends:
Investment income--net.................... --++ (.01) (.01) (.02) (.04)
In excess of investment income--net....... -- -- -- -- --++
-------- -------- -------- -------- -------
Total dividends............................. -- (.01) (.01) (.02) (.04)
-------- -------- -------- -------- -------
Net asset value, end of period.............. $ 7.17 $ 6.98 $ 5.46 $ 7.54 $ 9.23
======== ======== ======== ======== =======
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......... 2.72%++ 27.98% (27.51%) (18.12%) (7.27%)++
======== ======== ======== ======== =======
- -------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of waiver..................... .74%* .74% .75% .79% 1.09%*
======== ======== ======== ======== =======
Expenses.................................... .74%* .74% .75% .79% 1.12%*
======== ======== ======== ======== =======
Investment income--net...................... .04%* .13% .09% .57% 1.18%*
======== ======== ======== ======== =======
- -------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).... $199,519 $197,010 $200,524 $163,218 $32,480
======== ======== ======== ======== =======
Portfolio turnover.......................... 42.95% 134.62% 89.61% 94.56% 95.44%
======== ======== ======== ======== =======
- -------------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses. If
applicable, the Company's Investment Adviser waived a portion of its
management fee. Without such waiver, the Fund's performance would have been
lower.
*** Amount is less than $.01 per share.
+ Commencement of operations.
++ Amount is less than $(.01) per share.
+++ Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
++ Aggregate total investment return.
++++ Based on average shares outstanding.
See Notes to Financial Statements.
86
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--FUNDAMENTAL GROWTH V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co."), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Fundamental
Growth V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
87
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- Options--The Fund may write 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.
- Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-U.S. dollar-denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) 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 U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Dividends from foreign securities where the ex-dividend date may have passed are
subsequently recorded when the Fund has determined the ex-dividend date.
Interest income is recognized on the accrual basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
88
- --------------------------------------------------------------------------------
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities, but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .65% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Company. There is no increase in the aggregate fees paid by the Company for
these services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC") an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $2,009 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, MLPF&S earned $28,213 in commissions
on the execution of portfolio security transactions.
For the six months ended June 30, 2004, the Fund reimbursed MLIM $2,018 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co., is
the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $82,885,021 and $81,661,403, respectively.
Net realized gains for the six months ended June 30, 2004 and net unrealized
apprecia-
89
- --------------------------------------------------------------------------------
tion/depreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Unrealized
Realized Appreciation/
Gains Depreciation
- -------------------------------------------------------------------
Long-term investments................ $13,231,364 $20,573,296
Foreign currency transactions........ 174 (112)
----------- -----------
Total................................ $13,231,538 $20,573,184
=========== ===========
- -------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $18,946,460, of which $24,552,114 related to appreciated securities
and $5,605,654 related to depreciated securities. At June 30, 2004, the
aggregate cost of investments for federal income tax purposes was $182,138,590.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$2,743,430 and $44,206,000 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -------------------------------------------------------------------
Shares sold........................... 1,603,831 $ 11,365,470
Shares issued to shareholders in
reinvestment of dividends............ 580 4,035
---------- ------------
Total issued.......................... 1,604,411 11,369,505
Shares redeemed....................... (2,006,536) (14,112,935)
---------- ------------
Net decrease.......................... (402,125) $ (2,743,430)
========== ============
- -------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold......................... 4,832,027 $ 28,735,114
Shares issued to shareholders in
reinvestment of dividends.......... 31,567 220,023
----------- ------------
Total issued........................ 4,863,594 28,955,137
Shares redeemed..................... (13,386,595) (73,161,137)
----------- ------------
Net decrease........................ (8,523,001) $(44,206,000)
=========== ============
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$45,411,983, of which $110,592 expires in 2008, $10,750,741 expires in 2009,
$20,235,625 expires in 2010 and $14,315,025 expires in 2011. This amount will be
available to offset like amounts of any future taxable gains.
90
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
During the six months ended June 30, 2004, global earnings recovery continued
with many companies reporting strong numbers. Despite the solid corporate
earnings, however, financial markets were held back, struggling to assess the
implications of an up-tick in the interest rate cycle and tighter financial
conditions globally.
Markets started 2004 positively as investors continued to focus on
increasingly tangible prospects for a global economic recovery. However,
positive sentiment weakened slightly and markets entered a trading range as
macroeconomic data displayed a mixed picture toward the end of the first
quarter. News of the Madrid terrorist bombings in March caused further declines
in investor sentiment. Concern about U.S. interest rates rising was an
increasingly dominant theme during the period, with the Federal Reserve Board
announcing a widely anticipated 25 basis point (.25%) interest rate increase on
June 30, 2004. Oil pricing also was a major focus, and equity markets were
tested by the prospect of a sustained period of high oil prices. A high oil
price leads to higher costs for consumers and businesses, and could translate
into either lower profit margins for companies, or to cost-push inflation.
FUND PERFORMANCE
For the six-month period ended June 30, 2004, Global Allocation V.I. Fund's
Class I, Class II and Class III Shares had respective total returns of +3.37%,
+3.28% and +3.25%. Fund results were slightly below the +3.85% return of its
broad-based, all-equity benchmark, the unmanaged Financial Times Stock Exchange
(FTSE) World Index, but significantly exceeded the +1.84% return of its
Reference Portfolio for the same six-month period. Since the Fund invests in a
combination of equities and bonds, the Reference Portfolio provides a truer
representation of the Fund's composition and, therefore, a more comparable means
for measurement. Returns for each component of the Reference Portfolio for the
six months ended June 30, 2004, were as follows: the Standard & Poor's 500 (S&P
500) Index returned +3.44%; the Financial Times Stock Exchange (FTSE) World
Index (Ex-U.S.) returned +4.26%; the Merrill Lynch Treasury Index GA05 Index
returned -.51%; and the Citigroup World Government Bond Index (Ex-U.S.) returned
- -1.86%.
The Fund also outperformed its comparable Lipper category of Global Core
Funds, which posted an average return of +2.45% for the six-month period ended
June 30, 2004. (Funds in this Lipper category invest in companies inside and
outside the United States. Core funds typically have an average price-to-cash
flow ratio, price-to-book ratio and three-year sales-per-share growth value
comparable to the S&P/ Citigroup World Broad Market Index.)
The Fund's performance reflected an asset allocation strategy that included a
relatively modest overweight position in equities at the beginning of the
period, and a significant underweight in fixed income, particularly
high-quality, long-term U.S. government bonds. The Fund benefited from the
continued broad-based appreciation in global equity markets, notably in the
United States and Japan, as well as effective stock selection in the financials,
consumer staples and telecommunications sectors. The Fund's overweight position
in international equities contributed to its outperformance of the Reference
Portfolio.
Although the Fund was underweight in fixed income as a whole thereby helping
to mitigate the impact of weakness in that sector, it continued to benefit from
the makeup of its fixed income component. This included significant exposure to
U.S. corporate and high yield securities as well as European and Canadian
sovereign debt, which we favored over U.S. Treasury issues.
PORTFOLIO ACTIVITY
We continued to focus on attractively valued stocks, particularly in the
United States and Asia. Our strategy included taking profits in those stocks
that outperformed, notably in the financials, information technology and energy
sectors in the earlier part of the period. We began the period with an equity
weighting of 63% of net assets, slightly overweight relative to the Reference
Portfolio's 60% allocation. As of June 30, 2004, the Fund's equity weighting
stood at a neutral 60%, reflecting a reduction in our European and Asian equity
exposure as these markets appreciated.
The Fund was significantly underweight in fixed income securities for the
duration of the six-month period. At the start of the period, approximately 22%
of the Fund's net assets was invested in bonds worldwide compared to the
Reference Portfolio's fixed income allocation of 40%. While exposure to
U.S.-denominated corporate bonds and euro-denominated corporate bonds decreased
due to profit-taking, the Fund increased its weighting in British
pound-denominated bonds. Reflecting these changes, the
91
- --------------------------------------------------------------------------------
Fund's fixed income weighting decreased to 20% of net assets at the close of the
period. (The Fund's U.S. fixed income exposure includes bonds of non-U.S.
issuers denominated in U.S. dollars.)
Approximately 3.8% of the Fund's net assets was invested in convertible
securities as of June 30, 2004, compared to 4.8% at December 31, 2003. These
securities are reported as a portion of the Fund's fixed income securities,
although some of these securities may tend to perform similar to equities. Given
the changes outlined above, primarily the decrease in equity and fixed income
exposure, the Fund's cash holdings increased from 15% of net assets to 20% over
the past six months. Cash is actively managed and, as such, allocations to cash
are an integral part of the Fund's investment strategy. In the Fund's current
strategy, cash can be considered zero-duration fixed income investments and
include short-term U.S. dollar and non-U.S. dollar fixed income securities and
other money-market type instruments.
CURRENT POSITION
Compared to its Reference Portfolio, the Fund ended the period relatively
neutral in equities (60%), significantly underweight in fixed income securities
(20%) and overweight in cash reserves (20%). Within the equity segment, the Fund
was underweight in U.S. and European stocks and overweight in Asian stocks. In
terms of sector allocations, the Fund was overweight in the energy, materials
and telecommunications industries and underweight in the healthcare,
industrials, consumer discretionary, financials, consumer staples, utilities and
technology sectors. The Fund ended the six-month period with little exposure to
long-term, high-grade fixed income securities. We find the yields on these
instruments to be unattractive given the associated risk of future interest rate
increases.
As for currency exposure, we ended the period with an underweight in the euro
and the Japanese yen and modestly overweight the U.S. dollar. We have small
overweight positions in several Asian currencies.
The investment team continues to look for undervalued securities that are
expected to generate above-average rates of return. At the close of the period,
the portfolio's equity allocation--although neutral relative to our Reference
Portfolio--was still higher than during most of the Fund's history. For that
reason, we expect the Fund may exhibit a somewhat higher beta versus the S&P 500
Index and higher volatility in net asset value than historically has been the
case. Nevertheless, given the Fund's current positioning, we believe that both
of these measures should remain below those typical of most all-equity funds in
most market conditions.
IN CONCLUSION
We thank you for your continued investment in Global Allocation V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Dennis W. Stattman
Dennis Stattman
Vice President and Senior Portfolio Manager
July 12, 2004
92
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +3.37% +20.44%
- -----------------------------------------------------------------------------------------
Class II Shares* +3.28 --
- -----------------------------------------------------------------------------------------
Class III Shares* +3.25 --
- -----------------------------------------------------------------------------------------
FTSE World Index** +3.85 +24.76
- -----------------------------------------------------------------------------------------
Reference Portfolio*** +1.84 +14.99
- -----------------------------------------------------------------------------------------
U.S. Stocks: Standard & Poor's 500 Index**** +3.44 +19.11
- -----------------------------------------------------------------------------------------
Non-U.S. Stocks: FTSE World Index (Ex-U.S.) Equities***** +4.26 +32.01
- -----------------------------------------------------------------------------------------
U.S. Bonds: ML Treasury Index GA05+ -0.51 - 1.46
- -----------------------------------------------------------------------------------------
Non-U.S. Bonds: Citigroup World Government Bond Index
(Ex-U.S.)++ -1.86 + 7.60
- -----------------------------------------------------------------------------------------
</Table>
* Total investment returns are based on changes in net asset values for the
periods shown, and assume reinvestment of all dividends and capital gains
distributions at net asset value on the ex-dividend date. Insurance-related
fees and expenses are not reflected in these returns. Effective September 2,
2003, Class A Shares were redesignated Class I Shares. Class II Shares
commenced operations on 11/24/03. Class III Shares commenced operations on
11/18/03.
** This unmanaged market capitalization-weighted Index is comprised of nearly
2000 equities from 24 countries in 12 regions, including the United States.
*** The Reference Portfolio is an unmanaged weighted Index comprised as follows:
36% of the Standard & Poor's 500 Index; 24% FTSE World Index (Ex-U.S.)
Equities; 24% Merrill Lynch Treasury Index GA05; and 16% Citigroup World
Government Bond Index (Ex-U.S.).
**** This unmanaged broad-based Index is comprised of common stocks.
***** This unmanaged capitalization-weighted Index is comprised of 1,631
companies in 28 countries, excluding the United States.
+ This unmanaged Index is designed to track the total return of the current
coupon five-year U.S. Treasury bond.
++ This unmanaged market capitalization-weighted Index tracks 10 government
bond indexes, excluding the United States.
Past results shown should not be considered a representation of future
performance.
- --------------------------------------------------------------------------------
SUMMARY OF FUND'S OVERALL ASSET MIX
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERCENT OF FUND'S REFERENCE PORTFOLIO+
AS OF 6/30/04 NET ASSETS PERCENTAGES
- ------------------------------------------------------------------------------------------------------
U.S. Equities 30.5%* 36.0%
- ------------------------------------------------------------------------------------------------------
European Equities 8.6 14.4
- ------------------------------------------------------------------------------------------------------
Pacific Basin Equities 18.8 7.4
- ------------------------------------------------------------------------------------------------------
Other Equities 2.4 2.2
- ------------------------------------------------------------------------------------------------------
TOTAL EQUITIES 60.3 60.0
- ------------------------------------------------------------------------------------------------------
U.S. Dollar-Denominated Fixed Income Securities 8.3 24.0
- ------------------------------------------------------------------------------------------------------
U.S. Issuer 3.8 --
- ------------------------------------------------------------------------------------------------------
Non-U.S. Issuer 4.5 --
- ------------------------------------------------------------------------------------------------------
Non-U.S. Dollar-Denominated Fixed Income Securities 11.58 16.0
- ------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES 19.9 40.0
- ------------------------------------------------------------------------------------------------------
CASH & CASH EQUIVALENTS 19.8** --
- ------------------------------------------------------------------------------------------------------
</Table>
* Includes value of financial futures contracts.
** Cash & Cash Equivalents are reduced by the market (or nominal) value of long
financial futures contracts.
+ The unmanaged Reference Portfolio is an unmanaged weighted index comprised as
follows: 36% of the Standard & Poor's 500 Index; 24% FTSE World Index
(Ex-U.S.) Equities; 24% Merrill Lynch Treasury Index GA05; and 16% Citigroup
World Government Bond Index (Ex-U.S.).
93
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
PERIOD COVERED RETURN
- --------------------------------------------------------------------------------
One Year Ended 6/30/04 +20.44%
- --------------------------------------------------------------------------------
Five Years Ended 6/30/04 + 4.07
- --------------------------------------------------------------------------------
Ten Years Ended 6/30/04 + 6.73
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
AGGREGATE TOTAL RETURN--CLASS II SHARES* RETURN
- --------------------------------------------------------------------------------
Inception (11/24/03) through 6/30/04 +11.57%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
AGGREGATE TOTAL RETURN--CLASS III SHARES* RETURN
- --------------------------------------------------------------------------------
Inception (11/18/03) through 6/30/04 +11.12%
- --------------------------------------------------------------------------------
* Average Annual and Aggregate Total Returns are based on changes in net asset
values for the periods shown, and assume reinvestment of all dividends and
capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
Past results shown should not be considered a representation of future
performance.
94
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
AUSTRALIA FOOD PRODUCTS 494,000 +Burns, Philp & Company Limited...... $ 234,002 0.0%
-----------------------------------------------------------------------------------------------------
METALS & MINING 353,600 BHP Billiton Limited................. 3,086,362 0.6
16,000 Blue Scope Steel Limited............. 75,121 0.0
77,000 Rio Tinto Limited.................... 1,928,293 0.3
330,000 WMC Resources Limited................ 1,131,000 0.2
------------ -----
6,220,776 1.1
-----------------------------------------------------------------------------------------------------
OIL & GAS 50,200 Woodside Petroleum Limited........... 582,939 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN AUSTRALIA..... 7,037,717 1.2
- ----------------------------------------------------------------------------------------------------------------------
BELGIUM DIVERSIFIED 8,988 +Belgacom SA......................... 273,600 0.0
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN BELGIUM....... 273,600 0.0
- ----------------------------------------------------------------------------------------------------------------------
BRAZIL BEVERAGES 18,469 Companhia de Bebidas das Americas
(ADR)*............................. 370,673 0.0
-----------------------------------------------------------------------------------------------------
METALS & MINING 23,040 Companhia Siderurgica Nacional
(ADR)*............................. 280,166 0.1
2,500 Companhia Vale do Rio Doce (ADR)*.... 118,875 0.0
22,840 Companhia Vale do Rio Doce (Sponsored
ADR)*.............................. 893,044 0.2
------------ -----
1,292,085 0.3
-----------------------------------------------------------------------------------------------------
OIL & GAS 49,100 Petroleo Brasileiro SA--Petrobras
(ADR)*............................. 1,378,237 0.2
-----------------------------------------------------------------------------------------------------
PAPER & FOREST 8,100 Votorantim Celulose e Papel SA
PRODUCTS (ADR)*............................. 257,580 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN BRAZIL........ 3,298,575 0.5
- ----------------------------------------------------------------------------------------------------------------------
CANADA COMMUNICATIONS 539,928 +Nortel Networks Corporation......... 2,694,241 0.5
EQUIPMENT
-----------------------------------------------------------------------------------------------------
METALS & MINING 98,700 Placer Dome Inc...................... 1,642,368 0.3
-----------------------------------------------------------------------------------------------------
ROAD & RAIL 6,000 CP Railway Limited................... 146,560 0.0
13,800 CP Railway Limited................... 339,894 0.1
------------ -----
486,454 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CANADA........ 4,823,063 0.9
- ----------------------------------------------------------------------------------------------------------------------
CHILE ELECTRIC UTILITIES 18,300 Empresa Nacional de Electricidad SA
(Endesa) (ADR)*.................... 226,737 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CHILE......... 226,737 0.0
- ----------------------------------------------------------------------------------------------------------------------
CHINA AUTOMOBILES 514,000 Denway Motors Limited................ 186,165 0.0
-----------------------------------------------------------------------------------------------------
INSURANCE 7,200 +China Life Insurance Co., Limited
(ADR)*............................. 169,850 0.0
55,500 +Ping An Insurance (Group) Company of
China Limited...................... 75,425 0.0
------------ -----
245,275 0.0
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 160,000 Hainan Meilan Airport Company Limited
INFRASTRUCTURE 'H'................................ 122,054 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CHINA......... 553,494 0.0
- ----------------------------------------------------------------------------------------------------------------------
CZECH COMMERCIAL BANKS 6,400 Komercni Banka AS (GDR)**............ 239,215 0.1
REPUBLIC
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE CZECH
REPUBLIC............................. 239,215 0.1
- ----------------------------------------------------------------------------------------------------------------------
FINLAND COMMUNICATIONS 13,100 Nokia Oyj 'A' (ADR)*................. 190,474 0.0
EQUIPMENT
-----------------------------------------------------------------------------------------------------
PAPER & FOREST 34,055 Stora Enso Oyj 'R'................... 461,978 0.1
PRODUCTS
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN FINLAND....... 652,452 0.1
- ----------------------------------------------------------------------------------------------------------------------
</Table>
95
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
FRANCE AUTOMOBILES 9,320 PSA Peugeot Citroen.................. $ 518,994 0.1%
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 17,037 BNP Paribas SA....................... 1,047,804 0.2
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 4,431 Vinci SA............................. 446,373 0.1
ENGINEERING
-----------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 5,882 Lafarge SA (Ordinary)................ 524,559 0.1
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 26,073 France Telecom SA.................... 679,479 0.1
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 17,530 Accor SA............................. 739,864 0.1
LEISURE
-----------------------------------------------------------------------------------------------------
INSURANCE 25,488 Axa.................................. 561,281 0.1
-----------------------------------------------------------------------------------------------------
METALS & MINING 25,732 Arcelor.............................. 432,034 0.1
-----------------------------------------------------------------------------------------------------
OIL & GAS 6,765 TotalFinaElf SA...................... 1,289,741 0.2
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN FRANCE........ 6,240,129 1.1
- ----------------------------------------------------------------------------------------------------------------------
GERMANY AIR FREIGHT & 20,692 Deutsche Lufthansa AG (Registered
LOGISTICS Shares)............................ 281,456 0.1
24,446 Deutsche Post AG (Registered
Shares)............................ 527,925 0.1
------------ -----
809,381 0.2
-----------------------------------------------------------------------------------------------------
AUTO COMPONENTS 4,921 Continental AG....................... 237,330 0.0
-----------------------------------------------------------------------------------------------------
AUTOMOBILES 11,108 Bayerische Motoren Werke (BMW) AG.... 491,524 0.1
-----------------------------------------------------------------------------------------------------
CHEMICALS 8,364 Linde AG............................. 460,365 0.1
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 24,244 Hochtief AG.......................... 575,181 0.1
ENGINEERING
-----------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 10,143 Deutsche Boerse AG................... 515,462 0.1
SERVICES
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 45,563 +Deutsche Telekom AG (Registered
TELECOMMUNICATION Shares)............................ 800,470 0.1
SERVICES
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 13,581 E.On AG.............................. 979,833 0.2
-----------------------------------------------------------------------------------------------------
INSURANCE 2,014 Allianz AG (Registered Shares)....... 218,153 0.0
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 5,694 Schering AG.......................... 335,504 0.1
-----------------------------------------------------------------------------------------------------
TEXTILES, APPAREL & 4,390 Adidas-Salomon AG.................... 524,122 0.1
LUXURY GOODS
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN GERMANY....... 5,947,325 1.1
- ----------------------------------------------------------------------------------------------------------------------
HONG KONG COMMERCIAL BANKS 70,400 HSBC Holdings PLC.................... 1,060,540 0.2
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 187,380 Hutchison Whampoa Limited............ 1,279,262 0.2
CONGLOMERATES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN HONG KONG..... 2,339,802 0.4
- ----------------------------------------------------------------------------------------------------------------------
HUNGARY COMMERCIAL BANKS 8,300 OTP Bank Rt. (GDR)**................. 339,056 0.1
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 11,350 Magyar Tavkozlesi Rt (ADR)*.......... 227,144 0.0
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN HUNGARY....... 566,200 0.1
- ----------------------------------------------------------------------------------------------------------------------
</Table>
96
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
INDIA AUTOMOBILES 34,000 Bajaj Auto Limited................... $ 654,153 0.1%
27,300 Hero Honda Motors Ltd. .............. 301,354 0.0
38,900 Maruti Udyog Limited................. 340,602 0.1
12,000 Tata Motors Limited.................. 99,237 0.0
------------ -----
1,395,346 0.2
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 19,200 ICICI Bank Limited (ADR)*............ 232,320 0.0
33,900 Oriental Bank of Commerce............ 177,224 0.0
34,450 State Bank of India.................. 322,695 0.1
------------ -----
732,239 0.1
-----------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 80,346 +Gujarat Ambuja Cements Limited...... 497,105 0.1
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 194,000 Mahanagar Telephone Nigam Ltd. ...... 556,787 0.1
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
HOUSEHOLD PRODUCTS 261,000 Hindustan Lever Ltd. ................ 722,682 0.1
-----------------------------------------------------------------------------------------------------
IT SERVICES 17,319 Infosys Technologies Limited......... 2,080,503 0.4
-----------------------------------------------------------------------------------------------------
OIL & GAS 20,200 Bharat Petroleum Corporation Ltd. ... 156,086 0.0
34,300 Hindustan Petroleum Corporation
Ltd. .............................. 250,936 0.0
391,000 Reliance Industries Ltd. ............ 3,653,586 0.7
------------ -----
4,060,608 0.7
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 22,200 Dr. Reddy's Laboratories Limited..... 355,103 0.1
22,800 Ranbaxy Laboratories Limited......... 451,016 0.1
------------ -----
806,119 0.2
-----------------------------------------------------------------------------------------------------
ROAD & RAIL 27,000 Container Corporation of India
Limited............................ 331,781 0.1
-----------------------------------------------------------------------------------------------------
THRIFTS & MORTGAGE 80,000 Housing Development Finance
FINANCE Corporation Ltd. (HDFC)............ 899,880 0.2
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN INDIA......... 12,083,050 2.2
- ----------------------------------------------------------------------------------------------------------------------
INDONESIA COMMERCIAL BANKS 643,000 PT Bank Danamon Indonesia Tbk........ 193,191 0.0
1,679,000 PT Bank Mandiri...................... 209,819 0.1
------------ -----
403,010 0.1
-----------------------------------------------------------------------------------------------------
FOOD PRODUCTS 1,751,900 PT Indofood Sukses Makmur Tbk........ 130,426 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN INDONESIA..... 533,436 0.1
- ----------------------------------------------------------------------------------------------------------------------
IRELAND COMMERCIAL BANKS 49,178 Bank of Ireland...................... 655,763 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN IRELAND....... 655,763 0.1
- ----------------------------------------------------------------------------------------------------------------------
ISRAEL COMMUNICATIONS 196,400 +ECI Telecom Limited (U.S. Registered
EQUIPMENT Shares)............................ 1,341,412 0.2
8,738 +ECtel Ltd. ......................... 25,253 0.0
------------ -----
1,366,665 0.2
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 41,500 Clal Industries Ltd. ................ 199,801 0.0
CONGLOMERATES
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 8,738 Teva Pharmaceutical Industries Ltd.
(ADR)*............................. 587,980 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN ISRAEL........ 2,154,446 0.3
- ----------------------------------------------------------------------------------------------------------------------
ITALY COMMERCIAL BANKS 189,067 Capitalia SpA........................ 591,633 0.1
314,740 Intesa BCI SpA....................... 1,229,583 0.2
------------ -----
1,821,216 0.3
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 205,932 Telecom Italia SpA................... 640,148 0.1
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 55,512 Enel SpA............................. 445,080 0.1
-----------------------------------------------------------------------------------------------------
INSURANCE 19,011 Societa Assicuratrice Industriale
SpA................................ 423,644 0.1
-----------------------------------------------------------------------------------------------------
OIL & GAS 62,231 ENI SpA.............................. 1,235,566 0.2
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN ITALY......... 4,565,654 0.8
- ----------------------------------------------------------------------------------------------------------------------
</Table>
97
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
JAPAN AUTO COMPONENTS 24,500 Toyota Industries Corporation........ $ 588,278 0.1%
-----------------------------------------------------------------------------------------------------
AUTOMOBILES 122,000 Fuji Heavy Industries, Ltd. ......... 684,269 0.1
10,900 Honda Motor Co., Ltd. ............... 525,446 0.1
85,000 Suzuki Motor Corporation............. 1,497,228 0.3
------------ -----
2,706,943 0.5
-----------------------------------------------------------------------------------------------------
BEVERAGES 30,000 Coca-Cola West Japan Company
Limited............................ 742,336 0.2
13,000 Kinki Coca-Cola Bottling Co.,
Ltd. .............................. 121,523 0.0
------------ -----
863,859 0.2
-----------------------------------------------------------------------------------------------------
CHEMICALS 61,000 Asahi Chemical Industry Co., Ltd. ... 315,859 0.1
71,000 Shin-Etsu Chemical Co., Ltd. ........ 2,537,690 0.4
------------ -----
2,853,549 0.5
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 85,714 The Bank of Yokohama, Ltd. .......... 535,737 0.1
21,900 Shinsei Bank, Ltd. .................. 139,691 0.0
------------ -----
675,428 0.1
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 117,000 JGC Corporation...................... 1,125,876 0.2
ENGINEERING
-----------------------------------------------------------------------------------------------------
CONSUMER FINANCE 36,000 Credit Saison Co., Ltd. ............. 1,082,161 0.2
-----------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 33,000 Murata Manufacturing Co., Ltd. ...... 1,881,135 0.3
INSTRUMENTS
-----------------------------------------------------------------------------------------------------
FOOD & STAPLES 35,300 Ito-Yokado Co., Ltd. ................ 1,510,801 0.3
RETAILING
15,000 +Seiyu, Ltd. ........................ 49,214 0.0
------------ -----
1,560,015 0.3
-----------------------------------------------------------------------------------------------------
GAS UTILITIES 258,000 Tokyo Gas Co......................... 915,053 0.2
-----------------------------------------------------------------------------------------------------
HOUSEHOLD PRODUCTS 26,300 Rohto Pharmaceutical Co., Ltd. ...... 300,565 0.1
-----------------------------------------------------------------------------------------------------
INSURANCE 495,000 Aioi Insurance Company, Limited...... 2,191,129 0.4
460 Millea Holdings, Inc................. 6,829,492 1.2
674,000 Mitsui Sumitomo Insurance Company,
Limited............................ 6,331,393 1.1
98,000 NIPPONKOA Insurance Company,
Limited............................ 628,695 0.1
------------ -----
15,980,709 2.8
-----------------------------------------------------------------------------------------------------
MACHINERY 13,000 Fanuc Ltd. .......................... 775,604 0.2
130,000 Kubota Corporation................... 691,014 0.1
------------ -----
1,466,618 0.3
-----------------------------------------------------------------------------------------------------
OFFICE ELECTRONICS 45,000 Canon, Inc........................... 2,371,351 0.4
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 12,000 Kyorin Pharmaceutical Co., Ltd. ..... 175,631 0.0
43,500 Takeda Pharmaceutical Co., Ltd. ..... 1,909,591 0.3
------------ -----
2,085,222 0.3
-----------------------------------------------------------------------------------------------------
REAL ESTATE 250 Marco Polo Investment Holdings
Limited............................ 350,000 0.1
-----------------------------------------------------------------------------------------------------
WIRELESS 335 NTT DoCoMo, Inc. .................... 598,680 0.1
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN JAPAN......... 37,405,442 6.7
- ----------------------------------------------------------------------------------------------------------------------
MALAYSIA FOOD PRODUCTS 94,000 IOI Corporation Berhad............... 201,605 0.0
-----------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 136,400 Resorts World Berhad................. 321,258 0.1
LEISURE
-----------------------------------------------------------------------------------------------------
MACHINERY 20 +Crest Petroleum Berhad.............. 6 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN MALAYSIA...... 522,869 0.1
- ----------------------------------------------------------------------------------------------------------------------
MEXICO BEVERAGES 13,300 Fomento Economico Mexicano, SA de CV
(ADR)*............................. 609,672 0.1
-----------------------------------------------------------------------------------------------------
</Table>
98
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
MEXICO
(CONCLUDED)
CONSTRUCTION MATERIALS 9,363 Cemex SA de CV (ADR)*................ $ 272,463 0.1%
-----------------------------------------------------------------------------------------------------
FOOD & STAPLES 1,828 Wal-Mart de Mexico SA de CV 'V'...... 5,421 0.0
RETAILING
-----------------------------------------------------------------------------------------------------
MEDIA 28,026 Grupo Televisa, SA (ADR)*............ 1,268,737 0.2
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN MEXICO........ 2,156,293 0.4
- ----------------------------------------------------------------------------------------------------------------------
NETHERLANDS CHEMICALS 12,072 Akzo Nobel NV........................ 444,000 0.1
-----------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 44,100 Buhrmann NV.......................... 438,355 0.1
SUPPLIES
28,440 Vedior NV 'A'........................ 414,526 0.1
------------ -----
852,881 0.2
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 9,923 Imtech NV............................ 271,638 0.0
ENGINEERING
-----------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 37,027 ING Groep NV......................... 873,949 0.1
SERVICES
-----------------------------------------------------------------------------------------------------
FOOD & STAPLES 54,650 +Koninklijke Ahold NV................ 428,860 0.1
RETAILING
-----------------------------------------------------------------------------------------------------
FOOD PRODUCTS 30,152 Koninklijke Ahold NV (ADR)*.......... 239,105 0.0
-----------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 23,696 Koninklijke (Royal) Philips
Electronics OB.B. NV............... 638,002..... 0.1
-----------------------------------------------------------------------------------------------------
MEDIA 19,960 Wolters Kluwer NV 'A'................ 362,322 0.1
-----------------------------------------------------------------------------------------------------
OIL & GAS 28,260 Royal Dutch Petroleum Company........ 1,450,255 0.3
13,000 Royal Dutch Petroleum Company (NY
Registered Shares)................. 671,710 0.1
------------ -----
2,121,965 0.4
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
NETHERLANDS.......................... 6,232,722 1.1
- ----------------------------------------------------------------------------------------------------------------------
NORWAY COMMERCIAL BANKS 63,274 DNB Holding ASA...................... 431,777 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN NORWAY........ 431,777 0.1
- ----------------------------------------------------------------------------------------------------------------------
SINGAPORE BEVERAGES 78,000 Fraser & Neave Limited............... 633,981 0.1
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 52,000 Oversea-Chinese Banking Corporation
Ltd. .............................. 365,294 0.1
-----------------------------------------------------------------------------------------------------
HEALTH CARE PROVIDERS 467,000 Parkway Holdings Limited............. 303,660 0.0
& SERVICES
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 292,000 Keppel Corporation Ltd. ............. 1,195,158 0.2
CONGLOMERATES
-----------------------------------------------------------------------------------------------------
REAL ESTATE 450,000 Keppel Land Limited.................. 420,622 0.1
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 555,000 SembCorp Logistics Limited........... 592,876 0.1
INFRASTRUCTURE
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SINGAPORE..... 3,511,591 0.6
- ----------------------------------------------------------------------------------------------------------------------
SOUTH AFRICA OIL & GAS 18,704 Sasol Limited........................ 289,340 0.1
-----------------------------------------------------------------------------------------------------
PAPER & FOREST 18,700 Sappi Limited (ADR)*................. 287,045 0.0
PRODUCTS
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SOUTH AFRICA.. 576,385 0.1
- ----------------------------------------------------------------------------------------------------------------------
SOUTH KOREA CHEMICALS 32,500 Samsung Fine Chemicals Co., Ltd. .... 469,710 0.1
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 18,579 +Kookmin Bank........................ 577,227 0.1
65,000 Pusan Bank........................... 360,017 0.1
------------ -----
937,244 0.2
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 136,900 KT Corporation (ADR)*................ 2,469,676 0.5
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 45,000 Korea Electric Power Corporation..... 724,362 0.1
-----------------------------------------------------------------------------------------------------
</Table>
99
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
SOUTH KOREA
(CONCLUDED)
FOOD PRODUCTS 13,800 Cheil Jedang Corporation............. $ 746,430 0.1%
-----------------------------------------------------------------------------------------------------
METALS & MINING 4,087 POSCO................................ 527,013 0.1
80,000 POSCO (ADR)*......................... 2,680,800 0.5
------------ -----
3,207,813 0.6
-----------------------------------------------------------------------------------------------------
TEXTILES, APPAREL & 21,353 Cheil Industries Inc. ............... 247,625 0.0
LUXURY GOODS
-----------------------------------------------------------------------------------------------------
TOBACCO 65,000 KT&G Corporation..................... 1,501,947 0.3
-----------------------------------------------------------------------------------------------------
WIRELESS 1,300 SK Telecom Co., Ltd. ................ 213,760 0.0
TELECOMMUNICATION
SERVICES
24,600 SK Telecom Co., Ltd. (ADR)*.......... 516,354 0.1
------------ -----
730,114 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SOUTH KOREA... 11,034,921 2.0
- ----------------------------------------------------------------------------------------------------------------------
SPAIN COMMERCIAL BANKS 40,684 Banco Bilbao Vizcaya, SA............. 543,490 0.1
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 20,034 Union Electrica Fenosa, SA........... 427,283 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SPAIN......... 970,773 0.2
- ----------------------------------------------------------------------------------------------------------------------
SWEDEN COMMERCIAL SERVICES & 36,170 Securitas AB 'B'..................... 451,348 0.1
SUPPLIES
-----------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 1 +Ainax AB............................ 26 0.0
SERVICES
-----------------------------------------------------------------------------------------------------
INSURANCE 107,077 Skandia Forsakrings AB............... 443,492 0.1
-----------------------------------------------------------------------------------------------------
MACHINERY 13,885 Volvo AB 'B'......................... 482,928 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SWEDEN........ 1,377,794 0.3
- ----------------------------------------------------------------------------------------------------------------------
SWITZERLAND CAPITAL MARKETS 23,984 Credit Suisse Group.................. 852,194 0.2
9,067 UBS AG (Registered Shares)........... 638,904 0.1
------------ -----
1,491,098 0.3
-----------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 11,905 Holderbank Finan Glaris Ltd.
(Registered Shares)................ 647,342 0.1
-----------------------------------------------------------------------------------------------------
FOOD PRODUCTS 3,998 Nestle SA (Registered Shares)........ 1,066,218 0.2
-----------------------------------------------------------------------------------------------------
INSURANCE 3,642 +Swiss Life Holding.................. 508,176 0.1
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 14,006 Novartis AG (Registered Shares)...... 617,879 0.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SWITZERLAND... 4,330,713 0.8
- ----------------------------------------------------------------------------------------------------------------------
TAIWAN COMMERCIAL BANKS 75,000 +First Financial Holding Co.,
Ltd. .............................. 54,400 0.0
720,522 SinoPac Holdings Company............. 376,968 0.1
491,000 Taishin Financial Holdings Co.,
Ltd. .............................. 404,301 0.1
------------ -----
835,669 0.2
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 70,000 Chunghwa Telecom Co., Ltd. (ADR)*.... 1,234,800 0.2
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
MACHINERY 380,000 Yuangtay Engineering Co., Ltd. ...... 202,200 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN TAIWAN........ 2,272,669 0.4
- ----------------------------------------------------------------------------------------------------------------------
THAILAND COMMERCIAL BANKS 1,179,000 Siam Commercial Bank Public Company
Limited (Registered Shares)........ 1,333,710 0.3
-----------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 162,000 Siam Cement Public Company Limited
'Foreign'.......................... 966,809 0.2
41,600 Siam City Cement Public Company
Limited 'Foreign'.................. 215,707 0.0
------------ -----
1,182,516 0.2
-----------------------------------------------------------------------------------------------------
FOOD PRODUCTS 212,000 Thai Union Frozen Products Public
Company Limited 'Foreign'.......... 106,298 0.0
-----------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 2,245,000 Land and Houses Public Company
Limited 'Foreign'.................. 535,374 0.1
-----------------------------------------------------------------------------------------------------
</Table>
100
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
THAILAND
(CONCLUDED)
OIL & GAS 75,900 PTT Exploration and Production Public
Company Limited 'Foreign'.......... $ 497,522 0.1%
260,000 PTT Public Company Limited
'Foreign'.......................... 979,332 0.2
------------ -----
1,476,854 0.3
-----------------------------------------------------------------------------------------------------
REAL ESTATE 887,500 Sansiri Public Company Limited
'Foreign'.......................... 105,497 0.0
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 125,300 Bangkok Expressway Public Company
INFRASTRUCTURE Limited 'Foreign'.................. 72,940 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THAILAND...... 4,813,189 0.9
- ----------------------------------------------------------------------------------------------------------------------
TURKEY COMMERCIAL BANKS 26,274,020 Turkiye Is Bankasi (Isbank) 'C'...... 95,606 0.0
-----------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 42,212,085 Haci Omer Sabanci Holdings AS........ 125,157 0.0
SERVICES
81,338 Koc Holding AS....................... 367 0.0
------------ -----
125,524 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN TURKEY........ 221,130 0.0
- ----------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM AEROSPACE & DEFENSE 165,727 BAE Systems PLC...................... 658,947 0.1
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 95,523 Barclays PLC......................... 813,752 0.1
32,620 HBOS PLC............................. 403,742 0.1
58,510 HSBC Holdings PLC.................... 870,085 0.2
29,731 Royal Bank of Scotland Group PLC..... 856,204 0.1
------------ -----
2,943,783 0.5
-----------------------------------------------------------------------------------------------------
FOOD & STAPLES 46,144 Boots Group PLC...................... 575,733 0.1
RETAILING
-----------------------------------------------------------------------------------------------------
FOOD PRODUCTS 61,458 Unilever PLC......................... 602,966 0.1
-----------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 72,269 Compass Group PLC.................... 441,016 0.1
LEISURE
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 49,690 Smiths Group PLC..................... 672,692 0.1
CONGLOMERATES
-----------------------------------------------------------------------------------------------------
INSURANCE 40,880 AVIVA PLC............................ 421,833..... 0.1
83,196 Prudential Corporation PLC........... 715,906 0.1
------------ -----
1,137,739 0.2
-----------------------------------------------------------------------------------------------------
METALS & MINING 60,510 Anglo American PLC................... 1,238,009 0.2
-----------------------------------------------------------------------------------------------------
OIL & GAS 172,712 BP Amoco PLC......................... 1,525,348 0.3
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 30,441 GlaxoSmithKline PLC.................. 616,085 0.1
-----------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 102,694 Kesa Electricals PLC................. 538,686 0.1
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 48,049 BAA PLC.............................. 482,302 0.1
INFRASTRUCTURE
-----------------------------------------------------------------------------------------------------
WIRELESS 703,932 Vodafone Group PLC................... 1,541,471 0.3
TELECOMMUNICATION
SERVICES
26,000 Vodafone Group PLC (ADR)*............ 574,600 0.1
------------ -----
2,116,071 0.4
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE UNITED
KINGDOM.............................. 13,549,377 2.4
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES AEROSPACE & DEFENSE 3,000 General Dynamics Corporation......... 297,900 0.1
8,300 Raytheon Company..................... 296,891 0.0
------------ -----
594,791 0.1
-----------------------------------------------------------------------------------------------------
AUTO COMPONENTS 33,100 +The Goodyear Tire & Rubber Company.. 300,879 0.1
-----------------------------------------------------------------------------------------------------
BEVERAGES 14,800 Anheuser-Busch Companies, Inc. ...... 799,200 0.1
8,100 +Constellation Brands, Inc. (Class
A)................................. 300,753 0.1
------------ -----
1,099,953 0.2
-----------------------------------------------------------------------------------------------------
</Table>
101
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES
(CONTINUED)
CAPITAL MARKETS 23,200 The Bank of New York Company,
Inc. .............................. $ 683,936 0.1%
28,000 J.P. Morgan Chase & Co. ............. 1,085,560 0.2
55,700 +Knight Trading Group, Inc. ......... 558,114 0.1
7,800 Mellon Financial Corporation......... 228,774 0.0
17,000 Morgan Stanley....................... 897,090 0.2
------------ -----
3,453,474 0.6
-----------------------------------------------------------------------------------------------------
CHEMICALS 23,100 E.I. du Pont de Nemours and
Company............................ 1,026,102 0.2
32,700 +Hercules Incorporated............... 398,613 0.1
20,200 Millennium Chemicals Inc. ........... 349,864 0.0
------------ -----
1,774,579 0.3
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 9,750 Bank of America Corporation.......... 825,045 0.2
15,650 Charter One Financial, Inc. ......... 691,574 0.1
------------ -----
1,516,619 0.3
-----------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 6,000 Cendant Corporation.................. 146,880 0.0
SUPPLIES
13,200 H&R Block, Inc. ..................... 629,376 0.1
------------ -----
776,256 0.1
-----------------------------------------------------------------------------------------------------
COMMUNICATIONS 93,400 +3Com Corporation.................... 583,750 0.1
EQUIPMENT
123,600 +ADC Telecommunications, Inc. ....... 351,024 0.1
24,700 +Cisco Systems, Inc. ................ 585,390 0.1
9,700 +Comverse Technology, Inc. .......... 193,418 0.0
101,800 +Lucent Technologies Inc. ........... 384,804 0.1
14,500 Motorola, Inc. ...................... 264,625 0.0
51,400 +Paradyne Networks, Inc. ............ 282,700 0.0
97,700 +Tellabs, Inc. ...................... 853,898 0.2
------------ -----
3,499,609 0.6
-----------------------------------------------------------------------------------------------------
COMPUTERS & 12,600 +Apple Computer, Inc. ............... 410,004 0.1
PERIPHERALS
19,160 +EMC Corporation..................... 218,424 0.0
59,311 Hewlett-Packard Company.............. 1,251,462 0.2
9,900 International Business Machines
Corporation........................ 872,685 0.2
86,200 +Maxtor Corporation.................. 571,506 0.1
3,100 +NCR Corporation..................... 153,729 0.0
264,000 +Sun Microsystems, Inc. ............. 1,145,760 0.2
------------ -----
4,623,570 0.8
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 12,400 Chicago Bridge & Iron Company NV (NY
ENGINEERING Registered Shares)................. 345,340 0.0
251,100 +Foster Wheeler Ltd. ................ 349,029 0.1
146,400 +McDermott International, Inc. ...... 1,487,424 0.3
252,900 +Quanta Services, Inc. .............. 1,573,038 0.3
------------ -----
3,754,831 0.7
-----------------------------------------------------------------------------------------------------
CONTAINERS & PACKAGING 37,600 +Crown Holdings, Inc. ............... 374,872 0.1
21,800 +Smurfit-Stone Container
Corporation........................ 434,910 0.1
------------ -----
809,782 0.2
-----------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 49,100 CIT Group Inc. ...................... 1,880,039 0.3
SERVICES
77,900 Citigroup Inc.(k).................... 3,622,350 0.6
11,822 Leucadia National Corporation........ 587,553 0.1
------------ -----
6,089,942 1.0
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 28,200 ALLTEL Corporation................... 1,427,484 0.3
TELECOMMUNICATION
SERVICES
1,890 +AboveNet, Inc. ..................... 54,810 0.0
21,100 BellSouth Corporation................ 553,242 0.1
50,400 +Cincinnati Bell Inc. ............... 223,776 0.0
29,863 +MCI, Inc. .......................... 430,923 0.1
52,800 SBC Communications Inc. ............. 1,280,400 0.2
52,000 Sprint Corporation................... 915,200 0.2
32,800 Verizon Communications............... 1,187,032 0.2
------------ -----
6,072,867 1.1
-----------------------------------------------------------------------------------------------------
</Table>
102
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 13,100 DTE Energy Company................... $ 531,074 0.1%
22,900 PPL Corporation...................... 1,051,110 0.2
------------ -----
1,582,184 0.3
-----------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 71,195 +Solectron Corporation............... 460,632 0.1
INSTRUMENTS
16,400 +Waters Corporation.................. 783,592 0.1
------------ -----
1,244,224 0.2
-----------------------------------------------------------------------------------------------------
ENERGY EQUIPMENT & 6,000 Baker Hughes Incorporated............ 225,900 0.0
SERVICE
31,200 ENSCO International Incorporated..... 907,920 0.2
37,700 GlobalSantaFe Corporation............ 999,050 0.2
18,500 +Input/Output, Inc. ................. 153,365 0.0
34,900 +Key Energy Services, Inc. .......... 329,456 0.1
6,300 +Noble Corporation................... 238,707 0.0
37,500 +Rowan Companies, Inc. .............. 912,375 0.2
26,500 Schlumberger Limited................. 1,683,015 0.3
6,500 Tidewater Inc. ...................... 193,700 0.0
11,000 +Transocean Inc. .................... 318,340 0.1
------------ -----
5,961,828 1.1
-----------------------------------------------------------------------------------------------------
FOOD & STAPLES 15,600 CVS Corporation...................... 655,512 0.1
RETAILING
6,600 SYSCO Corporation.................... 236,742 0.1
7,800 +Safeway Inc. ....................... 197,652 0.0
65,900 Wal-Mart Stores, Inc. ............... 3,476,884 0.6
15,700 Walgreen Co. ........................ 568,497 0.1
------------ -----
5,135,287 0.9
-----------------------------------------------------------------------------------------------------
FOOD PRODUCTS 9,400 Archer-Daniels-Midland Company....... 157,732 0.0
8,800 Bunge Limited........................ 342,672 0.1
9,500 ConAgra Foods, Inc. ................. 257,260 0.0
14,700 Sara Lee Corporation................. 337,953 0.1
139,800 Tyson Foods, Inc. (Class A).......... 2,928,810 0.5
------------ -----
4,024,427 0.7
-----------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT 13,200 Baxter International Inc. ........... 455,532 0.1
& SUPPLIES
2,780 +Hospira, Inc. ...................... 76,728 0.0
------------ -----
532,260 0.1
-----------------------------------------------------------------------------------------------------
HEALTH CARE PROVIDERS 3,300 Aetna Inc. (New Shares).............. 280,500 0.0
& SERVICES
6,500 AmerisourceBergen Corporation........ 388,570 0.1
154,800 +Beverly Enterprises, Inc.(a)........ 1,331,280 0.2
6,200 CIGNA Corporation.................... 426,622 0.1
8,000 Cardinal Health, Inc. ............... 560,400 0.1
3,800 HCA Inc. ............................ 158,042 0.0
16,400 +LifePoint Hospitals, Inc. .......... 610,408 0.1
9,300 Manor Care, Inc. .................... 303,924 0.1
117,100 +Stewart Enterprises, Inc. (Class
A)................................. 953,194 0.2
25,900 +Tenet Healthcare Corporation........ 347,319 0.1
22,600 +Triad Hospitals, Inc. .............. 841,398 0.1
22,850 +WellChoice Inc. .................... 945,990 0.2
------------ -----
7,147,647 1.3
-----------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 2,900 Darden Restaurants, Inc. ............ 59,595 0.0
LEISURE
575,200 +La Quinta Corporation............... 4,831,680 0.9
------------ -----
4,891,275 0.9
-----------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 22,900 Maytag Corporation................... 561,279 0.1
-----------------------------------------------------------------------------------------------------
</Table>
103
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES
(CONTINUED)
HOUSEHOLD PRODUCTS 15,700 Kimberly-Clark Corporation........... $ 1,034,316 0.2%
-----------------------------------------------------------------------------------------------------
INFORMATION TECHNOLOGY 11,500 Automatic Data Processing, Inc. ..... 481,620 0.1
SERVICES
3,100 +Computer Sciences Corporation....... 143,933 0.0
6,600 First Data Corporation............... 293,832 0.1
15,400 +Sykes Enterprises, Incorporated..... 116,424 0.0
13,200 +Unisys Corporation.................. 183,216 0.0
------------ -----
1,219,025 0.2
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 195,500 General Electric Company............. 6,334,200 1.1
CONGLOMERATES
45,600 Tyco International Ltd. ............. 1,511,184 0.3
------------ -----
7,845,384 1.4
-----------------------------------------------------------------------------------------------------
INSURANCE 45,800 ACE Limited(k)....................... 1,936,424 0.3
25,300 The Allstate Corporation............. 1,177,715 0.2
55,600 American International Group,
Inc. .............................. 3,963,168 0.7
22,000 Assurant, Inc. ...................... 580,360 0.1
6,800 Bristol West Holdings, Inc. ......... 123,692 0.0
8,100 The Hartford Financial Services
Group, Inc. ....................... 556,794 0.1
6,500 Horace Mann Educators Corporation.... 113,620 0.0
24,300 Marsh & McLennan Companies, Inc. .... 1,102,734 0.2
14,700 MetLife, Inc. ....................... 526,995 0.1
9,800 Prudential Financial, Inc. .......... 455,406 0.1
28,645 The St. Paul Companies, Inc. ........ 1,161,268 0.2
5,700 UnumProvident Corporation............ 90,630 0.0
16,400 XL Capital Ltd. (Class A)............ 1,237,544 0.2
------------ -----
13,026,350 2.2
-----------------------------------------------------------------------------------------------------
INTERNET SOFTWARE & 2,500 +webMethods, Inc. ................... 21,425 0.0
SERVICES
-----------------------------------------------------------------------------------------------------
LEISURE EQUIPMENT & 9,000 Eastman Kodak Company................ 242,820 0.0
PRODUCTS
-----------------------------------------------------------------------------------------------------
MACHINERY 3,100 Deere & Company...................... 217,434 0.0
-----------------------------------------------------------------------------------------------------
MEDIA 39,579 +Comcast Corporation (Class A)....... 1,109,399 0.2
23,873 +The DIRECTV Group, Inc. ............ 408,228 0.1
18,100 +EchoStar Communications Corporation
(Class A).......................... 556,575 0.1
43,000 +Liberty Media Corporation (Class
A)................................. 386,570 0.1
2,150 +Liberty Media International, Inc.
(Class A) ......................... 79,765 0.0
10,919 +NTL Incorporated.................... 629,153 0.1
43,900 +Time Warner Inc. ................... 771,762 0.1
52,000 Viacom, Inc. (Class B)............... 1,857,440 0.3
16,700 The Walt Disney Company.............. 425,683 0.1
------------ -----
6,224,575 1.1
-----------------------------------------------------------------------------------------------------
METALS & MINING 118,600 +AK Steel Holding Corporation........ 625,022 0.1
15,800 Alcoa Inc. .......................... 521,874 0.1
12,600 Arch Coal, Inc. ..................... 461,034 0.1
6,200 CONSOL Energy Inc. .................. 223,200 0.0
41,800 +Commonwealth Industries, Inc. ...... 432,212 0.1
20,800 Freeport-McMoRan Copper & Gold, Inc.
(Class B).......................... 689,520 0.1
63,000 +Inco Limited........................ 2,177,280 0.4
7,500 Nucor Corporation.................... 575,700 0.1
10,000 United States Steel Corporation...... 351,200 0.1
------------ -----
6,057,042 1.1
-----------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 37,700 +The AES Corporation................. 374,361 0.1
UNREGULATED POWER
-----------------------------------------------------------------------------------------------------
</Table>
104
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES
(CONTINUED)
MULTILINE RETAIL 9,900 +Kohl's Corporation.................. $ 418,572 0.1%
13,200 Target Corporation................... 560,604 0.1
------------ -----
979,176 0.2
-----------------------------------------------------------------------------------------------------
OIL & GAS 12,600 Amerada Hess Corporation............. 997,794 0.2
37,518 ChevronTexaco Corporation............ 3,530,819 0.6
12,504 ConocoPhillips....................... 953,930 0.2
3,100 Devon Energy Corporation............. 204,600 0.0
457,300 El Paso Corporation.................. 3,603,524 0.6
53,000 Exxon Mobil Corporation.............. 2,353,730 0.4
58,800 Kerr-McGee Corporation............... 3,161,676 0.6
48,400 Marathon Oil Corporation............. 1,831,456 0.3
9,800 Noble Energy, Inc. .................. 499,800 0.1
34,600 Occidental Petroleum Corporation..... 1,674,986 0.3
25,200 +Stone Energy Corporation............ 1,151,136 0.2
26,500 Unocal Corporation................... 1,007,000 0.2
4,200 +Whiting Petroleum Corporation....... 105,630 0.0
22,700 The Williams Companies, Inc. ........ 270,130 0.1
------------ -----
21,346,211 3.8
-----------------------------------------------------------------------------------------------------
PAPER & FOREST 26,400 Bowater Incorporated................. 1,097,976 0.2
PRODUCTS
16,600 Deltic Timber Corporation............ 637,440 0.1
------------ -----
1,735,416 0.3
-----------------------------------------------------------------------------------------------------
PERSONAL PRODUCTS 13,200 The Gillette Company................. 559,680 0.1
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 27,800 Abbott Laboratories.................. 1,133,128 0.2
56,100 Bristol-Myers Squibb Company......... 1,374,450 0.2
17,200 Eli Lilly and Company................ 1,202,452 0.2
4,100 +IVAX Corporation.................... 98,359 0.0
52,100 Johnson & Johnson.................... 2,901,970 0.5
41,200 Merck & Co., Inc. ................... 1,957,000 0.4
151,900 Pfizer, Inc. ........................ 5,207,132 0.9
56,000 Schering-Plough Corporation.......... 1,034,880 0.2
3,300 +Watson Pharmaceuticals, Inc. ....... 88,770 0.0
18,600 Wyeth................................ 672,576 0.1
------------ -----
15,670,717 2.7
-----------------------------------------------------------------------------------------------------
REAL ESTATE 9,900 American Financial Realty Trust...... 141,471 0.0
6,460 Catellus Development Corporation..... 159,239 0.0
7,800 Cedar Shopping Centers Inc. ......... 89,622 0.0
39,530 Friedman, Billings, Ramsey Group,
Inc. (Class A)..................... 782,299 0.1
18,900 Nationwide Health Properties,
Inc. .............................. 357,210 0.1
6,500 The St. Joe Company.................. 258,050 0.1
------------ -----
1,787,891 0.3
-----------------------------------------------------------------------------------------------------
ROAD & RAIL 13,100 CSX Corporation...................... 429,287 0.1
19,400 +Swift Transportation Co., Inc. ..... 348,230 0.1
19,700 Union Pacific Corporation............ 1,171,165 0.2
------------ -----
1,948,682 0.4
-----------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 65,800 +Advanced Micro Devices, Inc. ....... 1,046,220 0.2
SEMICONDUCTOR
EQUIPMENT
62,905 +Agere Systems Inc. (Class A)........ 144,682 0.0
34,499 +Agere Systems Inc. (Class B)........ 74,173 0.0
25,200 Intel Corporation.................... 695,520 0.1
72,100 +Lattice Semiconductor Corporation... 505,421 0.1
------------ -----
2,466,016 0.4
-----------------------------------------------------------------------------------------------------
SOFTWARE 8,290 +Check Point Software Technologies
Ltd. .............................. 223,747 0.1
206,700 Computer Associates International,
Inc. .............................. 5,800,016 1.0
18,800 +Compuware Corporation............... 124,080 0.0
221,800 Microsoft Corporation(k)............. 6,334,608 1.1
26,400 +Siebel Systems, Inc. ............... 281,952 0.1
</Table>
105
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES
(CONCLUDED)
SOFTWARE
(CONCLUDED)
6,600 +THQ Inc. ........................... $ 151,140 0.0%
8,200 +VERITAS Software Corporation........ 227,140 0.1
------------ -----
13,142,683 2.4
-----------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 18,300 Circuit City Stores--Circuit City
Group.............................. 236,985 0.0
38,900 The Home Depot, Inc. ................ 1,369,280 0.2
6,500 +Office Depot, Inc. ................. 116,415 0.0
59,200 +Toys 'R' Us, Inc. .................. 943,056 0.2
------------ -----
2,665,736 0.4
-----------------------------------------------------------------------------------------------------
TEXTILES, APPAREL & 98,900 +Unifi, Inc. ........................ 289,777 0.1
LUXURY GOODS
-----------------------------------------------------------------------------------------------------
THRIFTS & MORTGAGE 6,500 Washington Mutual, Inc. ............. 251,160 0.0
FINANCE
-----------------------------------------------------------------------------------------------------
TOBACCO 34,400 Altria Group, Inc. .................. 1,721,720 0.3
-----------------------------------------------------------------------------------------------------
WIRELESS 88,100 +AT&T Wireless Services, Inc. ....... 1,261,592 0.2
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE UNITED
STATES............................... 167,536,752 29.6
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN COMMON STOCKS
(COST--$260,263,965)................. 309,135,055 54.7
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
MUTUAL FUNDS
- ----------------------------------------------------------------------------------------------------------------------
VIETNAM 110,287 +Vietnam Enterprise Investments
Limited (Redeemable Shares)........ 143,373 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN MUTUAL FUNDS
(COST--$130,000)..................... 143,373 0.0
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
PREFERRED STOCKS
- ----------------------------------------------------------------------------------------------------------------------
AUSTRALIA COMMERCIAL BANKS 31,600 National Australia Bank Limited
(7.875% Convertible)............... 1,120,536 0.2
-----------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS IN
AUSTRALIA............................ 1,120,536 0.2
- ----------------------------------------------------------------------------------------------------------------------
BRAZIL METALS & MINING 564,500 Caemi Mineracao e Metalurgica SA..... 215,082 0.0
38,500 Usinas Siderurgicas de Minas Gerais
SA 'A'............................. 400,291 0.1
-----------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS IN BRAZIL..... 615,373 0.1
- ----------------------------------------------------------------------------------------------------------------------
CAYMAN ISLANDS INSURANCE 20,000 XL Capital Ltd. (6.50%
Convertible)....................... 507,800 0.1
-----------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS IN THE CAYMAN
ISLANDS.............................. 507,800 0.1
- ----------------------------------------------------------------------------------------------------------------------
GERMANY CHEMICALS 5,004 Henkel KGaA.......................... 427,264 0.1
-----------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS IN GERMANY.... 427,264 0.1
- ----------------------------------------------------------------------------------------------------------------------
UNITED DIVERSIFIED 9,829 McLeodUSA Incorporated (7%,
STATES TELECOMMUNICATION Convertible)(Series A)............. 25,565 0.0
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS IN THE UNITED
STATES............................... 25,565 0.0
-----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN PREFERRED STOCKS
(COST--$2,885,055)................... 2,696,538 0.5
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
WARRANTS(C)
- ----------------------------------------------------------------------------------------------------------------------
MALAYSIA OIL & GAS 101,940 Crest Petroleum Berhad............... 16,498 0.0
-----------------------------------------------------------------------------------------------------
TOTAL WARRANTS IN MALAYSIA........... 16,498 0.0
- ----------------------------------------------------------------------------------------------------------------------
</Table>
106
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY++ HELD WARRANTS(C) VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES DIVERSIFIED 795 AboveNet, Inc. ...................... $ 13,118 0.0%
TELECOMMUNICATION
SERVICES
936 AboveNet, Inc. ...................... 13,572 0.0
21,779 McLeodUSA Incorporated............... 2,831 0.0
------------ -----
29,521 0.0
-----------------------------------------------------------------------------------------------------
TOTAL WARRANTS IN THE UNITED
STATES............................. 29,521 0.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN WARRANTS
(COST--$229,064)..................... 46,019 0.0
- ----------------------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
RIGHTS
- -----------------------------------------------------------------------------------------------------------------------------
UNITED STATES COMMERCIAL 52,600 Information Resources, Inc.(f) ...... 154,118 0.0
SERVICES &
SUPPLIES
------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN RIGHTS
(COST--$88,368)...................... 154,118 0.0
- -----------------------------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
CURRENCY FACE
DENOMINATION AMOUNT FIXED INCOME SECURITIES
- -----------------------------------------------------------------------------------------------------------------------------
BRAZIL FOREIGN Federal Republic of Brazil:
GOVERNMENT
OBLIGATIONS
US$ 500,000 10.125% due 5/15/2027.............. 445,000 0.1
950,000 8.25% due 1/20/2034................ 718,675 0.1
725,000 11% due 8/17/2040.................. 683,313 0.1
------------ -----
1,846,988 0.3
------------------------------------------------------------------------------------------------------------
METALS & BRL 10,296 Companhia Vale do Rio Doce(g)........ 0 0.0
MINING
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
BRAZIL............................... 1,846,988 0.3
- -----------------------------------------------------------------------------------------------------------------------------
CANADA FOREIGN C$ 8,000,000 Canadian Government, 4.25% due
GOVERNMENT 12/01/2004......................... 6,016,632 1.1
OBLIGATIONS
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
CANADA............................... 6,016,632 1.1
- -----------------------------------------------------------------------------------------------------------------------------
CAYMAN ISLANDS DIVERSIFIED SMFG Finance (Cayman) Ltd.
FINANCIAL (Convertible):
SERVICES
Y 33,000,000 2.25% due 7/11/05(a)............... 722,815 0.1
18,000,000 2.25% due 7/11/05 (Regulation S)... 394,263 0.1
------------ -----
1,117,078 0.2
------------------------------------------------------------------------------------------------------------
INDUSTRIAL US$ 450,000 Hutchison Whampoa International Ltd.,
CONGLOMERATES 5.45% due 11/24/2010............... 438,419 0.1
------------------------------------------------------------------------------------------------------------
OIL & GAS 290,000 Momenta Cayman 2.50% due 8/01/2007
(Regulation S) (Convertible)....... 292,175 0.0
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN THE
CAYMAN ISLANDS....................... 1,847,672 0.3
- -----------------------------------------------------------------------------------------------------------------------------
EUROPE COMMERCIAL European Investment Bank:
BANKS
L 1,200,000 6% due 11/26/2004.................. 2,184,443 0.4
E 2,350,000 3.50% due 10/15/2005............... 2,893,349 0.5
L 3,750,000 6.125% due 12/07/2005.............. 6,911,277 1.2
E 3,900,000 4% due 1/15/2007................... 4,859,976 0.9
3,325,000 3.55% due 4/15/2008................ 4,059,496 0.7
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
EUROPE............................... 20,908,541 3.7
- -----------------------------------------------------------------------------------------------------------------------------
FRANCE CONTAINERS & US$ 950,000 Crown Euro Holdings SA,
PACKAGING 10.875% due 3/01/2013.............. 1,083,000 0.2
------------------------------------------------------------------------------------------------------------
</Table>
107
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CURRENCY FACE PERCENT OF
COUNTRY INDUSTRY++ DENOMINATION AMOUNT FIXED INCOME SECURITIES VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------------
FRANCE
(CONCLUDED)
REAL ESTATE E 426,860 Societe Fonciere Lyonnaise SA, 4% due
10/31/2004 (Convertible)........... $ 672,812 0.1%
------------------------------------------------------------------------------------------------------------
ROAD & RAIL L 450,000 Reseau Ferre de France,
6.625% due 3/29/2005............... 825,072 0.1
------------------------------------------------------------------------------------------------------------
SOFTWARE E Infogrames Entertainment SA
(Convertible):
460,200 1.50% due 7/01/2005................ 567,081 0.1
98,700 4% due 4/01/2009................... 85,774 0.0
------------ -----
649,317 0.1
------------------------------------------------------------------------------------------------------------
SPECIALTY 2,550,000 ERAP, 2.875% due 7/12/2006........... 3,110,493 0.6
RETAIL
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
FRANCE............................... 6,340,694 1.1
- -----------------------------------------------------------------------------------------------------------------------------
GERMANY COMMERCIAL Kreditanstalt fuer Wiederaufbau:
BANKS
L 2,250,000 4.125% due 6/07/2006............... 3,999,975 0.7
475,000 4.80% due 10/27/2006............... 850,645 0.1
E 2,550,000 3.125% due 11/15/2006.............. 3,117,958 0.6
------------ -----
7,968,578 1.4
------------------------------------------------------------------------------------------------------------
FOREIGN Bundesrepublic Deutschland:
GOVERNMENT 3,040,000 6.50% due 10/14/2005............... 3,883,680 0.7
OBLIGATIONS 9,980,000 5.25% due 1/04/2011................ 13,066,673 2.3
------------ -----
16,950,353 3.0
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
GERMANY.............................. 24,918,931 4.4
- -----------------------------------------------------------------------------------------------------------------------------
INDIA AUTOMOBILES US$ 500,000 Tata Engineering & Locomotive Company
Ltd., 1% due 7/31/2008
(Convertible)(a)................... 731,250 0.1
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
INDIA................................ 731,250 0.1
- -----------------------------------------------------------------------------------------------------------------------------
JAPAN COMMERCIAL Y 28,000,000 The Bank of Fukuoka, Ltd. 1.10% due
BANKS 9/28/2007 (Convertible)............ 363,785 0.1
91,000,000 The Bank of Kyoto, Ltd., 1.90% due
9/30/2009 (Convertible)............ 1,104,631 0.2
------------ -----
1,468,416 0.3
------------------------------------------------------------------------------------------------------------
REAL ESTATE US$ 1,250,000 Marco Polo Investment Holdings
Limited, 6.25% due 9/30/2007....... 1,437,500 0.3
------------------------------------------------------------------------------------------------------------
TRADING Y 85,000,000 Mitsubishi Corporation, 0% due
COMPANIES & 6/17/2011 (Convertible)(b)......... 849,104 0.1
DISTRIBUTORS
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
JAPAN................................ 3,755,020 0.7
- -----------------------------------------------------------------------------------------------------------------------------
LUXEMBOURG INDUSTRIAL Tyco International Group SA:
CONGLOMERATES US$ 415,000 5.875% due 11/01/2004.............. 419,837 0.1
E 175,000 4.375% due 11/19/2004.............. 213,978 0.0
US$ 358,000 2.75% due 1/15/2018
(Convertible)(a)................... 537,895 0.1
------------ -----
1,171,710 0.2
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
LUXEMBOURG........................... 1,171,710 0.2
- -----------------------------------------------------------------------------------------------------------------------------
MEXICO OIL & GAS L 310,000 Petroleos Mexicanos, 14.50% due
3/31/2006.......................... 636,393 0.1
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
MEXICO............................... 636,393 0.1
- -----------------------------------------------------------------------------------------------------------------------------
</Table>
108
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CURRENCY FACE PERCENT OF
COUNTRY INDUSTRY++ DENOMINATION AMOUNT FIXED INCOME SECURITIES VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------------
NETHERLANDS ELECTRICAL E 1,450,000 Infineon Technology Holdings, 4.25%
EQUIPMENT due 2/06/2007 (Convertible)........ $ 1,734,505 0.3%
------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS 825,000 Royal Numico NV, 4.25% due 6/26/2005
(Regulation S) (Convertible)....... 1,013,774 0.2
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN THE
NETHERLANDS.......................... 2,748,279 0.5
- -----------------------------------------------------------------------------------------------------------------------------
SWEDEN FOREIGN GOV- SEK 10,725,000 Swedish Government Index Linked
ERNMENT Notes, 4% due 12/01/2008........... 1,754,054 0.3
OBLIGATIONS
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN
SWEDEN............................... 1,754,054 0.3
- -----------------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM DIVERSIFIED Colt Telecom Group PLC:
TELECOMMU-
NICATION
SERVICES
DEM 2,765,000 2% due 8/06/2005................... 1,943,610 0.3
E 1,250,000 2% due 3/29/2006................... 1,657,686 0.3
250,000 2% due 12/16/2006 (Regulation S)
(Convertible)...................... 343,704 0.1
450,000 2% due 4/03/2007 (Regulation S)
(Convertible)...................... 624,142 0.1
------------ -----
4,569,142 0.8
------------------------------------------------------------------------------------------------------------
INSURANCE US$ 300,000 Swiss Life Finance, 2% due 5/20/2005
(Convertible)...................... 336,000 0.1
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN THE
UNITED KINGDOM....................... 4,905,142 0.9
- -----------------------------------------------------------------------------------------------------------------------------
UNITED STATES AEROSPACE & 230,000 GenCorp Inc., 5.75% due 4/15/2007
DEFENSE (Convertible)...................... 242,650 0.0
------------------------------------------------------------------------------------------------------------
AIRLINES 389,111 Northwest Airlines, Inc.,
9.485% due 4/01/2015............... 271,813 0.0
------------------------------------------------------------------------------------------------------------
BIOTECHNOLOGY 825,000 Abgenix, Inc., 3.50% due 3/15/2007
(Convertible)...................... 766,219 0.1
------------------------------------------------------------------------------------------------------------
COMMUNI- 500,000 Corning Incorporated,
CATIONS 7% due 3/15/2007................... 500,000 0.1
EQUIPMENT
380,000 Lucent Technologies Inc., 8% due
8/01/2031 (Convertible)............ 426,550 0.1
------------ -----
926,550 0.2
------------------------------------------------------------------------------------------------------------
CONSTRUCTION & Foster Wheeler Ltd.:
ENGINEERING
2,265,000 6.75% due 11/15/2005............... 2,072,475 0.4
2,800,000 6.50% due 6/01/2007 (Convertible).. 1,960,000 0.3
950,000 6.50% due 6/01/2007
(Convertible)(a)................... 665,000 0.1
974,000 J. Ray McDermott, S.A.,
11% due 12/15/2013(a).............. 939,910 0.2
250,000 McDermott Inc.,
7.84% due 4/04/2005................ 252,500 0.0
------------ -----
5,889,885 1.0
------------------------------------------------------------------------------------------------------------
CONTAINERS & 560,000 Anchor Glass Container Corporation,
PACKAGING 11% due 2/15/2013.................. 640,500 0.1
560,000 Crown Cork & Seal Company, Inc.,
7.50% due 12/15/2096............... 442,400 0.1
------------ -----
1,082,900 0.2
------------------------------------------------------------------------------------------------------------
DIVERSIFIED 1,960,000 AboveNet, Inc., Term,
TELECOMMUNICATION 11% due 9/30/2008(j)............... 1,906,100 0.3
SERVICES
690,000 Level 3 Communications, Inc.,
9.125% due 5/01/2008............... 546,825 0.1
MCI, Inc.:
861,000 5.908% due 5/01/2007............... 835,170 0.2
861,000 6.688% due 5/01/2009............... 796,425 0.1
739,000 7.735% due 5/01/2014............... 661,405 0.1
------------ -----
4,745,925 0.8
------------------------------------------------------------------------------------------------------------
</Table>
109
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CURRENCY FACE PERCENT OF
COUNTRY INDUSTRY++ DENOMINATION AMOUNT FIXED INCOME SECURITIES VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------------
UNITED STATES
(CONCLUDED)
ELECTRIC US$ 4,730,193 Empresa Electrica del Norte Grande SA
UTILITIES (EDELNOR),
4% due 11/05/2017(b)............... $ 3,665,900 0.7%
------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS 775,000 Burns Philp Capital Property Ltd.,
10.75% due 2/15/2011............... 825,375 0.1
------------------------------------------------------------------------------------------------------------
HEALTH CARE 400,000 Beverly Enterprises, Inc.,
PROVIDERS & 7.875% due 6/15/2014............... 393,500 0.1
SERVICES
------------------------------------------------------------------------------------------------------------
INSURANCE 250,000 Crum & Forster Holdings Corp.,
10.375% due 6/15/2013.............. 272,500 0.1
------------------------------------------------------------------------------------------------------------
MEDIA 296,199 Avalon Cable LLC,
11.875% due 12/01/2008............. 313,971 0.1
------------------------------------------------------------------------------------------------------------
MULTI- L 213,000 The AES Corporation,
UTILITIES & 8.375% due 3/01/2011............... 366,962 0.1
UNREGULATED
POWER
Calpine Corporation:
US$ 625,000 7.625% due 4/15/2006............... 550,000 0.1
150,000 7.875% due 4/01/2008............... 97,500 0.0
500,000 8.75% due 7/15/2013(a)............. 410,000 0.1
Calpine Generating Company LLC(a)(h):
1,800,000 5% due 4/01/2009................... 1,795,500 0.3
1,000,000 7% due 4/01/2010................... 955,000 0.2
500,000 Gemstone Investors Limited,
7.71% due 10/31/2004(a)............ 503,750 0.1
------------ -----
4,678,712 0.9
------------------------------------------------------------------------------------------------------------
OIL & GAS 265,000 CITGO Petroleum Corporation, 11.375%
due 2/01/2011...................... 307,400 0.0
------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 260,000 Valeant Pharmaceuticals
International, 6.50% due 7/15/2008
(Convertible)...................... 268,775 0.1
------------------------------------------------------------------------------------------------------------
SEMICONDUC- 625,000 LSI Logic Corporation, 4% due
TORS & SEMI- 11/01/2006 (Convertible)........... 610,938 0.1
CONDUCTOR
EQUIPMENT
------------------------------------------------------------------------------------------------------------
SOFTWARE 325,000 Computer Associates International,
Inc., 5% due 3/15/2007
(Convertible)(a)................... 401,375 0.1
------------------------------------------------------------------------------------------------------------
TEXTILES, 641,859 Galey & Lord, Inc., Term,
APPAREL & due 9/05/2009 (j).................. 308,092 0.1
LUXURY GOODS
------------------------------------------------------------------------------------------------------------
WIRELESS 800,000 Nextel Communications, Inc., 5.25%
TELECOMMUNICATION due 1/15/2010 (Convertible)........ 778,000 0.1
SERVICES
------------------------------------------------------------------------------------------------------------
TOTAL FIXED INCOME SECURITIES IN THE
UNITED STATES........................ 26,750,480 4.8
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN FIXED INCOME
SECURITIES (COST--$93,894,152)....... 104,331,786 18.5
- -----------------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL
INTEREST OTHER INTERESTS(I)
- -----------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED US$ 1,400,000 AboveNet, Inc. (Litigation Trust
TELECOMMU- Certificates)...................... 0 0.0
NICATION
SERVICES
2,577,870 WilTel Communications Group, Inc.
(Litigation Trust Certificates).... 0 0.0
------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN OTHER INTERESTS
(COST--$0)........................... 0 0.0
- -----------------------------------------------------------------------------------------------------------------------------
</Table>
110
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CURRENCY FACE PERCENT OF
DENOMINATION AMOUNT U.S. GOVERNMENT OBLIGATIONS VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------------
US$ 1,250,000 U.S. Treasury Notes,
4% due 6/15/2009................... $ 1,260,694 0.2%
4,625,000 U.S. Treasury Notes,
4.75% due 5/15/2014................ 4,673,265 0.8
------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN U.S. GOVERNMENT
OBLIGATIONS (COST--$5,875,832)....... 5,933,959 1.0
- -----------------------------------------------------------------------------------------------------------------------------
<Caption>
COUNTRY INDUSTRY++ SHORT-TERM SECURITIES
- -----------------------------------------------------------------------------------------------------------------------------
AUSTRALIA FOREIGN A$ 1,900,000 CUTLASS Securitisation Limited,
COMMERCIAL 5.37% due 7/09/2004................ 1,322,010 0.2
PAPER***
------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS IN
AUSTRALIA............................ 1,322,010 0.2
- -----------------------------------------------------------------------------------------------------------------------------
DENMARK TIME DEPOSITS Danish Time Deposit:
DKK 3,398,363 2.07% due 7/02/2004................ 556,265 0.1
2,500,000 2.06% due 7/09/2004................ 409,216 0.1
2,542,731 2.06% due 7/16/2004................ 416,210 0.1
------------ -----
1,381,691 0.3
------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS IN
DENMARK.............................. 1,381,691 0.3
- -----------------------------------------------------------------------------------------------------------------------------
JAPAN TIME DEPOSITS Japanese Time Deposit:
Y 138,550,307 0.001% due 7/02/2004............... 1,269,764 0.2
138,550,333 0.001% due 7/16/2004............... 1,269,764 0.2
------------ -----
2,539,528 0.4
------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS IN
JAPAN................................ 2,539,528 0.4
- -----------------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL
INTEREST
- -----------------------------------------------------------------------------------------------------------------------------
UNITED STATES US$ 131,659,083 Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I(d)............. 131,659,083 23.3
285,000 Merrill Lynch Liquidity Series, LLC
Money Market Series(d)(e).......... 285,000 0.1
------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM INVESTMENTS IN
UNITED STATES........................ 131,944,083 23.4
------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SHORT-TERM
SECURITIES (COST--$137,172,733)...... 137,187,312 24.3
------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$500,539,169)................. 559,628,160 99.0
- -----------------------------------------------------------------------------------------------------------------------------
<Caption>
NUMBER OF
CONTRACTS OPTIONS CALL OPTIONS WRITTEN
- -----------------------------------------------------------------------------------------------------------------------------
183 Circuit City Stores--Circuit City
Group, expiring January 2005 at
USD 12.5, Broker Morgan Stanley.... (34,770) 0.0
97 Converse Technology, Inc., expiring
October 2004 at USD 22.5, Broker
UBS Warburg........................ (5,335) 0.0
Lucent Technologies Inc.:
271 expiring January 2005 at USD 5,
Broker Citigroup Global Markets.... (7,083) 0.0
292 expiring January 2005 at USD 5,
Broker Credit Suisse First
Boston............................. (4,177) 0.0
131 Maytag Corporation, expiring January
2005 at USD 25, Broker Credit
Suisse First Boston................ (23,580) 0.0
</Table>
111
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
NUMBER OF PERCENT OF
OPTIONS CONTRACTS CALL OPTIONS WRITTEN VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------------------
McDermott International, Inc.:
55 expiring November 2004 at USD 7.5,
Broker Citigroup Global Markets.... $ (19,800) 0.0%
230 expiring November 2004 at USD 10,
Broker Citigroup Global Markets.... (44,850) 0.0
87 expiring February 2005 at USD 12.5,
Broker Citigroup Global Markets.... (12,180) 0.0
131 Nokia Oyj (ADR), expiring January
2005 at USD 15, Broker Morgan
Stanley............................ (17,030) 0.0
Nortel Networks Corporation:
1,354 expiring September 2004 at USD 4,
Broker Citigroup Global Markets.... (162,480) 0.0
1,100 expiring January 2005 at USD 5,
Broker UBS Warburg................. (99,000) 0.0
1,309 expiring January 2006 at USD 2.5,
Broker UBS Warburg................. (398,634) 0.1
656 expiring January 2006 at USD 2.5,
Broker Morgan Stanley.............. (190,866) 0.1
150 Quanta Services, Inc., expiring
August 2004 at USD 7.5, Broker
Morgan Stanley..................... (2,250) 0.0
66 THQ Inc., expiring September 2004 at
USD 20, Broker UBS Warburg......... (23,100) 0.0
259 Tenet Healthcare Corporation, expir-
ing January 2005 at USD 10, Broker
Morgan Stanley..................... (108,780) 0.0
66 Toys 'R' Us, Inc., expiring January
2005 at USD 15, Broker Morgan
Stanley............................ (17,820) 0.0
124 Tyson Foods, Inc. (Class A), expiring
January 2005 at USD 17.5, Broker
Morgan Stanley..................... (50,840) 0.0
25 webMethods, Inc., expiring October
2004 at USD 7.5, Broker UBS
Warburg............................ (4,125) 0.0
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL CALL OPTIONS WRITTEN
(PREMIUMS RECEIVED--$843,383)........ (1,226,700) 0.2
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS, NET OF OPTIONS
WRITTEN (COST--$499,695,786)......... 558,401,460 98.8
OTHER ASSETS LESS LIABILITIES........ 6,626,580 1.2
------------ -----
NET ASSETS........................... $565,028,040 100.0%
============ =====
- -----------------------------------------------------------------------------------------------------------------------------
</Table>
112
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
* American Depositary Receipts (ADR).
** Global Depositary Receipts (GDR).
*** Foreign Commercial Paper is traded on a discount basis; the interest rates
shown reflect the discount rates paid at the time of purchase by the Fund.
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management.
This definition may not apply for purposes of this report, which may
combine such industry sub-classifications for reporting ease.
(a) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(b)Represents a zero coupon or step bond; the interest rate shown reflects the
effective yield at the time of purchase of the Fund.
(c) 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.
(d)Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------
NET INTEREST/DIVIDEND
AFFILIATE ACTIVITY INCOME
- -----------------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $ 55,461,077 $685,106
Merrill Lynch Liquidity Series, LLC Money Market Series..... $ (61,238) $ 2,203
Merrill Lynch Premier Institutional Fund.................... (115,412) $ 687
- -----------------------------------------------------------------------------------------------
</Table>
(e) Security was purchased with the cash proceeds from securities loans.
(f) The rights entitle the holder to cash distributions on future litigation
settlements. .
(g) Received through a bonus issue from Companhia Vale do Rio Doce. As of June
30, 2004, the bonds have not commenced trading and the coupon rate has not
been determined. This security is a perpetual bond and has no definite
maturity date.
(h) Floating rate note.
(i) Other interests represent beneficial interest in liquidation trusts and
other reorganization entities and are non-income producing.
(j) Floating rate corporate debt in which the Fund invests generally pays
interest at rates that are periodically redetermined by reference to a base
lending rate plus a premium. These base lending rates are generally (i) the
lending rate offered by one or more major European banks, such as LIBOR
(London InterBank Offered Rate), (ii) the prime rate offered by one or more
major U.S. banks, or (iii)the certificate of deposit rate. Corporate bond
loans represent .1% of the Fund's net assets.
(k) All or a portion of security held as collateral in connection with open
financial futures contracts.
Financial futures contracts purchased as of June 30, 2004 were as follows:
<Table>
<Caption>
- --------------------------------------------------------------------------------------------------------------
NUMBER OF FACE UNREALIZED
CONTRACTS ISSUE EXCHANGE EXPIRATION DATE VALUE APPRECIATION/DEPRECIATION
- --------------------------------------------------------------------------------------------------------------
31 FTSE LIFFE Sept. 2004 $ 2,531,328 $(17,799)
131 Nikkei 225 Index OSAKA Sept. 2004 13,799,599 475,157
17 S&P 500 Index Chicago Mercantile Sept. 2004 4,818,076 28,624
32 Topix Index Tokyo Sept. 2004 3,393,148 98,214
- --------------------------------------------------------------------------------------------------------------
TOTAL UNREALIZED APPRECIATION/DEPRECIATION--NET $584,196
========
- --------------------------------------------------------------------------------------------------------------
</Table>
Financial futures contracts sold as of June 30, 2004 were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------------------------------
NUMBER OF FACE UNREALIZED
CONTRACTS ISSUE EXCHANGE EXPIRATION DATE VALUE DEPRECIATION
- ------------------------------------------------------------------------------------------
7 DJ Euro Stoxx 50 Euronext Paris September 2004 $238,014 $(1,897)
- ------------------------------------------------------------------------------------------
</Table>
113
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
Forward foreign exchange contracts as of June 30, 2004 were as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------------
FOREIGN CURRENCY SETTLEMENT UNREALIZED
SOLD DATE DEPRECIATION
- ----------------------------------------------------------------------------
E 3,360,000 July 2004 $(26,060)
- ----------------------------------------------------------------------------
TOTAL UNREALIZED DEPRECIATION ON FORWARD FOREIGN
EXCHANGE CONTRACT (US$ COMMITMENT--$4,060,607) $(26,060)
========
- ----------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
114
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (including
securities loaned of $272,700) (identified
cost--$368,595,086)....................................... $427,684,077
Investments in affiliated securities, at value (identified
cost--$131,944,083)....................................... 131,944,083
Cash........................................................ 2,107,135
Foreign cash (cost--$4,757,627)............................. 4,721,377
Receivables:
Securities sold........................................... $ 2,059,845
Interest (including $126,096 from affiliates)............. 2,016,013
Dividends................................................. 590,507
Variation margin.......................................... 59,401
Capital shares sold....................................... 12,125
Options written........................................... 11,266
Securities lending--net................................... 213 4,749,370
------------
Prepaid expenses and other assets........................... 108,760
------------
Total assets................................................ 571,314,802
------------
- -------------------------------------------------------------------------------------------
LIABILITIES:
Collateral on securities loaned, at value................... 285,000
Options written, at value (premiums received--$843,383)..... 1,226,700
Unrealized depreciation on forward foreign exchange
contracts................................................. 26,060
Payables:
Securities purchased...................................... 4,536,458
Capital shares redeemed................................... 59,268
Investment adviser........................................ 49,982
Other affiliates.......................................... 6,414
Distributor............................................... 730 4,652,852
------------
Accrued expenses and other liabilities...................... 96,150
------------
Total liabilities........................................... 6,286,762
------------
- -------------------------------------------------------------------------------------------
NET ASSETS.................................................. $565,028,040
============
- -------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 200,000,000
shares authorized......................................... $ 4,804,535
Class II Shares of Common Stock, $.10 par value, 200,000,000
shares authorized......................................... 14,811
Class III Shares of Common Stock, $.10 par value,
200,000,000 shares authorized............................. 23,567
Paid-in capital in excess of par............................ 588,660,085
Undistributed investment income............................. $ 1,706,175
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (89,338,333)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 59,157,200
------------
Total accumulated losses--net............................... (28,474,958)
------------
NET ASSETS.................................................. $565,028,040
============
- -------------------------------------------------------------------------------------------
NET ASSET VALUE:
Class I--Based on net assets of $560,755,652 and 48,045,352
shares outstanding........................................ $ 11.67
============
Class II--Based on net assets of $1,727,357 and 148,113
shares outstanding........................................ $ 11.66
============
Class III--Based on net assets of $2,545,031 and 235,672
shares outstanding........................................ $ 10.80
============
- -------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
115
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Interest ($685,106 from affiliates)......................... $ 4,018,805
Dividends (net of $248,550 foreign withholding tax)......... 3,223,989
Securities lending--net..................................... 2,890
------------
Total income................................................ 7,245,684
------------
- -------------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $ 1,755,424
Custodian fees.............................................. 107,991
Accounting services......................................... 90,157
Professional fees........................................... 27,097
Printing and shareholder reports............................ 21,092
Directors' fees and expenses................................ 14,909
Pricing services............................................ 10,209
Transfer agent fees--Class I................................ 2,252
Distribution Fees--Class II................................. 1,359
Distribution Fees--Class III................................ 1,209
Transfer fees--Class II..................................... 8
Transfer fees--Class III.................................... 4
Other....................................................... 16,557
------------
Total expenses.............................................. 2,048,268
------------
Investment income--net...................................... 5,197,416
------------
- -------------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain on:
Investments--net.......................................... 19,747,794
Foreign currency transactions--net........................ 7,639,641 27,387,435
------------
Change in unrealized appreciation/depreciation on:
Investments--net (net of $63,671 deferred foreign capital
gain tax)............................................... (15,272,895)
Foreign currency transactions--net........................ (3,972) (15,276,867)
------------ ------------
Total realized and unrealized gain on investments and
foreign currency transactions--net........................ 12,110,568
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 17,307,984
============
- -------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
116
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE IN NET ASSETS: 2004 2003
- ------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 5,197,416 $ 8,489,415
Realized gain on investments and foreign currency
transactions--net......................................... 27,387,435 1,796,489
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (15,276,867) 110,654,715
------------ ------------
Net increase in net assets resulting from operations........ 17,307,984 120,940,619
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... -- (13,448,103)
Class II.................................................. -- (46,657)
Class III................................................. -- (871)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. -- (13,495,631)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share
transactions.............................................. 38,213,118 52,548,174
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 55,521,102 159,993,162
Beginning of period......................................... 509,506,938 349,513,776
------------ ------------
End of period*.............................................. $565,028,040 $509,506,938
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess of)
investment income--net.................................... $ 1,706,175 $ (3,491,241)
============ ============
- ------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
117
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,++
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 11.29 $ 8.62 $ 9.74 $ 10.85 $ 14.13
-------- -------- -------- -------- --------
Investment income--net***............................. .11 .21 .26 .24 .27
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net.................. .27 2.77 (1.05) (1.20) (1.62)
-------- -------- -------- -------- --------
Total from investment operations...................... .38 2.98 (.79) (.96) (1.35)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.............................. -- (.31) (.33) (.15) (.24)
In excess of investment income--net................. -- -- -- -- (.06)
Realized gain on investments--net................... -- -- -- -- (1.20)
In excess of realized gain on investments--net...... -- -- -- -- (.43)
-------- -------- -------- -------- --------
Total dividends and distributions..................... -- (.31) (.33) (.15) (1.93)
-------- -------- -------- -------- --------
Net asset value, end of period........................ $ 11.67 $ 11.29 $ 8.62 $ 9.74 $ 10.85
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................... 3.37%+ 34.57% (8.15%) (8.86%) (9.62%)
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................. .76%* .75% .77% .75% .73%
======== ======== ======== ======== ========
Investment income--net................................ 1.92%* 2.16% 2.77% 2.42% 2.03%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).............. $560,756 $507,674 $349,514 $424,542 $552,853
======== ======== ======== ======== ========
Portfolio turnover.................................... 26.44% 47.41% 55.50% 107.28% 118.64%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Aggregate total investment return.
++ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
See Notes to Financial Statements.
118
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
FINANCIAL HIGHLIGHTS (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS II
----------------------------------
FOR THE SIX FOR THE PERIOD
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED MONTHS ENDED NOVEMBER 24, 2003+
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. JUNE 30, TO DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003
- ------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 11.29 $ 10.73
------- -------
Investment income--net***................................... .10 .01
Realized and unrealized gain on investments and foreign
currency
transactions--net......................................... .27 .85
------- -------
Total from investment operations............................ .37 .86
------- -------
Less dividends on investment income--net.................... -- (.30)
------- -------
Net asset value, end of period.............................. $ 11.66 $ 11.29
======= =======
- ------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... 3.28%++ 8.05%++
======= =======
- ------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... .90%* .95%*
======= =======
Investment income--net...................................... 1.76%* .87%*
======= =======
- ------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 1,727 $ 1,797
======= =======
Portfolio turnover.......................................... 26.44% 47.41%
======= =======
- ------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Commencement of operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
119
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS III
----------------------------------
FOR THE SIX FOR THE PERIOD
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED MONTHS ENDED NOVEMBER 18, 2003+
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. JUNE 30, TO DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003
- ------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 10.46 $ 10.00
------- -------
Investment income (loss)--net***............................ .08 --++++
Realized and unrealized gain on investments and foreign
currency transactions--net................................ .26 .76
------- -------
Total from investment operations............................ .34 .76
------- -------
Less dividends on investment income--net.................... -- (.30)
------- -------
Net asset value, end of period.............................. $ 10.80 $ 10.46
======= =======
- ------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... 3.25%++ 7.62%++
======= =======
- ------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... 1.01%* 1.08%*
======= =======
Investment income (loss)--net............................... 1.65%* (.24%)*
======= =======
- ------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 2,545 $ 37
======= =======
Portfolio turnover.......................................... 26.44% 47.41%
======= =======
- ------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Commencement of operations.
++ Aggregate total investment return.
++++ Amount is less than $(.01) per share.
See Notes to Financial Statements.
120
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL ALLOCATION V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Global
Allocation V.I. Fund (the "Fund") is classified as "non-diversified," as defined
in the Investment Company Act of 1940, as amended. Class I Shares, Class II
Shares and Class III Shares have equal voting, dividend, liquidation and other
rights, except that only shares of the respective classes are entitled to vote
on matters concerning only that class. In addition, Class II Shares and Class
III Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
121
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- - Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- - Options--The Fund may write 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.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- - Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-U.S. dollar-denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) 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 and liabilities expressed in
foreign currencies into U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Dividends from foreign securities where the ex-dividend date may have passed are
subsequently recorded when the Fund has determined the ex-dividend date.
Interest income is recognized on the accrual basis. The Fund amortizes all
premiums and discounts on debt securities.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be
122
- --------------------------------------------------------------------------------
maintained at all times in an amount equal to at least 100% of the current
market value of the loaned securities. The market value of the loaned securities
is determined at the close of business of the Fund and any additional required
collateral is delivered to the Fund on the next business day. Where the Fund
receives securities as collateral for the loaned securities, it collects a fee
from the borrower. The Fund typically receives the income on the loaned
securities but does not receive the income on the collateral. Where the Fund
receives cash collateral, it may invest such collateral and retain the amount
earned on such investment, net of any amount rebated to the borrower. Loans of
securities are terminable at any time and the borrower, after notice, is
required to return borrowed securities within five business days. The Fund may
pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
(h) Expenses--Certain expenses have been allocated to the individual Funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the fund. For such services, the Fund pays a monthly fee at
the annual rate of .65% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Fund. There is no increase in the aggregate fees paid by the Fund for these
services.
Pursuant to the Distribution Plans adopted by the Company, in accordance with
Rule 12b-1 under the Investment Fund Act of 1940, the Fund pays the Distributor
an ongoing distribution fee each month at the annual rate of .15% of the average
daily value of the Fund's Class II net assets and .25% of the average daily
value of the Fund's Class III net assets.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $1,239 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, MLPF&S earned $24,773 in commissions
on the execution of portfolio security transactions.
In addition, the Fund reimbursed MLIM $5,458 for certain accounting services
for the six months ended June 30, 2004.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $110,427,656 and $113,978,627, respectively.
Net realized gains (losses) for the six months ended June 30, 2004 and net
unrealized appre-
123
- --------------------------------------------------------------------------------
ciation/depreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- --------------------------------------------------------------------
Realized Unrealized
Gains/ Appreciation/
Losses Depreciation
- --------------------------------------------------------------------
Long-term investments.................. $16,815,231 $59,074,412
Short-term investments................. -- 14,579
Options written........................ 71,810 (383,317)
Financial futures contracts............ 2,860,753 582,299
Deferred foreign capital gain tax...... -- (63,671)
Forward foreign exchange contracts..... (479,791) (26,060)
Foreign currency transactions.......... 8,119,432 (41,042)
----------- -----------
Total.................................. $27,387,435 $59,157,200
=========== ===========
- --------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $55,584,706, of which $73,709,177 related to appreciated securities
and $18,124,471 related to depreciated securities. At June 30, 2004, the
aggregate cost of investments, net of options written for federal income tax
purposes was $502,816,754.
Transactions in options written for the six months ended June 30, 2004 were as
follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Number
of Premiums
Call Options Written Contracts Received
- -------------------------------------------------------------------
Outstanding call options written,
beginning of year........................ 1,619 $ 262,718
Options written........................... 6,586 843,383
Options expired........................... (662) (107,631)
Options exercised......................... (487) (86,145)
Options closed............................ (470) (68,942)
----- ---------
Outstanding call options written, end of
year..................................... 6,586 $ 843,383
===== =========
- -------------------------------------------------------------------
</Table>
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions was
$38,213,118 and $52,548,174 for the six months ended June 30, 2004 and for the
year ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -------------------------------------------------------------------
Shares sold........................... 4,148,520 $ 48,116,523
Shares redeemed....................... (1,068,928) (12,244,636)
---------- ------------
Net increase.......................... 3,079,592 $ 35,871,887
========== ============
- -------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold.......................... 2,877,951 $ 29,936,117
Shares issued resulting from
reorganization...................... 3,065,898 32,889,845
Shares issued to shareholders in
reinvestment of dividends........... 1,198,707 13,448,103
---------- ------------
Total issued......................... 7,142,556 76,274,065
Shares redeemed...................... (2,713,738) (25,470,442)
---------- ------------
Net increase......................... 4,428,818 $ 50,803,623
========== ============
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class II Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -----------------------------------------------------------------
Shares sold................................ 5,656 $ 66,081
Shares redeemed............................ (16,687) (191,528)
------- ---------
Net decrease............................... (11,031) $(125,447)
======= =========
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class II Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold............................... 2 $ 18
Shares issued resulting from
reorganization........................... 157,666 1,691,394
Shares issued to shareholders in
reinvestment of dividends................ 4,140 46,657
------- ----------
Total issued.............................. 161,808 1,738,069
Shares redeemed........................... (2,664) (29,968)
------- ----------
Net increase.............................. 159,144 $1,708,101
======= ==========
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class III Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -----------------------------------------------------------------
Shares sold............................... 238,523 $2,534,513
Shares redeemed........................... (6,347) (67,835)
------- ----------
Net increase.............................. 232,176 $2,466,678
======= ==========
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- ------------------------------------------------------------------
Class III Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- ------------------------------------------------------------------
Shares sold.................................... 3,414 $35,589
Shares issued to shareholders in reinvestment
of dividends.................................. 83 871
----- -------
Total issued................................... 3,497 36,460
Shares redeemed................................ (1) (10)
----- -------
Net increase................................... 3,496 $36,450
===== =======
- ------------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
124
- --------------------------------------------------------------------------------
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$114,728,724, of which $26,493,279 expires in 2005, $3,974,688 expires in 2006,
$9,930,235 expires in 2008, $39,451,861 expires in 2009, $24,405,402 expires in
2010 and $10,473,259 expires in 2011. This amount will be available to offset
like amounts of any future taxable gains.
125
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the six-month period ended June 30, 2004, Global Growth V.I. Fund's Class
I Shares had a total return of +.35%. This compared to a return of +3.52% for
the Fund's benchmark, the Morgan Stanley Capital International (MSCI) World
Index.
The unfavorable performance comparison is due to declines in the stock markets
of China, Australia, Japan, Canada, South Korea, Russia, Sweden, France and
Denmark, where the Fund had meaningful investments. In particular, we were
focused on companies that could benefit from a continued rise in real economic
growth over both the intermediate-term and the long-term from a continued
expansion of the Chinese economy. During the second quarter of 2004, the Chinese
government reduced the availability of commercial and consumer credit in order
to curtail the dramatic rate of real growth in the nation's economy. This had a
negative impact on the stock markets of China and its trading partners.
The first half of 2004 has mirrored the first half of 2003 in some respects.
In the first half of 2004, we have had to contend with the negative effects of
the Chinese government's efforts to restrain economic growth and the modest
impact of the bird flu outbreak in Asia. In the first half of 2003, we witnessed
the negative economic impact associated with the outbreak of Severe Acute
Respiratory Syndrome. During the second half of 2003, we saw a major resurgence
of real economic growth in Asia motivated by the continued real growth policies
of the Chinese government. We believe we could see a similar resumption of real
growth rates and stock market strength during the remainder of 2004.
Similarly, as in the first half of 2003, Fund performance lagged that of its
benchmark because of our focus on the largest of the large-capitalization growth
companies, which significantly underperformed the smaller companies in the
large-capitalization sector. Since the Fund is positioned to benefit from a
continued uptrend in real economic growth in China, comparative investment
results during the first half of 2004 have not been as attractive as a more
diversified portfolio.
We believe the Chinese government has relaxed its economic growth restraints
somewhat. Furthermore, we anticipate that the Chinese government will, over the
long run, continue to foster policies that will allow the Chinese economy to
grow at the fastest rate among the five or six largest economies in the world.
If this scenario plays out, we would expect the market valuations of the stocks
in the Fund to recover and continue to appreciate. In our view, the absolute and
relative performance of the Fund's holdings in June started to reflect
investors' beliefs that the period of restraint by the Chinese authorities was
passing.
The most attractive overall investment returns during the period came from
stock holdings in the United States, Norwegian and German stock markets. In
terms of industry sectors, consumer discretionary has been the most important,
with positive investment returns from eBay Inc., Porsche AG, Mandalay Resort
Group, PETsMart, Inc., Esprit Holdings Ltd., Chico's FAS, Inc. and Station
Casinos, Inc. In the health care sector, the positive contributors were Alcon,
Inc., Gilead Sciences, Inc. and Varian Medical Systems, Inc. Holdings in the
industrials, materials and information technology industries had the most
negative absolute and relative effect on performance during the period.
PORTFOLIO ACTIVITY
We have a strategic focus rather than a short-term trading strategy. However,
we have taken meaningful profits in stock holdings in the energy, materials,
information technology and industrial sectors, where valuations were at
relatively high levels.
We also reduced our overweighting in the consumer discretionary sector during
the past six months. We trimmed our holding in Lowe's Companies, Inc. as a
result of a relatively high valuation and, after a relatively short investment
period, we sold Mandalay Resort when MGM Mirage, Inc. announced an agreement to
purchase the casino company. The Fund realized a modest profit from Ross Stores,
Inc., which we liquidated when it appeared to us that its management was not
doing an effective job of transitioning to a new inventory-management system. In
addition, the Fund realized a substantial capital gain on its investment in eBay
Inc., which we reduced as a result of its relatively high valuation. Finally, we
liquidated our position in Australia-based Woolworths Limited when it appeared
an adverse change in the competitive retail environment was imminent. As a
result of these reductions and sales, the Fund's weighting in the consumer
discretionary sector declined from more than 20% of net assets at year-end 2003
to just over 16% of net assets on June 30, 2004.
126
- --------------------------------------------------------------------------------
We also reduced our position in the energy sector from slightly more than 15%
of net assets at year-end 2003 to just over 12% at the end of June 2004. We took
profits through reductions in U.K.-based BG Group PLC, Canada's Suncor Energy,
Inc. and Australia's Woodside Petroleum Limited. The Fund realized a capital
loss on its investment in YUKOS, the largest Russian energy company.
The industrial sector of the Fund was increased during the period from more
than 15% of net assets to over 20%. In the area of heavy-duty truck
manufacturing, Cummins Inc. and PACCAR Inc. were added to the portfolio. In
addition, the information technology sector was increased from almost 18% of net
assets at year-end 2003 to about 22% on June 30, 2004. This largely reflected
the re-introduction of Microsoft Corporation to the portfolio after we had
liquidated the position in late March 2003 based on concerns about the
competitive threat from Linux operating systems and applications. Our outlook
for Microsoft has again turned positive.
IN CONCLUSION
Overall, our investment strategy has not changed. We continue to seek to take
advantage of the potential above-average growth of the Chinese economy in this
decade. We did not change our strategy during the first half of 2003 when the
Fund underperformed its benchmark, nor have we changed our strategy during the
first half of 2004. We are committed to our long-run strategic perspective on
the stock investments in the Fund, and avoiding reaction to short-term
developments.
We appreciate your investment in Global Growth V.I. Fund of Merrill Lynch
Variable Series Funds, Inc., and we look forward to serving your future
investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Lawrence R. Fuller
Lawrence R. Fuller
Vice President and Portfolio Manager
July 12, 2004
127
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +25.44%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 - 3.63
- --------------------------------------------------------------------------
Inception (6/05/98) through 6/30/04 - 0.83
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +0.35% +25.44%
- -----------------------------------------------------------------------------------------
MSCI World Index** +3.52 +24.00
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset values for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
** This unmanaged market-capitalization weighted Index is comprised of a
representative sampling of large-, medium- and small-capitalization
companies in 23 countries, including the United States.
Past results shown should not be considered a representation of future
performance.
128
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
NORTH SHARES PERCENT OF
AMERICA INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
CANADA METALS & MINING 60,700 Barrick Gold Corporation.............. $ 1,203,361 1.2%
31,700 Teck Cominco Limited 'B'.............. 567,444 0.6
----------- ----------
1,770,805 1.8
-----------------------------------------------------------------------------------------------------
OIL & GAS 50,000 Suncor Energy, Inc. .................. 1,268,320 1.3
61,700 TransCanada Corporation............... 1,214,902 1.3
----------- ----------
2,483,222 2.6
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CANADA 4,254,027 4.4
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES BIOTECHNOLOGY 27,600 +Gilead Sciences, Inc. ............... 1,849,200 1.9
-----------------------------------------------------------------------------------------------------
CHEMICALS 10,600 Air Products and Chemicals, Inc. ..... 555,970 0.6
14,600 Praxair, Inc. ........................ 582,686 0.6
----------- ----------
1,138,656 1.2
-----------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 18,200 +Monster Worldwide Inc. .............. 468,104 0.5
SUPPLIES
-----------------------------------------------------------------------------------------------------
COMMUNICATIONS 55,700 +Cisco Systems, Inc. ................. 1,320,090 1.4
EQUIPMENT
330,000 +Lucent Technologies Inc. ............ 1,247,400 1.3
51,000 Motorola, Inc. ....................... 930,750 1.0
----------- ----------
3,498,240 3.7
-----------------------------------------------------------------------------------------------------
COMPUTERS & 79,200 +EMC Corporation...................... 902,880 1.0
PERIPHERALS...........
74,100 Hewlett-Packard Company............... 1,563,510 1.6
32,300 +SanDisk Corporation.................. 700,587 0.7
----------- ----------
3,166,977 3.3
-----------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 38,600 Rockwell Automation, Inc. ............ 1,447,886 1.5
-----------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 31,900 +Agilent Technologies, Inc. .......... 934,032 1.0
INSTRUMENTS
7,800 Tektronix, Inc. ...................... 265,356 0.3
----------- ----------
1,199,388 1.3
-----------------------------------------------------------------------------------------------------
ENERGY EQUIPMENT & 9,300 Diamond Offshore Drilling, Inc. ...... 221,619 0.2
SERVICE
19,800 Schlumberger Limited.................. 1,257,498 1.3
22,200 +Transocean Inc. ..................... 642,468 0.7
----------- ----------
2,121,585 2.2
-----------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT 29,700 +Boston Scientific Corporation........ 1,271,160 1.3
& SUPPLIES
21,800 Medtronic, Inc. ...................... 1,062,096 1.1
12,600 +Varian Medical Systems, Inc. ........ 999,810 1.1
----------- ----------
3,333,066 3.5
-----------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 13,200 Station Casinos, Inc. ................ 638,880 0.7
LEISURE
15,800 +Wynn Resorts, Limited................ 610,354 0.6
----------- ----------
1,249,234 1.3
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 44,200 3M Co. ............................... 3,978,442 4.2
CONGLOMERATES
66,900 General Electric Company.............. 2,167,560 2.3
----------- ----------
6,146,002 6.5
-----------------------------------------------------------------------------------------------------
INTERNET & CATALOG 22,200 +eBay Inc. ........................... 2,041,290 2.1
RETAIL
-----------------------------------------------------------------------------------------------------
INTERNET SOFTWARE & 22,600 +Yahoo! Inc. ......................... 821,058 0.9
SERVICES
-----------------------------------------------------------------------------------------------------
MACHINERY 8,000 Cummins Inc. ......................... 500,000 0.5
21,100 PACCAR Inc. .......................... 1,223,589 1.3
----------- ----------
1,723,589 1.8
-----------------------------------------------------------------------------------------------------
METALS & MINING 9,700 Freeport-McMoRan Copper & Gold, Inc.
(Class B)........................... 321,555 0.3
14,000 Phelps Dodge Corporation.............. 1,085,140 1.2
----------- ----------
1,406,695 1.5
-----------------------------------------------------------------------------------------------------
</Table>
129
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
NORTH
AMERICA SHARES PERCENT OF
(CONCLUDED) INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES
(CONCLUDED)
OIL & GAS 5,600 Apache Corporation.................... $ 243,880 0.2%
56,500 Chesapeake Energy Corporation......... 831,680 0.9
3,700 Devon Energy Corporation.............. 244,200 0.3
10,600 Frontline Limited..................... 365,806 0.4
----------- ----------
1,685,566 1.8
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 16,900 +Forest Laboratories, Inc. ........... 957,047 1.0
-----------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 39,100 Intel Corporation..................... 1,079,160 1.2
SEMICONDUCTOR
EQUIPMENT
31,500 Texas Instruments Incorporated........ 761,670 0.8
----------- ----------
1,840,830 2.0
-----------------------------------------------------------------------------------------------------
SOFTWARE 19,400 +Electronic Arts Inc. ................ 1,058,270 1.1
85,000 Microsoft Corporation................. 2,427,600 2.5
38,000 +Oracle Corporation................... 453,340 0.5
----------- ----------
3,939,210 4.1
-----------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 29,900 Best Buy Co., Inc. ................... 1,517,126 1.6
8,900 Lowe's Companies, Inc. ............... 467,695 0.5
----------- ----------
1,984,821 2.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
UNITED STATES 42,018,444 44.2
- ----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN NORTH AMERICA
(COST--$42,965,918) 46,272,471 48.6
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
PACIFIC
BASIN
- ----------------------------------------------------------------------------------------------------------------------
AUSTRALIA AIRLINES 476,300 Qantas Airways Limited................ 1,167,903 1.2
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 40,200 Australia and New Zealand Banking
Group Ltd. ......................... 511,901 0.5
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 29,600 Wesfarmers Limited.................... 606,209 0.6
CONGLOMERATES
-----------------------------------------------------------------------------------------------------
MEDIA 71,600 The News Corporation Limited.......... 632,435 0.7
-----------------------------------------------------------------------------------------------------
METALS & MINING 232,400 Alumina Limited....................... 854,778 0.9
142,000 BHP Billiton Limited.................. 1,239,433 1.3
242,900 WMC Resources Limited................. 832,484 0.9
----------- -----
2,926,695 3.1
-----------------------------------------------------------------------------------------------------
MULTILINE RETAIL 245,800 Harvey Norman Holdings Limited........ 482,852 0.5
-----------------------------------------------------------------------------------------------------
OIL & GAS 95,900 Woodside Petroleum Limited............ 1,113,622 1.2
-----------------------------------------------------------------------------------------------------
ROAD & RAIL 73,900 Toll Holdings Limited................. 551,852 0.6
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN AUSTRALIA 7,993,469 8.4
- ----------------------------------------------------------------------------------------------------------------------
CHINA INTERNET SOFTWARE & 7,400 +SINA.com............................. 244,126 0.3
SERVICES
-----------------------------------------------------------------------------------------------------
METALS & MINING 1,417,800 Aluminum Corporation of China
Limited............................. 758,906 0.8
487,200 Yanzhou Coal Mining Co. Ltd. 'H'...... 530,937 0.5
----------- -----
1,289,843 1.3
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CHINA 1,533,969 1.6
- ----------------------------------------------------------------------------------------------------------------------
HONG KONG AIRLINES 700,300 Cathay Pacific Airways................ 1,319,830 1.4
-----------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 264,700 Cheung Kong Infrastructure Holdings
Limited............................. 638,011 0.7
-----------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 338,000 Techtronic Industries Company
Limited............................. 539,514 0.6
-----------------------------------------------------------------------------------------------------
MARINE 551,400 China Shipping Development Company
Limited 'H'......................... 328,728 0.3
-----------------------------------------------------------------------------------------------------
OIL & GAS 1,628,700 PetroChina Company Limited............ 751,727 0.8
-----------------------------------------------------------------------------------------------------
</Table>
130
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
PACIFIC
BASIN SHARES PERCENT OF
(CONCLUDED) INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
HONG KONG
(CONCLUDED)
SPECIALTY RETAIL 116,000 Esprit Holdings Limited............... $ 519,039 0.5%
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 266,700 China Merchants Holdings International
INFRASTRUCTURE Company Limited..................... 359,028 0.4
268,300 Cosco Pacific Limited................. 373,222 0.4
----------- -----
732,250 0.8
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN HONG KONG 4,829,099 5.1
- ----------------------------------------------------------------------------------------------------------------------
INDIA AUTOMOBILES 25,000 Hero Honda Motors Ltd. ............... 275,965 0.3
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 11,000 Larsen & Toubro Ltd. ................. 166,776 0.2
ENGINEERING
-----------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 8,800 +Ultratech Cemco Ltd. ................ 65,576 0.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN INDIA 508,317 0.5
- ----------------------------------------------------------------------------------------------------------------------
JAPAN METALS & MINING 22,500 JFE Holdings, Inc. ................... 551,597 0.6
-----------------------------------------------------------------------------------------------------
OFFICE ELECTRONICS 18,000 Canon, Inc. .......................... 948,540 1.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN JAPAN 1,500,137 1.6
- ----------------------------------------------------------------------------------------------------------------------
SOUTH KOREA AUTOMOBILES 35,100 Hyundai Motor Company Ltd. ........... 1,350,234 1.4
-----------------------------------------------------------------------------------------------------
CHEMICALS 7,100 LG Chem, Ltd. ........................ 240,251 0.3
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 12,800 KT Corporation........................ 428,144 0.4
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
MACHINERY 22,600 Daewoo Shipbuilding & Marine
Engineering Co., Ltd. .............. 272,843 0.3
-----------------------------------------------------------------------------------------------------
METALS & MINING 4,800 POSCO................................. 618,953 0.7
-----------------------------------------------------------------------------------------------------
OIL & GAS 23,200 S-Oil Corporation..................... 967,754 1.0
-----------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 7,600 Samsung Electronics................... 3,137,343 3.3
SEMICONDUCTOR
EQUIPMENT
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SOUTH KOREA 7,015,522 7.4
- ----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE PACIFIC
BASIN (COST--$20,401,262) 23,380,513 24.6
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
WESTERN
EUROPE
- ----------------------------------------------------------------------------------------------------------------------
DENMARK MARINE 190 A P Moller--Maersk A/S................ 1,306,216 1.3
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN DENMARK 1,306,216 1.3
- ----------------------------------------------------------------------------------------------------------------------
FRANCE ENERGY EQUIPMENT & 4,283 Compagnie Francaise d'Etudes et de
SERVICE Construction (Technip SA)........... 581,017 0.6
-----------------------------------------------------------------------------------------------------
MEDIA 25,400 Societe Television Francaise 1........ 800,076 0.9
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN FRANCE 1,381,093 1.5
- ----------------------------------------------------------------------------------------------------------------------
GERMANY DISTRIBUTORS 11,100 Medion AG............................. 447,550 0.5
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 16,700 Siemens AG............................ 1,201,000 1.2
CONGLOMERATES
-----------------------------------------------------------------------------------------------------
SOFTWARE 1,600 SAP AG (Systeme, Anwendungen, Produkte
in der Datenverarbeitung)........... 265,249 0.3
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN GERMANY 1,913,799 2.0
- ----------------------------------------------------------------------------------------------------------------------
NORWAY OIL & GAS 26,400 Frontline Limited..................... 908,375 1.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN NORWAY 908,375 1.0
- ----------------------------------------------------------------------------------------------------------------------
</Table>
131
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
WESTERN
EUROPE SHARES PERCENT OF
(CONCLUDED) INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
SPAIN COMMERCIAL BANKS 29,900 Banco Popular Espanol SA.............. $ 1,688,659 1.8%
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 67,491 ACS, Actividades de Construccion y
ENGINEERING Servicios, SA....................... 1,137,264 1.2
-----------------------------------------------------------------------------------------------------
INFORMATION TECHNOLOGY 152,100 Amadeus Global Travel Distribution SA
SERVICES 'A'................................. 997,433 1.0
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SPAIN 3,823,356 4.0
- ----------------------------------------------------------------------------------------------------------------------
SWEDEN COMMUNICATIONS 170,000 +Telefonaktiebolaget LM Ericsson AB
EQUIPMENT 'B'................................. 500,999 0.5
-----------------------------------------------------------------------------------------------------
MACHINERY 16,400 SKF AB 'B'............................ 601,969 0.7
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SWEDEN 1,102,968 1.2
- ----------------------------------------------------------------------------------------------------------------------
SWITZERLAND HEALTH CARE EQUIPMENT 15,000 Alcon, Inc. .......................... 1,179,750 1.2
& SUPPLIES
5,000 SYNTHES, INC. ........................ 569,906 0.6
----------- -----
1,749,656 1.8
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SWITZERLAND 1,749,656 1.8
- ----------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM COMMERCIAL BANKS 101,300 HSBC Holdings PLC..................... 1,506,402 1.6
-----------------------------------------------------------------------------------------------------
HOUSEHOLD PRODUCTS 40,900 Reckitt Benckiser PLC................. 1,157,827 1.2
-----------------------------------------------------------------------------------------------------
MEDIA 77,500 British Sky Broadcasting Group PLC
("BSkyB")........................... 874,197 0.9
-----------------------------------------------------------------------------------------------------
METALS & MINING 39,200 Rio Tinto PLC (Registered Shares)..... 942,643 1.0
-----------------------------------------------------------------------------------------------------
OIL & GAS 191,700 BG Group PLC.......................... 1,181,134 1.3
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
UNITED KINGDOM 5,662,203 6.0
- ----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN WESTERN EUROPE
(COST--$14,813,590) 17,847,666 18.8
- ----------------------------------------------------------------------------------------------------------------------
PACIFIC
BASIN PREFERRED STOCKS
- ----------------------------------------------------------------------------------------------------------------------
AUSTRALIA MEDIA 71,472 The News Corporation Limited.......... 585,002 0.6
-----------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS IN THE PACIFIC
BASIN (COST--$490,205) 585,002 0.6
- ----------------------------------------------------------------------------------------------------------------------
WESTERN
EUROPE
- ----------------------------------------------------------------------------------------------------------------------
GERMANY AUTOMOBILES 5,126 Porsche AG............................ 3,430,413 3.6
-----------------------------------------------------------------------------------------------------
TOTAL PREFERRED STOCKS IN WESTERN
EUROPE (COST--$2,285,410) 3,430,413 3.6
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL INTEREST SHORT-TERM SECURITIES
- ----------------------------------------------------------------------------------------------------------------------
$1,412,694 Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I(a).............. 1,412,694 1.5
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$1,412,694) 1,412,694 1.5
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$82,369,079)................... 92,928,759 97.7
OTHER ASSETS LESS LIABILITIES......... 2,169,704 2.3
----------- -----
NET ASSETS............................ $95,098,463 100.0%
=========== =====
- ----------------------------------------------------------------------------------------------------------------------
</Table>
132
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
(a) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------------
NET INTEREST/
AFFILIATE ACTIVITY DIVIDEND INCOME
- ---------------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $(5,483,702) $27,751
Merrill Lynch Liquidity Series, LLC Money Market Series..... $ (281,249) $ 1,968
Merrill Lynch Premier Institutional Fund.................... (93,751) $ 650
- ---------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
133
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (identified
cost--$80,956,385)........................................ $ 91,516,065
Investments in affiliated securities, at value (identified
cost--$1,412,694)......................................... 1,412,694
Cash........................................................ 724,093
Foreign cash (cost--$18,369)................................ 18,330
Receivables:
Securities sold........................................... $ 1,189,309
Dividends................................................. 154,260
Capital shares sold....................................... 96,314
Interest from affiliates.................................. 7,458
Securities lending--net................................... 1 1,447,342
-------------
Prepaid expenses............................................ 445
------------
Total assets................................................ 95,118,969
------------
- --------------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Investment adviser........................................ 9,688
Other affiliates.......................................... 1,356
Capital shares redeemed................................... 1,321 12,365
-------------
Accrued expenses and other liabilities...................... 8,141
------------
Total liabilities........................................... 20,506
------------
- --------------------------------------------------------------------------------------------
NET ASSETS.................................................. $ 95,098,463
============
- --------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized+........................................ $ 1,113,610
Paid-in capital in excess of par............................ 190,473,444
Undistributed investment income--net........................ $ 775,555
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (107,828,255)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 10,564,109
-------------
Total accumulated losses--net............................... (96,488,591)
------------
NET ASSETS.................................................. $ 95,098,463
============
- --------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $95,098,463 and 11,136,103
shares outstanding........................................ $ 8.54
============
- --------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II and Class III as of June 30,
2004.
See Notes to Financial Statements.
134
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends (net of $56,899 foreign withholding tax).......... $ 1,210,310
Interest from affiliates.................................... 27,751
Securities lending--net..................................... 2,618
-----------
Total income................................................ 1,240,679
-----------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $ 363,108
Custodian fees.............................................. 28,381
Professional fees........................................... 18,198
Accounting services......................................... 16,027
Printing and shareholder reports............................ 4,458
Directors' fees and expenses................................ 3,141
Pricing services............................................ 2,872
Transfer agent fees......................................... 2,590
Other....................................................... 10,445
-----------
Total expenses.............................................. 449,220
-----------
Investment income--net...................................... 791,459
-----------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain (loss) on:
Investments--net.......................................... 7,780,587
Foreign currency transactions--net........................ (67,888) 7,712,699
-----------
Change in unrealized appreciation on:
Investments--net.......................................... (8,368,683)
Foreign currency transactions--net........................ (1,560) (8,370,243)
----------- -----------
Total realized and unrealized loss on investments and
foreign currency transactions--net........................ (657,544)
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 133,915
===========
- -----------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
135
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- -----------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 791,459 $ 1,015,659
Realized gain (loss) on investments and foreign currency
transactions--net......................................... 7,712,699 (4,598,980)
Change in unrealized appreciation on investments and foreign
currency transactions--net................................ (8,370,243) 28,447,042
----------- -----------
Net increase in net assets resulting from operations........ 133,915 24,863,721
----------- -----------
- -----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... -- (880,010)
----------- -----------
Net decrease in net assets resulting from dividends to
shareholders.............................................. -- (880,010)
----------- -----------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (2,771,199) (7,424,222)
----------- -----------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (2,637,284) 16,559,489
Beginning of period......................................... 97,735,747 81,176,258
----------- -----------
End of period*.............................................. $95,098,463 $97,735,747
=========== ===========
- -----------------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess)
investment income--net.................................... $ 775,555 $ (15,904)
=========== ===========
- -----------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
136
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,+
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 8.52 $ 6.43 $ 8.91 $ 11.70 $ 14.78
------- -------- -------- -------- --------
Investment income--net***............................. .07 .09 .02 .06 .06
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net.................. (.05) 2.08 (2.49) (2.75) (2.26)
------- -------- -------- -------- --------
Total from investment operations...................... .02 2.17 (2.47) (2.69) (2.20)
------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.............................. -- (.08) (.01) (.10) (.05)
Realized gain on investments--net................... -- -- -- -- (.26)
In excess of realized gain on investments--net...... -- -- -- -- (.57)
------- -------- -------- -------- --------
Total dividends and distributions..................... -- (.08) (.01) (.10) (.88)
------- -------- -------- -------- --------
Net asset value, end of period........................ $ 8.54 $ 8.52 $ 6.43 $ 8.91 $ 11.70
======= ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................... .35%++ 33.56% (27.74%) (23.03%) (15.00%)
======= ======== ======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................. .93%* .88% .90% .88% .83%
======= ======== ======== ======== ========
Investment income--net................................ 1.63%* 1.23% .24% .59% .46%
======= ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).............. $95,098 $ 97,736 $ 81,176 $127,926 $278,452
======= ======== ======== ======== ========
Portfolio turnover.................................... 43.55% 131.50% 138.30% 155.91% 95.98%
======= ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
++ Aggregate total investment return.
See Notes to Financial Statements.
137
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GLOBAL GROWTH V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Global Growth
V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation, and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
138
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- Options--The Fund may write 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.
- Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-U.S. dollar-denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) 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 and liabilities expressed in
foreign currencies into U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Dividends from foreign securities where the ex-dividend date may have passed are
subsequently recorded when the Fund has determined the ex-dividend date.
Interest income is recognized on the accrual basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Expenses--Certain expenses have been allocated to the individual Funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each Fund included in the Company.
139
- --------------------------------------------------------------------------------
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned security is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. Where the Fund receives cash collateral, it
may invest such collateral and retain the amount earned on such investment, net
of any amount rebated to the borrower. The Fund typically receives the income on
the loaned securities but does not receive the income on the collateral. Loans
of securities are terminable at any time and the borrower, after notice, is
required to return borrowed securities within five business days. The Fund may
pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
2. INVESTMENT ADVISORY AGREEMENT AND
TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the funds. For such services, the Fund pays a monthly fee
at the annual rate of .75% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Fund. There is no increase in the aggregate fees paid by the Fund for these
services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Fund also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $1,117 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, MLPF&S earned $14,873 in commissions
on the execution of portfolio security transactions for the Fund.
In addition, the Fund reimbursed MLIM $1,090 for certain accounting services
for the six months ended June 30, 2004.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's Distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $42,795,373 and $39,707,539, respectively.
140
- --------------------------------------------------------------------------------
Net realized gains/losses for the six months ended June 30, 2004 and net
unrealized appreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- --------------------------------------------------------------------
Realized Unrealized
Gains/Losses Appreciation
- --------------------------------------------------------------------
Long-term investments.................. $7,780,587 $10,559,680
Foreign currency transactions.......... (67,888) 4,429
---------- -----------
Total.................................. $7,712,699 $10,564,109
========== ===========
- --------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $10,485,151, of which $13,294,243 related to appreciated securities
and $2,809,092 related to depreciated securities. At June 30, 2004, the
aggregate cost of investments for federal income tax purposes was $82,443,608.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$2,771,199 and $7,424,222 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -------------------------------------------------------------------
Shares sold........................... 1,152,828 $ 9,946,877
Shares redeemed....................... (1,492,167) (12,718,076)
---------- ------------
Net decrease.......................... (339,339) $ (2,771,199)
========== ============
- -------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold.......................... 743,756 $ 5,363,765
Shares issued to shareholders in
reinvestment of dividends........... 103,897 880,010
---------- ------------
Total issued......................... 847,653 6,243,775
Shares redeemed...................... (1,993,343) (13,667,997)
---------- ------------
Net decrease......................... (1,145,690) $ (7,424,222)
========== ============
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$115,466,424, of which $67,641,756 expires in 2009, $41,396,526 expires in 2010
and $6,428,142 expires in 2011. This amount will be available to offset like
amounts of any future taxable gains.
141
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
The first six months of the year can be described as a tale of two quarters.
At the beginning of the year, the yield on the 10-year Treasury bond stood at
4.25%. In the three months that followed, interest rates bottomed at 3.84% on
fears that the economy was not growing and concerns over the relatively weak
employment picture.
In the second quarter, a surge in job creation led to a dramatic rise in
interest rates, with the 10-year Treasury bond closing at a yield of 4.58% by
the end of June. The improvement in employment, along with an up-tick in
inflation, led the Federal Reserve Board to raise short-term interest rates for
the first time in more than four years on June 30. We also saw the spread
between short-term and long-term interest rates--as measured by two-year and
10-year rates --flatten by more than 50 basis points (.50%).
In addition, the overall environment continued to reward investors for taking
on risk, as spread sectors continued to outperform the Treasury sector. For
example, excess returns for the high yield and crossover credit sectors were 135
basis points and 96 basis points, respectively. The asset-backed and mortgage
sectors also had positive excess returns.
PORTFOLIO MATTERS
For the six-month period ended June 30, 2004, Government Bond V.I. Fund's
Class I Shares had a total return of +.36%. This compared to a return of +.26%
for the benchmark Citigroup Government/Mortgage Index for the same period.
In managing the portfolio, we continued with a theme we wrote about in the
annual report to shareholders. That is, we maintained virtually no exposure to
agency debentures in favor of structured product. Our emphasis on structured
product continues to be weighted toward the commercial real estate sector, where
we are able to receive incremental yields over agency debentures without the
prepayment and extension risk that exists in the residential mortgage market.
As interest rates rise and it becomes more expensive for individuals to own
homes, we believe the multifamily subsector of the commercial real estate sector
will benefit the most. More people are likely to rent due to the increased costs
associated with buying, providing a boost to the sector. We increased the Fund's
overall exposure to this sector through investments in the Ginnie Mae project
loan market. In addition, we purchased specific tranches of project loan
collateralized mortgage obligations to further take advantage of this view.
In addition to individual security selection in these sectors, we also
utilized derivative applications to gain exposure to certain markets. Throughout
the period, we added to our overweight positions in spread product through the
use of total return swaps in the mortgage and commercial mortgage-backed
securities sectors. By using the derivative market, we were able to receive the
return of the appropriate index in exchange for a floating rate payment.
LOOKING AHEAD
Going forward, we intend to maintain our overweights to structured product and
to continue to use the derivatives market to help implement our overall asset
allocation decisions. Given the recent duration extension of the benchmark, we
have positioned the Fund's duration slightly shorter relative to that of the
benchmark. We expect the Federal Reserve Board to continue to increase interest
rates in the near term, but at a much slower pace than the market seems to be
anticipating.
IN CONCLUSION
We thank you for your continued investment in Government Bond V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Thomas F. Musmanno
Thomas F. Musmanno
Vice President and Co-Portfolio Manager
- -s- Frank Viola
Frank Viola
Vice President and Co-Portfolio Manager
July 12, 2004
142
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 -0.50%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 +6.16
- --------------------------------------------------------------------------
Ten Years Ended 6/30/04 +6.44
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH STANDARDIZED
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN 30-DAY YIELD
- --------------------------------------------------------------------------------------------------------
Class I Shares* +0.36% -0.50% 2.78%
- --------------------------------------------------------------------------------------------------------
Citigroup Government/Mortgage Index** +0.26 +0.34 --
- --------------------------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net asset
values for the periods shown, and assume reinvestment of all dividends and
capital gains distributions at net asset value on the payable date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
** This unmanaged Index is comprised of 30-year and 15-year GNMA, FNMA and FHLMC
securities, and FNMA and FHLMC debentures and Treasury securities.
Past results shown should not be considered a representation of future
performance.
143
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE
AMOUNT U.S. GOVERNMENT & AGENCY OBLIGATIONS VALUE
- ---------------------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE
OBLIGATIONS+--51.6%
Federal Home Loan Mortgage Corporation(a):
$ 13,433,555 Series 2564, Class OF, 1.539% due 2/15/2026........ $ 13,448,486
12,785,340 Series 2594, Class DF, 1.539% due 12/15/2027....... 12,804,310
12,327,936 Series 2614, Class EF, 1.639% due 12/15/2017....... 12,353,400
Federal National Mortgage Association:
107,740,686 ACES, Series 2002-M1, Class X, 1.201% due
5/25/2032(c)....................................... 4,104,996
47,343,772 ACES, Series 2002-M2, Class N, 1.532% due
8/25/2012(c)....................................... 4,418,689
56,305,687 ACES, Series 2003-M1, Class X, 1.099% due
2/25/2033(c)....................................... 2,627,009
129,962,309 Grantor Trust, Series 2003-T, Class1 IO, 0.546% due
11/25/2012(c)...................................... 4,845,372
5,429,925 Series 2003-27, Class FP, 1.60% due 6/25/2028(a)... 5,452,840
8,426,618 Series 2003-33, Class LF, 1.65% due 7/25/2017(a)... 8,442,937
10,629,969 Series 2003-34, Class FS, 1.70% due 1/25/2032(a)... 10,613,252
6,844,825 Series 2003-41, Class YF, 1.60% due 6/25/2028(a)... 6,855,188
7,184,179 Series 2003-48, Class HA, 3.50% due 11/25/2017..... 6,988,055
5,181,474 Whole Loan, Series 2002-W11, Class AV1, 1.47% due
11/25/2032(a)...................................... 5,185,907
6,827,860 Whole Loan, Series 2003-W16, Class AF1, 1.39% due
2/25/2023(a)....................................... 6,829,954
Government National Mortgage Association:
6,700,000 Series 2002-83, Class B, 4.695% due 12/16/2024..... 6,645,117
60,112,128 Series 2002-83, Class IO, 1.574% due
10/16/2042(c)...................................... 3,679,812
5,600,000 Series 2002-94, Class D, 5.045% due 11/16/2028..... 5,495,749
87,111,158 Series 2002-94, Class XB, 2.349% due
11/16/2007(c)...................................... 2,734,419
7,000,000 Series 2003-17, Class C, 4.825% due 7/16/2031...... 6,604,031
95,945,067 Series 2003-17, Class IO, 1.24% due 3/16/2043(c)... 5,983,940
6,217,292 Series 2003-49, Class C, 4.485% due 10/16/2033..... 5,626,480
129,518,158 Series 2003-59, Class XB, 2.364% due
7/16/2010(c)....................................... 7,559,832
13,250,000 Series 2003-108, Class C, 4.919% due 2/16/2034..... 13,085,261
43,845,258 Series 2003-109, Class IO, 1.098% due
11/16/2043(c)...................................... 2,510,584
29,609,403 Series 2004-9, Class IO, 1.383% due 3/16/2034(c)... 1,865,537
55,819,587 Series 2004-10, Class IO, 1.064% due
1/16/2044(c)....................................... 3,113,684
45,500,000 Series 2004-43, Class IO, 1.121% due
6/16/2044(c)....................................... 2,623,359
3,253,863 Series 2004-43, Class Z, 4.50% due 6/16/2044....... 2,328,546
3,255,052 Series 2004-45, Class Z, 5.751% due 6/16/2045...... 3,130,190
- ---------------------------------------------------------------------------------------------------------------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS
(COST--$179,196,966)................................. 177,956,936
- ---------------------------------------------------------------------------------------------------------------------
FEDERAL HOME LOAN MORTGAGE
CORPORATION--12.7%
Federal Home Loan Mortgage Corporation-- Gold
Program:
1,352,823 6.50% due 3/01/2016................................ 1,429,795
3,044,230 6% due 4/01/2016................................... 3,178,246
978,552 6.50% due 5/01/2016................................ 1,034,056
1,863,556 6% due 4/01/2017................................... 1,944,578
706,208 6% due 5/01/2017................................... 736,913
1,183,910 5.50% due 11/01/2017............................... 1,212,679
4,601,600 5% due 7/15/2019................................... 4,603,036
98 6.50% due 7/01/2029................................ 102
148,359 7% due 7/01/2029................................... 157,058
32,223 7.50% due 8/01/2029................................ 34,727
328,103 8% due 12/01/2029.................................. 356,557
365,652 8% due 4/01/2030................................... 397,061
189,586 8% due 7/01/2030................................... 205,872
1,490,119 7% due 3/01/2031................................... 1,575,738
21,591 7.50% due 9/01/2031................................ 23,254
2,000,000 6% due 6/01/2034................................... 2,045,202
</Table>
144
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE
AMOUNT U.S. GOVERNMENT & AGENCY OBLIGATIONS (CONTINUED) VALUE
- ---------------------------------------------------------------------------------------------------------------------
FEDERAL HOME LOAN MORTGAGE
CORPORATION
(CONCLUDED)
$ 13,438,153 5.50% due 7/15/2034................................ $ 13,375,155
11,312,300 6% due 7/15/2034................................... 11,549,157
- ---------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL HOME LOAN MORTGAGE CORPORATION
(COST--$43,270,855).................................. 43,859,186
- ---------------------------------------------------------------------------------------------------------------------
FEDERAL NATIONAL MORTGAGE
ASSOCIATION--7.4%
Federal National Mortgage Association:
1,125,596 8% due 4/01/2008................................... 1,192,930
869,642 5.50% due 12/01/2017............................... 891,980
570,490 4.50% due 9/01/2018................................ 558,999
4,244,936 5% due 7/15/2019................................... 4,248,918
945,286 4.50% due 9/01/2028................................ 926,246
73,019 7% due 10/01/2028.................................. 77,347
162,383 7% due 12/01/2028.................................. 172,009
28,149 7% due 2/01/2029................................... 29,800
246,594 7% due 3/01/2029................................... 261,054
386,238 7% due 5/01/2029................................... 408,888
111,314 7% due 5/01/2029................................... 117,913
1,326,958 7% due 6/01/2029................................... 1,404,770
362,756 7% due 6/01/2029................................... 384,258
295,303 7% due 7/01/2029................................... 312,620
64,139 7% due 9/01/2029................................... 67,901
5,373 7% due 2/01/2030................................... 5,686
98,379 8% due 2/01/2030................................... 107,087
19,979 8% due 12/01/2030.................................. 21,724
2,615 8% due 1/01/2031................................... 2,843
149,192 8% due 2/01/2031................................... 162,217
1,751,680 7.50% due 5/01/2032................................ 1,875,029
9,737,668 6.50% due 9/01/2032................................ 10,146,532
582,170 8% due 11/01/2032.................................. 632,995
1,483,160 6.50% due 2/01/2033................................ 1,545,434
- ---------------------------------------------------------------------------------------------------------------------
TOTAL FEDERAL NATIONAL MORTGAGE ASSOCIATION
(COST--$25,247,476).................................. 25,555,180
- ---------------------------------------------------------------------------------------------------------------------
GOVERNMENT NATIONAL MORTGAGE
ASSOCIATION+--24.5%
Government National Mortgage Association:
4,601,000 4.90% due 3/15/2005................................ 4,443,393
3,787,342 5% due 11/15/2005.................................. 3,658,913
7,952,658 5% due 11/15/2005.................................. 7,617,576
6,275,000 5.47% due 12/15/2005............................... 6,229,431
2,778,000 4.55% due 11/15/2006............................... 2,579,743
3,280,000 5.05% due 7/15/2008................................ 3,177,867
2,881,000 5.15% due 8/15/2008................................ 2,780,764
2,830,000 5.55% due 12/15/2009............................... 2,827,184
5,145,000 5.525% due 12/15/2035.............................. 5,098,778
12,090,886 5.13% due 4/01/2044................................ 11,567,834
6,390,000 5.10% due 10/15/2044............................... 6,243,151
2,122,000 5.25% due 10/15/2044............................... 2,088,837
4,157,000 5.38% due 5/15/2045................................ 4,139,333
3,130,000 5.55% due 5/15/2045................................ 3,102,704
3,500,000 5.30% due 6/15/2045................................ 3,437,847
576,627 5.60% due 8/15/2045................................ 571,598
2,533,373 5.60% due 8/15/2045................................ 2,523,260
10,000,000 5.25% due 9/30/2045................................ 9,696,250
2,909,114 5.13% due 3/15/2046................................ 2,783,266
- ---------------------------------------------------------------------------------------------------------------------
TOTAL GOVERNMENT NATIONAL MORTGAGE ASSOCIATION
(COST--$89,984,613).................................. 84,567,729
- ---------------------------------------------------------------------------------------------------------------------
</Table>
145
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
FACE
AMOUNT U.S. GOVERNMENT & AGENCY OBLIGATIONS (CONCLUDED) VALUE
- ---------------------------------------------------------------------------------------------------------------------
U.S. TREASURY BONDS &
NOTES--9.9%
U.S. Treasury Bonds:
$ 2,590,000 8.125% due 8/15/2019(b)............................ $ 3,392,092
8,610,000 7.25% due 8/15/2022................................ 10,549,936
8,938,000 6.25% due 8/15/2023................................ 9,897,441
7,963,000 5.375% due 2/15/2031............................... 8,031,123
2,000,000 U.S. Treasury Notes, 6.875% due 5/15/2006............ 2,152,968
- ---------------------------------------------------------------------------------------------------------------------
TOTAL U.S. TREASURY BONDS & NOTES
(COST--$33,899,737).................................. 34,023,560
- ---------------------------------------------------------------------------------------------------------------------
U.S. TREASURY INFLATION 4,252,196 U.S. Treasury Inflation Indexed Notes, 3.50% due
INDEXED NOTES--1.4% 1/15/2011.......................................... 4,721,264
- ---------------------------------------------------------------------------------------------------------------------
TOTAL U.S. TREASURY INFLATION INDEXED NOTES
(COST--$4,636,917)................................... 4,721,264
- ---------------------------------------------------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT & AGENCY OBLIGATIONS
(COST--$376,236,564)--107.5%......................... 370,683,855
- ---------------------------------------------------------------------------------------------------------------------
<Caption>
NON U.S. GOVERNMENT & AGENCY OBLIGATIONS
- ---------------------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE 90,178,518 CS First Boston Mortgage Securities Corp., Series
OBLIGATIONS+--11.7% 2003-CPN1 Class ASP, 1.584% due 3/15/2035(c)....... 5,828,337
13,102,366 Countrywide Home Loans, Series 2003-10 Class A6,
1.65% due 5/25/2033(a)............................. 13,112,367
1,923,789 GMAC Mortgage Corporation Loan Trust, Series
2003-GH2-A1, 1.50% due 7/25/2012(a)................ 1,924,125
7,852,015 GS Mortgage Securities Corp., Series 2003-FL6A, Class
A1, 1.389% due 11/15/2015(a)....................... 7,855,743
3,957,468 Greenwich Capital Commercial Funding Corporation,
Series 2003-FL1, Class A, 1.681% due 1/05/2006(a).. 3,958,043
5,600,000 Wachovia Bank Commercial Mortgage Trust, Series
2003-WHL2, Class A3, 1.559% due 6/15/2013(a)....... 5,601,112
2,158,842 Washington Mutual, Series 2002-AR19, Class A8, 4.56%
due 2/25/2033(a)................................... 2,160,591
- ---------------------------------------------------------------------------------------------------------------------
TOTAL NON U.S. GOVERNMENT & AGENCY OBLIGATIONS
(COST--$40,614,722).................................. 40,440,318
- ---------------------------------------------------------------------------------------------------------------------
<Caption>
REPURCHASE AGREEMENTS
- ---------------------------------------------------------------------------------------------------------------------
REPURCHASE AGREEMENTS--13.8% 17,692,187 Greenwich Capital Markets, Inc., purchased on
6/23/2004 to yield 1.10% to 7/23/2004, repurchase
price $17,708,405, collateralized by U.S. Treasury
Bond, 6.125% due 11/15/2027........................ 17,692,187
30,000,000 Morgan Stanley & Co., Inc., purchased on 6/30/2004 to
yield 1.48% to 7/01/2004, repurchase price
$30,001,233, collateralized by FHARM, 4.32% due
12/01/2033......................................... 30,000,000
- ---------------------------------------------------------------------------------------------------------------------
TOTAL REPURCHASE AGREEMENTS
(COST--$47,692,187).................................. 47,692,187
- ---------------------------------------------------------------------------------------------------------------------
<Caption>
SMALL BUSINESS ADMINISTRATION
- ---------------------------------------------------------------------------------------------------------------------
SMALL BUSINESS 4,199,652 Small Business Administration Participation
ADMINISTRATION--1.1% Certificates, Series 2003-20F, Class 1, 4.07% due
6/01/2023.......................................... 3,889,603
- ---------------------------------------------------------------------------------------------------------------------
TOTAL SMALL BUSINESS ADMINISTRATION
(COST--$4,199,652)................................... 3,889,603
- ---------------------------------------------------------------------------------------------------------------------
</Table>
146
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
NUMBER OF
OPTIONS CONTRACTS ISSUE VALUE
- ---------------------------------------------------------------------------------------------------------------------
CALL OPTIONS PURCHASED--0.0% $ 674 Eurodollar Futures, expiring July 2004 at $98.25,
Broker Credit Suisse First Boston.................. $ 4,213
674 ++Eurodollar Futures, expiring July 2004 at $98.50,
Broker Credit Suisse First Boston.................. 4,212
28 ++LIBOR Linked Floor, expiring April 2005 at $.015,
Broker J.P. Morgan Chase Bank...................... 476
52 ++Swaption, expiring August 2004 at $2.25, Broker
Lehman Brothers Special Finance(d)................. 11,700
- ---------------------------------------------------------------------------------------------------------------------
TOTAL OPTIONS PURCHASED (PREMIUMS PAID--$188,580).... 20,601
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (COST--$468,931,705)--134.1%....... 462,726,564
- ---------------------------------------------------------------------------------------------------------------------
CALL OPTIONS 20 ++CPI Linked Floor, expiring April 1009 at $1.00,
WRITTEN--0.0% Broker Morgan Stanley Capital Services, Inc. ...... (31,200)
1,348 Eurodollar Futures, expiring July 2004 at $98.38,
Broker Credit Suisse First Boston.................. (8,425)
7 ++Swaption, expiring August 2004 at $5.25, Broker
Lehman Brothers Special Finance(d)................. (100,750)
- ---------------------------------------------------------------------------------------------------------------------
TOTAL OPTIONS WRITTEN (PREMIUMS
RECEIVED--$214,395).................................. (140,375)
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS, NET OF OPTIONS WRITTEN--NET
(COST--$468,717,310)--134.1%......................... 462,586,189
LIABILITIES IN EXCESS OF OTHER ASSETS--(34.1%)....... (117,677,224)
-------------
NET ASSETS--100.0%................................... $ 344,908,965
=============
- ---------------------------------------------------------------------------------------------------------------------
</Table>
+ Mortgage-Backed Securities are subject to principal paydowns as a result of
prepayments or refinancing of the underlying mortgage instruments. As a
result, the average life may be substantially less than the original
maturity.
++ One contract represents a notional amount of $1,000,000.
(a) Floating rate note.
(b) All or a portion of security held as collateral in connection with open
financial futures contracts.
(c) Securities which receive some or all of the interest portion of the
underlying collateral and little or no principal. Interest only securities
have either a nominal or a notional amount of principal.
(d) This European style swaption, which can be exercised only to the expiration
date, represents a standby commitment whereby the Fund is obligated to
enter into a predetermined interest rate swap contract upon exercise of the
swaption.
Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------------
NET DIVIDEND
AFFILIATE ACTIVITY INCOME
- -------------------------------------------------------------------------------------
Merrill Lynch Premier Institutional Fund.................... (8,155,000) $6,983
- -------------------------------------------------------------------------------------
</Table>
Financial futures contracts sold as of June 30, 2004 were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------------------------------
NUMBER OF UNREALIZED
CONTRACTS ISSUE EXPIRATION DATE FACE VALUE DEPRECIATION
- -------------------------------------------------------------------------------------------
216... 10-Year U.S. Treasury Notes September 2004 $23,423,857 $(192,263)
- -------------------------------------------------------------------------------------------
</Table>
Covered short sales entered into as of June 30, 2004 were as follows:
<Table>
<Caption>
- ----------------------------------------------
SHARES ISSUE VALUE
- ----------------------------------------------
16,250,000.. U.S. Treasury Bonds $(17,807,075)
- ----------------------------------------------
TOTAL (PROCEEDS--$17,470,020)... $(17,807,075)
============
- ----------------------------------------------
</Table>
147
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
Swap contracts outstanding as of June 30, 2004 are as follows:
<Table>
<Caption>
- -----------------------------------------------------------------------------------------------------
NOTIONAL UNREALIZED APPRECIATION/
AMOUNT DEPRECIATION
- -----------------------------------------------------------------------------------------------------
Receive a variable rate equal to 3-month USD LIBOR and pay a
fixed rate of 4.83% interest Broker, J.P. Morgan Chase
Bank Expires May 2014..................................... $75,800,000 $1,519,019
Receive a variable rate equal to 3-month USD LIBOR and pay a
fixed rate of 4.12% interest Broker, J.P. Morgan Chase
Bank Expires May 2009..................................... $13,150,000 71,710
Receive a variable rate equal to 3-month USD LIBOR and pay a
fixed rate of 3.25% interest Broker, Lehman Brothers
Special Finance Expires May 2007.......................... $ 6,500,000 50,630
Pay 3.50% on TIPS adjusted principal and receive a fixed
rate of 4.17% interest Broker, Morgan Stanley Capital
Services Inc. Expires January 2011........................ $ 4,725,000 (48,528)
Receive a variable return based on 3-month USD LIBOR, plus
.42% which is capped at a fixed coupon of 8% and callable
quarterly beginning September 2004 and pay a floating rate
based on 3-month USD LIBOR Broker, J.P. Morgan Chase Bank
Expires March 2010........................................ $10,000,000 (1,033)
Receive a variable rate equal to Lehman Brothers CMBS AAA
Index Total Return and pay floating rate based on 1-month
USD LIBOR, minus .55% Broker, Lehman Brothers Special
Finance Expires September 2004............................ $33,000,000 --
Receive a variable rate equal to Lehman Brothers U.S.
Treasury Index Total Return and pay a floating rate based
on 1-month USD LIBOR, minus .20% Broker, Lehman Brothers
Special Finance Expires December 2004..................... $28,000,000 --
Receive a variable rate equal to Lehman Brothers MBS Fixed
Rate Index Total Return and pay a floating rate based on
1-month USD LIBOR, minus .15% Broker, Lehman Brothers
Special Finance Expires September 2004.................... $10,000,000 --
Receive a variable rate equal to Lehman Brothers U.S.
Treasury Index Total Return and pay a floating rate based
on 1-month USD LIBOR, minus .20% Broker, Lehman Brothers
Special Finance Expires August 2004....................... $24,500,000 --
Receive a variable rate equal to Lehman Brothers MBS Fixed
Rate Index Total Return and pay a floating rate based on
1-month USD LIBOR, minus .17% Broker, UBS Warburg Expires
November 2004............................................. $16,800,000 --
Receive a variable rate equal to Lehman Brothers CMBS
Investment Grade Spread Return and pay a floating rate
based on 1-month USD LIBOR, minus .65% Broker, Deutsche
Bank AG London Expires October 2004....................... $ 8,000,000 --
Receive a variable rate equal to Lehman Brothers MBS Fixed
Rate Index Total Return and pay a floating rate based on
1-month USD LIBOR, minus .16% Broker, UBS Warburg Expires
August 2004............................................... $26,000,000 --
Sold credit default protection on Capital One Multi-Asset
Execution Trust and receive .75% interest Broker, Deutsche
Bank AG London Expires March 2011......................... $ 2,000,000 (5,666)
- -----------------------------------------------------------------------------------------------------
TOTAL....................................................... $1,586,132
==========
- -----------------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
148
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments, in unaffiliated securities, at value
(identified cost--$468,743,125)........................... $462,705,963
Options purchased, at value (premiums paid--$188,580)....... 20,601
Unrealized appreciation on swaps............................ 1,640,326
Receivables:
Interest.................................................. $ 19,174,260
Swaps..................................................... 266,786
Capital shares sold....................................... 282,146 19,723,192
------------
Prepaid expenses............................................ 3,350
------------
Total assets................................................ 484,093,432
------------
- -------------------------------------------------------------------------------------------
LIABILITIES:
U.S. Treasury Bonds sold short, at market value
(proceeds--$17,470,020)................................... 17,807,075
Reverse repurchase agreements............................... 18,059,487
Options written, at value (premiums received--$214,395)..... 140,375
Unrealized depreciation on swaps............................ 54,194
Payables:
Securities purchased...................................... 101,707,359
Custodian bank............................................ 972,036
Capital shares redeemed................................... 197,060
Variation margin.......................................... 155,250
Investment adviser........................................ 23,506
Other affiliates.......................................... 4,871
Interest on loans......................................... 4,135 103,064,217
------------
Accrued expenses and other liabilities...................... 59,119
------------
Total liabilities........................................... 139,184,467
------------
- -------------------------------------------------------------------------------------------
NET ASSETS.................................................. $344,908,965
============
- -------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 300,000,000
shares authorized+........................................ $ 3,290,356
Paid-in capital in excess of par............................ 343,727,544
Undistributed investment income--net........................ $ 126,805
Undistributed realized capital gains on investments and
foreign currency transactions--net........................ 2,837,746
Unrealized depreciation on investments and foreign currency
transactions--net......................................... (5,073,486)
------------
Total accumulated losses--net............................... (2,108,935)
------------
NET ASSETS.................................................. $344,908,965
============
- -------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $344,908,965 and 32,903,558
shares outstanding........................................ $ 10.48
============
- -------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares, respectively.
++ The Fund had no outstanding shares for Class II or Class III as of June 30,
2004.
See Notes to Financial Statements.
149
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Interest.................................................... $ 6,744,896
Securities lending--net..................................... 6,983
-----------
Total income................................................ 6,751,879
-----------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $ 944,770
Interest expense............................................ 82,397
Accounting services......................................... 66,350
Custodian fees.............................................. 20,546
Professional fees........................................... 18,234
Printing and shareholder reports............................ 18,220
Directors' fees and expenses................................ 11,919
Pricing services............................................ 6,475
Transfer agent fees......................................... 2,590
Other....................................................... 14,544
-----------
Total expenses.............................................. 1,186,045
-----------
Investment income--net...................................... 5,565,834
-----------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS AND FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain (loss) on:
Investments--net.......................................... 1,741,810
Foreign currency transactions--net........................ (27) 1,741,783
-----------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (5,359,547)
Foreign currency transactions--net........................ 753 (5,358,794)
----------- -----------
Total realized and unrealized loss on investments and
foreign currency transactions--net........................ (3,617,011)
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 1,948,823
===========
- -----------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
150
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
INCREASE (DECREASE) IN NET ASSETS: JUNE 30, 2004 DECEMBER 31, 2003
- ------------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 5,565,834 $ 17,821,674
Realized gain on investments and foreign currency
transactions--net......................................... 1,741,783 9,146,917
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (5,358,794) (14,825,160)
------------ -------------
Net increase in net assets resulting from operations........ 1,948,823 12,143,431
------------ -------------
- ------------------------------------------------------------------------------------------------
DIVIDENDS & DISTRIBUTIONS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... (5,432,533) (19,097,124)
Realized gain on investments--net:
Class I................................................... -- (12,287,843)
------------ -------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. (5,432,533) (31,384,967)
------------ -------------
- ------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (66,174,822) (151,979,630)
------------ -------------
- ------------------------------------------------------------------------------------------------
NET ASSETS:
Total decrease in net assets................................ (69,658,532) (171,221,166)
Beginning of period......................................... 414,567,497 585,788,663
------------ -------------
End of period*.............................................. $344,908,965 $ 414,567,497
============ =============
- ------------------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess of)
investment income--net.................................... $ 126,805 $ (6,496)
============ =============
- ------------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
151
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE CLASS I
BEEN DERIVED FROM INFORMATION PROVIDED IN THE -------------------------------------------------------------
FINANCIAL STATEMENTS.
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31,+
MONTHS ENDED --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: JUNE 30, 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................ $ 10.59 $ 11.06 $ 10.67 $ 10.54 $ 10.03
-------- -------- -------- -------- --------
Investment income--net***........................... .16 .37 .48 .55 .64
Realized and unrealized gain (loss) on investments
and foreign currency transactions--net............ (.12) (.15) .50 .17 .47
-------- -------- -------- -------- --------
Total from investment operations.................... .04 .22 .98 .72 1.11
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net............................ (.15) (.39) (.44) (.55) (.60)
Realized gain on investments--net................. -- (.30) (.15) (.04) --
-------- -------- -------- -------- --------
Total dividends and distributions................... (.15) (.69) (.59) (.59) (.60)
-------- -------- -------- -------- --------
Net asset value, end of period...................... $ 10.48 $ 10.59 $ 11.06 $ 10.67 $ 10.54
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................. .36%++ 2.07% 9.78% 7.04% 11.50%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, excluding interest expense................ .58%* .58% .58% .59% .57%
======== ======== ======== ======== ========
Expenses............................................ .63%* .59% .58% .59% .57%
======== ======== ======== ======== ========
Investment income--net.............................. 2.94%* 3.39% 4.40% 5.13% 6.26%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)............ $344,909 $414,567 $585,789 $473,765 $332,219
======== ======== ======== ======== ========
Portfolio turnover.................................. 82.04% 212.80% 208.26% 155.31% 70.01%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
++ Aggregate total investment return.
See Notes to Financial Statements.
152
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--GOVERNMENT BOND V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Government Bond
V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be
153
- --------------------------------------------------------------------------------
valued at their fair value as determined in good faith by the Fund's Board of
Directors or by the Investment Adviser using a pricing service and/or procedures
approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- - Options--The Fund may purchase and write 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 loss or gain to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- - Swaps--The Fund may enter into swap agreements, which are over-the-counter
contracts in which the Fund and a counterparty agree to make periodic net
payments on a specified notional amount. The net payments can be made for a set
period of time or may be triggered by a predetermined credit event. The net
periodic payments may be based on a fixed or variable interest rate; the change
in market value of a specified security, basket of securities, or index; or the
return generated by a security.
(c) Repurchase agreements--The Fund may invest in U.S. government securities
pursuant to repurchase agreements. Under such agreements, the counterparty
agrees to repurchase the security at a mutually agreed upon time and price. The
Fund takes possession of the underlying securities, marks to market such
securities and, if necessary, receives additional securities daily to ensure
that the contract is fully collateralized. If the counterparty defaults and the
fair value of the collateral declines, liquidation of the collateral by the Fund
may be delayed or limited.
(d) Reverse repurchase agreements--The Fund may enter into reverse repurchase
agreements. Under reverse repurchase agreements, the Fund sells securities to
the counterparty and agrees to repurchase them at a mutually agreed upon date
and price, and may exchange their respective commitments to pay or receive
interest. If the counterparty defaults on its obligation, the Fund's ability to
receive interest will be delayed or limited. Furthermore, if the Fund does not
have sufficient income to pay its obligation under the reverse repurchase
agreement, the Fund would be in default and the counterparty would be able to
terminate the repurchase agreement.
(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.
(f) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Interest income is recognized on the accrual basis. The
Fund amortizes all premiums and discounts on debt securities.
(g) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates.
154
- --------------------------------------------------------------------------------
(h) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(i) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within three business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
(j) Custodian bank--The Fund recorded an amount payable to the custodian bank
reflecting an overnight overdraft which resulted from management estimates of
available cash.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .50% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Fund. There is no increase in the aggregate fees paid by the Fund for these
services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $1,759 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, the Fund reimbursed MLIM $4,143 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $359,977,548 and $383,876,703, respectively.
Net realized gains(losses) for the six months ended June 30, 2004 and net
unrealized appre-
155
- --------------------------------------------------------------------------------
ciation/depreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------
Unrealized
Realized Appreciation/
Gains (Losses) Depreciation
- ----------------------------------------------------------------------
Long-term investments................. $(1,071,932) $(6,037,162)
Options purchased..................... 12,654 (167,979)
Options written....................... (38,961) 74,020
Financial futures contracts........... 180,672 (192,263)
Swaps................................. 2,659,377 1,586,132
Short Sales........................... -- (337,055)
Foreign currency transactions......... (27) 821
----------- -----------
Total................................. $ 1,741,783 $(5,073,486)
=========== ===========
- ----------------------------------------------------------------------
</Table>
Transactions in options written for the six months ended June 30, 2004 were as
follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Number of Premiums
Call Options Written Contracts Received
- -------------------------------------------------------------------
Outstanding call options written, beginning
of period.................................. 3 $ 16,665
Options written............................. 1,682 625,494
Options closed.............................. (20) (350,258)
Options expired............................. (290) (77,506)
----- ---------
Outstanding call options written, end of
period..................................... 1,375 $ 214,395
===== =========
- -------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -------------------------------------------------------------------
Number of Premiums
Put Options Written Contracts Received
- -------------------------------------------------------------------
Outstanding put options written, beginning of
period...................................... 3 $ 16,665
Options written.............................. 38 24,795
Options expired.............................. (41) (41,460)
--- --------
Outstanding put options written, end of
period...................................... -- $ --
=== ========
- -------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized depreciation for federal income tax purposes
aggregated $6,550,586, of which $2,753,367 related to appreciated securities and
$9,303,953 related to depreciated securities. At June 30, 2004, the aggregate
cost of investments, net of options written, for federal income tax purposes was
$451,329,700.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets resulting from capital share transactions were
$66,174,822 and $151,979,630 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Class I Shares For the Six Dollar
Months Ended June 30, 2004 Shares Amount
- ------------------------------------------------------------------
Shares sold............................ 484,540 $ 5,196,004
Shares issued to shareholders in
reinvestment of dividends and
distributions......................... 511,992 5,432,533
---------- ------------
Total issued........................... 996,532 10,628,537
Shares redeemed........................ (7,227,101) (76,803,359)
---------- ------------
Net decrease........................... (6,230,569) $(66,174,822)
========== ============
- ------------------------------------------------------------------
</Table>
<Table>
<Caption>
- ------------------------------------------------------------------
Class I Shares For the Year Dollar
Ended December 31, 2003 Shares Amount
- ------------------------------------------------------------------
Shares sold.......................... 2,616,943 $ 28,860,715
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 2,896,853 31,384,967
----------- -------------
Total issued......................... 5,513,796 60,245,682
Shares redeemed...................... (19,361,464) (212,225,312)
----------- -------------
Net decrease......................... (13,847,668) $(151,979,630)
=========== =============
- ------------------------------------------------------------------
</Table>
5. REVERSE REPURCHASE AGREEMENTS:
For the six months ended June 30, 2004, the average amount borrowed under
reverse repurchase agreements was approximately $15,588,000 and the daily
weighted average interest rate was 1.06%.
6. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
7. DISTRIBUTION TO SHAREHOLDERS:
The Fund paid an ordinary income dividend in the amount of $.296307 per share on
July 1, 2004 to shareholders of record on June 30, 2004.
156
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the six-month period ended June 30, 2004, High Current Income V.I. Fund's
Class I Shares had a total return of +2.74%. This compared favorably to the
+2.47% return of the Fund's benchmark, the unmanaged Credit Suisse First Boston
(CSFB) High Yield Index, and the +1.15% average return of the Lipper High
Current Yield Funds category for the same period. (Funds in this Lipper category
aim for high relative current yield from fixed income securities. There are no
quality or maturity restrictions, but the funds tend to invest in lower-grade
debt issues.)
Favorable security selection outweighed adverse sector allocation decisions
for the period, contributing to the Fund's favorable relative performance. In
particular, security selection was strong in the airlines, paper and packaging
sectors. Our avoidance of unsecured airline paper proved beneficial, as many of
these bonds declined precipitously during the period in response to rising fuel
prices and continued financial distress at several large carriers.
As for sector allocation, our overweight position in airlines proved
detrimental to performance, as the entire sector weakened owing to the factors
cited above. Our average cash position of about 5% during the period was also a
drag on performance. In contrast, our underweight in telecommunications aided
returns, as the competitive environment in this sector has become more intense
with the recent emergence of MCI, Inc. from bankruptcy. Overweight positions in
steel and manufacturing also boosted returns, as both sectors are benefiting
from the strengthening economy.
At the individual issuer level, the bonds of Consolidated Container Company
and Energy Corp. of America rose significantly during the period. Both companies
reported improved earnings, and Consolidated Container also completed a new
senior bond issue that eliminated bank amortization concerns. On the downside,
the bonds of packaging manufacturer Tekni-Plex, Inc. traded off from well over
par, due to concerns over high resin costs. The bonds of Trico Marine Services
(a small Fund holding) fell sharply during the period, as this supply boat
company defaulted. We are evaluating the potential for bondholder recovery in
this restructuring.
INVESTMENT ENVIRONMENT
The six-month period was a volatile one for the high yield asset class. The
period saw heavy mutual fund outflows, a sharp sell-off in the U.S. Treasury
market in April, and a large new-issue calendar. Offsetting these negative
factors were a declining default rate, healthy economic data (particularly in
the industrial sector) and modestly rising equity markets. Against this
backdrop, the spread of the CSFB High Yield Index over U.S. Treasury issues
narrowed to 456 basis points (4.56%), in from 486 basis points at year-end 2003.
As was the case in 2003, the lowest tier of the credit universe--those
securities in the CCC and distressed rating categories--recorded the best total
return for the period.
The period started off well, with three straight months of positive returns,
as the strong momentum from the fourth quarter of 2003 continued into the new
year. The picture changed abruptly in late April, as the Treasury market decline
coupled with heavy new-issue supply and large mutual fund redemptions proved to
be a lethal mix for the high yield market. Perhaps spurred by May's correction
and continued solid economic numbers, flows into high yield mutual funds turned
positive in June, and the market posted a healthy return of +1.55%, as measured
by the CSFB High Yield Index, for the month.
We expect that U.S. economic growth will moderate in the latter half of the
year, owing to a confluence of negative factors--sustained high oil prices,
rising interest rates and heightened geopolitical concerns. Nevertheless, we
expect the default rate to continue to decline, reflecting the overall
improvement in market credit quality due to recent trends in new issuance and
the healthy economy. In addition, the distressed debt proportion of the high
yield universe has shrunk dramatically since mid-2002. Finally, we expect
lower-tier credits will continue to have access to the capital markets, thus
enabling refinancing and/or debt paydowns. Moody's Investors Service reported
that the global speculative-grade default rate for the 12 months ended June 30,
2004, declined to 3.3%. The agency projects that the default rate will decline
to 2.8% by the end of 2004. We believe that declining default risk will be a key
driver of the market's return for the second half. While said return is likely
to be modest (low-to-mid single digits), we expect that high yield will be one
of the best-performing fixed income asset classes, given the sector's
historically low correlation with Treasuries.
PORTFOLIO ACTIVITY
We selectively participated in the new-issue market, which was quite active
during the period
157
- --------------------------------------------------------------------------------
as issuers sought to take advantage of the low interest rate environment. Among
our larger purchases were two tranches of bonds of Nalco Company (a global
producer of water treatment and process chemicals), a zero-coupon bond of Pliant
Corporation (a privately held flexible packaging manufacturer), Solo Cup
Company, CSC Holdings, Inc. (a major cable operator in the New York City area)
and Emmis Operating Company (a radio and TV broadcaster). On the sell side, we
took advantage of the strong market and disposed of a number of positions for
relative value reasons. Major sales included the bonds of two paper companies,
Abitibi-Consolidated Inc. and Bowater Incorporated; L-3 Communications
Corporation (a defense contractor); and two emerging markets issuers, SABESP and
Petrobras International Finance Company. We also liquidated distressed positions
in Doman Industries Limited and Ormet Corporation.
The Fund's industry weightings changed modestly during the period. Consumer
products and manufacturing increased, largely reflecting new-issue purchases.
U.S. cable declined significantly because of the redemption of a preferred stock
of CSC Holdings. This security had been one of the Fund's largest holdings. Our
exposure to the paper sector also declined materially, reflecting a tender
(Ainsworth Lumber Company) and sales of several high-quality names for relative
value reasons and one distressed credit (Doman Industries). Our wireless weight
also declined, again reflecting sales for relative value reasons and our
concerns about increasing competition.
Our heaviest overweights relative to the Index are in packaging, manufacturing
and chemicals. We favor packaging for its stable end markets. We have trimmed
some positions for relative value reasons and because of our concerns over
possible margin erosion due to high resin prices. We are overweight in
manufacturing, as we feel the industrial economy continues to have positive
momentum based on recent Institute for Supply Management data. Finally, we like
chemicals, as we feel fundamentals in this sector are improving. Importantly, we
hold a number of specialty producers, which tend to be less cyclical. We are
underweight in healthcare and information technology, as we feel both sectors
offer poor relative value in light of the risks (that is, government
reimbursement in the case of healthcare and rapid technological change in
information technology).
As can be seen by our purchase activity, we strive to diversify our holdings
across a number of sectors. We prefer issuers that are leaders in their
industries. As of June 30, 2004, the Fund's average credit rating was B as
measured by Standard & Poor's, comparable to the average rating of our
benchmark. The Fund's cash position was approximately 4% at the close of the
period.
IN CONCLUSION
We thank you for your continued investment in High Current Income V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Robert F. Murray
Robert F. Murray
Vice President and Portfolio Manager
July 12, 2004
158
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- ---------------------------------------------------------------------
One Year Ended 6/30/04 +13.33%
- ---------------------------------------------------------------------
Five Years Ended 6/30/04 + 5.13
- ---------------------------------------------------------------------
Ten Years Ended 6/30/04 + 6.38
- ---------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH STANDARDIZED
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN 30-DAY YIELD
- --------------------------------------------------------------------------------------------------------
Class I Shares* +2.74% +13.33% 7.70%
- --------------------------------------------------------------------------------------------------------
Credit Suisse First Boston High Yield Index** +2.47 +11.75 --
- --------------------------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net asset
values for the periods shown, and assume reinvestment of all dividends and
capital gains distributions at net asset value on the payable date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
** This unmanaged market-weighted Index is comprised of 1,637 high yield debt
securities rated BBB or lower.
Past results shown should not be considered a representation of future
performance.
159
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY+ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- --------------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE--1.7% B B3 $ 250,000 Argo-Tech Corporation, 9.25% due
6/01/2011(e)............................ $ 257,500
B+ B1 1,600,000 Armor Holdings, Inc., 8.25% due
8/15/2013............................... 1,712,000
B B2 450,000 DRS Technologies, Inc., 6.875% due
11/01/2013.............................. 438,750
B B3 250,000 Hexcel Corporation, 9.875% due
10/01/2008.............................. 274,375
B B3 400,000 K & F Industries, Inc., 9.625% due
12/15/2010.............................. 438,500
BB- Ba3 750,000 L-3 Communications Corporation, 6.125% due
7/15/2013............................... 723,750
B- B3 400,000 TD Funding Corp., 8.375% due 7/15/2011.... 406,000
B B2 1,075,000 The Titan Corporation, 8% due
5/15/2011(e)............................ 1,085,750
------------
5,336,625
- --------------------------------------------------------------------------------------------------------------------------
AIRLINES--1.5% BB B1 2,500,000 American Airlines, Inc., 7.80% due
10/01/2006.............................. 2,285,784
BB- B2 2,839,684 Continental Airlines, Inc., 7.033% due
6/15/2011............................... 2,300,968
------------
4,586,752
- --------------------------------------------------------------------------------------------------------------------------
AUTOMOTIVE--2.4% CCC+ B3 400,000 Advanced Accessory Systems, 10.75% due
6/15/2011............................... 388,000
B B3 1,650,000 Asbury Automotive Group, Inc., 8% due
3/15/2014............................... 1,575,750
B- B3 1,000,000 Autocam Corporation, 10.875% due
6/15/2014(e)............................ 970,000
BBB- Ba2 750,000 AutoNation, Inc., 9% due 8/01/2008........ 847,500
B- B3 250,000 Keystone Automotive Operations, Inc.,
9.75% due 11/01/2013(e)................. 267,500
Metaldyne Corporation:
B Caa1 1,805,000 11% due 6/15/2012....................... 1,534,250
B B3 1,000,000 10% due 11/01/2013(e)................... 980,000
BB- B1 446,000 TRW Automotive Inc., 9.375% due
2/15/2013............................... 502,865
B- B2 375,000 Tenneco Automotive Inc., 10.25% due
7/15/2013............................... 423,750
------------
7,489,615
- --------------------------------------------------------------------------------------------------------------------------
BROADCASTING--2.3% B- B2 2,150,000 Emmis Operating Company, 6.875% due
5/15/2012(e)............................ 2,107,000
B+ Ba3 500,000 Entercom Radio, LLC, 7.625% due
3/01/2014............................... 516,875
B- B3 1,750,000 NextMedia Operating, Inc., 10.75% due
7/01/2011............................... 1,953,438
B- B3 972,000 Salem Communications Holding Corporation,
9% due 7/01/2011........................ 1,054,620
B B2 1,000,000 Sinclair Broadcast Group, Inc., 8% due
3/15/2012............................... 1,022,500
B B2 675,000 Young Broadcasting Inc., 8.50% due
12/15/2008(e)........................... 710,438
------------
7,364,871
- --------------------------------------------------------------------------------------------------------------------------
CABLE--INTERNATIONAL--0.5% NR* Ca 1,000,000 Cable Satisfaction International, Inc.,
12.75% due 3/01/2010 (Convertible)(c)... 190,000
B B3 1,000,000 Kabel Deutschland GmbH, 10.625% due
7/01/2014(e)............................ 1,027,500
B- B3 325,000 NTL Cable PLC, 8.75% due 4/15/2014(e)..... 333,125
------------
1,550,625
- --------------------------------------------------------------------------------------------------------------------------
CABLE--U.S.--1.7% CCC- Caa1 409,637 Avalon Cable LLC, 11.875% due
12/01/2008.............................. 434,215
BB- B1 2,200,000 CSC Holdings, Inc., 6.75% due
4/15/2012(e)............................ 2,112,000
CCC- Ca 1,000,000 Charter Communications Holdings, LLC,
10.75% due 10/01/2009................... 840,000
</Table>
160
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY+ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- --------------------------------------------------------------------------------------------------------------------------
CABLE--U.S.
(CONCLUDED)
CCC- Caa1 $ 1,500,000 Charter Communications Holdings II, LLC,
10.25% due 9/15/2010.................... $ 1,511,340
B B2 475,000 Inmarsat Finance PLC, 7.625% due
6/30/2012(e)............................ 459,563
------------
5,357,118
- --------------------------------------------------------------------------------------------------------------------------
CHEMICALS--9.5% B- B3 1,300,000 BCP Caylux Holdings Luxembourg SCA, 9.625%
due 6/15/2014(e)........................ 1,347,125
NR* NR* 2,000,000 Braskem SA, 12.50% due 11/05/2008(e)...... 1,960,000
B B2 2,000,000 Ethyl Corporation, 8.875% due 5/01/2010... 2,110,000
CCC+ NR* 900,000 HMP Equity Holdings Corporation, 14.939%
due 5/15/2008(d)........................ 522,000
NR* B3 750,000 Hanna (M.A.) Company, 6.875% due
12/01/2004.............................. 752,813
B- B3 1,400,000 Huntsman International LLC, 9.875% due
3/01/2009............................... 1,512,000
BB- B1 500,000 ISP Chemco Inc., 10.25% due 7/01/2011..... 556,250
B+ B1 675,000 Invista, 9.25% due 5/01/2012(e)........... 678,375
BB- Ba3 1,000,000 MacDermid, Inc., 9.125% due 7/15/2011..... 1,115,000
BBB- Ba1 1,500,000 Methanex Corporation, 8.75% due
8/15/2012............................... 1,687,500
BB+ Ba2 1,900,000 NOVA Chemicals Corporation, 6.50% due
1/15/2012............................... 1,871,500
Nalco Company(e):
B- B2 500,000 7.75% due 11/15/2011.................... 523,750
B- Caa1 425,000 8.875% due 11/15/2013................... 445,188
B- Caa2 5,000,000 Nalco Finance Holdings Inc., 9.139% due
2/01/2014(d)(e)......................... 3,312,500
NR* NR* 850,668 Noveon International, Inc., 13% due
8/31/2011(a)............................ 901,708
BB- B2 2,400,000 Omnova Solutions Inc., 11.25% due
6/01/2010............................... 2,616,000
B+ B3 1,250,000 PolyOne Corporation, 10.625% due
5/15/2010............................... 1,325,000
CCC+ B3 2,500,000 Rhodia SA, 7.625% due 6/01/2010(e)........ 2,262,500
B- B3 1,250,000 Rockwood Specialties Group, Inc., 10.625%
due 5/15/2011........................... 1,331,250
B- Caa1 1,175,000 Terra Capital, Inc., 11.50% due
6/01/2010............................... 1,286,625
B- B3 300,000 United Agri Products, Inc., 8.25% due
12/15/2011(e)........................... 334,500
B+ Ba3 1,475,000 Westlake Chemical Corporation, 8.75% due
7/15/2011............................... 1,600,375
------------
30,051,959
- --------------------------------------------------------------------------------------------------------------------------
CONSUMER-- B- Caa1 325,000 Simmons Company, 7.875% due 1/15/2014..... 331,500
DURABLES--0.3% B B2 610,000 Tempur-Pedic, Inc., 10.25% due 8/15/2010.. 687,775
------------
1,019,275
- --------------------------------------------------------------------------------------------------------------------------
CONSUMER-- NON- B- B3 250,000 American Achievement Corporation, 8.25%
DURABLES--3.7% due 4/01/2012(e)........................ 253,750
B- B3 650,000 Amscan Holdings, Inc., 8.75% due
5/01/2014(e)............................ 638,625
B B1 1,325,000 Armkel LLC/Armkel Finance, 9.50% due
8/15/2009............................... 1,447,562
B- B2 2,525,000 Chattem, Inc., 7% due 3/01/2014........... 2,424,000
B- B3 775,000 Elizabeth Arden, Inc., 7.75% due
1/15/2014............................... 788,562
B B3 325,000 Hines Nurseries, Inc., 10.25% due
10/01/2011.............................. 354,250
BB Ba3 250,000 K2 Inc., 7.375% due 7/01/2014(e).......... 254,375
B+ B2 300,000 North Atlantic Trading Company, Inc.,
9.25% due 3/01/2012(e).................. 290,250
B B2 1,500,000 Playtex Products, Inc., 8% due
3/01/2011(e)............................ 1,561,875
</Table>
161
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY+ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- --------------------------------------------------------------------------------------------------------------------------
CONSUMER--NON-DURABLES
(CONCLUDED)
B- B3 $ 3,000,000 Solo Cup Company, 8.50% due
2/15/2014(e)............................ $ 2,790,000
B- B3 750,000 United Industries Corporation, 9.875% due
4/01/2009............................... 780,000
------------
11,583,249
- --------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED MEDIA--6.4% B B2 625,000 Cadmus Communications Corporation, 8.375%
due 6/15/2014(e)........................ 625,000
Dex Media East LLC:
B B3 400,000 9.875% due 11/15/2009................... 449,000
B Caa1 500,000 12.125% due 11/15/2012.................. 583,750
B Caa2 700,000 Dex Media, Inc., 8% due 11/15/2013(e)..... 672,000
Dex Media West LLC:
B B3 2,800,000 8.50% due 8/15/2010..................... 3,052,000
B Caa1 1,525,000 9.875% due 8/15/2013.................... 1,673,687
B B2 2,100,000 Houghton Mifflin Company, 8.25% due
2/01/2011............................... 2,100,000
B Ba3 500,000 Lamar Media Corporation, 7.25% due
1/01/2013............................... 508,750
BBB- Baa3 1,000,000 Liberty Media Corporation, 0.75% due
3/30/2023 (Convertible)................. 1,141,250
B B3 1,700,000 Mail-Well I Corporation, 7.875% due
12/01/2013(e)........................... 1,547,000
CCC+ Caa1 800,000 Nebraska Book Company, Inc., 8.625% due
3/15/2012............................... 784,000
B B1 385,000 PEI Holdings, Inc., 11% due 3/15/2010..... 446,600
B B3 2,000,000 PRIMEDIA Inc., 7.625% due 4/01/2008....... 1,980,000
B+ B2 550,000 R.H. Donnelley Financial Corporation I,
10.875% due 12/15/2012(e)............... 638,000
BB- Ba3 1,375,000 The Reader's Digest Association, Inc.,
6.50% due 3/01/2011..................... 1,342,344
B- B2 1,000,000 Universal City Development Partners, Ltd.,
11.75% due 4/01/2010.................... 1,157,500
B- B3 400,000 Warner Music Group, 7.375% due
4/15/2014(e)............................ 386,000
BB- B1 971,000 Yell Finance BV, 10.75% due 8/01/2011..... 1,119,078
------------
20,205,959
- --------------------------------------------------------------------------------------------------------------------------
ENERGY--EXPLORATION & B B2 450,000 Encore Acquisition Company, 6.25% due
PRODUCTION--1.9% 4/15/2014(e)............................ 423,000
Plains Exploration & Production Company:
B NR* 1,500,000 8.75% due 7/01/2012..................... 1,635,000
BB- Ba2 375,000 7.125% due 6/15/2014(e)................. 381,563
Tri-Union Development Corporation(c):
D NR* 1,701,000 12.50% due 6/01/2006.................... 1,275,750
D Caa2 125,000 12.50% due 6/01/2006(e)................. 93,750
BB+ Ba2 2,000,000 Western Oil Sands Inc., 8.375% due
5/01/2012............................... 2,170,000
------------
5,979,063
- --------------------------------------------------------------------------------------------------------------------------
ENERGY--OTHER--5.8% BB- B2 2,400,000 AmeriGas Partners, LP, 8.875% due
5/20/2011............................... 2,556,000
B B2 525,000 CHC Helicopter Corporation, 7.375% due
5/01/2014(e)............................ 515,812
NR* Caa3 3,870,000 Energy Corporation of America, 9.50% due
5/15/2007............................... 3,637,800
B B2 650,000 Ferrellgas Partners LP, 8.75% due
6/15/2012............................... 693,875
B- B3 737,000 Giant Industries, Inc., 11% due
5/15/2012............................... 821,755
BB- B1 735,000 GulfTerra Energy Partners, LP, 8.50% due
6/01/2011............................... 795,638
B+ B2 250,000 North American Energy Partners, 8.75% due
12/01/2011(e)........................... 247,500
CCC B3 2,600,000 Ocean Rig Norway AS, 10.25% due
6/01/2008............................... 2,574,000
BB Ba2 1,000,000 Pacific Energy Partners, LP, 7.125% due
6/15/2014(e)............................ 1,015,000
</Table>
162
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY+ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- --------------------------------------------------------------------------------------------------------------------------
ENERGY--OTHER
(CONCLUDED)
BB- B1 $ 2,000,000 SESI, LLC, 8.875% due 5/15/2011........... $ 2,155,000
B B3 1,250,000 Star Gas Partners, LP, 10.25% due
2/15/2013............................... 1,337,500
B B1 1,500,000 Suburban Propane Partners, LP, 6.875% due
12/15/2013.............................. 1,450,323
D Ca 1,000,000 Trico Marine Services, Inc., 8.875% due
5/15/2012(c)............................ 530,000
------------
18,330,203
- --------------------------------------------------------------------------------------------------------------------------
FOOD & TOBACCO--3.9% B B3 950,000 American Seafoods Group LLC, 10.125% due
4/15/2010............................... 1,140,000
NR* NR* 329,669 Archibald Candy Corporation, 10% due
11/01/2007(c)........................... 227,472
Commonwealth Brands, Inc.(e):
NR* NR* 1,300,000 9.75% due 4/15/2008..................... 1,391,000
NR* NR* 2,000,000 10.625% due 9/01/2008................... 2,140,000
B B2 975,000 Del Monte Corporation, 8.625% due
12/15/2012.............................. 1,050,562
CCC B2 1,200,000 Doane Pet Care Company, 10.75% due
3/01/2010............................... 1,266,000
B+ B2 425,000 Dole Food Company, Inc., 8.875% due
3/15/2011............................... 449,437
B- B3 375,000 Domino's, Inc., 8.25% due 7/01/2011....... 397,500
B- B3 1,375,000 Merisant Company, 9.50% due
7/15/2013(e)............................ 1,464,375
NR* NR* 1,000,000 New World Pasta Company, 9.25% due
2/15/2009(c)............................ 100,000
BB Ba2 1,000,000 Smithfield Foods, Inc., 8% due
10/15/2009.............................. 1,077,500
B- Caa1 1,725,000 Tabletop Holdings, Inc., 12.25% due
5/15/2014(d)(e)......................... 1,052,250
B+ B2 575,000 The Wornick Company, 10.875% due
7/15/2011(e)............................ 587,938
------------
12,344,034
- --------------------------------------------------------------------------------------------------------------------------
GAMING--2.8% B+ B3 1,000,000 Argosy Gaming Company, 7% due
1/15/2014(e)............................ 975,000
B+ B1 1,125,000 Boyd Gaming Corporation, 8.75% due
4/15/2012............................... 1,198,125
B- Caa1 425,000 Global Cash Access LLC, 8.75% due
3/15/2012(e)............................ 442,000
B B2 775,000 The Majestic Star Casino, LLC, 9.50% due
10/15/2010.............................. 778,875
CCC+ Caa1 1,600,000 Pinnacle Entertainment, Inc., 8.75% due
10/01/2013.............................. 1,588,000
B B2 200,000 Poster Financial Group Inc., 8.75% due
12/01/2011(e)........................... 203,500
B- B3 250,000 Premier Entertainment Biloxi LLC, 10.75%
due 2/01/2012(e)........................ 262,500
B+ B2 350,000 River Rock Entertainment Authority, 9.75%
due 11/01/2011.......................... 381,500
B- Caa1 1,650,000 Trump Casino Holdings, LLC, 11.625% due
3/15/2010............................... 1,691,250
B- B3 1,000,000 Venetian Casino Resort, LLC, 11% due
6/15/2010............................... 1,155,000
------------
8,675,750
- --------------------------------------------------------------------------------------------------------------------------
HEALTH CARE--1.1% B B3 275,000 Alpharma Inc., 8.625% due 5/01/2011(e).... 284,625
B- B3 425,000 Concentra Operating Corporation, 9.125%
due 6/01/2012(e)........................ 444,125
B- B3 825,000 Tenet Healthcare Corporation, 9.875% due
7/01/2014(e)............................ 839,438
B B3 925,000 Triad Hospitals, Inc., 7% due
11/15/2013.............................. 878,750
VWR International, Inc.(e):
B B2 350,000 6.875% due 4/15/2012.................... 351,313
B B3 500,000 8% due 4/15/2014........................ 512,500
------------
3,310,751
- --------------------------------------------------------------------------------------------------------------------------
</Table>
163
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY+ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- --------------------------------------------------------------------------------------------------------------------------
HOUSING--2.0% B+ B2 $ 900,000 Building Materials Corporation of America,
7.75% due 7/15/2005..................... $ 904,500
BB- Ba3 1,500,000 Forest City Enterprises, Inc., 7.625% due
6/01/2015............................... 1,507,500
B- B3 425,000 MAAX Corporation, 9.75% due
6/15/2012(e)............................ 437,750
NR* NR* 3,000,000 Tapco International Corporation, 12.50%
due 8/01/2009(e)........................ 3,120,000
B- B3 425,000 U.S. Concrete, Inc., 8.375% due
4/01/2014(e)............................ 423,938
------------
6,393,688
- --------------------------------------------------------------------------------------------------------------------------
LEISURE--1.7% B- B1 959,000 FelCor Lodging LP, 9% due 6/01/2011....... 990,168
B+ B1 2,000,000 Intrawest Corporation, 10.50% due
2/01/2010............................... 2,162,500
B B2 1,625,000 John Q. Hammons Hotels, LP, 8.875% due
5/15/2012............................... 1,763,125
B- B3 500,000 True Temper Sports, Inc., 8.375% due
9/15/2011............................... 500,000
------------
5,415,793
- --------------------------------------------------------------------------------------------------------------------------
MANUFACTURING--8.8% B- B3 500,000 Aearo Company, 8.25% due 4/15/2012(e)..... 510,000
B+ Ba2 475,000 Airgas, Inc., 9.125% due 10/01/2011....... 535,562
CCC Caa2 2,250,000 Blount, Inc., 13% due 8/01/2009........... 2,410,312
BB- Ba3 3,000,000 Case New Holland Inc., 9.25% due
8/01/2011(e)............................ 3,150,000
B- B3 1,000,000 Columbus McKinnon Corporation, 10% due
8/01/2010............................... 1,060,000
B- B3 2,650,000 EaglePicher Incorporated, 9.75% due
9/01/2013............................... 2,848,750
B- B3 325,000 Erico International Corporation, 8.875%
due 3/01/2012(e)........................ 331,500
B- B3 1,500,000 FastenTech, Inc., 11.50% due
5/01/2011(e)............................ 1,661,250
B- B3 1,000,000 Invensys PLC, 9.875% due 3/15/2011(e)..... 995,000
B B2 500,000 Itron, Inc., 7.75% due 5/15/2012(e)....... 501,250
B+ B2 1,000,000 JLG Industries, Inc., 8.25% due
5/01/2008............................... 1,050,000
B- Caa1 1,200,000 Mueller Group, Inc., 10% due
5/01/2012(e)............................ 1,248,000
B+ B3 950,000 NMHG Holding Company, 10% due 5/15/2009... 1,045,000
B- B3 325,000 Rexnord Corporation, 10.125% due
12/15/2012.............................. 357,500
BB+ Ba3 2,000,000 SPX Corporation, 7.50% due 1/01/2013...... 2,050,000
B- Caa1 1,325,000 Sensus Metering Systems Inc., 8.625% due
12/15/2013(e)........................... 1,272,000
B B3 1,500,000 Superior Essex Communications LLC, 9% due
4/15/2012(e)............................ 1,432,500
B B3 2,000,000 Terex Corporation, 7.375% due
1/15/2014(e)............................ 1,960,000
BB- Ba3 1,850,000 Trinity Industries, Inc., 6.50% due
3/15/2014(e)............................ 1,692,750
B+ Ba3 625,000 Valmont Industries, Inc., 6.875% due
5/01/2014(e)............................ 614,063
B+ B3 1,000,000 Wolverine Tube, Inc., 10.50% due
4/01/2009............................... 1,095,000
------------
27,820,437
- --------------------------------------------------------------------------------------------------------------------------
METAL--OTHER--1.2% BB Ba3 750,000 Luscar Coal Ltd., 9.75% due 10/15/2011.... 843,750
BB Ba3 900,000 Massey Energy Company, 6.625% due
11/15/2010.............................. 895,500
NR* Ba2 2,250,000 Vale Overseas Ltd., 8.25% due 1/17/2034... 1,957,500
------------
3,696,750
- --------------------------------------------------------------------------------------------------------------------------
PACKAGING--8.8% B+ B2 750,000 Anchor Glass Container Corporation, 11%
due 2/15/2013........................... 857,812
B- B3 1,075,000 Berry Plastics Corporation, 10.75% due
7/15/2012............................... 1,193,250
</Table>
164
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY+ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- --------------------------------------------------------------------------------------------------------------------------
PACKAGING
(CONCLUDED)
Consolidated Container Company LLC:
CCC B3 $ 1,425,000 10.75% due 6/15/2009(d)(e).............. $ 1,083,000
CCC Caa2 4,000,000 10.125% due 7/15/2009................... 3,540,000
Crown Euro Holdings SA:
B+ B1 875,000 9.50% due 3/01/2011..................... 953,750
B B2 400,000 10.875% due 3/01/2013................... 456,000
CCC+ Caa1 375,000 Graham Packaging Company, 8.75% due
1/15/2008............................... 376,875
CCC+ Caa2 250,000 Graham Packaging Holdings Company, 10.75%
due 1/15/2009........................... 257,188
Owens-Brockway Glass Container, Inc.:
BB- B2 1,000,000 8.875% due 2/15/2009.................... 1,080,000
B B3 500,000 8.25% due 5/15/2013..................... 516,250
B Caa1 2,750,000 Owens-Illinois, Inc., 8.10% due
5/15/2007............................... 2,832,500
B+ B3 1,325,000 Plastipak Holdings, Inc., 10.75% due
9/01/2011............................... 1,424,375
Pliant Corporation:
B B3 2,000,000 11.125% due 6/15/2009(d)................ 1,685,000
B- Caa1 3,250,000 13% due 6/01/2010....................... 2,908,750
B- B2 1,150,000 Portola Packaging, Inc., 8.25% due
2/01/2012(e)............................ 920,000
Tekni-Plex, Inc.:
B- B3 4,500,000 12.75% due 6/15/2010.................... 4,320,000
B- B2 650,000 8.75% due 11/15/2013(e)................. 620,750
U.S. Can Corporation:
CCC+ Caa1 650,000 10.875% due 7/15/2010................... 666,250
CCC+ Caa2 1,400,000 12.375% due 10/01/2010.................. 1,288,000
B B2 700,000 Wise Metals Group LLC, 10.25% due
5/15/2012(e)............................ 717,500
------------
27,697,250
- --------------------------------------------------------------------------------------------------------------------------
PAPER--3.2% B+ B1 1,425,000 Ainsworth Lumber Co. Ltd., 6.75% due
3/15/2014(e)............................ 1,335,937
B Caa1 750,000 Caraustar Industries, Inc., 9.875% due
4/01/2011............................... 746,250
BB+ Ba2 1,500,000 Georgia-Pacific Corporation, 8.875% due
2/01/2010............................... 1,698,750
B- B2 875,000 Graphic Packaging International Inc.,
8.50% due 8/15/2011..................... 936,250
B B3 500,000 JSG Funding PLC, 9.625% due 10/01/2012.... 547,500
B+ B3 525,000 Millar Western Forest Products Ltd., 7.75%
due 11/15/2013(e)....................... 527,625
BB+ Ba2 1,200,000 Norampac Inc., 6.75% due 6/01/2013........ 1,176,000
BB Ba3 1,525,000 Norske Skog Canada Ltd., 8.625% due
6/15/2011............................... 1,616,500
B+ B2 300,000 Riverside Forest Products Ltd., 7.875% due
3/01/2014(e)............................ 306,000
BB- Ba3 1,000,000 Tembec Industries, Inc., 8.625% due
6/30/2009............................... 1,012,500
------------
9,903,312
- --------------------------------------------------------------------------------------------------------------------------
SERVICES--4.9% Allied Waste North America, Inc.:
BB- Ba3 900,000 7.875% due 4/15/2013.................... 940,500
BB- Ba3 2,000,000 6.125% due 2/15/2014(e)................. 1,830,000
B+ B2 1,500,000 7.375% due 4/15/2014.................... 1,458,750
Anthony Crane Rental, LP(a)(c):
NR* NR* 1,201,580 9.375% due 2/01/2008.................... 18,024
NR* NR* 11,125,105 12.375% due 2/01/2009................... 1,113
B B2 625,000 Buhrmann US Inc., 8.25% due
7/01/2014(e)............................ 623,437
B B3 675,000 Casella Waste Systems, Inc., 9.75% due
2/01/2013............................... 729,000
B- B2 875,000 The Coinmach Corporation, 9% due
2/01/2010............................... 877,187
</Table>
165
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY+ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- --------------------------------------------------------------------------------------------------------------------------
SERVICES
(CONCLUDED)
B B1 $ 275,000 Corrections Corporation of America, 7.50%
due 5/01/2011........................... $ 277,750
B B1 2,000,000 The Geo Group Inc., 8.25% due 7/15/2013... 1,980,000
CCC+ B3 900,000 Great Lakes Dredge & Dock Corporation,
7.75% due 12/15/2013.................... 760,500
BB- Ba2 925,000 MSW Energy Finance Co. II, Inc., 7.375%
due 9/01/2010(e)........................ 920,375
BB- B2 350,000 Mobile Mini, Inc., 9.50% due 7/01/2013.... 383,250
C Ca 1,150,000 Protection One Alarm Monitoring, Inc.,
8.125% due 1/15/2009.................... 782,000
B B3 1,225,000 Synagro Technologies, Inc., 9.50% due
4/01/2009............................... 1,280,125
B+ B2 2,000,000 United Rentals (North America), Inc., 7%
due 2/15/2014........................... 1,780,000
B- Caa1 400,000 Waste Services, Inc., 9.50% due
4/15/2014(e)............................ 410,000
B B2 400,000 Williams Scotsman, Inc., 10% due
8/15/2008............................... 436,000
------------
15,488,011
- --------------------------------------------------------------------------------------------------------------------------
STEEL--2.1% B+ B1 1,600,000 CSN Islands VIII Corp., 9.75% due
12/16/2013(e)........................... 1,432,000
BB- Ba3 1,250,000 California Steel Industries, Inc., 6.125%
due 3/15/2014........................... 1,165,625
B B2 1,000,000 Gerdau Ameristeel Corporation, 10.375% due
7/15/2011............................... 1,115,000
BB Ba3 500,000 International Steel Group, Inc., 6.50% due
4/15/2014(e)............................ 468,750
B B2 1,250,000 UCAR Finance Inc., 10.25% due 2/15/2012... 1,390,625
BB- B1 1,060,000 United States Steel Corporation, 9.75% due
5/15/2010............................... 1,173,950
------------
6,745,950
- --------------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS--1.4% B- B3 1,350,000 Cincinnati Bell Inc., 8.375% due
1/15/2014............................... 1,201,500
B B3 500,000 Qwest Communications International Inc.,
7.50% due 2/15/2014(e).................. 451,250
BB- Ba3 1,250,000 Qwest Corporation, 7.20% due 11/01/2004... 1,259,375
NR* Baa3 1,750,000 Tele Norte Leste Participacoes SA, 8% due
12/18/2013(e)........................... 1,566,250
------------
4,478,375
- --------------------------------------------------------------------------------------------------------------------------
TRANSPORTATION--1.0% NR* NR* 1,250,000 American Commercial Lines LLC, 11.25% due
1/01/2008(c)............................ 656,250
B- B3 425,000 Horizon Lines, LLC, 9% due 11/01/2012..... 425,000
B+ B1 550,000 OMI Corporation, 7.625% due 12/01/2013.... 539,000
BB+ Ba1 1,500,000 Overseas Shipholding Group, Inc., 8.25%
due 3/15/2013........................... 1,612,500
------------
3,232,750
- --------------------------------------------------------------------------------------------------------------------------
UTILITY--9.3% The AES Corporation:
B- B2 566,000 8.75% due 6/15/2008..................... 589,347
B- B2 674,000 9.375% due 9/15/2010.................... 718,652
B+ B1 2,000,000 8.75% due 5/15/2013(e).................. 2,142,500
NR* NR* 4,000,000 AES Drax Energy Limited, 11.50% due
8/30/2010(c)............................ 20,000
BB+ Ba1 1,560,725 AES Eastern Energy, LP, 9% due 1/02/2017.. 1,677,779
BB+ Ba3 750,000 AES Gener SA, 7.50% due 3/25/2014(e)...... 708,750
BB+ Ba1 4,773,822 Caithness Coso Funding Corp., 9.05% due
12/15/2009.............................. 5,203,466
Calpine Corporation:
CCC+ Caa1 2,000,000 8.75% due 7/15/2007..................... 1,420,000
B NR* 500,000 8.50% due 7/15/2010(e).................. 413,750
BB Ba1 2,486,000 ESI Tractebel Acquisition Corp., 7.99% due
12/30/2011.............................. 2,560,580
B- B3 1,500,000 El Paso Production Holding Company, 7.75%
due 6/01/2013........................... 1,376,250
B+ B2 1,100,000 NRG Energy, Inc., 8% due 12/15/2013(e).... 1,111,000
</Table>
166
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
S&P MOODY'S FACE
INDUSTRY+ RATINGS RATINGS AMOUNT CORPORATE BONDS VALUE
- --------------------------------------------------------------------------------------------------------------------------
UTILITY
(CONCLUDED)
BB Ba2 $ 3,000,000 Nevada Power Company, 9% due 8/15/2013.... $ 3,262,500
B+ B1 250,000 Northwest Pipeline Corporation, 8.125% due
3/01/2010............................... 269,375
BB- Ba2 2,500,000 SEMCO Energy, Inc., 7.75% due 5/15/2013... 2,575,000
B- B1 325,000 Southern Natural Gas Company, 8.875% due
3/15/2010............................... 355,063
B+ B1 3,000,000 Southern Star Central Corp., 8.50% due
8/01/2010............................... 3,180,000
B+ B1 1,000,000 Transcontinental Gas Pipeline Corporation,
7% due 8/15/2011........................ 1,025,000
B+ B3 725,000 The Williams Companies, Inc., 8.625% due
6/01/2010............................... 797,500
------------
29,406,512
- --------------------------------------------------------------------------------------------------------------------------
WIRELESS CCC Caa1 2,300,000 American Tower Corporation, 9.375% due
COMMUNICATIONS--3.2% 2/01/2009............................... 2,455,250
CCC B3 500,000 American Tower Escrow Corporation, 14.887%
due 8/01/2008(d)........................ 365,000
CCC B3 1,350,000 American Towers, Inc., 7.25% due
12/01/2011.............................. 1,353,375
CCC Caa1 875,000 Centennial Communications Corp., 10.125%
due 6/15/2013........................... 903,437
B- B3 2,500,000 Millicom International Cellular SA, 10%
due 12/01/2013(e)....................... 2,537,500
BB Ba3 900,000 Nextel Communications, Inc., 7.375% due
8/01/2015............................... 909,000
B- B2 400,000 Rural Cellular Corporation, 8.25% due
3/15/2012(e)............................ 409,000
CCC- Caa1 475,000 SBA Telecommunications, Inc., 9.75% due
12/15/2011(d)........................... 351,500
CCC+ B3 675,000 SpectraSite, Inc., 8.25% due 5/15/2010.... 695,250
------------
9,979,312
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN CORPORATE BONDS
(COST--$303,592,337)--93.1%............... 293,443,989
- --------------------------------------------------------------------------------------------------------------------------
<Caption>
SHARES
HELD COMMON STOCKS
- --------------------------------------------------------------------------------------------------------------------------
AIRLINES--0.0% 5,181 US Airways Group, Inc. (Class A)(c)....... 12,175
- --------------------------------------------------------------------------------------------------------------------------
ENERGY ACQUISITION & 27,435 Anchor Resources/Spinco LLC(c)............ 61,730
EXPLORATION--0.0%
- --------------------------------------------------------------------------------------------------------------------------
ENERGY--EXPLORATION & 2,000 Tribo Petroleum Corporation (Class A)(c).. 20
PRODUCTION--0.0%
1,180 Tri-Union Development Corporation(c)...... 0
------------
20
- --------------------------------------------------------------------------------------------------------------------------
FOOD & TOBACCO--0.0% 1,624 Archibald Candy Corporation(c)............ 16
- --------------------------------------------------------------------------------------------------------------------------
STEEL--0.0% 3,500,000 LTC Wheeling-Pittsburgh Corporation(c).... 35
68 Wheeling-Pittsburgh Corporation(c)........ 1,418
------------
1,453
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN COMMON STOCKS
(COST--$368,338)--0.0%.................... 75,394
- --------------------------------------------------------------------------------------------------------------------------
<Caption>
WARRANTS(B)
- --------------------------------------------------------------------------------------------------------------------------
AIRLINES--0.0% 3,178 US Airways Group, Inc. ................... 1,907
- --------------------------------------------------------------------------------------------------------------------------
CABLE--INTERNATIONAL--0.1% 22,461 NTL Incorporated.......................... 145,098
- --------------------------------------------------------------------------------------------------------------------------
PACKAGING--0.0% 4,000 Pliant Corporation........................ 40
- --------------------------------------------------------------------------------------------------------------------------
WIRELESS COMMUNICATIONS--0.0% 500 American Tower Escrow Corporation......... 95,000
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN WARRANTS
(COST--$54,991)--0.1%..................... 242,045
- --------------------------------------------------------------------------------------------------------------------------
</Table>
167
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
PREFERRED SECURITIES
- --------------------------------------------------------------------------------------------------------------------------
<Caption>
SHARES
INDUSTRY+ HELD PREFERRED STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------------
AIRLINES--0.0% 3,178 US Airways Group, Inc. (Convertible)...... $ 0
- --------------------------------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS--0.0% 49 PTV, Inc. ................................ 345
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN PREFERRED STOCKS
(COST--$4,164)--0.0%...................... 345
- --------------------------------------------------------------------------------------------------------------------------
<Caption>
S&P MOODY'S FACE
RATINGS RATINGS AMOUNT TRUST PREFERRED
- --------------------------------------------------------------------------------------------------------------------------
STEEL--1.1% BB- B1 $ 3,000,000 United States Steel Corporation, 10% due
12/31/2031.............................. 3,414,000
- --------------------------------------------------------------------------------------------------------------------------
UTILITY--0.2% BB+ Baa3 750,000 Citizens Utilities Trust, 5% due 1/15/2036
(Convertible)(c)........................ 749,083
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN TRUST PREFERRED
(COST--$3,565,017)--1.3%.................. 4,163,083
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN PREFERRED SECURITIES
(COST--$3,569,181)--1.3%.................. 4,163,428
- --------------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL
INTEREST OTHER INTERESTS(G)
- --------------------------------------------------------------------------------------------------------------------------
AIRLINES--0.7% $ 7,560,480 US Airways Group, Inc.--Certificate of
Beneficial Interest..................... 2,192,539
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN OTHER INTERESTS
(COST--$2,041,330)--0.7%.................. 2,192,539
- --------------------------------------------------------------------------------------------------------------------------
<Caption>
SHORT-TERM SECURITIES
- --------------------------------------------------------------------------------------------------------------------------
11,075,589 Merrill Lynch Liquidity Series, LLC Cash
Sweep Series I(f)....................... 11,075,589
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN SHORT-TERM SECURITIES
(COST--$11,075,589)--3.5%................. 11,075,589
- --------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$320,701,766)--98.7%............... 311,192,984
OTHER ASSETS LESS LIABILITIES--1.3%....... 3,920,274
------------
NET ASSETS--100.0%........................ $315,113,258
============
- --------------------------------------------------------------------------------------------------------------------------
</Table>
+ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
* Not Rated.
(a) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
(b) 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.
(c) Non-income producing security.
(d) Represents a zero coupon or step bond; the interest rate shown reflects the
effective yield at the time of purchase by the Fund.
(e) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(f) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- ------------------------------------------------------------------------------------
NET INTEREST
AFFILIATE ACTIVITY INCOME
- ------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $1,241,465 $84,517
- ------------------------------------------------------------------------------------
</Table>
(g) Other interests represent beneficial interest in liquidation trusts and
other reorganization entities.
See Notes to Financial Statements.
168
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (identified
cost--$309,626,177)....................................... $ 300,117,395
Investments in affiliates securities, at value (identified
cost--$11,075,589)........................................ 11,075,589
Receivables:
Interest (including $348 from affiliates)................. $ 6,084,771
Securities sold........................................... 1,220,669
Capital shares sold....................................... 39 7,305,479
-------------
Prepaid expenses and other assets........................... 258,530
-------------
Total assets................................................ 318,756,993
-------------
- ---------------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 2,294,775
Custodian bank............................................ 1,160,971
Capital shares redeemed................................... 137,923
Investment adviser........................................ 20,743
Other affiliates.......................................... 4,259 3,618,671
-------------
Accrued expenses and other liabilities...................... 25,064
-------------
Total liabilities........................................... 3,643,735
-------------
- ---------------------------------------------------------------------------------------------
NET ASSETS.................................................. $ 315,113,258
=============
- ---------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 200,000,000
shares authorized+........................................ $ 4,050,488
Paid-in capital in excess of par............................ 509,600,375
Undistributed investment income--net........................ $ 2,889,948
Accumulated realized capital losses on investments--net..... (191,918,771)
Unrealized depreciation on investments--net................. (9,508,782)
-------------
Total accumulated losses--net............................... (198,537,605)
-------------
NET ASSETS.................................................. $ 315,113,258
=============
- ---------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $315,113,258 and 40,504,876
shares outstanding........................................ $ 7.78
=============
- ---------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II or Class III as of June 30,
2004.
See Notes to Financial Statements.
169
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Interest (including $84,517 from affiliates)................ $12,852,678
Dividends................................................... 195,054
Other....................................................... 413,149
-----------
Total income................................................ 13,460,881
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $778,126
Accounting services......................................... 57,480
Professional fees........................................... 26,462
Printing and shareholder reports............................ 15,263
Pricing services............................................ 14,777
Custodian fees.............................................. 14,235
Directors' fees and expenses................................ 9,988
Transfer agent fees......................................... 2,607
Other....................................................... 11,124
--------
Total expenses.............................................. 930,062
-----------
Investment income--net...................................... 12,530,819
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET:
Realized loss on investments--net........................... (4,029,987)
Change in unrealized depreciation on investments--net....... 627,268
-----------
Total realized and unrealized loss on investments--net...... (3,402,719)
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 9,128,100
===========
- --------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
170
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- ------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $12,530,819 $ 25,039,180
Realized loss on investments--net........................... (4,029,987) (41,774,608)
Change in unrealized depreciation on investments--net....... 627,268 92,491,424
------------ ------------
Net increase in net assets resulting from operations........ 9,128,100 75,755,996
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... (12,254,076) (26,525,847)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (12,254,076) (26,525,847)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital
share transactions........................................ (17,388,109) 11,862,955
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (20,514,085) 61,093,104
Beginning of period......................................... 335,627,343 274,534,239
------------ ------------
End of period*.............................................. $315,113,258 $335,627,343
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed investment income--net...................... $ 2,889,948 $ 2,613,205
============ ============
- ------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
171
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,+
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period..................... $ 7.86 $ 6.69 $ 7.53 $ 8.06 $ 9.59
-------- -------- -------- -------- --------
Investment income--net++++............................... .30 .60 .68 .88 .96
Realized and unrealized gain (loss) on
investments--net....................................... (.09) 1.20 (.80) (.55) (1.59)
-------- -------- -------- -------- --------
Total from investment operations......................... .21 1.80 (.12) .33 (.63)
-------- -------- -------- -------- --------
Less dividends from investment income--net............... (.29) (.63) (.72) (.86) (.90)
-------- -------- -------- -------- --------
Net asset value, end of period........................... $ 7.78 $ 7.86 $ 6.69 $ 7.53 $ 8.06
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share....................... 2.74%++ 28.28% (1.39%) 4.01% (7.09%)
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................. .57%* .56% .57% .58% .54%
======== ======== ======== ======== ========
Investment income--net................................... 7.66%* 8.15% 9.75% 10.82% 10.72%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)................. $315,113 $335,627 $274,534 $364,723 $404,344
======== ======== ======== ======== ========
Portfolio turnover....................................... 29.67% 78.45% 51.73% 32.01% 28.63%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized
** Total investment returns exclude insurance-related fees and expenses.
+ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
++ Aggregate total investment return.
++++ Based on average shares outstanding.
See Notes to Financial Statements.
172
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--HIGH CURRENT INCOME V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, which
are not affiliated with ML & Co., for their separate accounts to fund benefits
under certain variable annuity and variable life insurance contracts. High
Current Income V.I. Fund (the "Fund") is classified as "diversified," as defined
in the Investment Company Act of 1940, as amended. Class I Shares, Class II
Shares and Class III Shares have equal voting, dividend, liquidation and other
rights, except that only shares of the respective classes are entitled to vote
on matters concerning only that class. In addition, Class II Shares and Class
III Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
173
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors.
(b) 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.
(c) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis. The Fund amortizes all
premiums and discounts on debt securities.
(d) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions from capital gains are recorded on the
ex-dividend dates.
(e) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(f) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
(g) Custodian bank--The Fund recorded an amount payable to the custodian bank
reflecting an overnight overdraft, which resulted from a failed trade that
settled the next day.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee
based upon the aggregate daily value of net assets of the Fund and the Company's
Core Bond Fund at the following annual rates: .55% of such average daily net
assets not exceeding $250 million; .50% of such average daily net assets in
excess of $250 million but not more than $500 million; .45% of such average
daily net assets in excess of $500 million but not more than $750 million; and
..40% of such average daily net assets in excess of $750 million. For the six
months ended June 30, 2004, the aggregate average daily net assets of the Fund
and Core Bond Fund was approximately $978,834,000. MLIM has entered into a
Sub-Advisory Agreement with Merrill Lynch Asset Management U.K., Limited ("MLAM
U.K."), an affiliate of MLIM, pursuant to which MLAM U.K. provides investment
advisory services to MLIM with respect to the Company. There is no increase in
the aggregate fees paid by the Company for these services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
invest-
174
- --------------------------------------------------------------------------------
ment company managed by MLIM, LLC or in registered money market funds advised by
MLIM or its affiliates.
For the six months ended June 30, 2004, MLPF&S earned $188 in commissions on
the execution of portfolio security transactions.
In addition, the Fund reimbursed MLIM $3,559 for certain accounting services
for the six months ended June 30, 2004.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD") which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $91,407,522 and $106,776,540, respectively.
Net realized losses for the six months ended June 30, 2004 and net unrealized
depreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Realized Unrealized
Losses Depreciation
- -------------------------------------------------------------------
Long-term investments.................. $(4,029,987) $(9,508,782)
----------- -----------
Total.................................. $(4,029,987) $(9,508,782)
=========== ===========
- -------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized depreciation for federal income tax purposes
aggregated $9,488,106, of which $13,735,058 related to appreciated securities
and $23,223,164 related to depreciated securities. At June 30, 2004, the
aggregate cost of investments for federal income tax purposes was $320,681,090.
4. CAPITAL SHARE TRANSACTIONS:
Transactions in capital shares were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- ------------------------------------------------------------------
Shares sold............................ 234,544 $ 1,853,580
Shares issued to shareholders in
reinvestment of dividends............. 1,566,946 12,254,076
---------- ------------
Total issued........................... 1,801,490 14,107,656
Shares redeemed........................ (4,020,046) (31,495,765)
---------- ------------
Net decrease........................... (2,218,556) $(17,388,109)
========== ============
- ------------------------------------------------------------------
</Table>
<Table>
<Caption>
- ------------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- ------------------------------------------------------------------
Shares sold............................ 2,278,573 $ 16,619,777
Shares issued to shareholders in
reinvestment of dividends............. 3,698,384 26,525,847
---------- ------------
Total issued........................... 5,976,957 43,145,624
Shares redeemed........................ (4,300,468) (31,282,669)
---------- ------------
Net increase........................... 1,676,489 $ 11,862,955
========== ============
- ------------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates,
is a party to a $500,000,000 credit agreement with Bank One, N.A. and certain
other lenders. The Fund may borrow under the credit agreement to fund
shareholder redemptions and for other lawful purposes other than for leverage.
The Fund may borrow up to the maximum amount allowable under the Fund's current
prospectus and statement of additional information, subject to various other
legal, regulatory or contractual limits. The Fund pays a commitment fee of .09%
per annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$179,662,227, of which $3,029,074 expires in 2006, $9,712,654 expires in 2007,
$23,145,308 expires in 2008, $35,064,410 expires in 2009, $63,839,053 expires in
2010 and $44,871,728 expires in 2011. This amount will be available to offset
like amounts of any future taxable gains.
7. DISTRIBUTIONS TO SHAREHOLDERS:
The Fund paid an ordinary income dividend in the amount of $.066335 per share on
July 1, 2004 to shareholders of record on June 30, 2004.
175
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
The past six months brought flat to slightly positive returns for global
equity markets, a trend that was influenced mainly by investor indecision. This
behavior stemmed from continued political tension in the United States, violence
in Iraq, record-high oil prices and improving economic data throughout the
period. A shift in investor favor from lower-quality, lower-price and
higher-beta (riskier) securities to higher-quality, higher-capitalization and
lower-beta stocks took place at the end of the first quarter and grew stronger
in the second quarter.
The six months ended with the Federal Reserve Board (the Fed) raising
short-term interest rates .25%, a less significant increase than some had
anticipated. With this news, along with higher-than-expected gross domestic
product (GDP) growth, the period ended with equity markets on the rise.
As the November presidential election nears, we expect that politics will
continue to spur market uncertainty, as will the Fed's monetary policy. Politics
also will be a primary driver of market performance overseas, as June month-end
brought the transfer of power in Iraq and parliamentary elections in the
European Union and Canada. While the euro has gradually lost ground this year,
returning -3.54% in the first half of 2004, the Asian economy appears to be
gaining strength. Since year-end 2003, the Japanese yen was up 1.81% compared to
the U.S. dollar.
PERFORMANCE REVIEW
Index 500 V.I. Fund was able to meet its objective of closely replicating the
returns of the Standard & Poor's 500 (S&P 500) Index for the period. For the six
months ended June 30, 2004, the Fund's Class I Shares had a total return of
+3.33%. This compared to the S&P 500 Index's return of +3.44% for the same
period.
The S&P 500 Index is a market-weighted index composed of 500 common stocks
issued by large-capitalization U.S. companies in a wide range of businesses. The
stocks included in the Index collectively represent a substantial portion of all
common stocks publicly traded in the United States.
On June 30, 2004, the S&P 500 Index closed at 1,140.84 with a price return of
2.60%. The Dow Jones Industrial Average closed at 10,435.48 with a price return
of -.18%, while the Nasdaq Composite Index returned +2.22% with a closing level
of 2,047.79, indicating that technology stocks underperformed the broader market
over the past six months. European markets delivered comparable gains, with the
Financial Times Stock Exchange 100 Index closing at 4,464.10, representing a
return of -.29% in sterling. In the meantime, the Morgan Stanley Capital
International World Index price return was up 2.53% in U.S. dollar terms, with a
closing level of 1,062.51 at June 30, 2004.
The value style of investing significantly outperformed the growth style for
the period, with the S&P 500 Barra Value Index returning +4.17% versus the S&P
500 Barra Growth Index's return of +2.72%.
Turning to sector performance, nine of the 10 S&P 500 sectors posted a
positive return for the period. The top performer was energy, which was up
11.90%, followed by industrials and consumer staples, with respective returns of
+6.42% and +5.13%. The worst performer for the period was materials, the only
sector with a negative return at -.36%. Also at the bottom were information
technology and consumer discretionary, with respective six-month returns of
+.09% and +.54%.
PORTFOLIO ACTIVITY
Over the course of the period, as the composition of the S&P 500 Index
changed, the Fund purchased and sold securities to maintain its objective of
seeking to replicate the risks and return of the benchmark.
Equity markets are expected to outperform cash and bonds for the rest of the
year, supported by positive corporate earnings and revenue growth along with GDP
growth, which is projected to reach five-year highs. For its part, we expect the
portfolio to continue to meet its objective of tracking the performance of the
Index for the remainder of 2004.
IN CONCLUSION
We thank you for your continued investment in Index 500 V.I. Fund of Merrill
Lynch Variable Series Funds, Inc., and we look forward to serving your future
investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Richard J. Vella
Richard J. Vella
Vice President and Senior Portfolio Manager
July 12, 2004
176
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------
One Year Ended 6/30/04 +18.67%
- --------------------------------------------------------------------
Five Years Ended 6/30/04 - 2.56
- --------------------------------------------------------------------
Inception (12/13/96) through 6/30/04 + 7.33
- --------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +3.33% +18.67%
- -----------------------------------------------------------------------------------------
S&P 500(R) Index** +3.44 +19.11
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset values for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
** This unmanaged Index covers 500 industrial, utility, transportation and
financial companies of the U.S. markets (mostly NYSE issues), representing
about 75% of NYSE market capitalization and 30% of NYSE issues.
Past results shown should not be considered a representation of future
performance.
S&P 500 is a registered trademark of the McGraw-Hill Companies.
177
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MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE--2.0% 31,828 The Boeing Company..................................... $ 1,626,092
7,664 General Dynamics Corporation........................... 761,035
4,363 Goodrich Corporation................................... 141,056
33,063 Honeywell International Inc. .......................... 1,211,098
16,433 Lockheed Martin Corporation............................ 855,831
13,840 Northrop Grumman Corporation........................... 743,208
16,546 Raytheon Company....................................... 591,850
7,483 Rockwell Collins, Inc. ................................ 249,334
19,782 United Technologies Corporation........................ 1,809,657
------------
7,989,161
- --------------------------------------------------------------------------------------------------------------------
AIR FREIGHT & 11,455 FedEx Corp. ........................................... 935,759
LOGISTICS--1.1%
2,484 Ryder System, Inc. .................................... 99,534
43,400 United Parcel Service, Inc. (Class B).................. 3,262,378
------------
4,297,671
- --------------------------------------------------------------------------------------------------------------------
AIRLINES--0.1% 3,099 Delta Air Lines, Inc. ................................. 22,065
31,275 Southwest Airlines Co. ................................ 524,482
------------
546,547
- --------------------------------------------------------------------------------------------------------------------
AUTO COMPONENTS--0.2% 3,206 Cooper Tire & Rubber Company........................... 73,738
5,998 Dana Corporation....................................... 117,561
23,785 Delphi Corporation..................................... 254,024
5,934 +The Goodyear Tire & Rubber Company.................... 53,940
7,146 Johnson Controls, Inc. ................................ 381,453
6,374 Visteon Corporation.................................... 74,385
------------
955,101
- --------------------------------------------------------------------------------------------------------------------
AUTOMOBILES--0.7% 72,271 Ford Motor Company..................................... 1,131,041
21,083 General Motors Corporation............................. 982,257
11,552 Harley-Davidson, Inc. ................................. 715,531
------------
2,828,829
- --------------------------------------------------------------------------------------------------------------------
BEVERAGES--2.8% 1,341 Adolph Coors Company (Class B)......................... 97,008
30,931 Anheuser-Busch Companies, Inc. ........................ 1,670,274
5,418 Brown-Forman Corporation (Class B)..................... 261,527
93,796 The Coca-Cola Company.................................. 4,734,822
18,137 Coca-Cola Enterprises Inc. ............................ 525,792
11,004 The Pepsi Bottling Group, Inc. ........................ 336,062
65,739 PepsiCo, Inc. ......................................... 3,542,017
------------
11,167,502
- --------------------------------------------------------------------------------------------------------------------
BIOTECHNOLOGY--1.3% 49,123 +Amgen Inc. ........................................... 2,680,642
8,452 Applera Corporation-Applied Biosystems Group........... 183,831
12,926 +Biogen Idec Inc. ..................................... 817,569
6,921 +Chiron Corporation.................................... 308,953
8,100 +Genzyme Corporation................................... 383,373
8,200 +Gilead Sciences, Inc. ................................ 549,400
9,558 +MedImmune, Inc. ...................................... 223,657
------------
5,147,425
- --------------------------------------------------------------------------------------------------------------------
BUILDING PRODUCTS--0.2% 8,300 +American Standard Companies, Inc. .................... 334,573
18,251 Masco Corporation...................................... 569,066
------------
903,639
- --------------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS--2.8% 28,532 The Bank of New York Company, Inc. .................... 841,123
4,053 The Bear Stearns Companies Inc. ....................... 341,708
53,065 The Charles Schwab Corporation......................... 509,955
14,100 +E*TRADE Financial Corp. .............................. 157,215
4,200 Federated Investors, Inc. (Class B).................... 127,428
10,322 Franklin Resources, Inc. .............................. 516,926
18,400 The Goldman Sachs Group, Inc. ......................... 1,732,544
9,211 Janus Capital Group Inc. .............................. 151,889
10,700 Lehman Brothers Holdings, Inc. ........................ 805,175
</Table>
178
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS (CONCLUDED)
16,311 Mellon Financial Corporation........................... $ 478,402
36,979 Merrill Lynch & Co., Inc. ............................. 1,996,126
42,363 Morgan Stanley......................................... 2,235,496
9,201 Northern Trust Corporation............................. 389,018
13,293 State Street Corporation............................... 651,889
5,293 T. Rowe Price Group Inc. .............................. 266,767
------------
11,201,661
- --------------------------------------------------------------------------------------------------------------------
CHEMICALS--1.6% 8,689 Air Products and Chemicals, Inc. ...................... 455,738
35,936 The Dow Chemical Company............................... 1,462,595
37,596 E.I. du Pont de Nemours and Company.................... 1,670,014
2,958 Eastman Chemical Company............................... 136,748
11,176 Ecolab Inc. ........................................... 354,279
4,830 Engelhard Corporation.................................. 156,057
1,911 Great Lakes Chemical Corporation....................... 51,712
4,276 +Hercules Incorporated................................. 52,124
3,599 International Flavors & Fragrances Inc. ............... 134,603
10,267 Monsanto Company....................................... 395,280
6,643 PPG Industries, Inc. .................................. 415,121
13,454 Praxair, Inc. ......................................... 536,949
8,588 Rohm and Haas Company.................................. 357,089
2,617 Sigma-Aldrich Corporation.............................. 155,999
------------
6,334,308
- --------------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS--6.4% 14,630 AmSouth Bancorporation................................. 372,626
22,196 BB&T Corporation....................................... 820,586
78,506 Bank of America Corporation............................ 6,643,178
43,165 +Bank One Corporation.................................. 2,201,415
7,786 Charter One Financial, Inc. ........................... 344,063
6,426 Comerica Incorporated.................................. 352,659
21,619 Fifth Third Bancorp.................................... 1,162,670
4,700 First Horizon National Corporation..................... 213,709
10,605 Huntington Bancshares Incorporated..................... 242,855
16,003 KeyCorp................................................ 478,330
4,600 M&T Bank Corporation................................... 401,580
9,000 Marshall & Ilsley Corporation.......................... 351,810
28,025 National City Corporation.............................. 981,155
6,700 North Fork Bancorporation.............................. 254,935
11,264 PNC Bank Corp. ........................................ 597,893
8,346 Regions Financial Corporation.......................... 305,046
12,738 SouthTrust Corporation................................. 494,362
10,196 SunTrust Banks, Inc. .................................. 662,638
11,710 Synovus Financial Corp. ............................... 296,497
73,004 U.S. Bancorp........................................... 2,011,990
8,912 Union Planters Corporation............................. 265,667
50,622 Wachovia Corporation................................... 2,252,679
65,003 Wells Fargo & Company.................................. 3,720,122
3,424 Zions Bancorporation................................... 210,405
------------
25,638,870
- --------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 10,194 +Allied Waste Industries, Inc. ........................ 134,357
SUPPLIES--1.1%
6,500 +Apollo Group, Inc. (Class A).......................... 573,885
4,267 Avery Dennison Corporation............................. 273,131
40,228 Cendant Corporation.................................... 984,781
6,636 Cintas Corporation..................................... 316,338
1,997 Deluxe Corporation..................................... 86,870
5,979 Equifax Inc. .......................................... 147,980
6,781 H&R Block, Inc. ....................................... 323,318
5,471 +Monster Worldwide Inc. ............................... 140,714
9,815 Pitney Bowes Inc. ..................................... 434,314
7,844 R.R. Donnelley & Sons Company.......................... 259,009
</Table>
179
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES &
SUPPLIES (CONCLUDED)
6,986 +Robert Half International Inc. ....................... $ 207,973
23,310 Waste Management, Inc. ................................ 714,452
------------
4,597,122
- --------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS 31,149 +ADC Telecommunications, Inc. ......................... 88,463
EQUIPMENT--3.2%
6,225 +Andrew Corporation.................................... 124,562
15,613 +Avaya Inc. ........................................... 246,529
20,403 +CIENA Corporation..................................... 75,899
260,515 +Cisco Systems, Inc. .................................. 6,174,205
7,676 +Comverse Technology, Inc. ............................ 153,059
52,858 +Corning Incorporated.................................. 690,325
52,777 +JDS Uniphase Corporation.............................. 200,025
164,942 +Lucent Technologies Inc. ............................. 623,481
91,236 Motorola, Inc. ........................................ 1,665,057
4,443 +QLogic Corporation.................................... 118,139
31,384 QUALCOMM Incorporated.................................. 2,290,404
5,880 Scientific-Atlanta, Inc. .............................. 202,860
16,033 +Tellabs, Inc. ........................................ 140,128
------------
12,793,136
- --------------------------------------------------------------------------------------------------------------------
COMPUTERS & 13,895 +Apple Computer, Inc. ................................. 452,143
PERIPHERALS--3.7%
97,176 +Dell Inc. ............................................ 3,480,844
94,104 +EMC Corporation....................................... 1,072,786
13,979 +Gateway Inc. ......................................... 62,906
118,943 Hewlett-Packard Company................................ 2,509,697
64,834 International Business Machines Corporation............ 5,715,117
4,707 +Lexmark International, Inc. (Class A)................. 454,367
3,670 +NCR Corporation....................................... 181,995
13,365 +Network Appliance, Inc. .............................. 287,748
128,012 +Sun Microsystems, Inc. ............................... 555,572
------------
14,773,175
- --------------------------------------------------------------------------------------------------------------------
CONSTRUCTION & 3,474 Fluor Corporation...................................... 165,606
ENGINEERING--0.0%
- --------------------------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS--0.0% 3,950 Vulcan Materials Company............................... 187,823
- --------------------------------------------------------------------------------------------------------------------
CONSUMER FINANCE--1.3% 49,578 American Express Company............................... 2,547,318
8,832 Capital One Financial Corporation...................... 603,932
49,139 MBNA Corporation....................................... 1,267,295
11,179 +Providian Financial Corporation....................... 163,996
17,923 SLM Corporation........................................ 724,985
------------
5,307,526
- --------------------------------------------------------------------------------------------------------------------
CONTAINERS & PACKAGING--0.2% 2,418 Ball Corporation....................................... 174,217
4,156 Bemis Company, Inc. ................................... 117,407
6,867 +Pactiv Corporation.................................... 171,263
3,260 +Sealed Air Corporation................................ 173,660
1,954 Temple-Inland, Inc. ................................... 135,315
------------
771,862
- --------------------------------------------------------------------------------------------------------------------
DISTRIBUTORS--0.1% 7,338 Genuine Parts Company.................................. 291,172
- --------------------------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 199,051 Citigroup Inc. ........................................ 9,255,872
SERVICES--3.3%
80,191 J.P. Morgan Chase & Co. ............................... 3,109,005
6,202 Moody's Corporation.................................... 401,021
12,300 The Principal Financial Group, Inc. ................... 427,794
------------
13,193,692
- --------------------------------------------------------------------------------------------------------------------
DIVERSIFIED 11,887 ALLTEL Corporation..................................... 601,720
TELECOMMUNICATION
SERVICES--2.8%
30,579 AT&T Corporation....................................... 447,371
72,025 BellSouth Corporation.................................. 1,888,495
6,102 CenturyTel, Inc. ...................................... 183,304
11,103 +Citizens Communications Company....................... 134,346
68,696 +Qwest Communications International Inc. .............. 246,619
</Table>
180
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
DIVERSIFIED
TELECOMMUNICATION SERVICES
(CONCLUDED)
127,484 SBC Communications Inc. ............................... $ 3,091,487
53,163 Sprint Corporation..................................... 935,669
107,718 Verizon Communications................................. 3,898,314
------------
11,427,325
- --------------------------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES--1.9% 6,422..... +Allegheny Energy, Inc. ............................... 98,963
6,597 Ameren Corporation..................................... 283,407
16,118 American Electric Power Company, Inc. ................. 515,776
3,554 +CMS Energy Corporation................................ 32,448
12,483 CenterPoint Energy, Inc. .............................. 143,554
6,873 Cinergy Corp. ......................................... 261,174
8,158 Consolidated Edison, Inc. ............................. 324,362
6,723 DTE Energy Company..................................... 272,550
13,196 Edison International................................... 337,422
8,672 Entergy Corporation.................................... 485,719
25,478 Exelon Corporation..................................... 848,163
6,907 FPL Group, Inc. ....................................... 441,703
12,688 FirstEnergy Corp. ..................................... 474,658
16,381 +PG&E Corporation...................................... 457,685
6,279 PPL Corporation........................................ 288,206
3,524 Pinnacle West Capital Corporation...................... 142,334
9,429 Progress Energy, Inc. ................................. 415,347
27,918 The Southern Company................................... 813,810
7,715 TECO Energy, Inc. ..................................... 92,503
12,058 TXU Corporation........................................ 488,470
15,384 Xcel Energy, Inc. ..................................... 257,067
------------
7,475,321
- --------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT--0.5% 7,676 American Power Conversion Corporation.................. 150,833
4,015 Cooper Industries, Ltd. (Class A)...................... 238,531
16,975 Emerson Electric Company............................... 1,078,761
3,261 +Power-One, Inc. ...................................... 35,806
7,183 Rockwell Automation, Inc. ............................. 269,434
2,265 Thomas & Betts Corporation............................. 61,676
------------
1,835,041
- --------------------------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 18,994 +Agilent Technologies, Inc. ........................... 556,144
INSTRUMENTS--0.5%
7,715 +Jabil Circuit, Inc. .................................. 194,264
7,263 Molex Incorporated..................................... 232,997
4,309 PerkinElmer, Inc. ..................................... 86,352
20,009 +Sanmina--SCI Corporation.............................. 182,082
35,035 +Solectron Corporation................................. 226,676
9,028 Symbol Technologies, Inc. ............................. 133,073
3,831 Tektronix, Inc. ....................................... 130,331
5,200 +Waters Corporation.................................... 248,456
------------
1,990,375
- --------------------------------------------------------------------------------------------------------------------
ENERGY EQUIPMENT & 6,200 +BJ Services Company................................... 284,208
SERVICE--0.9%
12,708 Baker Hughes Incorporated.............................. 478,456
16,902 Halliburton Company.................................... 511,455
4,846 +Nabors Industries, Ltd. .............................. 219,136
5,087 +Noble Corporation..................................... 192,746
2,635 +Rowan Companies, Inc. ................................ 64,110
22,645 Schlumberger Limited................................... 1,438,184
12,311 +Transocean Inc. ...................................... 356,280
------------
3,544,575
- --------------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS--1.3% 24,982 Archer-Daniels-Midland Company......................... 419,198
15,993 Campbell Soup Company.................................. 429,892
21,932 ConAgra Foods, Inc. ................................... 593,919
14,508 General Mills, Inc. ................................... 689,565
13,549 H.J. Heinz Company..................................... 531,121
9,948 Hershey Foods Corporation.............................. 460,294
</Table>
181
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS (CONCLUDED)
15,789 Kellogg Company........................................ $ 660,770
5,600 McCormick & Company Incorporated....................... 190,400
31,417 Sara Lee Corporation................................... 722,277
8,616 Wm. Wrigley Jr. Company................................ 543,239
------------
5,240,675
- --------------------------------------------------------------------------------------------------------------------
FOOD & STAPLES 12,547 Albertson's, Inc. ..................................... 332,997
RETAILING--3.4%
15,257 CVS Corporation........................................ 641,099
16,805 Costco Wholesale Corporation........................... 690,181
29,126 +The Kroger Co. ....................................... 530,093
5,192 SUPERVALU Inc. ........................................ 158,927
24,571 SYSCO Corporation...................................... 881,362
17,147 +Safeway Inc. ......................................... 434,505
165,116 Wal-Mart Stores, Inc. ................................. 8,711,520
39,644 Walgreen Co. .......................................... 1,435,509
5,423 Winn-Dixie Stores, Inc. ............................... 39,046
------------
13,855,239
- --------------------------------------------------------------------------------------------------------------------
GAS UTILITIES--0.1% 6,117 KeySpan Corporation.................................... 224,494
1,729 NICOR, Inc. ........................................... 58,734
9,311 NiSource Inc. ......................................... 191,993
985 Peoples Energy Corporation............................. 41,518
------------
516,739
- --------------------------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT & 2,073 Bausch & Lomb Incorporated............................. 134,890
SUPPLIES--2.2%
23,558 Baxter International Inc. ............................. 812,986
9,788 Becton, Dickinson and Company.......................... 507,018
10,025 Biomet, Inc. .......................................... 445,511
32,182 +Boston Scientific Corporation......................... 1,377,390
4,354 C.R. Bard, Inc. ....................................... 246,654
11,591 Guidant Corporation.................................... 647,705
46,662 Medtronic, Inc. ....................................... 2,273,373
1,931 +Millipore Corporation................................. 108,850
6,394 +St. Jude Medical, Inc. ............................... 483,706
15,396 Stryker Corporation.................................... 846,780
7,136 +Thermo Electron Corporation........................... 219,361
9,416 +Zimmer Holdings, Inc. ................................ 830,491
------------
8,934,715
- --------------------------------------------------------------------------------------------------------------------
HEALTH CARE PROVIDERS & 5,543 Aetna Inc. (New Shares)................................ 471,155
SERVICES--2.1%
4,035 AmerisourceBergen Corporation.......................... 241,212
4,918 +Anthem, Inc. ......................................... 440,456
4,963 CIGNA Corporation...................................... 341,504
16,237 Cardinal Health, Inc. ................................. 1,137,402
17,650 +Caremark Rx, Inc. .................................... 581,391
2,700 +Express Scripts, Inc. ................................ 213,921
18,655 HCA Inc. .............................................. 775,861
9,400 Health Management Associates, Inc. (Class A)........... 210,748
6,052 +Hospira, Inc. ........................................ 167,035
6,457 +Humana Inc. .......................................... 109,123
9,014 IMS Health Incorporated................................ 211,288
4,249 Manor Care, Inc. ...................................... 138,857
10,507 McKesson HBOC, Inc. ................................... 360,705
11,183 +Medco Health Solutions, Inc. ......................... 419,363
4,000 Quest Diagnostics Incorporated......................... 339,800
17,912 +Tenet Healthcare Corporation.......................... 240,200
23,698 UnitedHealth Group Incorporated........................ 1,475,201
5,984 +WellPoint Health Networks Inc. ....................... 670,268
------------
8,545,490
- --------------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 24,373 Carnival Corporation................................... 1,145,531
LEISURE--1.4%
7,161 Darden Restaurants, Inc. .............................. 147,159
4,355 Harrah's Entertainment, Inc. .......................... 235,606
</Table>
182
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS &
LEISURE (CONCLUDED)
14,763 Hilton Hotels Corporation.............................. $ 275,478
13,408 International Game Technology.......................... 517,549
8,683 Marriott International, Inc. (Class A)................. 433,108
47,972 McDonald's Corporation................................. 1,247,272
14,422 +Starbucks Corporation................................. 627,069
8,009 Starwood Hotels & Resorts Worldwide, Inc. ............. 359,204
4,219 Wendy's International, Inc. ........................... 146,990
12,242 +YUM! Brands, Inc. .................................... 455,647
------------
5,590,613
- --------------------------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES--0.5% 3,085 The Black & Decker Corporation......................... 191,671
4,772 Centex Corporation..................................... 218,319
5,599 Fortune Brands, Inc. .................................. 422,333
1,289 KB HOME................................................ 88,464
7,955 Leggett & Platt, Incorporated.......................... 212,478
3,236 Maytag Corporation..................................... 79,314
10,585 Newell Rubbermaid, Inc. ............................... 248,748
4,342 Pulte Corporation...................................... 225,914
2,441 Snap-On Incorporated................................... 81,896
3,141 The Stanley Works...................................... 143,167
2,634 Whirlpool Corporation.................................. 180,692
------------
2,092,996
- --------------------------------------------------------------------------------------------------------------------
HOUSEHOLD PRODUCTS--2.1% 8,968 The Clorox Company..................................... 482,299
19,885 Colgate-Palmolive Company.............................. 1,162,278
19,321 Kimberly-Clark Corporation............................. 1,272,867
99,506 The Procter & Gamble Company........................... 5,417,107
------------
8,334,551
- --------------------------------------------------------------------------------------------------------------------
IT SERVICES--1.2% 4,700 +Affiliated Computer Services, Inc. (Class A).......... 248,818
22,755 Automatic Data Processing, Inc. ....................... 952,979
7,008 +Computer Sciences Corporation......................... 325,381
6,934 +Convergys Corporation................................. 106,784
18,238 Electronic Data Systems Corporation.................... 349,258
33,608 First Data Corporation................................. 1,496,228
6,755 +Fiserv, Inc. ......................................... 262,702
14,260 Paychex, Inc. ......................................... 483,129
5,423 Sabre Holdings Corporation (Class A)................... 150,271
11,600 +Sungard Data Systems Inc. ............................ 301,600
12,869 +Unisys Corporation.................................... 178,622
------------
4,855,772
- --------------------------------------------------------------------------------------------------------------------
INDUSTRIAL 30,146 3M Co. ................................................ 2,713,441
CONGLOMERATES--4.7%
406,365 General Electric Company++............................. 13,166,226
5,880 Textron, Inc. ......................................... 348,978
77,163 Tyco International Ltd. ............................... 2,557,182
------------
18,785,827
- --------------------------------------------------------------------------------------------------------------------
INSURANCE--4.7% 10,900 ACE Limited............................................ 460,852
19,942 AFLAC Incorporated..................................... 813,833
26,445 The Allstate Corporation............................... 1,231,015
4,132 Ambac Financial Group, Inc. ........................... 303,454
101,007 American International Group, Inc. .................... 7,199,779
11,375 Aon Corporation........................................ 323,846
7,298 The Chubb Corporation.................................. 497,578
7,287 Cincinnati Financial Corporation....................... 317,130
10,677 The Hartford Financial Services Group, Inc. ........... 733,937
6,266 Jefferson--Pilot Corporation........................... 318,313
6,831 Lincoln National Corporation........................... 322,765
7,176 Loews Corporation...................................... 430,273
5,588 MBIA, Inc. ............................................ 319,187
19,460 Marsh & McLennan Companies, Inc. ...................... 883,095
28,853 MetLife, Inc. ......................................... 1,034,380
</Table>
183
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
INSURANCE (CONCLUDED)
8,394 The Progressive Corporation............................ $ 716,008
21,200 Prudential Financial, Inc. ............................ 985,164
5,344 SAFECO Corporation..................................... 235,136
25,637 The St. Paul Companies, Inc. .......................... 1,039,324
5,097 Torchmark Corporation.................................. 274,219
10,489 UnumProvident Corporation.............................. 166,775
5,155 XL Capital Ltd. (Class A).............................. 388,996
------------
18,995,059
- --------------------------------------------------------------------------------------------------------------------
INTERNET & CATALOG 25,300 +eBay Inc. ............................................ 2,326,335
RETAIL--0.6%
- --------------------------------------------------------------------------------------------------------------------
INTERNET SOFTWARE & 51,860 +Yahoo! Inc. .......................................... 1,884,074
SERVICES--0.5%
- --------------------------------------------------------------------------------------------------------------------
LEISURE EQUIPMENT & 3,676 Brunswick Corporation.................................. 149,981
PRODUCTS--0.2%
10,611 Eastman Kodak Company.................................. 286,285
6,745 Hasbro, Inc. .......................................... 128,155
15,480 Mattel, Inc. .......................................... 282,510
------------
846,931
- --------------------------------------------------------------------------------------------------------------------
MACHINERY--1.5% 13,142 Caterpillar Inc. ...................................... 1,044,000
2,527 Crane Co. ............................................. 79,323
1,195 Cummins Inc. .......................................... 74,688
11,866 Danaher Corporation.................................... 615,252
9,488 Deere & Company........................................ 665,488
8,734 Dover Corporation...................................... 367,701
5,278 Eaton Corporation...................................... 341,698
3,578 ITT Industries, Inc. .................................. 296,974
11,466 Illinois Tool Works Inc. .............................. 1,099,475
6,179 Ingersoll-Rand Company (Class A)....................... 422,087
1 +Kadant Inc. .......................................... 23
2,717 +Navistar International Corporation.................... 105,311
6,046 PACCAR Inc. ........................................... 350,608
4,810 Pall Corporation....................................... 125,974
4,235 Parker-Hannifin Corporation............................ 251,813
------------
5,840,415
- --------------------------------------------------------------------------------------------------------------------
MEDIA--3.7% 23,645 Clear Channel Communications, Inc. .................... 873,683
64,291 +Comcast Corporation (Class A)......................... 1,802,077
22,411 +Comcast Corporation (Special Class A)................. 618,768
3,185 Dow Jones & Company, Inc. ............................. 143,644
10,447 Gannett Co., Inc. ..................................... 886,428
16,133 +The Interpublic Group of Companies, Inc. ............. 221,506
3,635 Knight Ridder, Inc. ................................... 261,720
7,852 The McGraw-Hill Companies, Inc. ....................... 601,228
1,932 Meredith Corporation................................... 106,183
5,677 The New York Times Company (Class A)................... 253,819
7,317 Omnicom Group Inc. .................................... 555,287
177,548 +Time Warner Inc. ..................................... 3,121,294
12,377 Tribune Company........................................ 563,649
12,498 +Univision Communications Inc. (Class A)............... 399,061
67,407 Viacom, Inc. (Class B)................................. 2,407,778
78,982 The Walt Disney Company................................ 2,013,251
------------
14,829,376
- --------------------------------------------------------------------------------------------------------------------
METALS & MINING--0.7% 33,424 Alcoa Inc. ............................................ 1,103,995
3,561 Allegheny Technologies Incorporated.................... 64,276
6,008 Freeport-McMoRan Copper & Gold, Inc. (Class B)......... 199,165
16,303 Newmont Mining Corporation............................. 631,904
2,735 Nucor Corporation...................................... 209,939
3,244 +Phelps Dodge Corporation.............................. 251,442
</Table>
184
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
METALS & MINING (CONCLUDED)
4,389 United States Steel Corporation........................ $ 154,142
3,672 Worthington Industries, Inc. .......................... 75,386
------------
2,690,249
- --------------------------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 23,622 +The AES Corporation................................... 234,566
UNREGULATED POWER--0.7%
21,387 +Calpine Corporation................................... 92,392
6,552 Constellation Energy Group............................. 248,321
11,861 Dominion Resources, Inc. .............................. 748,192
34,526 Duke Energy Corporation................................ 700,533
17,646 +Dynegy Inc. (Class A)................................. 75,172
9,114 Public Service Enterprise Group Incorporated........... 364,833
8,817 Sempra Energy.......................................... 303,569
------------
2,767,578
- --------------------------------------------------------------------------------------------------------------------
MULTILINE RETAIL--1.1% 4,445 +Big Lots, Inc. ....................................... 64,275
3,726 Dillard's, Inc. (Class A).............................. 83,090
12,688 Dollar General Corporation............................. 248,177
6,627 Family Dollar Stores, Inc. ............................ 201,593
6,930 Federated Department Stores, Inc. ..................... 340,263
10,635 J.C. Penney Company, Inc. ............................. 401,578
12,525 +Kohl's Corporation.................................... 529,557
12,147 The May Department Stores Company...................... 333,921
5,384 Nordstrom, Inc. ....................................... 229,412
8,195 Sears, Roebuck & Co. .................................. 309,443
35,134 Target Corporation..................................... 1,492,141
------------
4,233,450
- --------------------------------------------------------------------------------------------------------------------
OFFICE ELECTRONICS--0.1% 30,023 +Xerox Corporation..................................... 435,334
- --------------------------------------------------------------------------------------------------------------------
OIL & GAS--5.7% 3,705 Amerada Hess Corporation............................... 293,399
9,668 Anadarko Petroleum Corporation......................... 566,545
12,566 Apache Corporation..................................... 547,249
3,091 Ashland Inc. .......................................... 163,236
15,136 Burlington Resources Inc. ............................. 547,620
41,211 ChevronTexaco Corporation.............................. 3,878,367
26,376 ConocoPhillips......................................... 2,012,225
9,201 Devon Energy Corporation............................... 607,266
3,716 EOG Resources, Inc. ................................... 221,882
24,712 El Paso Corporation.................................... 194,731
251,746 Exxon Mobil Corporation++.............................. 11,180,040
4,321 Kerr-McGee Corporation................................. 232,340
4,948 Kinder Morgan, Inc. ................................... 293,367
12,123 Marathon Oil Corporation............................... 458,734
15,079 Occidental Petroleum Corporation....................... 729,974
2,578 Sunoco, Inc. .......................................... 164,012
10,510 Unocal Corporation..................................... 399,380
5,400 Valero Energy Corporation.............................. 398,304
20,307 The Williams Companies, Inc. .......................... 241,653
------------
23,130,324
- --------------------------------------------------------------------------------------------------------------------
PAPER & FOREST 9,804 Georgia-Pacific Corporation............................ 362,552
PRODUCTS--0.5%
18,724 International Paper Company............................ 836,963
4,487 Louisiana-Pacific Corporation.......................... 106,118
8,342 MeadWestvaco Corporation............................... 245,171
8,629 Weyerhaeuser Company................................... 544,662
------------
2,095,466
- --------------------------------------------------------------------------------------------------------------------
PERSONAL PRODUCTS--0.7% 3,481 Alberto-Culver Company (Class B)....................... 174,537
18,094 Avon Products, Inc. ................................... 834,857
38,658 The Gillette Company................................... 1,639,099
------------
2,648,493
- --------------------------------------------------------------------------------------------------------------------
</Table>
185
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS--8.0% 60,220 Abbott Laboratories.................................... $ 2,454,567
4,827 Allergan Inc. ......................................... 432,113
74,863 Bristol-Myers Squibb Company........................... 1,834,143
43,448 Eli Lilly and Company.................................. 3,037,450
14,218 +Forest Laboratories, Inc. ............................ 805,165
114,353 Johnson & Johnson...................................... 6,369,462
9,316 +King Pharmaceuticals, Inc. ........................... 106,668
85,679 Merck & Co., Inc. ..................................... 4,069,753
9,230 Mylan Laboratories, Inc. .............................. 186,908
294,660 Pfizer, Inc. .......................................... 10,100,945
56,511 Schering-Plough Corporation............................ 1,044,323
3,540 +Watson Pharmaceuticals, Inc. ......................... 95,226
51,351 Wyeth.................................................. 1,856,852
------------
32,393,575
- --------------------------------------------------------------------------------------------------------------------
REAL ESTATE--0.4% 3,600 Apartment Investment & Management Company (Class A).... 112,068
14,080 Equity Office Properties Trust......................... 382,976
11,100 Equity Residential Properties Trust.................... 330,003
7,300 Plum Creek Timber Company Inc. ........................ 237,834
7,000 ProLogis Trust......................................... 230,440
7,200 Simon Property Group, Inc. ............................ 370,224
------------
1,663,545
- --------------------------------------------------------------------------------------------------------------------
ROAD & RAIL--0.4% 15,566 Burlington Northern Santa Fe Corporation............... 545,900
8,254 CSX Corporation........................................ 270,483
16,486 Norfolk Southern Corporation........................... 437,209
9,207 Union Pacific Corporation.............................. 547,356
------------
1,800,948
- --------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 15,172 +Advanced Micro Devices, Inc. ......................... 241,235
SEMICONDUCTOR
EQUIPMENT--3.7%
14,447 +Altera Corporation.................................... 321,012
14,473 Analog Devices, Inc. .................................. 681,389
64,862 +Applied Materials, Inc. .............................. 1,272,592
12,021 +Applied Micro Circuits Corporation.................... 63,952
12,098 +Broadcom Corporation (Class A)........................ 565,823
248,988 Intel Corporation...................................... 6,872,069
7,100 +KLA-Tencor Corporation................................ 350,598
14,696 +LSI Logic Corporation................................. 111,984
11,264 Linear Technology Corporation.......................... 444,590
12,287 Maxim Integrated Products, Inc. ....................... 644,085
24,026 +Micron Technology, Inc. .............................. 367,838
6,400 +NVIDIA Corporation.................................... 131,200
14,708 +National Semiconductor Corporation.................... 323,429
5,142 +Novellus Systems, Inc. ............................... 161,664
6,833 +PMC--Sierra, Inc. .................................... 98,054
7,438 +Teradyne, Inc. ....................................... 168,843
67,771 Texas Instruments Incorporated......................... 1,638,703
13,313 Xilinx, Inc. .......................................... 443,456
------------
14,902,516
- --------------------------------------------------------------------------------------------------------------------
SOFTWARE--4.6% 8,580 Adobe Systems Incorporated............................. 398,970
3,826 Autodesk, Inc. ........................................ 163,791
9,501 +BMC Software, Inc. ................................... 175,769
6,529 +Citrix Systems, Inc. ................................. 132,930
22,710 Computer Associates International, Inc. ............... 637,243
14,818 +Compuware Corporation................................. 97,799
11,400 +Electronic Arts Inc. ................................. 621,870
7,393 +Intuit Inc. .......................................... 285,222
3,066 +Mercury Interactive Corporation....................... 152,779
415,586 Microsoft Corporation++................................ 11,869,136
14,882 +Novell, Inc. ......................................... 124,860
201,385 +Oracle Corporation.................................... 2,402,523
</Table>
186
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES
INDUSTRY++ HELD COMMON STOCKS VALUE
- --------------------------------------------------------------------------------------------------------------------
SOFTWARE (CONCLUDED)
10,277 +Parametric Technology Corporation..................... $ 51,385
15,082 +PeopleSoft, Inc. ..................................... 279,017
19,457 +Siebel Systems, Inc. ................................. 207,801
12,000 +Symantec Corporation.................................. 525,360
16,615 +VERITAS Software Corporation.......................... 460,236
------------
18,586,691
- --------------------------------------------------------------------------------------------------------------------
SPECIALTY RETAIL--2.3% 12,200 +AutoNation, Inc. ..................................... 208,620
3,208 +AutoZone, Inc. ....................................... 256,961
10,748 +Bed, Bath & Beyond Inc. .............................. 413,260
12,512 Best Buy Co., Inc. .................................... 634,859
2,579 Boise Cascade Corporation.............................. 97,073
5,865 Circuit City Stores--Circuit City Group................ 75,952
35,563 The Gap, Inc. ......................................... 862,403
85,959 The Home Depot, Inc. .................................. 3,025,757
16,379 Limited Brands, Inc. .................................. 306,287
30,111 Lowe's Companies, Inc. ................................ 1,582,333
12,840 +Office Depot, Inc. ................................... 229,964
7,183 RadioShack Corporation................................. 205,649
6,566 The Sherwin-Williams Company........................... 272,817
18,195 Staples, Inc. ......................................... 533,295
20,156 The TJX Companies, Inc. ............................... 486,566
5,647 Tiffany & Co. ......................................... 208,092
8,268 +Toys 'R' Us, Inc. .................................... 131,709
------------
9,531,597
- --------------------------------------------------------------------------------------------------------------------
TEXTILES, APPAREL & LUXURY 5,000 Jones Apparel Group, Inc. ............................. 197,400
GOODS--0.3%
4,308 Liz Claiborne, Inc. ................................... 155,002
9,817 Nike, Inc. (Class B)................................... 743,638
1,524 Reebok International Ltd. ............................. 54,834
4,508 V. F. Corporation...................................... 219,540
------------
1,370,414
- --------------------------------------------------------------------------------------------------------------------
THRIFTS & MORTGAGE 10,729 Countrywide Financial Corporation...................... 753,712
FINANCE--1.9%
37,434 Fannie Mae............................................. 2,671,290
27,150 Freddie Mac............................................ 1,718,595
5,899 Golden West Financial Corporation...................... 627,359
3,367 MGIC Investment Corporation............................ 255,421
11,600 Sovereign Bancorp, Inc. ............................... 256,360
33,115 Washington Mutual, Inc. ............................... 1,279,564
------------
7,562,301
- --------------------------------------------------------------------------------------------------------------------
TOBACCO--1.1% 78,989 Altria Group, Inc.++................................... 3,953,399
3,200 R.J. Reynolds Tobacco Holdings, Inc. .................. 216,288
6,399 UST Inc. .............................................. 230,364
------------
4,400,051
- --------------------------------------------------------------------------------------------------------------------
TRADING COMPANIES & 3,521 W. W. Grainger, Inc. .................................. 202,458
DISTRIBUTORS--0.0%
- --------------------------------------------------------------------------------------------------------------------
WIRELESS TELECOMMUNICATION 106,259 +AT&T Wireless Services, Inc. ......................... 1,521,629
SERVICES--0.7%
42,224 +Nextel Communications, Inc. (Class A)................. 1,125,692
------------
2,647,321
- --------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST--312,319,393)--101.8%............................ 409,901,583
- --------------------------------------------------------------------------------------------------------------------
</Table>
187
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. PORTFOLIO
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
BENEFICIAL
INTEREST SHORT-TERM SECURITIES VALUE
- --------------------------------------------------------------------------------------------------------------------
$3,869,156 Merrill Lynch Liquidity Series, LLC Cash Sweep Series
I(a)................................................. $ 3,869,156
2,426,200 Merrill Lynch Liquidity Series, LLC Money Market
Series(a)(b)......................................... 2,426,200
- --------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$6,295,356)--1.6%............................... 6,295,356
- --------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS--(COST--$318,614,749)--103.4%........ 416,196,939
LIABILITIES IN EXCESS OF OTHER ASSETS--(3.4)%.......... (13,615,379)
------------
NET ASSETS--100.0%..................................... $402,581,560
============
- --------------------------------------------------------------------------------------------------------------------
</Table>
+ Non-income producing security.
++ Portion of holdings pledged as collateral for financial futures contracts.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
(a) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------
DIVIDEND/INTEREST
AFFILIATE NET ACTIVITY INCOME
- ----------------------------------------------------------------------------------------------
Merrill Lynch & Co., Inc. .................................. 1,100 $11,481
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $(16,230,600) $24,507
Merrill Lynch Liquidity Series, LLC Money Market Series..... $ (2,828,300) $ 4,262
Merrill Lynch Premier Institutional Fund.................... (1,751,500) $ 1,313
- ----------------------------------------------------------------------------------------------
</Table>
(b) Security was purchased with the cash proceeds from securities loans.
(c) Financial futures contracts purchased as of June 30, 2004 were as follows:
<Table>
<Caption>
- ---------------------------------------------------------------------------------------
NUMBER OF FACE UNREALIZED
CONTRACTS ISSUE EXPIRATION DATE VALUE APPRECIATION
- ---------------------------------------------------------------------------------------
12 S&P 500 Financial Futures Index September 2004 $3,397,712 $23,593
- ---------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
188
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments, in unaffiliated securities, at value (including
securities loaned of $2,313,550) (identified
cost--$311,046,344)....................................... $407,905,457
Investments, in affiliated securities, at value (identified
cost--$7,568,405)......................................... 8,291,482
Receivables:
Securities sold........................................... $ 475,246
Dividends................................................. 461,158
Variation margin.......................................... 18,523
Capital shares sold....................................... 10,427
Interest from affiliates.................................. 6,930
Securities lending--net................................... 281 972,565
------------
Prepaid expenses............................................ 2,187
------------
Total assets................................................ 417,171,691
------------
- -------------------------------------------------------------------------------------------
LIABILITIES:
Collateral on securities loaned, at value................... 2,426,200
Payables:
Capital shares redeemed................................... 10,756,411
Securities purchased...................................... 957,865
Custodian bank............................................ 400,108
Investment adviser........................................ 16,838
Other affiliates.......................................... 5,502 12,136,724
------------
Accrued expenses............................................ 27,207
------------
Total liabilities........................................... 14,590,131
------------
- -------------------------------------------------------------------------------------------
NET ASSETS.................................................. $402,581,560
============
- -------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized+........................................ $ 2,760,238
Paid-in capital in excess of par............................ 358,551,162
Undistributed investment income--net........................ $ 2,635,097
Accumulated realized capital losses on investments--net..... (58,970,720)
Unrealized appreciation on investments--net................. 97,605,783
------------
Total accumulated earnings--net............................. 41,270,160
------------
NET ASSETS.................................................. $402,581,560
============
- -------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $402,581,560 and 27,602,381
shares outstanding........................................ $ 14.59
============
- -------------------------------------------------------------------------------------------
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II or Class
III as of June 30, 2004.
</Table>
See Notes to Financial Statements.
189
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends (includes $11,481 from affiliates)................ $ 3,480,207
Interest from affiliates.................................... 24,507
Securities lending--net..................................... 5,575
-----------
Total income................................................ 3,510,289
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $650,943
Accounting services......................................... 71,647
Professional fees........................................... 20,624
Printing and shareholder reports............................ 19,031
Custodian fees.............................................. 18,171
Directors' fees and expenses................................ 12,850
Transfer agent fees......................................... 2,451
Pricing services............................................ 615
Other....................................................... 29,587
--------
Total expenses.............................................. 825,919
-----------
Investment income--net...................................... 2,684,370
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET:
Realized loss on investments--net........................... (2,394,477)
Change in unrealized appreciation on investments--net....... 13,582,068
-----------
Total realized and unrealized gain on investments--net...... 11,187,591
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $13,871,961
===========
- --------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
190
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- ------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 2,684,370 $ 5,383,428
Realized loss on investments--net........................... (2,394,477) (616,543)
Change in unrealized appreciation on investments--net....... 13,582,068 96,651,551
------------ ------------
Net increase in net assets resulting from operations........ 13,871,961 101,418,436
------------ ------------
- ------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income net:......................................
Class I................................................... -- (5,400,005)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. -- (5,400,005)
------------ ------------
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital
share transactions........................................ (59,994,154) 32,944,949
------------ ------------
- ------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (46,122,193) 128,963,380
Beginning of period......................................... 448,703,753 319,740,373
------------ ------------
End of period*.............................................. $402,581,560 $448,703,753
============ ============
- ------------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess of)
investment income--net.................................... $ 2,635,097 $ (49,273)
============ ============
- ------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
191
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE FOR THE SIX
FINANCIAL STATEMENTS. MONTHS ENDED
JUNE 30, FOR THE YEAR ENDED DECEMBER 31,***
------------ --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 14.12 $ 11.15 $ 14.58 $ 16.79 $ 18.73
-------- -------- -------- -------- --------
Investment income--net .09+ .18+ .15+ .15 .16
Realized and unrealized gain (loss) on
investments--net.................................... .38 2.96 (3.41) (2.21) (1.91)
-------- -------- -------- -------- --------
Total from investment operations...................... .47 3.14 (3.26) (2.06) (1.75)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.............................. -- (.17) (.17) (.15) (.16)
In excess of investment income--net................. -- -- -- -- --++
In excess of realized gain on investments--net...... -- -- -- -- (.03)
-------- -------- -------- -------- --------
Total dividends and distributions..................... -- (.17) (.17) (.15) (.19)
-------- -------- -------- -------- --------
Net asset value, end of period........................ $ 14.59 $ 14.12 $ 11.15 $ 14.58 $ 16.79
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................... 3.33%++ 28.14% (22.40%) (12.28%) (9.37%)
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.............................................. .38%* .38% .40% .40% .35%
======== ======== ======== ======== ========
Investment income--net................................ 1.23%* 1.41% 1.20% .94% .88%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).............. $402,582 $448,704 $319,740 $482,374 $545,167
======== ======== ======== ======== ========
Portfolio turnover.................................... 1.93% 2.30% 7.79% 3.46% 7.31%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
+ Based on average shares outstanding.
++ Amount is less than $(.01) per share.
++ Aggregate total investment return.
See Notes to Financial Statements.
192
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INDEX 500 V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Index 500 V.I.
Fund (the "Fund") is classified as "non-diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
193
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment techniques to provide liquidity or as a proxy for a direct investment
in securities underlying the Fund's index. Losses may arise due to changes in
the value of the contract or if the counterparty does not perform under the
contract.
- - Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- - Options--The Fund may purchase and write covered 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.
(c) 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 and liabilities expressed in
foreign currencies into U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities, but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss
194
- --------------------------------------------------------------------------------
where the value of the collateral falls below the market value of the borrowed
securities, in the event of borrower default or in the event of losses on
investments made with cash collateral.
(i) Short sales--When the Fund engages in a short sale, an amount equal to the
proceeds 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 market value of the short sale. The Fund maintains a segregated
account of securities as collateral for the short sales. The Fund is exposed to
market risk based on the amount, if any, that the market value of the stock
exceeds the market value of the securities in the segregated account. The Fund
is required to repay the counterparty any dividends or interest received on the
security sold short.
(j) Custodian Bank--The Fund recorded an amount payable to the custodian bank
reflecting an overnight overdraft, which resulted from failed security
transactions.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .30% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management, U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Fund. There is no increase in the aggregate fees paid by the Fund for these
services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated, a subsidiary of ML & Co., or its affiliates.
Pursuant to that order, the Company also has retained Merrill Lynch Investment
Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities lending
agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $2,389 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, the Fund reimbursed MLIM $4,614 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $8,284,908 and $50,859,810, respectively.
Net realized gains (losses) for the six months ended June 30, 2004 and net
unrealized appreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ---------------------------------------------------------------------
Realized Unrealized
Gains (Losses) Appreciation
- ---------------------------------------------------------------------
Long-term investments................. $(3,201,756) $97,582,190
Financial futures contracts........... 807,279 23,593
----------- -----------
Total................................. $(2,394,477) $97,605,783
=========== ===========
- ---------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $88,891,950, of which $121,861,414 related to appreciated securities
and $32,969,464 related to depreciated securities. At June 30, 2004, the
aggregate cost of investments for federal income tax purposes was $327,304,989.
4. CAPITAL SHARE TRANSACTIONS:
Net increase (decrease) in net assets derived from capital share transactions
were $(59,994,154) and $32,944,949 for the six months ended June 30, 2004 and
the year ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -------------------------------------------------------------------
Shares sold........................... 1,273,448 $ 18,298,977
Shares redeemed....................... (5,451,695) (78,293,131)
---------- ------------
Net decrease.......................... (4,178,247) $(59,994,154)
========== ============
- -------------------------------------------------------------------
</Table>
195
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold.......................... 8,471,346 $ 98,954,749
Shares issued to shareholders in
reinvestment of dividends........... 383,251 5,400,005
---------- ------------
Total issued......................... 8,854,597 104,354,754
Shares redeemed...................... (5,740,498) (71,409,805)
---------- ------------
Net increase......................... 3,114,099 $ 32,944,949
========== ============
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$47,550,622, of which $3,261,712 expires in 2008, $14,759,870 expires in 2009,
$27,649,566 expires in 2010 and $1,879,474 expires in 2011. This amount will be
available to offset like amounts of any future taxable gains.
196
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
During the six months ended June 30, 2004, global earnings recovery continued
with many companies reporting strong numbers. Despite the strong corporate
earnings, however, financial markets were held back, struggling to assess the
implications of an up-tick in the interest rate cycle and tighter financial
conditions globally.
Markets started 2004 positively as investors continued to focus on
increasingly tangible prospects for a global economic recovery. However,
positive sentiment weakened slightly and markets entered a trading range as
macroeconomic data displayed a mixed picture toward the end of the first
quarter. News of the Madrid terrorist bombings in March caused further declines
in investor sentiment. Concern about U.S. interest rates rising was an
increasingly dominant theme during the period, with the Federal Reserve Board
announcing a widely anticipated 25 basis point (.25%) interest rate increase on
June 30, 2004. Oil pricing also was a major focus, and equity markets were
tested by the prospect of a sustained period of high oil prices. A high oil
price leads to higher costs for consumers and businesses, and could translate
into either lower profit margins for companies, or to cost-push inflation.
FUND PERFORMANCE
For the six-month period ended June 30, 2004, International Value V.I. Fund's
Class I Shares had a total return of +5.43%. The Fund outperformed its unmanaged
benchmark, the Morgan Stanley Capital International Europe, Australasia, Far
East (MSCI EAFE) Index, which returned +4.56% for the same period.
The Fund's outperformance was a result of good stock picking, with sector
selection having a slightly negative effect. From a portfolio perspective, the
cyclical sectors such as capital goods, automobiles and materials were the best
performers. The worst contributing sectors were hotels, restaurants and leisure,
energy, and technology hardware and equipment.
At the individual stock level, the Fund benefited from its overweight
positions in Japanese consumer financial companies Promise Co. Ltd., Sanyo
Shinpan Finance Co., Ltd. and Mitsui Sumitomo Insurance Company, Limited. Other
strong performers were Japanese beer company Asahi Breweries Limited and Toyota
Motor Corporation. In Europe, aerospace and defense company BAE Systems and
construction engineer Vinci SA had a positive impact on performance.
The largest detractors from relative performance were insurer Swiss Life
Holding, Japanese electronic component manufacturer Mabuchi Motor Co., Ltd.,
German construction company Hochtief AG and airline Deutsche Lufthansa AG.
PORTFOLIO ACTIVITY
The main transactions during the period were all a result of bottom-up stock
picking. Major purchases included Hochtief, whose assets, we believe, are worth
more than the share price indicates, and Dutch logistics/mail provider TPG NV,
given its attractive valuation and good growth prospects. We also increased the
Fund's exposure to financials by establishing new positions in Italian retail
bank Capitalia SpA, Norwegian commercial bank DNB Holding ASA and Japanese
consumer finance company Acom Co., Ltd. In the United Kingdom, we initiated a
new position in retailer Boots Group PLC based on the low valuation placed on
the core franchise at a time when new management is revitalizing the store
network.
The new positions were funded by selling Japanese financials Mitsui Sumitomo
Insurance Company and Sanyo Shinpan Finance Co., Ltd. as both stocks reached
their target prices. We also sold food retailer J Sainsbury PLC after the
company reported disappointing trading numbers and announced expansion plans. In
mainland Europe, several positions also reached their target price and were sold
out of the portfolio. These included Dutch publisher Wolters Kluwer NV, French
bank Credit Agricole SA and Italian cement producer Buzzi Unicem SpA.
CURRENT POSITION
At period-end, the largest sector exposures in the Fund were banks,
diversified financials and energy. As we employ a bottom-up approach, the sector
exposure within the Fund is largely the result of stock selection among
undervalued equity investments rather than perceived fundamentals in a given
sector. Within the banking sector, we favor the domestically oriented retail
banks--such as Italian banks Capitalia SpA and Intesa BCI SpA and Norwegian bank
DNB--which offer strong growth prospects, a low risk profile and stand to
benefit from a rising interest rate environment. Other significant holdings in
this sector are BNP Paribas SA and Royal Bank of Scotland Group PLC. The Fund's
exposure to
197
- --------------------------------------------------------------------------------
diversified financials is mainly through its holdings in Japanese consumer
financial companies Promise, Acom Co., Ltd. and Mitsubishi Securities. Within
the energy sector, we hold a number of companies that are highly cash
generative, offer a high dividend yield and provide good portfolio
diversification.
The Fund has limited exposure to growth-oriented sectors, such as technology
hardware and equipment, software and services, and media, where it is more
difficult to find companies that are trading at attractive valuations.
We continue to believe that fundamental factors such as earnings growth and
cash-flow generation will be increasingly important to investors and believe
that the Fund is well positioned for progress in the future.
LOOKING AHEAD
Consensus earnings growth for 2004 is forecast to be 17%-18% for the world,
the United States and Europe (ex UK), with 10%-15% projected for Japan and 7%
for the United Kingdom. This would lift the level of earnings well above our
estimate of the trend for most major markets. The United States and, to a lesser
extent, the United Kingdom are well ahead of the cycle, with peak margins and
strong sales growth. Japan and Europe are earlier in the cycle, with depressed
margins and an improving sales outlook offering the scope to substantially
improve earnings for several years. U.S. real reported earnings reached the peak
levels realized in 2000 on the back of very strong first-quarter results, having
enjoyed close to an 80% recovery from the 2002 lows. Each successive U.S.
quarterly report has brought a better outcome than expected (stronger sales,
better margins and lower tax, interest rate and one-off charges), but we are
close to the point at which there are natural limits to further improvement.
Substantial parts of the European equity market have been laggards, with real
earnings still 25% off the previous peak in the United Kingdom, and 30%-50% off
peak levels in Europe. Earnings revisions remain stronger in mainland Europe
than the United Kingdom, helped by a larger cyclical stock component and recent
currency weakness versus the U.S. dollar, and a greater than 20% rate of
earnings growth is possible.
"Sustainability" of earnings growth becomes the key issue at this late stage
in the earnings cycle. Bottom-up earnings forecasts are being revised upward by
analysts, on the basis of economic recovery and as companies become more
optimistic. However, with the exception of Japan--which is starting from a low
base--we are skeptical about the scope for forecasts to be beaten. We believe
there is potential for a substantial earnings rebound in Japan.
Top-line growth has been a major driver for earnings upgrades in those markets
where the currency backdrop is supportive: the U.S. dollar's depreciation was a
major factor generating the first-quarter earnings surprise (for
cyclicals/technology companies). The immediate outlook is less positive. Oil
company earnings are being revised upward after the recent strength in the oil
price; surprisingly, energy users (apart from airlines) have not been downgraded
yet. There are concerns that financial companies, which are an important part of
all equity markets, especially the United States, will see less positive
revisions as interest rates rise.
Global monetary conditions are currently into their tightening phase, with the
U.S. Federal Reserve Board already increasing the Federal Funds target rate on
June 30 from 1% to 1.25%, and the futures markets are now fully discounting an
interest rate hike at the next six Federal Open Market Committee meetings. In an
environment where U.S. data releases are generating significant volatility,
there is scope for liquidity to tighten further even after the first interest
rate rise.
At the same time, it is worth reiterating that monetary conditions remain
extremely accommodative, even in regions where tightening has begun in earnest.
Elsewhere, the Bank of Japan has reaffirmed its commitment to quantitative
easing, while the European Central Bank remains some way off tightening and
there may even be scope for further easing of European liquidity conditions.
198
- --------------------------------------------------------------------------------
IN CONCLUSION
We thank you for your continued investment in International Value V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- James A. Macmillan
James A. Macmillan
Vice President and Portfolio Manager
July 12, 2004
199
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +34.94%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 + 5.21
- --------------------------------------------------------------------------
Inception (6/10/98) through 6/30/04 + 5.52
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +5.43% +34.94%
- -----------------------------------------------------------------------------------------
MSCI EAFE Index** +4.56 +32.37
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset values for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective November 24, 2003, shares of the Fund were designated Class I
Shares.
** The unmanaged Index measures the total returns of developed foreign stock
markets in Europe, Australasia and the Far East (in U.S. dollars).
Past results shown should not be considered a representation of future
performance.
200
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY* HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
AUSTRALIA COMMERCIAL BANKS 349,000 Australia and New Zealand Banking
Group Ltd. ......................... $ 4,444,113 1.3%
-----------------------------------------------------------------------------------------------------
OIL & GAS 1,262,067 Santos Limited........................ 6,092,550 1.9
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN AUSTRALIA 10,536,663 3.2
- ----------------------------------------------------------------------------------------------------------------------
BELGIUM DIVERSIFIED 108,950 +Belgacom SA.......................... 3,316,502 1.0
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN BELGIUM 3,316,502 1.0
- ----------------------------------------------------------------------------------------------------------------------
FINLAND PAPER & FOREST 231,820 Stora Enso Oyj 'R'.................... 3,144,789 1.0
PRODUCTS
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN FINLAND 3,144,789 1.0
- ----------------------------------------------------------------------------------------------------------------------
FRANCE AUTOMOBILES 74,750 PSA Peugeot Citroen................... 4,162,534 1.3
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 124,344 BNP Paribas SA........................ 7,647,363 2.4
-----------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 89,287 Societe BIC SA........................ 3,973,723 1.2
SUPPLIES
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 33,365 Vinci SA.............................. 3,361,144 1.0
ENGINEERING
-----------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 64,654 Lafarge SA (Ordinary)................. 5,765,873 1.8
-----------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 149,654 Accor SA.............................. 6,316,236 1.9
LEISURE
-----------------------------------------------------------------------------------------------------
METALS & MINING 193,390 Arcelor............................... 3,246,974 1.0
-----------------------------------------------------------------------------------------------------
OIL & GAS 44,822 TotalFinaElf SA....................... 8,545,273 2.6
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN FRANCE 43,019,120 13.2
- ----------------------------------------------------------------------------------------------------------------------
GERMANY AIRLINES 291,268 Deutsche Lufthansa AG (Registered
Shares)............................. 3,961,870 1.2
-----------------------------------------------------------------------------------------------------
CHEMICALS 65,307 Linde AG.............................. 3,594,579 1.1
-----------------------------------------------------------------------------------------------------
CONSTRUCTION & 176,889 Hochtief AG........................... 4,196,634 1.3
ENGINEERING
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 192,641 +Deutsche Telekom AG (Registered
TELECOMMUNICATION Shares)............................. 3,384,399 1.1
SERVICES
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 73,754 E.On AG............................... 5,321,156 1.6
-----------------------------------------------------------------------------------------------------
TEXTILES, APPAREL & 27,789 Adidas-Salomon AG..................... 3,317,725 1.0
LUXURY GOODS
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN GERMANY 23,776,363 7.3
- ----------------------------------------------------------------------------------------------------------------------
IRELAND COMMERCIAL BANKS 55,000 Allied Irish Banks PLC................ 851,838 0.2
332,028 Allied Irish Banks PLC................ 5,130,316 1.6
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN IRELAND 5,982,154 1.8
- ----------------------------------------------------------------------------------------------------------------------
ITALY COMMERCIAL BANKS 1,640,694 Capitalia SpA......................... 5,134,099 1.6
2,401,006 Intesa BCI SpA........................ 9,379,922 2.9
------------ -----
14,514,021 4.5
-----------------------------------------------------------------------------------------------------
DIVERSIFIED 2,095,655 Telecom Italia SpA.................... 6,514,429 2.0
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
INSURANCE 156,851 Fondiaria--SAI........................ 3,495,293 1.0
-----------------------------------------------------------------------------------------------------
OIL & GAS 312,622 ENI SpA............................... 6,206,957 1.9
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN ITALY 30,730,700 9.4
- ----------------------------------------------------------------------------------------------------------------------
JAPAN AUTOMOBILES 196,400 Honda Motor Co., Ltd. ................ 9,467,663 2.9
275,200 Toyota Motor Corporation.............. 11,147,725 3.4
------------ -----
20,615,388 6.3
-----------------------------------------------------------------------------------------------------
</Table>
201
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY* HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
JAPAN
(CONCLUDED)
BEVERAGES 625,000 Asahi Breweries Limited............... $ 6,890,666 2.1%
-----------------------------------------------------------------------------------------------------
CAPITAL MARKETS 236,000 Mitsubishi Securities................. 3,099,372 0.9
-----------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 275,000 Toppan Printing Co., Ltd. ............ 3,112,542 1.0
SUPPLIES
-----------------------------------------------------------------------------------------------------
CONSUMER FINANCE 85,000 Acom Co., Ltd. ....................... 5,523,072 1.7
105,500 Promise Co., Ltd. .................... 7,038,812 2.2
------------ -----
12,561,884 3.9
-----------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 304,000 Sekisui House, Ltd. .................. 3,373,908 1.0
-----------------------------------------------------------------------------------------------------
MACHINERY 494,000 Amada Co., Ltd. ...................... 3,259,680 1.0
-----------------------------------------------------------------------------------------------------
OIL & GAS 432,000 Showa Shell Sekiyu K.K. .............. 3,883,902 1.2
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 115,400 Takeda Chemical Industries, Ltd. ..... 5,065,903 1.6
-----------------------------------------------------------------------------------------------------
SOFTWARE 100,000 Namco Ltd. ........................... 2,804,381 0.9
-----------------------------------------------------------------------------------------------------
TOBACCO 800 Japan Tobacco, Inc. .................. 6,217,294 1.9
-----------------------------------------------------------------------------------------------------
WIRELESS 3,130 NTT DoCoMo, Inc. ..................... 5,593,640 1.7
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN JAPAN 76,478,560 23.5
- ----------------------------------------------------------------------------------------------------------------------
NETHERLANDS AIR FREIGHT & 190,557 TNT Post Group NV..................... 4,353,978 1.3
LOGISTICS
-----------------------------------------------------------------------------------------------------
CHEMICALS 97,094 Akzo Nobel NV......................... 3,571,052 1.1
-----------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 256,792 Buhrmann NV........................... 2,552,521 0.8
SUPPLIES 236,258 Vedior NV 'A'......................... 3,443,571 1.0
------------ -----
5,996,092 1.8
-----------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 213,005 ING Groep NV.......................... 5,027,560 1.6
SERVICES
-----------------------------------------------------------------------------------------------------
FOOD & STAPLES 434,283 +Koninklijke Ahold NV................. 3,407,989 1.1
RETAILING
140,242 Koninklijke Ahold NV (ADR)(b)......... 1,112,119 0.3
------------ -----
4,520,108 1.4
-----------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 201,771 Koninklijke (Royal) Philips
Electronics NV...................... 5,432,577 1.7
-----------------------------------------------------------------------------------------------------
INSURANCE 241,847 Aegon NV.............................. 2,915,950 0.9
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE NETHERLANDS 31,817,317 9.8
- ----------------------------------------------------------------------------------------------------------------------
NEW ZEALAND DIVERSIFIED 907,309 Telecom Corporation of New Zealand
TELECOMMUNICATION Limited............................. 3,387,977 1.0
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN NEW ZEALAND 3,387,977 1.0
- ----------------------------------------------------------------------------------------------------------------------
NORWAY COMMERCIAL BANKS 623,445 DNB Holding ASA....................... 4,254,339 1.3
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN NORWAY 4,254,339 1.3
- ----------------------------------------------------------------------------------------------------------------------
SWEDEN DIVERSIFIED FINANCIAL 368,871 Investor AB 'B'....................... 3,770,510 1.2
SERVICES
-----------------------------------------------------------------------------------------------------
MACHINERY 102,023 Volvo AB 'B'.......................... 3,548,414 1.1
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SWEDEN 7,318,924 2.3
- ----------------------------------------------------------------------------------------------------------------------
SWITZERLAND CAPITAL MARKETS 166,862 Credit Suisse Group................... 5,928,904 1.8
-----------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 52,508 Holcim (Registered Shares)............ 2,855,154 0.9
-----------------------------------------------------------------------------------------------------
INSURANCE 24,527 +Swiss Life Holding................... 3,422,304 1.0
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 107,701 Novartis AG (Registered Shares)....... 4,751,262 1.5
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SWITZERLAND 16,957,624 5.2
- ----------------------------------------------------------------------------------------------------------------------
</Table>
202
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY* HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM AEROSPACE & DEFENSE 1,198,397 BAE Systems PLC....................... $ 4,764,944 1.5%
-----------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 548,448 Barclays PLC.......................... 4,672,182 1.4
210,488 Royal Bank of Scotland Group PLC...... 6,061,712 1.9
------------ -----
10,733,894 3.3
-----------------------------------------------------------------------------------------------------
FOOD & STAPLES 376,099 Boots Group PLC....................... 4,692,542 1.4
RETAILING
-----------------------------------------------------------------------------------------------------
FOOD PRODUCTS 429,893 Unilever PLC.......................... 4,217,695 1.3
-----------------------------------------------------------------------------------------------------
INDUSTRIAL 445,295 Smiths Group PLC...................... 6,028,304 1.9
CONGLOMERATES
-----------------------------------------------------------------------------------------------------
INSURANCE 316,729 AVIVA PLC............................. 3,268,267 1.0
-----------------------------------------------------------------------------------------------------
OIL & GAS 1,551,434 Shell Transport & Trading Company
PLC................................. 11,380,709 3.5
-----------------------------------------------------------------------------------------------------
PHARMACEUTICALS 205,726 GlaxoSmithKline PLC................... 4,163,618 1.3
-----------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 880,852 Kesa Electricals PLC.................. 4,620,551 1.4
-----------------------------------------------------------------------------------------------------
TRANSPORTATION 433,662 BAA PLC............................... 4,352,978 1.3
INFRASTRUCTURE
-----------------------------------------------------------------------------------------------------
WIRELESS 2,000,794 Vodafone Group PLC.................... 4,381,340 1.3
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
UNITED KINGDOM 62,604,842 19.2
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN COMMON STOCKS
(COST--$260,227,649) 323,325,874 99.2
- ----------------------------------------------------------------------------------------------------------------------
</Table>
<Table>
<Caption>
PREFERRED STOCKS
- -------------------------------------------------------------------------------------------------------------------------
GERMANY HOUSEHOLD PRODUCTS 19,632 Henkel KGaA (Non-Convertible).......... 1,676,269 0.5
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN PREFERRED STOCKS
(COST--$1,180,957) 1,676,269 0.5
- -------------------------------------------------------------------------------------------------------------------------
BENEFICIAL INTEREST OTHER INTERESTS(A)
- -------------------------------------------------------------------------------------------------------------------------
UNITED ELECTRIC UTILITIES 54,000 British Energy PLC (Deferred Shares)... 0 0.0
KINGDOM
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN OTHER INTERESTS
(COST--$0) 0 0.0
- -------------------------------------------------------------------------------------------------------------------------
FACE AMOUNT SHORT-TERM SECURITIES
- -------------------------------------------------------------------------------------------------------------------------
TIME DEPOSITS US$ 5,338,874 Brown Brothers Harriman & Co., 0.76%
due 7/01/2004........................ 5,338,874 1.6
------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS IN
SHORT-TERM SECURITIES
(COST--$5,338,874) 5,338,874 1.6
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$266,747,480)................... 330,341,017 101.3
LIABILITIES IN EXCESS OF OTHER
ASSETS............................... (4,327,814) (1.3)
------------ -----
NET ASSETS............................. $326,013,203 100.0%
============ =====
- -------------------------------------------------------------------------------------------------------------------------
</Table>
+ Non-income producing security.
* For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
203
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------------------------------
NET INTEREST/DIVIDEND
AFFILIATE ACTIVITY INCOME
- ----------------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Money Market Series..... $(10,656,674) $ 14,529
Merrill Lynch Premier Institutional Fund.................... (3,552,226) $ 4,692
- ----------------------------------------------------------------------------------------------
</Table>
(a) Other interests represent beneficial interest in liquidation trusts and
other reorganization entities and are non-income producing.
(b) American Depositary Receipts (ADR).
See Notes to Financial Statements.
204
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (identified
cost--$266,747,480)....................................... $330,341,017
Cash........................................................ 1,428
Foreign cash (cost--$22,569)................................ 22,569
Receivables:
Dividends................................................. $ 1,372,107
Securities sold........................................... 1,075,515
Capital shares sold....................................... 216,731
Interest.................................................. 113 2,664,466
------------
Prepaid expenses............................................ 3,817
------------
Total assets................................................ 333,033,297
------------
- -------------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Capital shares redeemed................................... 6,659,356
Securities purchased...................................... 260,377
Investment adviser........................................ 34,139
Other affiliates.......................................... 4,312 6,958,184
------------
Accrued expenses and other liabilities...................... 61,910
------------
Total liabilities........................................... 7,020,094
------------
- -------------------------------------------------------------------------------------------
NET ASSETS.................................................. $326,013,203
============
- -------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized+........................................ $ 2,709,939
Paid-in capital in excess of par............................ 328,829,342
Undistributed investment income--net........................ $ 3,806,646
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (72,953,940)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 63,621,216
------------
Total accumulated losses--net............................... (5,526,078)
------------
NET ASSETS.................................................. $326,013,203
============
- -------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $326,013,203 and 27,099,386
shares outstanding........................................ $ 12.03
============
- -------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II or Class III as of June 30,
2004.
See Notes to Financial Statements.
205
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends (net of $877,856 foreign withholding tax)......... $ 5,794,917
Securities lending--net..................................... 19,221
Interest.................................................... 7,366
-----------
Total income................................................ 5,821,504
-----------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $ 1,220,170
Custodian fees.............................................. 64,024
Accounting services......................................... 48,250
Professional fees........................................... 17,738
Printing and shareholder reports............................ 16,862
Trustee's fees and expenses................................. 9,190
Pricing fees................................................ 3,431
Transfer agent fees......................................... 2,142
Other....................................................... 14,491
-----------
Total expenses.............................................. 1,396,298
-----------
Investment income--net...................................... 4,425,206
-----------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain from:
Investments--net.......................................... 15,624,397
Foreign currency transactions--net........................ 10,890 15,635,287
-----------
Change in unrealized appreciation on:
Investments--net.......................................... (2,867,281)
Foreign currency transactions--net........................ (96,562) (2,963,843)
----------- -----------
Total realized and unrealized gain on investments and
foreign currency transactions--net........................ 12,671,444
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $17,096,650
===========
- -----------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
206
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE IN NET ASSETS: 2004 2003
- -----------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 4,425,206 $ 5,262,954
Realized gain (loss) on investments and foreign currency
transactions--net......................................... 15,635,287 (397,444)
Change in unrealized appreciation on investments and foreign
currency transactions--net................................ (2,963,843) 88,498,071
------------ ------------
Net increase in net assets resulting from operations........ 17,096,650 93,363,581
------------ ------------
- -----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... -- (8,834,795)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. -- (8,834,795)
------------ ------------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (10,975,429) (4,638,718)
------------ ------------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 6,121,221 79,890,068
Beginning of period......................................... 319,891,982 240,001,914
------------ ------------
End of period*.............................................. $326,013,203 $319,891,982
============ ============
- -----------------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess of)
investment income--net.................................... $ 3,806,646 $ (618,560)
============ ============
- -----------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
207
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,++
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 11.41 $ 8.26 $ 9.69 $ 11.68 $ 11.52
-------- -------- -------- -------- --------
Investment income--net................................ .16+ .19+ .13+ .20+ .22
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net.................. .46 3.29 (1.21) (1.71) .10
-------- -------- -------- -------- --------
Total from investment operations...................... .62 3.48 (1.08) (1.51) .32
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net.............................. -- (.33) (.35) (.24) (.11)
Realized gain on investments--net................... -- -- -- (.24) (.05)
-------- -------- -------- -------- --------
Total dividends and distributions..................... -- (.33) (.35) (.48) (.16)
-------- -------- -------- -------- --------
Net asset value, end of period........................ $ 12.03 $ 11.41 $ 8.26 $ 9.69 $ 11.68
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.................... 5.43%++ 42.24%++++ (11.54%) (12.90%) 2.85%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, excluding reorganization expenses........... .86%* .87% .91% .99% .93%
======== ======== ======== ======== ========
Expenses.............................................. .86%* .89% .91% 1.01% .93%
======== ======== ======== ======== ========
Investment income--net................................ 2.71%* 2.08% 1.38% 1.83% 2.20%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).............. $326,013 $319,892 $240,002 $349,318 $356,292
======== ======== ======== ======== ========
Portfolio turnover.................................... 33% 54% 55% 62% 39%
======== ======== ======== ======== ========
- -------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding.
++ Effective November 24, 2003, Shares of the Fund were designated Class I
Shares.
++ Aggregate total investment return.
++++ In 2003, .12% of the Fund's total return consisted of voluntary
reimbursements by the Investment Adviser for the realized losses on foreign
currency transactions.
See Notes to Financial Statements.
208
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--INTERNATIONAL VALUE V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. International
Value V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be
209
- --------------------------------------------------------------------------------
valued at their fair value as determined in good faith by the Company's Board of
Directors or by the Investment Adviser using a pricing service and/or procedures
approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- Options--The Fund may purchase and write 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 loss or gain to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-U.S. dollar-denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) 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 U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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, withholding taxes may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Dividends from foreign securities where the ex-dividend date may have passed are
subsequently recorded when the Fund has determined the ex-dividend date.
Interest income is recognized on the accrual basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective
210
- --------------------------------------------------------------------------------
aggregate net asset value of each fund included in the Company.
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities, but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
an annual rate of .75% of the average daily value of the Fund's net assets. MLIM
has entered into a Sub-Advisory Agreement with Merrill Lynch Asset Management
U.K. Limited. ("MLAM U.K."), an affiliate of MLIM, pursuant to which MLAM U.K.
provides investment advisory services to MLIM with respect to the Fund. There is
no increase in the aggregate fees paid by the Fund for these services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $8,099 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, MLPF&S earned $5,776 in commissions on
the execution of portfolio security transactions.
In addition, the Fund reimbursed MLIM $3,204 for certain accounting services
for the six months ended June 30, 2004.
Financial Data Services, Inc. ("FDS"), an indirect, wholly-owned subsidiary of
ML & Co., is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or,
directors of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $107,491,520 and $111,871,685, respectively.
Net realized gains for the six months ended June 30, 2004 and net unrealized
appreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Realized Unrealized
Gains Appreciation
- ------------------------------------------------------------------
Long-term investments................ $15,624,397 $63,593,537
Foreign currency transactions........ 10,890 27,679
----------- -----------
Total................................ $15,635,287 $63,621,216
=========== ===========
- ------------------------------------------------------------------
</Table>
As of June 30, 2004, net unrealized appreciation for federal income tax
purposes aggregated $61,839,592, of which $66,758,349 related to appreciated
securities and $4,918,757 related to
211
- --------------------------------------------------------------------------------
depreciated securities. At June 30, 2004, the aggregate cost of investments for
federal income tax purposes was $268,501,425.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$10,975,429 and $4,638,718 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -------------------------------------------------------------------
Shares sold........................... 2,336,061 $ 27,335,927
Shares redeemed....................... (3,263,348) (38,311,356)
---------- ------------
Net decrease.......................... (927,287) $(10,975,429)
========== ============
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold......................... 8,655,371 $ 78,202,592
Shares issued to shareholders in
reinvestment of dividends.......... 785,018 8,834,795
----------- ------------
Total issued........................ 9,440,389 87,037,387
Shares redeemed..................... (10,461,080) (91,676,105)
----------- ------------
Net decrease........................ (1,020,691) $ (4,638,718)
=========== ============
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. COMMITMENTS:
At June 30, 2004, the Fund had entered into foreign exchange contracts under
which it had agreed to purchase and sell various foreign currencies with
approximate values of $238,000 and $1,067,000, respectively.
7. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$87,183,238, of which $15,582,411 expires in 2008, $18,093,629 expires in 2009,
$41,856,405 expires in 2010 and $11,650,793 expires in 2011. This amount will be
available to offset like amounts of any future taxable gains.
212
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
Large Cap Core V.I. Fund invests primarily in a diversified portfolio of
equity securities of large cap companies that Fund management selects from among
those included in the Russell 1000 Index. Our investment process attempts to add
value through both security selection and portfolio construction. Security
selection involves the use of quantitative selection criteria, including
earnings momentum, earnings surprise and valuation. These criteria are input
into a proprietary quantitative model and are subject to selective fundamental
overrides. Portfolio construction consists of an optimization process with risk
management controlling style, capitalization, sector and individual security
allocations.
FUND PERFORMANCE
For the six-month period ended June 30, 2004, Large Cap Core V.I. Fund's Class
I Shares had a total return of +5.88%, 2.55 percentage points ahead of the
unmanaged benchmark, the Russell 1000 Index, which returned +3.33% for the same
period. The Fund's relative outperformance was a result of stock selection
within the healthcare, telecommunication services and utilities sectors, which
was partially offset by poor stock selection within information technology. The
Fund also benefited from an underweight position in materials.
INVESTMENT ENVIRONMENT
Concerns that inflation and interest rates may rise at a faster pace than
previously assumed inevitably lead to worries about how the economy and
financial markets might be affected. Leveraged activities increased during the
long period of exceptionally low interest rates, raising the question of how
much damage will be caused as interest rates increase. We doubt that rising
interest rates will pose a major threat to the economy during the next year.
Even if interest rates rise at a faster pace than currently discounted, it is
hard to imagine that monetary policy will become restrictive in the next 12
months. Such a restrictive policy stance would be signaled by interest rates at
or above nominal gross domestic product growth and/or a flat or inverted yield
curve. Eventually this point will come, but probably not before 2006. In past
cycles, the economy did not run into major problems until the yield curve became
flat or inverted. We believe this is a long way off. The bottom line, in our
view, is that the economic outlook for 2005 remains bright. The gradual
withdrawal of policy stimulus means that growth will slowly decelerate. In our
opinion, there is no reason why growth should fall significantly until policy
becomes restrictive or there is a negative shock that throws the economy off
course. As far as the financial markets are concerned, investors have had plenty
of warning to unwind leveraged trades that are vulnerable to higher short-term
interest rates. The Federal Reserve Board has been careful to telegraph its
intentions in order to avoid a repeat of 1994, when rising interest rates caught
many highly leveraged investors off guard.
PORTFOLIO ACTIVITY
As of June 30, 2004, our biggest overweights included consumer discretionary
and information technology, although our overweighting was as low as it has been
in some time. Similarly, our underweights included financials, consumer staples
and industrials. We expect to continue to increase quality and capitalization as
well as reduce cyclicality during the balance of the year while, as always,
focusing on companies that we believe have good earnings momentum, earnings
surprise and valuation characteristics.
During the period, we accelerated our move toward less cyclicality and higher
quality. From a sector standpoint, we increased our weightings in energy,
materials and healthcare and decreased our exposure to information technology,
industrials and financials. Our largest purchases included ConocoPhillips,
Lucent Technologies, Inc., QUALCOMM Incorporated, The Gillette Company and Xerox
Corporation, while our largest sales included Lehman Brothers Holdings, Inc.,
Citigroup Inc., Sprint Corp (PCS Group), Dell Inc., Oxford Health Plans, Inc.
and Countrywide Credit Industries Inc.
LOOKING AHEAD
The stock market has had to deal with much bad news in recent months including
a tense geopolitical situation, high oil prices and a repricing of Fed policy.
Moreover, equities were due for a pause given that the Standard & Poor's 500
(S&P 500) Index rose more than 40% between March 2003 and March 2004, almost
without a break. Under the circumstances, the market's recent stumble so far has
been minor, with the S&P 500 Index suffering a peak-to-trough decline of a
little more than 6%. It would have been much worse but for the continued
impressive performance of corporate earnings.
The turnaround in corporate finances in the past few years has been truly
spectacular. Profit margins have hit a new post-World War II high. The
combination of tight cost control, surging
213
- --------------------------------------------------------------------------------
productivity and improved sales volumes has allowed the corporate sector to
thrive despite limited pricing power. Earnings will continue to rise in the next
year, but the pace of growth may decelerate. Margins actually dipped lower in
the first quarter and a more pronounced decline will have occurred in the second
quarter given that productivity growth slowed sharply. Estimates of forward
earnings continue to rise strongly. The eventual combination of a sharp
deceleration in earnings growth and rising interest rates is not exactly
positive for stocks. This is especially true given that valuations are at best
neutral. The forward price-earnings ratio is still high by historical standards,
but looks reasonable when adjusted for the level of interest rates. However,
interest rates are headed up, not down. There is still a good chance that stocks
will make further gains in the near term. Interest rates, although rising, will
still be at historically low levels for some time, and earnings growth, although
decelerating, will still be decent.
Our view is that consumers should be relatively immune to the initial phase of
interest rate increases, assuming oil prices abate, because of the improvement
in incomes. We also believe that the bond market is in a rally phase inside this
cyclical bear market that started last June, and that the equity market is the
most difficult call. We have been concerned about the rise of the dollar, the
rise of interest rates, the rise of oil prices and geopolitics. We have gotten
some relief from the lower dollar and declining interest rates. As for oil
prices, the best we can say is that at least they seem to have stopped going up,
and the geopolitical backdrop is still a concern.
Putting this all together, we believe that rising earnings will eventually
carry stock prices higher as concerns about interest rates, oil prices, global
uncertainty and the presidential election eventually pass or are ameliorated to
some degree.
IN CONCLUSION
We thank you for your continued investment in Large Cap Core V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Robert C. Doll, Jr.
Robert C. Doll, Jr.
Senior Vice President and Portfolio Manager
July 12, 2004
214
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +23.32%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 + 2.30
- --------------------------------------------------------------------------
Ten Years Ended 6/30/04 +10.51
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +5.88% +23.32%
- -----------------------------------------------------------------------------------------
Russell 1000(R) Index** +3.33 +19.48
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset values for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
** This unmanaged Index measures the performance of the 1,000 largest companies
in the Russell 3000 Index, which represents approximately 92% of the total
market capitalization of the Russell 3000 Index.
Past results shown should not be considered a representation of future
performance.
Russell 1000 is a registered trademark of the Frank Russell Company.
215
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE 180,000 Honeywell International Inc. ............. $ 6,593,400 1.3%
- ---------------------------------------------------------------------------------------------------------------------
AUTO COMPONENTS 85,000 Lear Corporation.......................... 5,014,150 1.0
- ---------------------------------------------------------------------------------------------------------------------
AUTOMOBILES 42,000 Ford Motor Company........................ 657,300 0.1
129,000 General Motors Corporation................ 6,010,110 1.2
------------ -----
6,667,410 1.3
- ---------------------------------------------------------------------------------------------------------------------
BIOTECHNOLOGY 100,000 +Genentech, Inc. ......................... 5,620,000 1.1
74,000 +Invitrogen Corporation................... 5,327,260 1.0
------------ -----
10,947,260 2.1
- ---------------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS 417,000 +E*TRADE Financial Corp. ................. 4,649,550 0.9
223,000 J.P. Morgan Chase & Co. .................. 8,645,710 1.6
------------ -----
13,295,260 2.5
- ---------------------------------------------------------------------------------------------------------------------
CHEMICALS 115,000 Eastman Chemical Company.................. 5,316,450 1.0
- ---------------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 37,000 Bank of America Corporation............... 3,130,940 0.6
- ---------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 79,000 +Career Education Corporation............. 3,599,240 0.7
SUPPLIES
- ---------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS EQUIPMENT 347,000 +Avaya Inc. .............................. 5,479,130 1.0
113,000 +Cisco Systems, Inc. ..................... 2,678,100 0.5
276,000 +Corning Incorporated..................... 3,604,560 0.7
1,576,000 +Lucent Technologies Inc. ................ 5,957,280 1.1
405,000 Motorola, Inc. ........................... 7,391,250 1.4
113,000 QUALCOMM Incorporated..................... 8,246,740 1.6
------------ -----
33,357,060 6.3
- ---------------------------------------------------------------------------------------------------------------------
COMPUTERS & PERIPHERALS 22,000 International Business Machines
Corporation............................. 1,939,300 0.4
109,000 +NCR Corporation.......................... 5,405,310 1.0
109,000 +SanDisk Corporation...................... 2,364,210 0.5
45,000 +Storage Technology Corporation........... 1,305,000 0.2
------------ -----
11,013,820 2.1
- ---------------------------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 133,000 Citigroup Inc. ........................... 6,184,500 1.2
SERVICES
- ---------------------------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 220,000 Edison International...................... 5,625,400 1.1
147,000 TXU Corporation........................... 5,954,970 1.1
------------ -----
11,580,370 2.2
- ---------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 163,000 Rockwell Automation, Inc. ................ 6,114,130 1.2
- ---------------------------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 200,000 +Agilent Technologies, Inc. .............. 5,856,000 1.1
INSTRUMENTS
117,000 +Waters Corporation....................... 5,590,260 1.1
------------ -----
11,446,260 2.2
- ---------------------------------------------------------------------------------------------------------------------
FOOD & STAPLES RETAILING 20,000 Wal-Mart Stores, Inc. .................... 1,055,200 0.2
- ---------------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS 340,000 Archer-Daniels-Midland Company............ 5,705,200 1.1
269,000 Tyson Foods, Inc. (Class A)............... 5,635,550 1.1
------------ -----
11,340,750 2.2
- ---------------------------------------------------------------------------------------------------------------------
HEALTH CARE 82,000 Bausch & Lomb Incorporated................ 5,335,740 1.0
EQUIPMENT & SUPPLIES
111,000 Becton, Dickinson and Company............. 5,749,800 1.1
96,000 C.R. Bard, Inc. .......................... 5,438,400 1.0
118,000 +Cytyc Corporation........................ 2,993,660 0.6
41,000 +Fisher Scientific International Inc. .... 2,367,750 0.5
23,000 +Zimmer Holdings, Inc. ................... 2,028,600 0.4
------------ -----
23,913,950 4.6
- ---------------------------------------------------------------------------------------------------------------------
HEALTH CARE 66,000 +Anthem, Inc. ............................ 5,910,960 1.1
PROVIDERS & SERVICES
84,000 CIGNA Corporation......................... 5,780,040 1.1
156,000 +DaVita, Inc. ............................ 4,809,480 0.9
238,000 +Humana Inc. ............................. 4,022,200 0.8
121,000 Omnicare, Inc. ........................... 5,180,010 1.0
151,000 +PacifiCare Health Systems, Inc. ......... 5,837,660 1.1
</Table>
216
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
HEALTH CARE
PROVIDERS & SERVICES
(CONCLUDED)
698,000 +Service Corporation International........ $ 5,144,260 1.0%
------------ -----
36,684,610 7.0
- ---------------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS 124,000 Applebee's International, Inc. ........... 2,854,480 0.5
& LEISURE
132,000 International Game Technology............. 5,095,200 1.0
251,000 McDonald's Corporation.................... 6,526,000 1.2
------------ -----
14,475,680 2.7
- ---------------------------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 186,000 D.R. Horton, Inc. ........................ 5,282,400 1.0
75,000 Fortune Brands, Inc. ..................... 5,657,250 1.1
76,000 KB HOME................................... 5,215,880 1.0
100,000 Lennar Corporation (Class A).............. 4,472,000 0.8
102,000 Pulte Corporation......................... 5,307,060 1.0
40,000 The Ryland Group, Inc. ................... 3,128,000 0.6
6,000 The Stanley Works......................... 273,480 0.1
29,000 +Toll Brothers, Inc. ..................... 1,227,280 0.2
------------ -----
30,563,350 5.8
- ---------------------------------------------------------------------------------------------------------------------
HOUSEHOLD PRODUCTS 28,000 The Procter & Gamble Company.............. 1,524,320 0.3
- ---------------------------------------------------------------------------------------------------------------------
IT SERVICES 200,000 +Cognizant Technology Solutions
Corporation............................. 5,082,000 0.9
122,000 +Computer Sciences Corporation............ 5,664,460 1.1
------------ -----
10,746,460 2.0
- ---------------------------------------------------------------------------------------------------------------------
INDUSTRIAL CONGLOMERATES 328,000 General Electric Company.................. 10,627,200 2.0
50,000 Textron, Inc. ............................ 2,967,500 0.6
------------ -----
13,594,700 2.6
- ---------------------------------------------------------------------------------------------------------------------
INSURANCE 62,000 The Allstate Corporation.................. 2,886,100 0.5
41,000 American International Group, Inc. ....... 2,922,480 0.5
30,000 Aon Corporation........................... 854,100 0.2
75,000 The Chubb Corporation..................... 5,113,500 1.0
28,600 Fidelity National Financial, Inc. ........ 1,067,924 0.2
92,000 The Hartford Financial Services Group,
Inc. ................................... 6,324,080 1.2
118,000 Lincoln National Corporation.............. 5,575,500 1.1
25,000 Loews Corporation......................... 1,499,000 0.3
89,000 MBIA, Inc. ............................... 5,083,680 1.0
108,000 MetLife, Inc. ............................ 3,871,800 0.7
40,000 SAFECO Corporation........................ 1,760,000 0.3
------------ -----
36,958,164 7.0
- ---------------------------------------------------------------------------------------------------------------------
MACHINERY 92,000 Cummins Inc. ............................. 5,750,000 1.1
- ---------------------------------------------------------------------------------------------------------------------
MEDIA 38,000 +Getty Images, Inc. ...................... 2,280,000 0.4
- ---------------------------------------------------------------------------------------------------------------------
METALS & MINING 75,000 Nucor Corporation......................... 5,757,000 1.1
66,000 Phelps Dodge Corporation.................. 5,115,660 1.0
------------ -----
10,872,660 2.1
- ---------------------------------------------------------------------------------------------------------------------
MULTILINE RETAIL 149,000 J.C. Penney Company, Inc. ................ 5,626,240 1.1
197,000 The May Department Stores Company......... 5,415,530 1.0
131,000 Nordstrom, Inc. .......................... 5,581,910 1.1
------------ -----
16,623,680 3.2
- ---------------------------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 1,208,000 +Dynegy Inc. (Class A).................... 5,146,080 1.0
UNREGULATED POWER
- ---------------------------------------------------------------------------------------------------------------------
OFFICE ELECTRONICS 405,000 +Xerox Corporation........................ 5,872,500 1.1
- ---------------------------------------------------------------------------------------------------------------------
OIL & GAS 77,000 Amerada Hess Corporation.................. 6,097,630 1.1
106,000 Anadarko Petroleum Corporation............ 6,211,600 1.2
100,000 ConocoPhillips............................ 7,629,000 1.4
186,000 Exxon Mobil Corporation................... 8,260,260 1.6
107,000 Kerr-McGee Corporation.................... 5,753,390 1.1
</Table>
217
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
OIL & GAS (CONCLUDED)
23,000 Sunoco, Inc. ............................. $ 1,463,260 0.3%
77,000 Valero Energy Corporation................. 5,679,520 1.1
------------ -----
41,094,660 7.8
- ---------------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCTS 166,000 Georgia-Pacific Corporation............... 6,138,680 1.2
- ---------------------------------------------------------------------------------------------------------------------
PERSONAL PRODUCTS 169,000 The Gillette Company...................... 7,165,600 1.4
- ---------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 103,000 Johnson & Johnson......................... 5,737,100 1.1
247,000 Pfizer, Inc. ............................. 8,467,160 1.6
------------ -----
14,204,260 2.7
- ---------------------------------------------------------------------------------------------------------------------
ROAD & RAIL 234,000 Norfolk Southern Corporation.............. 6,205,680 1.2
- ---------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 374,000 +Advanced Micro Devices, Inc. ............ 5,946,600 1.1
SEMICONDUCTOR EQUIPMENT
967,000 +Atmel Corporation........................ 5,724,640 1.1
251,000 +Cypress Semiconductor Corporation........ 3,561,690 0.7
265,000 +Fairchild Semiconductor Corporation...... 4,338,050 0.8
129,000 Intel Corporation......................... 3,560,400 0.7
104,000 +Silicon Laboratories Inc. ............... 4,820,400 0.9
48,000 Texas Instruments Incorporated............ 1,160,640 0.2
------------ -----
29,112,420 5.5
- ---------------------------------------------------------------------------------------------------------------------
SOFTWARE 141,000 Autodesk, Inc. ........................... 6,036,210 1.1
243,000 Microsoft Corporation..................... 6,940,080 1.3
422,000 +Novell, Inc. ............................ 3,540,580 0.7
127,000 +Symantec Corporation..................... 5,560,060 1.1
------------ -----
22,076,930 4.2
- ---------------------------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 143,000 Abercrombie & Fitch Co. (Class A)......... 5,541,250 1.0
219,000 Foot Locker, Inc. ........................ 5,330,460 1.0
258,000 The Gap, Inc. ............................ 6,256,500 1.2
130,000 The Home Depot, Inc. ..................... 4,576,000 0.9
35,000 +Urban Outfitters, Inc. .................. 2,131,850 0.4
------------ -----
23,836,060 4.5
- ---------------------------------------------------------------------------------------------------------------------
TEXTILES, APPAREL & 122,000 +Coach, Inc. ............................. 5,513,180 1.1
LUXURY GOODS
- ---------------------------------------------------------------------------------------------------------------------
THRIFTS & MORTGAGE 24,000 Countrywide Financial Corporation......... 1,686,000 0.3
FINANCE
- ---------------------------------------------------------------------------------------------------------------------
WIRELESS 236,000 +Nextel Communications, Inc. (Class A).... 6,291,760 1.2
TELECOMMUNICATION SERVICES
- ---------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST--$469,026,944)...................... 524,987,584 100.1
- ---------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL
INTEREST SHORT-TERM SECURITIES
- ---------------------------------------------------------------------------------------------------------------------
$86,686,650 Merrill Lynch Liquidity Series, LLC
Money Market Series(a)(b)................. 86,686,650 16.5
- ---------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$86,686,650)....................... 86,686,650 16.5
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$555,713,594)...................... 611,674,234 116.6
LIABILITIES IN EXCESS OF OTHER ASSETS..... (87,161,028) (16.6)
------------ -----
NET ASSETS................................ $524,513,206 100.0%
============ =====
- ---------------------------------------------------------------------------------------------------------------------
</Table>
218
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
(a) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- --------------------------------------------------------------------------------------------
INTEREST/
AFFILIATE NET ACTIVITY DIVIDEND INCOME
- --------------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... -- $ 272
Merrill Lynch Liquidity Series, LLC Money Market Series..... $ 41,019,637 $29,428
Merrill Lynch Premier Institutional Fund.................... (15,222,337) $ 7,922
- --------------------------------------------------------------------------------------------
</Table>
(b) Security was purchased with the cash proceeds from securities loans.
See Notes to Financial Statements.
219
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (including
securities loaned of $84,539,686) (identified
cost--$469,026,944)....................................... $524,987,584
Investments in affiliated securities, at value (identified
cost--$86,686,650)........................................ 86,686,650
Foreign cash (cost--$368)................................... 354
Receivables:
Securities sold........................................... $ 24,254,968
Dividends................................................. 413,320
Securities lending--net................................... 5,912
Capital shares sold....................................... 2,813
Interest from affiliates.................................. 239 24,677,252
------------
Prepaid expenses............................................ 2,517
------------
Total assets................................................ 636,354,357
------------
- -------------------------------------------------------------------------------------------
LIABILITIES:
Collateral on securities loaned, at value................... 86,686,650
Payables:
Securities purchased...................................... 23,618,389
Custodian bank............................................ 1,231,982
Capital shares redeemed................................... 246,526
Investment adviser........................................ 32,589
Other affiliates.......................................... 6,377 25,135,863
------------
Accrued expenses............................................ 18,638
------------
Total liabilities........................................... 111,841,151
------------
- -------------------------------------------------------------------------------------------
NET ASSETS.................................................. $524,513,206
============
- -------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 200,000,000
shares authorized+........................................ $ 1,953,627
Paid-in capital in excess of par............................ 522,615,092
Undistributed investment income--net........................ $ 1,296,856
Accumulated realized capital losses on investments--net..... (57,312,995)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 55,960,626
------------
Total accumulated losses--net............................... (55,513)
------------
NET ASSETS.................................................. $524,513,206
============
- -------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $524,513,206 and 19,536,266
shares outstanding........................................ $ 26.85
============
- -------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II or Class III as of June 30,
2004.
See Notes to Financial Statements.
220
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends................................................... $ 2,717,365
Securities lending--net..................................... 37,350
Interest from affiliates.................................... 272
------------
Total income................................................ 2,754,987
------------
- -------------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $ 1,194,427
Accounting services......................................... 80,728
Custodian fees.............................................. 30,554
Professional fees........................................... 23,088
Printing and shareholder reports............................ 22,988
Directors' fees and expenses................................ 15,339
Transfer agent fees......................................... 2,436
Pricing services............................................ 606
Other....................................................... 10,896
------------
Total expenses.............................................. 1,381,062
------------
Investment income--net...................................... 1,373,925
------------
- -------------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain on investments--net........................... 49,296,116
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... (20,722,812)
Foreign currency transactions--net........................ 4 (20,722,808)
------------ ------------
Total realized and unrealized gain on investments and
foreign currency transactions--net........................ 28,573,308
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 29,947,233
============
- -------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
221
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- -----------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 1,373,925 $ 1,770,351
Realized gain on investments--net........................... 49,296,116 41,268,251
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ (20,722,808) 84,388,416
------------ ------------
Net increase in net assets resulting from operations........ 29,947,233 127,427,018
------------ ------------
- -----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... -- (1,825,008)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. -- (1,825,008)
------------ ------------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (23,153,997) (42,808,187)
------------ ------------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 6,793,236 82,793,823
Beginning of period......................................... 517,719,970 434,926,147
------------ ------------
End of period*.............................................. $524,513,206 $517,719,970
============ ============
- -----------------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess of)
investment income--net.................................... $ 1,296,856 $ (77,069)
============ ============
- -----------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
222
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE -----------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,+
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period..................... $ 25.36 $ 19.35 $ 23.52 $ 25.61 $ 39.93
-------- -------- -------- -------- --------
Investment income--net++................................. .07 .08 .16 .20 .44
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net..................... 1.42 6.02 (4.15) (2.09) (4.16)
-------- -------- -------- -------- --------
Total from investment operations......................... 1.49 6.10 (3.99) (1.89) (3.72)
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................. -- (.09) (.18) (.20) (.48)
In excess of investment income--net.................... -- -- -- -- (.16)
Realized gain on investments--net...................... -- -- -- --++ (8.58)
In excess of realized gain on investments--net......... -- -- -- -- (1.38)
-------- -------- -------- -------- --------
Total dividends and distributions........................ -- (.09) (.18) (.20) (10.60)
-------- -------- -------- -------- --------
Net asset value, end of period........................... $ 26.85 $ 25.36 $ 19.35 $ 23.52 $ 25.61
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share....................... 5.88%++++ 31.52% (16.98%) (7.39%) (9.85%)
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................. .53%* .54% .56% .53% .49%
======== ======== ======== ======== ========
Investment income--net................................... .52%* .39% .74% .86% 1.14%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)................. $524,513 $517,720 $434,926 $596,738 $761,558
======== ======== ======== ======== ========
Portfolio turnover....................................... 65.48% 124.56% 115.39% 170.43% 102.12%
======== ======== ======== ======== ========
- ------------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
++ Amount is less than $(.01) per share.
++Based on average shares outstanding.
++++Aggregate total investment return.
See Notes to Financial Statements.
223
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP CORE V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Large Cap Core
V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
224
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- - Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- - Options--The Fund may write 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 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 gain or loss to the extent the cost of the closing
transaction exceeds the premium paid or received).
Written options are non-income producing investments.
(c) 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 and liabilities expressed in
foreign currencies into U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Dividends from foreign securities where the ex-dividend date may have passed are
subsequently recorded when the Fund has determined the ex-dividend date.
Interest income is recognized on the accrual basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it receives a fee from the borrower. The Fund typically receives the income on
the loaned securities, but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the
225
- --------------------------------------------------------------------------------
event of borrower default or in the event of losses on investments made with
cash collateral.
(i) Custodian bank--The Fund recorded an amount payable to the custodian bank
reflecting an overnight draft which resulted from management estimates of
available cash.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the fund. For such services, the Fund pays a monthly fee at
the following annual rates: .500% of the Fund's average daily net assets not
exceeding $250 million; .450% of average daily net assets in excess of $250
million but not exceeding $300 million; .425% of average daily net assets in
excess of $300 million but not exceeding $400 million; and .400% of average
daily net assets in excess of $400 million. MLIM has entered into a Sub-Advisory
Agreement with Merrill Lynch Asset Management, Ltd. ("MLAM U.K."), an affiliate
of MLIM, pursuant to which MLAM U.K. provides investment advisory services to
MLIM with respect to the Company. There is no increase in the aggregate fees
paid by the Company for these services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. As of June 30, 2004, the Fund lent securities
with a value of $12,157,283 to MLPF&S or its affiliates. For the six months
ended June 30, 2004, MLIM, LLC received $16,122 in securities lending agent fees
from the Fund.
For the six months ended June 30, 2004, the Fund reimbursed MLIM $5,280 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $343,592,527 and $364,683,644, respectively.
Net realized gains for the six months ended June 30, 2004 and net unrealized
appreciation/ depreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- --------------------------------------------------------------------
Unrealized
Realized Appreciation/
Gains Depreciation
- --------------------------------------------------------------------
Long-term investments.................. $49,296,116 $55,960,640
Foreign currency transactions.......... -- (14)
----------- -----------
Total.................................. $49,296,116 $55,960,626
=========== ===========
- --------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $48,359,640, of which $67,813,589 related to appreciated securities
and $19,453,949 related to depreciated securities. At June 30, 2004, the
aggregate cost of investments for federal income tax purposes was $563,314,594.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets resulting from capital share transactions were
$23,153,997 and $42,808,187 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -------------------------------------------------------------------
Shares sold........................... 189,550 $ 4,987,853
Shares redeemed....................... (1,070,577) (28,141,850)
---------- ------------
Net decrease.......................... (881,027) $(23,153,997)
========== ============
- -------------------------------------------------------------------
</Table>
226
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold.......................... 371,145 $ 8,119,902
Shares issued to shareholders in
reinvestment of dividends........... 71,879 1,825,008
---------- ------------
Total issued......................... 443,024 9,944,910
Shares redeemed...................... (2,502,401) (52,753,097)
---------- ------------
Net decrease......................... (2,059,377) $(42,808,187)
========== ============
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$99,008,110, of which $53,032,267 expires in 2009 and $45,975,843 expires in
2010. This amount will be available to offset like amounts of any future taxable
gains.
227
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
Large Cap Growth V.I. Fund invests primarily in a diversified portfolio of
equity securities of large cap companies that Fund management selects from among
those included in the Russell 1000 Growth Index. Our investment process attempts
to add value through both security selection and portfolio construction.
Security selection involves the use of quantitative selection criteria,
including earnings momentum, earnings surprise and valuation. These criteria are
input into a proprietary quantitative model and are subject to selective
fundamental overrides. Portfolio construction consists of an optimization
process with risk management controlling style, capitalization, sector and
individual security allocations.
FUND PERFORMANCE
For the six-month period ended June 30, 2004, Large Cap Growth V.I. Fund's
Class I Shares had a total return of +2.38%, .36 percentage points below the
unmanaged benchmark, the Russell 1000 Growth Index, which returned +2.74% for
the same period. The Fund's Class III Shares had a total return of +6.17% since
inception (May 19, 2004) through June 30, 2004. Fund performance benefited from
stock selection within the health care, consumer discretionary and
telecommunications sectors, although this was partially offset by poor stock
selection within financials, consumer staples and information technology. The
Fund was also disadvantaged by an underweight position in energy.
INVESTMENT ENVIRONMENT
Concerns that inflation and interest rates may rise at a faster pace than
previously assumed inevitably lead to worries about how the economy and
financial markets might be affected. Leveraged activities increased during the
long period of exceptionally low interest rates, raising the question of how
much damage will be caused as interest rates increase. We doubt that rising
interest rates will pose a major threat to the economy during the next year.
Even if interest rates rise at a faster pace than currently discounted, it is
hard to imagine that monetary policy will become restrictive in the next 12
months. Such a restrictive policy stance would be signaled by interest rates at
or above nominal gross domestic product growth and/or a flat or inverted yield
curve. Eventually this point will come, but probably not before 2006. In past
cycles, the economy did not run into major problems until the yield curve became
flat or inverted. We believe this is a long way off. The bottom line, in our
view, is that the economic outlook for 2005 remains bright. The gradual
withdrawal of policy stimulus means that growth will slowly decelerate. In our
opinion, there is no reason why growth should fall significantly until policy
becomes restrictive or there is a negative shock that throws the economy off
course. As far as the financial markets are concerned, investors have had
sufficient warning to unwind leveraged trades that are vulnerable to higher
short-term interest rates. The Federal Reserve Board has been careful to
telegraph its intentions in order to avoid a repeat of 1994 when rising interest
rates caught many highly leveraged investors off guard.
PORTFOLIO ACTIVITY
As of June 30, 2004, our biggest overweights included consumer discretionary
and information technology, although our overweighting was as low as it has been
in some time. Similarly, our underweights included financials, consumer staples
and industrials. We expect to continue to increase quality and capitalization as
well as reduce cyclicality during the balance of the year while, as always,
focusing on companies that we believe have good earnings momentum, earnings
surprise and valuation characteristics.
During the period, we accelerated our move toward less cyclicality and higher
quality. From a sector standpoint, we increased our weightings in health care,
consumer staples and energy, and decreased our exposure to telecommunication
services, consumer discretionary and industrials. Our largest purchases included
Pfizer, Inc., Johnson & Johnson, Microsoft Corporation, The Home Depot, Inc.,
QUALCOMM Incorporated and The Gillette Company, while our largest sales included
Intel Corporation, Altria Group, Inc., Oxford Health Plans, Inc., Mandalay
Resort Group and E.I. du Pont de Nemours and Company.
LOOKING AHEAD
The stock market has had to deal with much bad news in recent months including
a tense geopolitical situation, high oil prices and a repricing of Fed policy.
Moreover, equities were due for a pause given that the Standard & Poor's 500
(S&P 500) Index rose more than 40% between March 2003 and March 2004, almost
without a break. Under the circumstances, the market's recent stumble so far has
been minor, with the S&P 500 Index suffering a peak-to-trough decline of a
little more than 6%. It would have been much worse but for the continued
impressive performance of corporate earnings.
228
- --------------------------------------------------------------------------------
The turnaround in corporate finances in the past few years has been truly
spectacular. Profit margins have hit a new post-World War II high. The
combination of tight cost control, surging productivity and improved sales
volumes has allowed the corporate sector to thrive despite limited pricing
power. Earnings will likely continue to rise in the next year, but the pace of
growth may decelerate. Margins actually dipped lower in the first quarter of
2004 and a more pronounced decline will have occurred in the second quarter
given that productivity growth slowed sharply. Estimates of forward earnings
continue to rise strongly. The eventual combination of a sharp deceleration in
earnings growth and rising interest rates is not exactly positive for stocks.
This is especially true given that valuations are at best neutral. The forward
price-earnings ratio is still high by historical standards, but looks reasonable
when adjusted for the level of interest rates. However, interest rates are
headed up, not down. There is still a good chance that stocks will make further
gains in the near term. Interest rates, although rising, will still be at
historically low levels for some time, and earnings growth, although
decelerating, will still be decent.
Our view is that consumers should be relatively immune to the initial phase of
interest rate increases, assuming oil prices abate, because of the improvement
in incomes. We also believe that the bond market is in a rally phase inside this
cyclical bear market that started last June, and that the equity market is the
most difficult call. We have been concerned about the rise of the dollar, the
rise of interest rates, the rise of oil prices and geopolitics. We have gotten
some relief from the lower dollar and declining interest rates. As for oil
prices, the best we can say is that at least they seem to have stopped going up,
and the geopolitical backdrop is still a concern.
Putting this all together, we believe that rising earnings will eventually
carry stock prices higher as concerns about interest rates, oil prices, global
uncertainty and the presidential election eventually pass or have improved to
some degree.
IN CONCLUSION
We thank you for your continued investment in Large Cap Growth V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Robert C. Doll, Jr.
Robert C. Doll, Jr.
Senior Vice President and Portfolio Manager
July 12, 2004
229
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +22.32%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 - 1.65
- --------------------------------------------------------------------------
Inception (4/30/99) through 6/30/04 - 0.61
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
AGGREGATE TOTAL RETURN--CLASS III SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
Inception (5/19/04 through 6/30/04) +6.17%
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +2.38% +22.32%
- -----------------------------------------------------------------------------------------
Class III Shares** -- --
- -----------------------------------------------------------------------------------------
Russell 1000(R) Growth Index*** +2.74 +17.88
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset value for the period shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective November 24, 2003, the Fund's Class A Shares were redesignated
Class I Shares.
** Class III Shares commenced operations on May 19, 2004.
*** This unmanaged Index measures the performance of those Russell 1000
companies with higher price-to-book ratios and higher forecasted growth
values.
Past results shown should not be considered a representation of future
performance.
Russell 1000 is a registered trademark of the Frank Russell Company.
230
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE 28,000 L-3 Communications Holdings, Inc. ........ $ 1,870,400 1.0%
- ---------------------------------------------------------------------------------------------------------------------
AUTO COMPONENTS 24,000 Autoliv, Inc. ............................ 1,012,800 0.6
- ---------------------------------------------------------------------------------------------------------------------
BIOTECHNOLOGY 45,000 +Genentech, Inc. ......................... 2,529,000 1.4
17,000 +IDEXX Laboratories, Inc. ................ 1,069,980 0.6
25,000 +Invitrogen Corporation................... 1,799,750 1.0
------------ -----
5,398,730 3.0
- ---------------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS 156,000 +E*TRADE Financial Corp. ................. 1,739,400 1.0
- ---------------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 28,000 Commerce Bancorp, Inc. ................... 1,540,280 0.9
- ---------------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 22,000 +Apollo Group, Inc. (Class A)............. 1,942,380 1.1
SUPPLIES 34,000 +Career Education Corporation............. 1,549,040 0.9
------------ -----
3,491,420 2.0
- ---------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS EQUIPMENT 102,900 +Cisco Systems, Inc. ..................... 2,438,730 1.4
112,000 +Corning Incorporated..................... 1,462,720 0.8
81,000 +Juniper Networks, Inc. .................. 1,990,170 1.1
172,000 Motorola, Inc. ........................... 3,139,000 1.8
51,000 QUALCOMM Incorporated..................... 3,721,980 2.1
214,000 +Tellabs, Inc. ........................... 1,870,360 1.0
------------ -----
14,622,960 8.2
- ---------------------------------------------------------------------------------------------------------------------
COMPUTERS & PERIPHERALS 22,000 +Lexmark International, Inc. (Class A).... 2,123,660 1.2
- ---------------------------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 70,000 +Agilent Technologies, Inc. .............. 2,049,600 1.1
INSTRUMENTS 37,700 +Arrow Electronics, Inc. ................. 1,011,114 0.6
41,000 PerkinElmer, Inc. ........................ 821,640 0.5
42,000 +Waters Corporation....................... 2,006,760 1.1
------------ -----
5,889,114 3.3
- ---------------------------------------------------------------------------------------------------------------------
FOOD & STAPLES RETAILING 332,000 +Rite Aid Corporation..................... 1,733,040 1.0
14,000 Wal-Mart Stores, Inc. .................... 738,640 0.4
21,000 Whole Foods Market, Inc. ................. 2,004,450 1.1
------------ -----
4,476,130 2.5
- ---------------------------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT & 24,000 Bausch & Lomb Incorporated................ 1,561,680 0.8
SUPPLIES 41,000 Becton, Dickinson and Company............. 2,123,800 1.2
34,000 C.R. Bard, Inc. .......................... 1,926,100 1.1
78,000 +Cytyc Corporation........................ 1,978,860 1.1
31,000 +Fisher Scientific International Inc. .... 1,790,250 1.0
33,000 +Respironics, Inc. ....................... 1,938,750 1.1
23,000 +Varian Medical Systems, Inc. ............ 1,825,050 1.0
------------ -----
13,144,490 7.3
- ---------------------------------------------------------------------------------------------------------------------
HEALTH CARE PROVIDERS & 21,000 Aetna Inc. (New Shares)................... 1,785,000 1.0
SERVICES 22,000 +Anthem, Inc. ............................ 1,970,320 1.1
51,000 +DaVita, Inc. ............................ 1,572,330 0.9
27,000 +Laboratory Corporation of America
Holdings................................ 1,071,900 0.6
19,400 Omnicare, Inc. ........................... 830,514 0.5
1,000 +PacifiCare Health Systems, Inc. ......... 38,660 0.0
22,000 Quest Diagnostics Incorporated............ 1,868,900 1.0
------------ -----
9,137,624 5.1
- ---------------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 28,800 Applebee's International, Inc. ........... 662,976 0.4
LEISURE 26,000 International Game Technology............. 1,003,600 0.6
38,000 Station Casinos, Inc. .................... 1,839,200 1.0
------------ -----
3,505,776 2.0
- ---------------------------------------------------------------------------------------------------------------------
</Table>
231
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 63,000 D.R. Horton, Inc. ........................ $ 1,789,200 1.0%
21,000 Harman International Industries,
Incorporated............................ 1,911,000 1.1
36,000 Lennar Corporation (Class A).............. 1,609,920 0.9
------------ -----
5,310,120 3.0
- ---------------------------------------------------------------------------------------------------------------------
IT SERVICES 55,000 +CheckFree Corp. ......................... 1,650,000 0.9
73,000 +Cognizant Technology Solutions
Corporation............................. 1,854,930 1.0
40,000 +DST Systems, Inc. ....................... 1,923,600 1.1
------------ -----
5,428,530 3.0
- ---------------------------------------------------------------------------------------------------------------------
INSURANCE 46,000 Fidelity National Financial, Inc. ........ 1,717,640 1.0
- ---------------------------------------------------------------------------------------------------------------------
INTERNET SOFTWARE & SERVICES 87,000 +Yahoo! Inc. ............................. 3,160,710 1.8
- ---------------------------------------------------------------------------------------------------------------------
MACHINERY 54,000 Pentair, Inc. ............................ 1,816,560 1.0
- ---------------------------------------------------------------------------------------------------------------------
MEDIA 31,000 +Getty Images, Inc. ...................... 1,860,000 1.0
- ---------------------------------------------------------------------------------------------------------------------
METALS & MINING 23,000 Phelps Dodge Corporation.................. 1,782,730 1.0
- ---------------------------------------------------------------------------------------------------------------------
MULTILINE RETAIL 34,000 Nordstrom, Inc. .......................... 1,448,740 0.8
- ---------------------------------------------------------------------------------------------------------------------
OFFICE ELECTRONICS 137,000 +Xerox Corporation........................ 1,986,500 1.1
- ---------------------------------------------------------------------------------------------------------------------
OIL & GAS 31,000 Anadarko Petroleum Corporation............ 1,816,600 1.0
- ---------------------------------------------------------------------------------------------------------------------
PERSONAL PRODUCTS 71,000 The Gillette Company...................... 3,010,400 1.7
- ---------------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 127,000 Johnson & Johnson......................... 7,073,900 4.0
289,000 Pfizer, Inc. ............................. 9,906,920 5.5
------------ -----
16,980,820 9.5
- ---------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 121,000 +Advanced Micro Devices, Inc. ............ 1,923,900 1.1
SEMICONDUCTOR EQUIPMENT 50,000 Analog Devices, Inc. ..................... 2,354,000 1.3
328,000 +Atmel Corporation........................ 1,941,760 1.1
91,000 +Cree, Inc. .............................. 2,118,480 1.2
107,000 +Cypress Semiconductor Corporation........ 1,518,330 0.8
111,000 +Fairchild Semiconductor Corporation...... 1,817,070 1.0
85,000 Intel Corporation......................... 2,346,000 1.3
37,000 +Silicon Laboratories Inc. ............... 1,714,950 1.0
118,000 Texas Instruments Incorporated............ 2,853,240 1.6
------------ -----
18,587,730 10.4
- ---------------------------------------------------------------------------------------------------------------------
SOFTWARE 47,000 Autodesk, Inc. ........................... 2,012,070 1.1
277,000 Microsoft Corporation..................... 7,911,120 4.4
161,000 +Novell, Inc. ............................ 1,350,790 0.7
91,000 +Red Hat, Inc. ........................... 2,090,270 1.2
52,000 +Symantec Corporation..................... 2,276,560 1.3
------------ -----
15,640,810 8.7
- ---------------------------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 51,000 Abercrombie & Fitch Co. (Class A)......... 1,976,250 1.1
38,000 +AnnTaylor Stores Corporation............. 1,101,240 0.6
44,000 +Barnes & Noble, Inc. .................... 1,495,120 0.8
42,000 +Chico's FAS, Inc. ....................... 1,896,720 1.1
83,000 Claire's Stores, Inc. .................... 1,801,100 1.0
36,000 Foot Locker, Inc. ........................ 876,240 0.5
95,000 The Gap, Inc. ............................ 2,303,750 1.3
116,000 The Home Depot, Inc. ..................... 4,083,200 2.3
10,300 Michael's Stores, Inc. ................... 566,500 0.3
62,000 PETsMART, Inc. ........................... 2,011,900 1.1
10,000 Regis Corporation......................... 445,900 0.2
43,000 Staples, Inc. ............................ 1,260,330 0.7
86,000 The TJX Companies, Inc. .................. 2,076,040 1.2
30,000 +Urban Outfitters, Inc. .................. 1,827,300 1.0
------------ -----
23,721,590 13.2
- ---------------------------------------------------------------------------------------------------------------------
</Table>
232
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
TEXTILES, APPAREL & 44,000 +Coach, Inc. ............................. $ 1,988,360 1.1%
LUXURY GOODS 28,000 +The Timberland Company (Class A)......... 1,808,520 1.0
------------ -----
3,796,880 2.1
- ---------------------------------------------------------------------------------------------------------------------
WIRELESS 96,000 +Nextel Communications, Inc. (Class A).... 2,559,360 1.4
TELECOMMUNICATION
SERVICES
- ---------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS (COST--$167,654,783) 178,578,504 99.8
- ---------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL INTEREST SHORT-TERM SECURITIES
- ---------------------------------------------------------------------------------------------------------------------
$ 71,838 Merrill Lynch Liquidity Series, LLC Cash
Sweep Series I(a)....................... 71,838 0.0
10,274,050 Merrill Lynch Liquidity Series, LLC Money
Market Series(a)(b)..................... 10,274,050 5.7
- ---------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$10,345,888) 10,345,888 5.7
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (COST--$178,000,671).... 188,924,392 105.5
LIABILITIES IN EXCESS OF OTHER ASSETS..... (9,993,816) (5.5)
------------ -----
NET ASSETS................................ $178,930,576 100.0%
============ =====
- ---------------------------------------------------------------------------------------------------------------------
</Table>
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management.
This definition may not apply for purposes of this report, which may
combine such industry sub-classifications for reporting ease.
(a) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of
the Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- ------------------------------------------------------------------------------------------
NET INTEREST/
AFFILIATE ACTIVITY DIVIDEND INCOME
- ------------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $ (993,402) $10,372
Merrill Lynch Liquidity Series, LLC Money Market Series..... $9,175,300 $ 2,081
Merrill Lynch Premier Institutional Fund.................... (366,250) $ 511
- ------------------------------------------------------------------------------------------
</Table>
(b) Security was purchased with the cash proceeds from securities loans.
See Notes to Financial Statements.
233
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (including
securities loaned of $10,044,907)(identified
cost--$167,654,783)....................................... $178,578,504
Investments in affiliated securities, at value (identified
cost--$10,345,888)........................................ 10,345,888
Cash........................................................ 8,483
Receivables:
Securities sold........................................... $ 17,799,321
Dividends................................................. 59,354
Capital shares sold....................................... 49,024
Interest from affiliates.................................. 1,236
Securities lending--net................................... 600 17,909,535
------------
Prepaid expenses and other assets........................... 14,680
------------
Total assets................................................ 206,857,090
------------
- -------------------------------------------------------------------------------------------
LIABILITIES:
Collateral on securities loaned, at value................... 10,274,050
Payables:
Securities purchased...................................... 17,624,326
Investment adviser........................................ 15,747
Capital shares redeemed................................... 9,597
Other affiliates.......................................... 2,185
Distributor............................................... 16 17,651,871
------------
Accrued expenses............................................ 593
------------
Total liabilities........................................... 27,926,514
------------
- -------------------------------------------------------------------------------------------
NET ASSETS.................................................. $178,930,576
============
- -------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized+........................................ $ 1,887,564
Class III Shares of Common Stock, $.10 par value,
100,000,000 shares authorized+............................ 866
Paid-in capital in excess of par............................ 244,063,334
Accumulated investment loss--net............................ $ (76,009)
Accumulated realized capital losses on investments--net..... (77,868,900)
Unrealized appreciation on investments--net................. 10,923,721
------------
Total accumulated losses--net............................... (67,021,188)
------------
NET ASSETS.................................................. $178,930,576
============
- -------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $178,848,553 and 18,875,637
shares outstanding........................................ $ 9.48
============
Class III--Based on net assets of $82,023 and 8,658 shares
outstanding............................................... $ 9.47
============
- -------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares.
++ The Fund had no outstanding shares for Class II as of June 30, 2004.
See Notes to Financial Statements.
234
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends (net of $456 foreign withholding tax)............. $ 436,562
Interest from affiliates.................................... 10,372
Securities lending--net..................................... 2,592
-----------
Total income................................................ 449,526
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $431,026
Custodian fees.............................................. 22,370
Professional fees........................................... 21,787
Accounting services......................................... 21,170
Printing and shareholder reports............................ 11,683
Directors' fees and expenses................................ 4,389
Transfer agent fees--Class I................................ 3,866
Pricing services............................................ 597
Distribution fees--Class III................................ 20
Transfer agent fees--Class III.............................. 1
Other....................................................... 8,626
--------
Total expenses.............................................. 525,535
-----------
Investment loss--net........................................ (76,009)
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET:
Realized gain on investments--net........................... 3,283,524
Change in unrealized appreciation on investments--net....... (1,775,217)
-----------
Total realized and unrealized gain on investments--net...... 1,508,307
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 1,432,298
===========
- --------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
235
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JUNE 30, DECEMBER 31,
INCREASE IN NET ASSETS: 2004 2003
- -----------------------------------------------------------------------------------------------
OPERATIONS:
Investment loss--net........................................ $ (76,009) $ (228,062)
Realized gain on investments--net........................... 3,283,524 5,074,902
Change in unrealized appreciation on investments--net....... (1,775,217) 13,246,519
------------ -----------
Net increase in net assets resulting from operations........ 1,432,298 18,093,359
------------ -----------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share
transactions.............................................. 90,800,850 23,504,318
------------ -----------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 92,233,148 41,597,677
Beginning of period......................................... 86,697,428 45,099,751
------------ -----------
End of period*.............................................. $178,930,576 $86,697,428
============ ===========
- -----------------------------------------------------------------------------------------------
* Accumulated investment loss--net.......................... $ (76,009) --
============ ===========
- -----------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
236
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS -----------------------------------------------------------------------------
HAVE BEEN DERIVED FROM INFORMATION
PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,+
JUNE 30, --------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period...... $ 9.26 $ 6.91 $ 9.02 $ 9.95 $ 12.03
-------- ------- -------- ------- --------
Investment loss--net...................... (.01)*** (.03)*** (.04)*** (.03)*** --++
Realized and unrealized gain(loss) on
investments--net........................ .23 2.38 (2.07) (.90) (1.93)
-------- ------- -------- ------- --------
Total from investment operations.......... .22 2.35 (2.11) (.93) (1.93)
-------- ------- -------- ------- --------
Less dividends and distributions:
Investment income--net.................. -- -- -- --++ --
In excess of investment income--net..... -- -- -- -- --++
In excess of realized gain on
investments--net...................... -- -- -- -- (.15)
-------- ------- -------- ------- --------
Total dividends and distributions......... -- -- -- --++ (.15)
-------- ------- -------- ------- --------
Net asset value, end of period............ $ 9.48 $ 9.26 $ 6.91 $ 9.02 $ 9.95
======== ======= ======== ======= ========
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share........ 2.38%++ 34.01% (23.39%) (9.32%) (15.95%)
======== ======= ======== ======= ========
- -------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement and
excluding reorganization expense........ .79%* 1.02% 1.18% 1.15% 1.21%
======== ======= ======== ======= ========
Expenses, net of waiver................... .79%* 1.03% 1.18% 1.15% 1.21%
======== ======= ======== ======= ========
Expenses.................................. .79%* 1.03% 1.18% 1.15% 1.34%
======== ======= ======== ======= ========
Investment loss--net...................... (.11%)* (.39%) (.55%) (.29%) (.02%)
======== ======= ======== ======= ========
- -------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands).............................. $178,849 $86,697 $ 45,100 $47,868 $ 51,305
======== ======= ======== ======= ========
Portfolio turnover........................ 68.73% 140.87% 133.57% 172.49% 75.08%
======== ======= ======== ======= ========
- -------------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
++ Amount is less than $(.01) per share.
++ Aggregate total investment return.
See Notes to Financial Statements.
237
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS III
--------------
FOR THE PERIOD
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE BEEN DERIVED MAY 19,
FROM INFORMATION PROVIDED IN THE FINANCIAL STATEMENTS. 2004+ TO
INCREASE (DECREASE) IN NET ASSET VALUE: JUNE 30, 2004
- ----------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 8.92
-------
Investment loss--net***..................................... (.01)
Realized and unrealized gain on investments--net............ .56
-------
Total from investment operations............................ .55
-------
Net asset value, end of period.............................. $ 9.47
=======
- ----------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... 6.17%++
=======
- ----------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... 1.02%*
=======
Investment loss--net........................................ (.45%)*
=======
- ----------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 82
=======
Portfolio turnover.......................................... 68.73%
=======
- ----------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Commencement of operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
238
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP GROWTH V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Large Cap Growth
V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. Income, expenses
(other than expenses attributable to a specific class) and realized and
unrealized gains and losses on investments are allocated daily to each class
based on its relative net assets. The following is a summary of significant
accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the
Fund, which may use a matrix system for valuations. The procedures of a pricing
service and its valuations are reviewed by the officers of the Fund under the
general supervision of the Company's Board of Directors. Such valuations and
procedures will be reviewed periodically by the Board of Directors of the
Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such
239
- --------------------------------------------------------------------------------
periods that are expected to materially affect the value of such securities,
those securities may be valued at their fair value as determined in good faith
by the Company's Board of Directors or by the Investment Adviser using a pricing
service and/or procedures approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- Options--The Fund may purchase and write 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 loss or gain to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
- Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-U.S. dollar-denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) 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 U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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, withholding taxes may be imposed on interest, dividends and
capital gains at various rates.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Dividends from foreign securities where the ex-dividend date may have passed are
subsequently recorded when the Fund has determined the ex-dividend date.
Interest income is recognized on the accrual basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective
240
- --------------------------------------------------------------------------------
aggregate net asset value of each fund included in the Company.
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it receives a fee from the borrower. The Fund typically receives the income on
the loaned securities, but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with FAM Distributors, Inc. ("FAMD" or the
"Distributor"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
an annual rate of .65% of the average daily value of the Fund's net assets. MLIM
has entered into a Sub-Advisory Agreement with Merrill Lynch Asset Management,
U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which MLAM U.K.
provides investment advisory services to MLIM with respect to the Company. There
is no increase in the aggregate fees paid by the Company for these services.
Pursuant to the Distribution Plan adopted by the Company, in accordance with
Rule 12b-1 under the Investment Company Act of 1940, the Fund pays the
Distributor an ongoing distribution fee each month at the annual rate of .15% of
the average daily value of the Fund's Class II net assets and .25% of the
average daily value of the Fund's Class III net assets.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. As of June 30, 2004, the Fund lent securities with a value of
$1,590,000 to MLPF&S or its affiliates. Pursuant to that order, the Company also
has retained Merrill Lynch Investment Managers, LLC ("MLIM, LLC"), an affiliate
of MLIM, as the securities lending agent for a fee based on a share of the
returns on investment of cash collateral. MLIM, LLC may, on behalf of the
Company and the Fund, invest cash collateral received by the Fund for such
loans, among other things, in a private investment company managed by MLIM, LLC
or in registered money market funds advised by MLIM or its affiliates. For the
six months ended June 30, 2004, MLIM, LLC received $1,144 in securities lending
agent fees from the Fund.
For the six months ended June 30, 2004, the Fund reimbursed MLIM $1,399 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $185,523,588 and $94,560,865, respectively.
Net realized gains for the six months ended June 30, 2004 and net unrealized
appreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Realized Unrealized
Gains Appreciation
- ------------------------------------------------------------------
Long-term investments................. $3,283,524 $10,923,721
---------- -----------
Total................................. $3,283,524 $10,923,721
========== ===========
- ------------------------------------------------------------------
</Table>
241
- --------------------------------------------------------------------------------
As of June 30, 2004, net unrealized appreciation for federal income tax
purposes aggregated $9,895,424, of which $14,347,097 related to appreciated
securities and $4,451,673 related to depreciated securities. At June 30, 2004,
the aggregate cost of investments for federal income tax purposes was
$179,028,968.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$90,800,850 and $23,504,318 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -------------------------------------------------------------------
Shares sold........................... 10,734,719 $102,451,365
Shares redeemed....................... (1,225,869) (11,729,035)
---------- ------------
Net increase.......................... 9,508,850 $ 90,722,330
========== ============
- -------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold........................... 3,516,981 $27,921,616
Shares issued resulting from
reorganization....................... 522,519 4,650,671
---------- -----------
Total issued.......................... 4,039,500 32,572,287
Shares redeemed....................... (1,198,445) (9,067,969)
---------- -----------
Net increase.......................... 2,841,055 $23,504,318
========== ===========
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- ------------------------------------------------------------------
Class III Shares for the Period Dollar
May 19, 2004+ to June 30, 2004 Shares Amount
- ------------------------------------------------------------------
Shares sold.................................... 8,671 $78,645
Shares redeemed................................ (13) (125)
----- -------
Net increase................................... 8,658 $78,520
===== =======
- ------------------------------------------------------------------
</Table>
+ Commencement of operations.
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$80,124,127, of which $60,886,667 expires in 2008 and $19,237,460 expires in
2009. This amount will be available to offset like amounts of any future taxable
gains.
242
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
Large Cap Value V.I. Fund invests primarily in a diversified portfolio of
equity securities of large cap companies that Fund management selects from among
those included in the Russell 1000 Value Index. Our investment process attempts
to add value through both security selection and portfolio construction.
Security selection involves the use of quantitative selection criteria,
including earnings momentum, earnings surprise and valuation. These criteria are
input into a proprietary quantitative model and are subject to selective
fundamental overrides. Portfolio construction consists of an optimization
process with risk management controlling style, capitalization, sector and
individual security allocations.
FUND PERFORMANCE
For the six-month period ended June 30, 2004, Large Cap Value V.I. Fund's
Class I Shares had a total return of +7.39%, 3.45 percentage points ahead of the
unmanaged benchmark, the Russell 1000 Value Index, which returned +3.94% for the
same period. The Fund's relative outperformance was a result of stock selection
within the consumer discretionary, utilities, telecommunication services and
financials sectors, which was partially offset by an underweight position in
information technology.
INVESTMENT ENVIRONMENT
Concerns that inflation and interest rates may rise at a faster pace than
previously assumed inevitably lead to worries about how the economy and
financial markets might be affected. Leveraged activities increased during the
long period of exceptionally low interest rates, raising the question of how
much damage will be caused as interest rates increase. We doubt that rising
interest rates will pose a major threat to the economy during the next year.
Even if interest rates rise at a faster pace than currently discounted, it is
hard to imagine that monetary policy will become restrictive in the next 12
months. Such a restrictive policy stance would be signaled by interest rates at
or above nominal gross domestic product growth and/or a flat or inverted yield
curve. Eventually this point will come, but probably not before 2006. In past
cycles, the economy did not run into major problems until the yield curve became
flat or inverted. We believe this is a long way off. The bottom line, in our
view, is that the economic outlook for 2005 remains bright. The gradual
withdrawal of policy stimulus means that growth will slowly decelerate. In our
opinion, there is no reason why growth should fall significantly until policy
becomes restrictive or there is a negative shock that throws the economy off
course. As far as the financial markets are concerned, investors have had
sufficient warning to unwind leveraged trades that are vulnerable to higher
short-term interest rates. The Federal Reserve Board has been careful to
telegraph its intentions in order to avoid a repeat of 1994 when rising interest
rates caught many highly leveraged investors off guard.
PORTFOLIO ACTIVITY
As of June 30, 2004, our biggest overweights included consumer discretionary
and information technology, although our overweighting was as low as it has been
in some time. Similarly, our underweights included financials, consumer staples
and industrials. We expect to continue to increase quality and capitalization as
well as reduce cyclicality during the balance of the year while, as always,
focusing on companies that we believe have good earnings momentum, earnings
surprise and valuation characteristics.
During the period, we accelerated our move toward less cyclicality and higher
quality. From a sector standpoint, we increased our weightings in energy,
materials and health care and decreased our exposure to information technology,
consumer discretionary and financials. Our largest purchases included General
Electric Company, ChevronTexaco Corporation, The Allstate Corporation,
McDonald's Corporation and Lucent Technologies Inc., while our largest sales
included Wachovia Corporation, Federated Department Stores, Inc., Cendant
Corporation and Mandalay Resort Group.
LOOKING AHEAD
The stock market has had to deal with much bad news in recent months including
a tense geopolitical situation, high oil prices and a repricing of Fed policy.
Moreover, equities were due for a pause given that the Standard & Poor's 500
(S&P 500) Index rose more than 40% between March 2003 and March 2004, almost
without a break. Under the circumstances, the market's recent stumble has so far
been minor, with the S&P 500 Index suffering a peak-to-trough decline of a
little more than 6%. It would have been much worse but for the continued
impressive performance of corporate earnings.
The turnaround in corporate finances in the past few years has been truly
spectacular. Profit margins have hit a new post-World War II high. The
combination of tight cost control, surging
243
- --------------------------------------------------------------------------------
productivity and improved sales volumes has allowed the corporate sector to
thrive despite limited pricing power. Earnings will likely continue to rise in
the next year, but the pace of growth may decelerate. Margins actually dipped
lower in the first quarter of 2004 and a more pronounced decline will have
occurred in the second quarter given that productivity growth slowed sharply.
Estimates of forward earnings continue to rise strongly. The eventual
combination of a sharp deceleration in earnings growth and rising interest rates
is not exactly positive for stocks. This is especially true given that
valuations are at best neutral. The forward price-earnings ratio is still high
by historical standards, but looks reasonable when adjusted for the level of
interest rates. However, interest rates are headed up, not down. There is still
a good chance that stocks will make further gains in the near term. Interest
rates, although rising, will still be at historically low levels for some time,
and earnings growth, although decelerating, will still be decent.
Our view is that consumers should be relatively immune to the initial phase of
interest rate increases, assuming oil prices abate, because of the improvement
in incomes. We also believe that the bond market is in a rally phase inside this
cyclical bear market that started last June, and that the equity market is the
most difficult call. We have been concerned about the rise of the dollar, the
rise of interest rates, the rise of oil prices and geopolitics. We have gotten
some relief from the lower dollar and declining interest rates. As for oil
prices, the best we can say is that at least they seem to have stopped going up,
and the geopolitical backdrop is still a concern.
Putting this all together, we believe that rising earnings will eventually
carry stock prices higher as concerns about interest rates, oil prices, global
uncertainty and the presidential election eventually pass or have improved to
some degree.
IN CONCLUSION
We thank you for your continued investment in Large Cap Value V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Robert C. Doll, Jr.
Robert C. Doll, Jr.
Senior Vice President and Portfolio Manager
July 12, 2004
244
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +28.73%
- --------------------------------------------------------------------------
Inception (4/23/01) through 6/30/04 + 8.45
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +7.39% +28.73%
- -----------------------------------------------------------------------------------------
Russell 1000(R) Value Index** +3.94 +21.13
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset value for the period shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
** This unmanaged broad-based Index is a subset of the Russell 1000 Index
consisting of those Russell 1000 securities with lower price-to-book ratios
and have lower forecasted growth values.
Past results shown should not be considered a representation of future
performance.
Russell 1000 is a registered trademark of the Frank Russell Company.
245
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE 52,000 Honeywell International Inc. ............. $ 1,904,760 1.5%
- ---------------------------------------------------------------------------------------------------------------------
AUTO COMPONENTS 20,000 Dana Corporation.......................... 392,000 0.3
20,000 Lear Corporation.......................... 1,179,800 0.9
------------ -----
1,571,800 1.2
- ---------------------------------------------------------------------------------------------------------------------
AUTOMOBILES 36,000 General Motors Corporation................ 1,677,240 1.3
- ---------------------------------------------------------------------------------------------------------------------
BIOTECHNOLOGY 19,000 +Genentech, Inc........................... 1,067,800 0.9
18,000 +Invitrogen Corporation................... 1,295,820 1.0
------------ -----
2,363,620 1.9
- ---------------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS 6,000 The Bear Stearns Companies Inc. .......... 505,860 0.4
106,000 +E*TRADE Financial Corp. ................. 1,181,900 1.0
69,600 J.P. Morgan Chase & Co. .................. 2,698,392 2.1
------------ -----
4,386,152 3.5
- ---------------------------------------------------------------------------------------------------------------------
CHEMICALS 30,000 Eastman Chemical Company.................. 1,386,900 1.1
- ---------------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 15,000 Bank of America Corporation............... 1,269,300 1.0
10,000 Commerce Bancorp, Inc. ................... 550,100 0.4
------------ -----
1,819,400 1.4
- ---------------------------------------------------------------------------------------------------------------------
COMMUNICATIONS EQUIPMENT 64,000 +Avaya Inc. .............................. 1,010,560 0.8
103,000 +Corning Incorporated..................... 1,345,180 1.1
426,000 +Lucent Technologies Inc. ................ 1,610,280 1.3
69,000 Motorola, Inc. ........................... 1,259,250 1.0
114,000 +Tellabs, Inc. ........................... 996,360 0.8
------------ -----
6,221,630 5.0
- ---------------------------------------------------------------------------------------------------------------------
COMPUTERS & PERIPHERALS 26,000 +NCR Corporation.......................... 1,289,340 1.0
35,800 +Storage Technology Corporation........... 1,038,200 0.8
------------ -----
2,327,540 1.8
- ---------------------------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 100,000 Citigroup Inc. ........................... 4,650,000 3.7
SERVICES
- ---------------------------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 45,200 Alliant Energy Corporation................ 1,178,816 0.9
56,000 Edison International...................... 1,431,920 1.1
63,000 Northeast Utilities....................... 1,226,610 1.0
37,000 TXU Corporation........................... 1,498,870 1.2
------------ -----
5,336,216 4.2
- ---------------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 38,000 Rockwell Automation, Inc. ................ 1,425,380 1.1
- ---------------------------------------------------------------------------------------------------------------------
ELECTRONIC EQUIPMENT & 46,100 +Arrow Electronics, Inc. ................. 1,236,402 1.0
INSTRUMENTS
46,000 +Avnet, Inc. ............................. 1,044,200 0.8
5,000 +Tech Data Corporation.................... 195,650 0.1
------------ -----
2,476,252 1.9
- ---------------------------------------------------------------------------------------------------------------------
FOOD & STAPLES RETAILING 171,200 +Rite Aid Corporation..................... 893,664 0.7
- ---------------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS 86,000 Archer-Daniels-Midland Company............ 1,443,080 1.1
66,000 Tyson Foods, Inc. (Class A)............... 1,382,700 1.1
------------ -----
2,825,780 2.2
- ---------------------------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT & 19,000 Bausch & Lomb Incorporated................ 1,236,330 1.0
SUPPLIES
25,000 Becton, Dickinson and Company............. 1,295,000 1.0
20,000 C.R. Bard, Inc. .......................... 1,133,000 0.9
------------ -----
3,664,330 2.9
- ---------------------------------------------------------------------------------------------------------------------
HEALTH CARE PROVIDERS & 16,000 +Anthem, Inc. ............................ 1,432,960 1.1
SERVICES
22,000 CIGNA Corporation......................... 1,513,820 1.2
19,650 +DaVita, Inc. ............................ 605,810 0.5
61,000 +Humana Inc. ............................. 1,030,900 0.8
6,800 Omnicare, Inc. ........................... 291,108 0.2
36,000 +PacifiCare Health Systems, Inc. ......... 1,391,760 1.1
------------ -----
6,266,358 4.9
- ---------------------------------------------------------------------------------------------------------------------
</Table>
246
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 72,000 McDonald's Corporation.................... $ 1,872,000 1.5%
LEISURE
- ---------------------------------------------------------------------------------------------------------------------
HOUSEHOLD DURABLES 45,000 D.R. Horton, Inc. ........................ 1,278,000 1.0
17,000 Fortune Brands, Inc. ..................... 1,282,310 1.0
17,000 KB HOME................................... 1,166,710 0.9
24,000 Lennar Corporation (Class A).............. 1,073,280 0.9
18,000 M.D.C. Holdings, Inc. .................... 1,144,980 0.9
25,000 Pulte Corporation......................... 1,300,750 1.0
29,000 The Stanley Works......................... 1,321,820 1.0
------------ -----
8,567,850 6.7
- ---------------------------------------------------------------------------------------------------------------------
IT SERVICES 26,100 +Computer Sciences Corporation............ 1,211,823 1.0
- ---------------------------------------------------------------------------------------------------------------------
INDUSTRIAL CONGLOMERATES 128,000 General Electric Company.................. 4,147,200 3.3
- ---------------------------------------------------------------------------------------------------------------------
INSURANCE 42,000 The Allstate Corporation.................. 1,955,100 1.5
48,000 Aon Corporation........................... 1,366,560 1.1
29,000 Berkley (W.R.) Corporation................ 1,245,550 1.0
21,000 The Chubb Corporation..................... 1,431,780 1.1
35,000 Fidelity National Financial, Inc. ........ 1,306,900 1.0
25,000 The Hartford Financial Services Group,
Inc. ................................... 1,718,500 1.4
30,000 Lincoln National Corporation.............. 1,417,500 1.1
23,000 Loews Corporation......................... 1,379,080 1.1
22,000 MBIA, Inc. ............................... 1,256,640 1.0
41,000 MetLife, Inc. ............................ 1,469,850 1.2
22,000 Prudential Financial, Inc. ............... 1,022,340 0.8
30,000 SAFECO Corporation........................ 1,320,000 1.0
------------ -----
16,889,800 13.3
- ---------------------------------------------------------------------------------------------------------------------
MACHINERY 21,000 Cummins Inc. ............................. 1,312,500 1.0
- ---------------------------------------------------------------------------------------------------------------------
METALS & MINING 4,000 +Phelps Dodge Corporation................. 310,040 0.2
- ---------------------------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 238,400 +Dynegy Inc. (Class A).................... 1,015,584 0.8
UNREGULATED POWER
- ---------------------------------------------------------------------------------------------------------------------
MULTILINE RETAIL 38,000 J.C. Penney Company, Inc. ................ 1,434,880 1.1
51,000 The May Department Stores Company......... 1,401,990 1.1
31,000 Nordstrom, Inc. .......................... 1,320,910 1.1
57,700 Saks Incorporated......................... 865,500 0.7
------------ -----
5,023,280 4.0
- ---------------------------------------------------------------------------------------------------------------------
OFFICE ELECTRONICS 103,000 +Xerox Corporation........................ 1,493,500 1.2
- ---------------------------------------------------------------------------------------------------------------------
OIL & GAS 19,000 Amerada Hess Corporation.................. 1,504,610 1.2
27,000 Anadarko Petroleum Corporation............ 1,582,200 1.3
37,000 ChevronTexaco Corporation................. 3,482,070 2.7
31,000 ConocoPhillips............................ 2,364,990 1.9
95,000 Exxon Mobil Corporation................... 4,218,950 3.3
26,000 Kerr-McGee Corporation.................... 1,398,020 1.1
22,000 Sunoco, Inc. ............................. 1,399,640 1.1
21,000 Valero Energy Corporation................. 1,548,960 1.2
------------ -----
17,499,440 13.8
- ---------------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCTS 41,000 Georgia-Pacific Corporation............... 1,516,180 1.2
- ---------------------------------------------------------------------------------------------------------------------
PERSONAL PRODUCTS 31,000 The Gillette Company...................... 1,314,400 1.0
- ---------------------------------------------------------------------------------------------------------------------
ROAD & RAIL 57,000 Norfolk Southern Corporation.............. 1,511,640 1.2
- ---------------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 85,000 +Advanced Micro Devices, Inc. ............ 1,351,500 1.0
SEMICONDUCTOR EQUIPMENT
216,000 +Atmel Corporation........................ 1,278,720 1.0
51,400 +Cypress Semiconductor Corporation........ 729,366 0.6
61,000 +Fairchild Semiconductor Corporation...... 998,570 0.8
------------ -----
4,358,156 3.4
- ---------------------------------------------------------------------------------------------------------------------
SOFTWARE 31,000 Autodesk, Inc. ........................... 1,327,110 1.0
- ---------------------------------------------------------------------------------------------------------------------
</Table>
247
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- ---------------------------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 43,000 +AnnTaylor Stores Corporation............. $ 1,246,140 1.0%
33,600 +Barnes & Noble, Inc. .................... 1,141,728 0.9
7,500 Claire's Stores, Inc. .................... 162,750 0.1
55,000 Foot Locker, Inc. ........................ 1,338,700 1.1
------------ -----
3,889,318 3.1
- ---------------------------------------------------------------------------------------------------------------------
THRIFTS & MORTGAGE FINANCE 24,000 Countrywide Financial Corporation......... 1,686,000 1.3
- ---------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST--$107,249,682)...................... 126,142,843 99.3
- ---------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL
INTEREST SHORT-TERM SECURITIES
- ---------------------------------------------------------------------------------------------------------------------
$2,523,805 Merrill Lynch Liquidity Series, LLC Cash
Sweep Series I(a)....................... 2,523,805 2.0
1,350,000 Merrill Lynch Liquidity Series, LLC Money
Market Series(a)(b)..................... 1,350,000 1.0
- ---------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$3,873,805) 3,873,805 3.0
- ---------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS (COST--$111,123,487).... 130,016,648 102.3
LIABILITIES IN EXCESS OF OTHER ASSETS..... (2,972,107) (2.3)
------------ -----
NET ASSETS................................ $127,044,541 100.0%
============ =====
- ---------------------------------------------------------------------------------------------------------------------
</Table>
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
(a) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- --------------------------------------------------------------------------------------------
NET INTEREST/DIVIDEND
AFFILIATE ACTIVITY INCOME
- --------------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $2,183,451 $3,585
Merrill Lynch Liquidity Series, LLC Money Market Series..... $ (491,249) $ 797
Merrill Lynch Premier Institutional Fund.................... (613,751) $ 230
- --------------------------------------------------------------------------------------------
</Table>
(b) Security was purchased with the cash proceeds from securities loans.
See Notes to Financial Statements.
248
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (including
securities loaned of $1,305,000) (identified
cost--$107,249,682)....................................... $126,142,843
Investments in affiliated securities, at value (identified
cost--$3,873,805)......................................... 3,873,805
Receivables:
Securities sold........................................... $ 7,292,985
Capital shares sold....................................... 107,330
Dividends................................................. 90,688
Interest from affiliates.................................. 1,518
Securities lending--net................................... 82 7,492,603
-----------
Prepaid expenses and other assets........................... 6,483
------------
Total assets................................................ 137,515,734
------------
- ------------------------------------------------------------------------------------------
LIABILITIES:
Collateral on securities loaned, at value................... 1,350,000
Payables:
Securities purchased...................................... 9,092,158
Investment adviser........................................ 12,906
Capital shares redeemed................................... 11,228
Other affiliates.......................................... 2,058 9,118,350
-----------
Other liabilities........................................... 2,843
------------
Total liabilities........................................... 10,471,193
------------
- ------------------------------------------------------------------------------------------
NET ASSETS.................................................. $127,044,541
============
- ------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized+........................................ $ 993,727
Paid-in capital in excess of par............................ 100,326,887
Undistributed investment income--net........................ $ 483,384
Undistributed realized capital gains on investments--net.... 6,347,382
Unrealized appreciation on investments--net................. 18,893,161
-----------
Total accumulated earnings--net............................. 25,723,927
------------
NET ASSETS.................................................. $127,044,541
============
- ------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $127,044,541 and 9,937,274
shares outstanding........................................ $ 12.78
============
- ------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II or Class III as of June 30,
2004.
See Notes to Financial Statements.
249
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends................................................... $ 984,165
Interest from affiliates.................................... 3,585
Securities lending--net..................................... 1,027
-----------
Total income................................................ 988,777
-----------
- --------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $438,842
Accounting services......................................... 18,112
Professional fees........................................... 16,002
Custodian fees.............................................. 9,217
Printing and shareholder reports............................ 4,666
Directors' fees and expenses................................ 3,088
Transfer agent fees......................................... 2,363
Pricing services............................................ 593
Other....................................................... 7,799
--------
Total expenses.............................................. 500,682
-----------
Investment income--net...................................... 488,095
-----------
- --------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET:
Realized gain on investments--net........................... 9,726,781
Change in unrealized appreciation on investments--net....... (2,021,809)
-----------
Total realized and unrealized gain on investments--net...... 7,704,972
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 8,193,067
===========
- --------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
250
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE IN NET ASSETS: 2004 2003
- -----------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 488,095 $ 465,273
Realized gain on investments--net........................... 9,726,781 2,768,475
Change in unrealized appreciation on investments--net....... (2,021,809) 22,671,776
------------ ------------
Net increase in net assets resulting from operations........ 8,193,067 25,905,524
------------ ------------
- -----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... -- (455,009)
------------ ------------
Net decrease in net assets resulting from dividends to
shareholders.............................................. -- (455,009)
------------ ------------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share
transactions.............................................. 12,412,130 12,214,287
------------ ------------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase in net assets................................ 20,605,197 37,664,802
Beginning of period......................................... 106,439,344 68,774,542
------------ ------------
End of period*.............................................. $127,044,541 $106,439,344
============ ============
- -----------------------------------------------------------------------------------------------
* Undistributed (accumulated distributions in excess of)
investment income--net.................................... $ 483,384 $ (4,711)
============ ============
- -----------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
251
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS HAVE ---------------------------------------------------------------
BEEN DERIVED FROM INFORMATION PROVIDED IN THE
FINANCIAL STATEMENTS. FOR THE SIX FOR THE YEAR ENDED FOR THE PERIOD
MONTHS ENDED DECEMBER 31,++ APRIL 23, 2001+
JUNE 30, ---------------------------- TO DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001++
- -----------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............ $ 11.90 $ 8.92 $ 10.26 $ 10.00
-------- -------- ------- -------
Investment income--net.......................... .05** .06** .08** .02
Realized and unrealized gain (loss) on
investments--net.............................. .83 2.97 (1.37) .28
-------- -------- ------- -------
Total from investment operations................ .88 3.03 (1.29) .30
-------- -------- ------- -------
Less dividends from investment income--net...... -- (.05) (.05) (.04)
-------- -------- ------- -------
Net asset value, end of period.................. $ 12.78 $ 11.90 $ 8.92 $ 10.26
======== ======== ======= =======
- ----------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:***
Based on net asset value per share.............. 7.39%++ 33.98% (12.62%) 2.99%++
======== ======== ======= =======
- -----------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of waiver......................... .85%* .85% .95% 1.25%*
======== ======== ======= =======
Expenses........................................ .85%* .85% .95% 1.65%*
======== ======== ======= =======
Investment income--net.......................... .83%* .56% .81% .64%*
======== ======== ======= =======
- -----------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)........ $127,045 $106,439 $68,775 $16,103
======== ======== ======= =======
Portfolio turnover.............................. 57.98% 127.48% 101.99% 64.52%
======== ======== ======= =======
- -----------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Based on average shares outstanding.
*** Total investment returns exclude insurance-related fees and expenses. If
applicable, the Company's Investment Adviser waived a portion of its
management fee. Without such waiver, the Fund's performance would have
been lower.
+ Commencement of operations.
++ Effective September 2, 2003, Class A Shares were redesignated Class I Shares.
++ Aggregate total investment return.
See Notes to Financial Statements.
252
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--LARGE CAP VALUE V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Large Cap Value
V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. The following is
a summary of significant accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
253
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- Options--The Fund may write 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.
- Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-U.S. dollar-denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) 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 and liabilities expressed in
foreign currencies into U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Dividends from foreign securities where the ex-dividend date may have passed are
subsequently recorded when the Fund has determined the ex-dividend date.
Interest income is recognized on the accrual basis.
(f) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(h) Securities lending--The Fund may lend securities to financial institutions
that provide
254
- --------------------------------------------------------------------------------
cash or securities issued or guaranteed by the U.S. government as collateral,
which will be maintained at all times in an amount equal to at least 100% of the
current market value of the loaned securities. The market value of the loaned
securities is determined at the close of business of the Fund and any additional
required collateral is delivered to the Fund on the next business day. Where the
Fund receives securities as collateral for the loaned securities, it receives a
fee from the borrower. The Fund typically receives the income on the loaned
securities, but does not receive the income on the collateral. Where the Fund
receives cash collateral, it may invest such collateral and retain the amount
earned on such investment, net of any amount rebated to the borrower. Loans of
securities are terminable at any time and the borrower, after notice, is
required to return borrowed securities within five business days. The Fund may
pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .75% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management, U.K. Limited, ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Fund. There is no increase in the aggregate fees paid by the Fund for these
services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated, a subsidiary of ML & Co., or its affiliates.
Pursuant to that order, the Company also has retained Merrill Lynch Investment
Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities lending
agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates. For the six months ended June 30, 2004, MLIM,
LLC received $439 in securities lending agent fees from the Fund.
For the six months ended June 30, 2004, the Fund reimbursed MLIM $1,166 for
certain accounting services.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $79,962,309 and $68,205,674, respectively.
Net realized gains for the six months ended June 30, 2004 and net unrealized
appreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Realized Unrealized
Gains Appreciation
- -------------------------------------------------------------------
Long-term investments................... $9,726,781 $18,893,161
---------- -----------
Total................................... $9,726,781 $18,893,161
========== ===========
- -------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $18,644,895, of which $19,974,359 related to appreciated securities
and $1,329,464 related to depreciated securities. At June 30, 2004, the
255
- --------------------------------------------------------------------------------
aggregate cost of investments for federal income tax purposes was $111,371,753.
4. CAPITAL SHARE TRANSACTIONS:
Net increase in net assets derived from capital share transactions were
$12,412,130 and $12,214,287 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- ------------------------------------------------------------------
Shares sold........................... 1,947,917 $ 24,428,600
Shares redeemed....................... (956,057) (12,016,470)
--------- ------------
Net increase.......................... 991,860 $ 12,412,130
========= ============
- ------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold.......................... 2,446,151 $ 24,366,386
Shares issued to shareholders in
reinvestment of dividends........... 38,204 455,009
---------- ------------
Total issued......................... 2,484,355 24,821,395
Shares redeemed...................... (1,247,833) (12,607,108)
---------- ------------
Net increase......................... 1,236,522 $ 12,214,287
========== ============
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$3,131,133, all of which expires in 2010. This amount will be available to
offset like amounts of any future taxable gains.
256
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the six-month period ended June 30, 2004, Small Cap Value V.I. Fund
performed approximately in line with the Russell 2000 Index of small cap stocks.
The Fund's Class I, Class II and Class III Shares returned +6.72%, +6.65% and
+6.65%, respectively, compared to the +6.76% return of the Russell 2000 Index.
The Lipper Small Cap Value Funds category posted an average return of +8.15% for
the same period. (Funds in this Lipper category normally invest in
small-capitalization companies considered to be undervalued relative to a major
unmanaged stock index based on price-to-current earnings, book value, asset
value or other factors.)
Small cap stocks performed ahead of large cap stocks on a calendar
year-to-date basis, but early signs of the "quality trade" became apparent
during the month of June as the Standard & Poor's (S&P) 600 Index outpaced the
more "speculative" Russell 2000 Index. The S&P 600 Index has a higher earnings,
higher market cap bias than the Russell 2000 Index. We have gradually
repositioned the Fund to benefit from a shift toward higher-quality companies
with modest price-to-earnings ratios.
PORTFOLIO ACTIVITY
During the first half of the year, we added a few positions in the financial
services sector. We trimmed certain technology stocks given sharp price
appreciation, and completely eliminated several software stocks, including
Compuware Corporation and MatrixOne, Inc. Sales were motivated when company
fundamentals deteriorated, or when stocks surpassed our internal price targets.
We made new investments in Crown Holdings Inc., a consumer packaging company,
and Conseco, Inc., a provider of insurance products and services. When selecting
new stocks, we initiate discussions with company management teams to understand
their operating strategy. Many of our recent purchases involve situations where
there is a turnaround, a corporate restructuring, or an overhaul of the
executive management team. We seek to identify company-specific catalysts that
could cause the shares to move higher in the months ahead.
The addition of telecommunication equipment stocks is another recent portfolio
change. This is based on our view that capital spending for telecommunications
equipment is in the early stages of a rebound. We believe that spending on
telecommunications equipment could surpass analysts' estimates, and we favor
stocks with solid balance sheets that are, in most cases, profitable. Generally
speaking, they are not providers of cutting-edge technology, but rather are
companies positioned to take advantage of improved spending on legacy equipment
where upgrades have been neglected for a long time.
As of June 30, 2004, the Fund was underweight in the consumer discretionary
sector. We believe that rapid growth in consumer spending has largely run its
course and is now likely to wane with the anticipated slowdown in
mortgage-refinancing activity. The Fund retained its underweight position in
financial services stocks during the six-month period because few financial
stocks are trading near the low end of their historical valuation ranges, and
financials that are at low valuation levels often have credit-quality issues.
The Fund continues to hold selected investments in insurers, broker/ dealers,
asset management firms, and a basket of regional banks and thrifts that should
benefit from any further industry consolidation.
LOOKING AHEAD
We maintain a positive outlook for small cap stocks. Typically, micro-cap
stocks lead in the early stages of a market rebound. As the economic recovery
broadens, small and mid cap stocks usually follow. Small cap stocks over $500
million in market capitalization have not rallied as sharply as micro-caps, and
they presently appear more attractive on price-to-earnings and price-to-book
value ratios. Another factor supporting the continued favorable performance of
small cap stocks is the prospect for further merger-and-acquisition activity.
Companies have restructured and strengthened their balance sheets. Corporate
cash flow is at historically high levels, and management teams currently have
the resources to pursue takeovers.
257
- --------------------------------------------------------------------------------
IN CONCLUSION
We thank you for your continued investment in Small Cap Value V.I. Fund of
Merrill Lynch Variable Series Funds, Inc., and we look forward to serving your
future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- R. Elise Baum
R. Elise Baum, CFA(R)
Vice President and Portfolio Manager
July 12, 2004
- ---------------------------------------------------------
Effective July 26, 2004, Small Cap Value V.I. Fund changed its name to Value
Opportunities V.I. Fund of Merrill Lynch Variable Series Funds, Inc.
- ---------------------------------------------------------
CFA(R) is a trademark owned by the Association for Investment Management and
Research.
258
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +32.13%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 +14.22
- --------------------------------------------------------------------------
Ten Years Ended 6/30/04 +14.90
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS II SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +31.90%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 +14.05
- --------------------------------------------------------------------------
Inception (10/23/97) through 6/30/04 +10.20
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
AGGREGATE TOTAL RETURN--CLASS III SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED RETURN
- --------------------------------------------------------------------------
Inception (11/18/03) through 6/30/04 +14.06%
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +6.72% +32.13%
- -----------------------------------------------------------------------------------------
Class II Shares* +6.65 +31.90
- -----------------------------------------------------------------------------------------
Class III Shares* +6.65 --
- -----------------------------------------------------------------------------------------
Russell 2000(R) Index** +6.76 +33.37
- -----------------------------------------------------------------------------------------
</Table>
* Average annual, aggregate and total investment returns are based on changes
in net asset values for the periods shown, and assume reinvestment of all
dividends and capital gains distributions at net asset value on the
ex-dividend date. Insurance-related fees and expenses are not reflected in
these returns. Effective September 2, 2003, Class A and Class B Shares were
redesignated Class I and Class II Shares. Class III Shares commenced
operations on 11/18/03.
** This unmanaged Index is comprised of approximately 2,000
smaller-capitalization common stocks from various industrial sectors.
Past results shown should not be considered a representation of future
performance.
Russell 2000 is a registered trademark of the Frank Russell Company.
259
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------
AEROSPACE & DEFENSE 154,100 Raytheon Company.................... $ 5,512,157 0.9%
331,900 +Triumph Group, Inc. ............... 10,597,567 1.8
------------ -----
16,109,724 2.7
- -----------------------------------------------------------------------------------------------------------------
AIR FREIGHT & LOGISTICS 223,700 CNF Transportation Inc. ............ 9,296,972 1.5
- -----------------------------------------------------------------------------------------------------------------
AUTO COMPONENTS 179,100 American Axle & Manufacturing
Holdings, Inc. ................... 6,512,076 1.1
179,400 +Hayes Lemmerz International,
Inc. ............................. 2,708,940 0.5
53,600 +Shiloh Industries, Inc. ........... 785,776 0.1
------------ -----
10,006,792 1.7
- -----------------------------------------------------------------------------------------------------------------
BIOTECHNOLOGY 74,600 +Applera Corporation--Celera
Genomics Group.................... 858,646 0.2
16,600 +Charles River Laboratories
International, Inc. .............. 811,242 0.1
255,200 +Human Genome Sciences, Inc. ....... 2,967,976 0.5
151,200 +Incyte Genomics, Inc. ............. 1,155,168 0.2
275,700 +Maxygen Inc. ...................... 2,914,149 0.5
83,900 +Medarex, Inc. ..................... 611,631 0.1
446,300 +Vical Incorporated................. 2,601,929 0.4
------------ -----
11,920,741 2.0
- -----------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS 415,000 Janus Capital Group Inc. ........... 6,843,350 1.1
433,300 +Knight Trading Group, Inc. (Class
A)................................ 4,341,666 0.7
43,200 W.P. Stewart & Co., Ltd. ........... 885,168 0.2
------------ -----
12,070,184 2.0
- -----------------------------------------------------------------------------------------------------------------
CHEMICALS 42,700 Cytec Industries Inc. .............. 1,940,715 0.3
- -----------------------------------------------------------------------------------------------------------------
COMMERCIAL BANKS 127,100 Bank of Hawaii Corporation.......... 5,747,462 1.0
218,700 Banknorth Group, Inc. .............. 7,103,376 1.2
4,100 Banner Corporation.................. 119,146 0.0
330,400 The Colonial BancGroup, Inc. ....... 6,003,368 1.0
145,000 Compass Bancshares, Inc. ........... 6,235,000 1.1
700 First Merchants Corporation......... 18,165 0.0
228,600 First Midwest Bancorp, Inc. ........ 8,049,006 1.3
600 Mid-State Bancshares................ 14,106 0.0
300,500 Old National Bancorp................ 7,461,415 1.2
7,300 +Texas Capital Bancshares, Inc. .... 121,180 0.0
------------ -----
40,872,224 6.8
- -----------------------------------------------------------------------------------------------------------------
COMMERCIAL SERVICES & 765,500 +Allied Waste Industries, Inc. ..... 10,089,290 1.7
SUPPLIES
123,700 Ambassadors International, Inc. .... 1,582,123 0.3
275,800 +Cornell Companies, Inc. ........... 3,750,880 0.6
83,100 +Corrections Corporation of
America........................... 3,281,619 0.6
5,600 G & K Services, Inc. (Class A)...... 225,064 0.0
304,800 +United Rentals, Inc. .............. 5,452,872 0.9
------------ -----
24,381,848 4.1
- -----------------------------------------------------------------------------------------------------------------
COMMUNICATIONS EQUIPMENT 359,100 +Cable Design Technology............ 3,806,460 0.6
597,500 +CommScope, Inc. ................... 12,816,375 2.1
148,100 +Network Equipment Technologies,
Inc. ............................. 1,208,496 0.2
799,800 +Tellabs, Inc. ..................... 6,990,252 1.2
------------ -----
24,821,583 4.1
- -----------------------------------------------------------------------------------------------------------------
CONSTRUCTION & ENGINEERING 106,600 Fluor Corporation................... 5,081,622 0.8
324,400 +MasTec, Inc. ...................... 1,761,492 0.3
------------ -----
6,843,114 1.1
- -----------------------------------------------------------------------------------------------------------------
CONSTRUCTION MATERIALS 105,800 Martin Marietta Materials, Inc. .... 4,690,114 0.8
- -----------------------------------------------------------------------------------------------------------------
CONTAINERS & PACKAGING 464,000 +Crown Holdings, Inc. .............. 4,626,080 0.7
294,000 +Smurfit-Stone Container
Corporation....................... 5,865,300 1.0
------------ -----
10,491,380 1.7
- -----------------------------------------------------------------------------------------------------------------
</Table>
260
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL 26,500 Financial Select Sector SPDR
SERVICES Fund(d)........................... $ 757,370 0.1%
51,700 iShares S&P Midcap 400 Index
Fund(e)........................... 6,286,720 1.0
49,600 iShares S&P SmallCap 600/BARRA Value
Index Fund(g)..................... 5,441,120 0.9
39,000 iShares S&P SmallCap 600 Index
Fund(f)........................... 5,740,800 1.0
------------ -----
18,226,010 3.0
- -----------------------------------------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT 21,300 Belden Inc. ........................ 456,459 0.1
146,800 +Global Power Equipment Group
Inc. ............................. 1,177,336 0.2
------------ -----
1,633,795 0.3
- -----------------------------------------------------------------------------------------------------------------
ELECTRONIC 201,100 Anixter International Inc. ......... 6,843,433 1.1
EQUIPMENT & INSTRUMENTS 381,900 +Ingram Micro Inc. (Class A)........ 5,526,093 0.9
262,227 +Itron, Inc. ....................... 6,015,487 1.0
28,500 +Nu Horizons Electronics Corp. ..... 256,500 0.1
228,000 +Tech Data Corporation.............. 8,921,640 1.5
------------ -----
27,563,153 4.6
- -----------------------------------------------------------------------------------------------------------------
ENERGY EQUIPMENT & SERVICE 252,000 Diamond Offshore Drilling, Inc. .... 6,005,160 1.0
37,300 Energy Select Sector SPDR Fund(h)... 1,175,323 0.2
89,800 +FMC Technologies, Inc. ............ 2,586,240 0.4
337,000 +Key Energy Services, Inc. ......... 3,181,280 0.5
75,000 +National-Oilwell, Inc. ............ 2,361,750 0.4
21,100 Oil Service HOLDRs Trust(c). ....... 1,524,053 0.3
------------ -----
16,833,806 2.8
- -----------------------------------------------------------------------------------------------------------------
FOOD PRODUCTS 111,300 ConAgra Foods, Inc. ................ 3,014,004 0.5
66,100 Corn Products International,
Inc. ............................. 3,076,955 0.5
435,100 +Del Monte Foods Company............ 4,420,616 0.7
------------ -----
10,511,575 1.7
- -----------------------------------------------------------------------------------------------------------------
HEALTH CARE EQUIPMENT & 24,900 +Cutera, Inc. ...................... 338,391 0.1
SUPPLIES 42,300 Invacare Corp. ..................... 1,891,656 0.3
166,500 Mentor Corporation.................. 5,709,285 0.9
132,300 +STERIS Corporation................. 2,984,688 0.5
------------ -----
10,924,020 1.8
- -----------------------------------------------------------------------------------------------------------------
HEALTH CARE PROVIDERS & 38,300 +First Health Group Corp. .......... 597,863 0.1
SERVICES
526,300 Hooper Holmes, Inc. ................ 3,020,962 0.5
1,402,200 +WebMD Corporation.................. 13,068,504 2.2
------------ -----
16,687,329 2.8
- -----------------------------------------------------------------------------------------------------------------
HOTELS, RESTAURANTS & 122,000 Ambassadors Group, Inc. ............ 2,868,220 0.5
LEISURE
123,500 Bob Evans Farms, Inc. .............. 3,381,430 0.5
111,700 Dover Downs Gaming & Entertainment,
Inc. ............................. 1,256,625 0.2
12,200 Dover Motorsports, Inc. ............ 48,800 0.0
104,800 +Isle of Capri Casinos, Inc. ....... 1,828,760 0.3
416,100 +La Quinta Corporation.............. 3,495,240 0.6
------------ -----
12,879,075 2.1
- -----------------------------------------------------------------------------------------------------------------
INFORMATION TECHNOLOGY 788,300 +Convergys Corporation.............. 12,139,820 2.0
SERVICES
268,000 Sabre Holdings Corporation (Class
A)................................ 7,426,280 1.3
------------ -----
19,566,100 3.3
- -----------------------------------------------------------------------------------------------------------------
INSURANCE 17,900 American National Insurance
Company........................... 1,652,707 0.3
597,200 +Conseco, Inc. ..................... 11,884,280 2.0
108,000 Presidential Life Corporation....... 1,946,160 0.3
253,200 Protective Life Corporation......... 9,791,244 1.6
------------ -----
25,274,391 4.2
- -----------------------------------------------------------------------------------------------------------------
</Table>
261
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------
INTERNET & CATALOG RETAIL 75,200 +CHRONIMED Inc. .................... $ 612,880 0.1%
13,200 +Cabela's Incorporated (Class A).... 355,740 0.1
------------ -----
968,620 0.2
- -----------------------------------------------------------------------------------------------------------------
INTERNET SOFTWARE & SERVICES 372,600 +DoubleClick Inc. .................. 2,895,102 0.5
447,200 +Entrust Technologies Inc. ......... 2,012,400 0.3
460,800 +Retek Inc. ........................ 2,829,312 0.5
4,058,200 +Vignette Corporation............... 6,736,612 1.1
------------ -----
14,473,426 2.4
- -----------------------------------------------------------------------------------------------------------------
LEISURE EQUIPMENT & PRODUCTS 105,200 Callaway Golf Company............... 1,192,968 0.2
128,200 +Leapfrog Enterprises, Inc. ........ 2,549,898 0.4
209,600 The Nautilus Group, Inc. ........... 4,089,296 0.7
------------ -----
7,832,162 1.3
- -----------------------------------------------------------------------------------------------------------------
MACHINERY 161,200 Kaydon Corp. ....................... 4,985,916 0.8
84,400 Reliance Steel & Aluminum Co. ...... 3,403,008 0.6
185,800 +Wolverine Tube, Inc. .............. 2,025,220 0.3
------------ -----
10,414,144 1.7
- -----------------------------------------------------------------------------------------------------------------
MEDIA 299,200 +APAC Customer Services Inc. ....... 517,616 0.1
16,300 +Arbitron Inc. ..................... 595,276 0.1
331,500 +Catalina Marketing Corporation..... 6,063,135 1.0
27,000 +Entercom Communications Corp. ..... 1,007,100 0.2
161,500 Harte-Hanks, Inc. .................. 3,942,215 0.7
980,100 +Paxson Communications Corporation.. 3,185,325 0.5
498,200 The Reader's Digest Association,
Inc. (Class A).................... 7,966,218 1.3
353,700 +Valassis Communications, Inc....... 10,777,239 1.8
------------ -----
34,054,124 5.7
- -----------------------------------------------------------------------------------------------------------------
METALS & MINING 182,900 Gibraltar Steel Corporation......... 6,002,778 1.0
603,400 +GrafTech International Ltd. ....... 6,311,564 1.0
44,300 Quanex Corporation.................. 2,157,410 0.4
198,300 +Steel Dynamics, Inc. .............. 5,677,329 0.9
------------ -----
20,149,081 3.3
- -----------------------------------------------------------------------------------------------------------------
OIL & GAS 243,500 +Denbury Resources Inc. ............ 5,101,325 0.8
144,600 Noble Energy, Inc. ................. 7,374,600 1.2
160,100 +Plains Exploration & Production
Company........................... 2,937,835 0.5
190,500 +Plains Resources Inc. ............. 3,228,975 0.5
129,207 +Stone Energy Corporation........... 5,902,176 1.0
56,100 Vintage Petroleum, Inc. ............ 952,017 0.2
------------ -----
25,496,928 4.2
- -----------------------------------------------------------------------------------------------------------------
PAPER & FOREST PRODUCTS 13,500 +Mercer International, Inc. ........ 132,030 0.0
- -----------------------------------------------------------------------------------------------------------------
PHARMACEUTICALS 113,100 +aaiPharma Inc. .................... 613,002 0.1
580,800 +King Pharmaceuticals, Inc. ........ 6,650,160 1.1
------------ -----
7,263,162 1.2
- -----------------------------------------------------------------------------------------------------------------
REAL ESTATE 119,000 Brandywine Realty Trust............. 3,235,610 0.6
227,500 Trizec Properties, Inc. ............ 3,699,150 0.6
------------ -----
6,934,760 1.2
- -----------------------------------------------------------------------------------------------------------------
ROAD & RAIL 150,700 CSX Corporation..................... 4,938,439 0.8
504,400 +Kansas City Southern Industries,
Inc. ............................. 7,818,200 1.3
------------ -----
12,756,639 2.1
- -----------------------------------------------------------------------------------------------------------------
</Table>
262
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
INDUSTRY++ HELD COMMON STOCKS VALUE NET ASSETS
- -----------------------------------------------------------------------------------------------------------------
SEMICONDUCTORS & 550,600 +ANADIGICS, Inc. ................... $ 2,840,545 0.5%
SEMICONDUCTOR EQUIPMENT
647,700 +Applied Micro Circuits
Corporation....................... 3,445,764 0.6
88,100 +DSP Group, Inc. ................... 2,399,844 0.4
15,100 +PowerDsine Ltd. ................... 182,559 0.0
166,200 +TranSwitch Corporation............. 294,174 0.0
178,500 +TriQuint Semiconductor, Inc. ...... 974,610 0.2
104,800 +Zoran Corporation.................. 1,923,080 0.3
------------ -----
12,060,576 2.0
- -----------------------------------------------------------------------------------------------------------------
SOFTWARE 191,500 +Agile Software Corporation......... 1,675,625 0.3
278,200 +Ascential Software Corporation..... 4,448,418 0.8
223,300 +Borland Software Corporation....... 1,895,817 0.3
652,350 +E.piphany, Inc. ................... 3,150,851 0.5
746,800 +i2 Technologies, Inc. ............. 664,652 0.1
174,600 +JDA Software Group, Inc. .......... 2,299,482 0.4
139,500 +Network Associates, Inc. .......... 2,529,135 0.4
3,170,900 +Parametric Technology
Corporation....................... 15,854,500 2.7
281,300 +QRS Corporation.................... 1,842,515 0.3
12,200 +Salesforce.com, Inc. .............. 196,054 0.0
62,200 +Take-Two Interactive Software,
Inc. ............................. 1,905,808 0.3
------------ -----
36,462,857 6.1
- -----------------------------------------------------------------------------------------------------------------
SPECIALTY RETAIL 122,400 Christopher & Banks Corporation..... 2,167,704 0.4
403,200 Foot Locker, Inc. .................. 9,813,888 1.6
102,800 +Linens 'n Things, Inc. ............ 3,013,068 0.5
58,900 +The Men's Wearhouse, Inc. ......... 1,554,371 0.3
173,900 Pier 1 Imports, Inc. ............... 3,076,291 0.5
160,400 The Talbots, Inc. .................. 6,279,660 1.0
------------ -----
25,904,982 4.3
- -----------------------------------------------------------------------------------------------------------------
THRIFTS & MORTGAGE FINANCE 2,300 Anchor Bancorp, Inc. ............... 60,812 0.0
6,700 Dime Community Bancshares........... 117,116 0.0
200 Fidelity Bankshares, Inc. .......... 7,090 0.0
2,900 +FirstFed Financial Corp. .......... 120,640 0.0
7,700 +Franklin Bank Corporation.......... 121,814 0.1
218,900 Sovereign Bancorp, Inc. ............ 4,837,690 0.8
2,100 +Sterling Financial Corporation..... 66,927 0.0
------------ -----
5,332,089 0.9
- -----------------------------------------------------------------------------------------------------------------
TRADING COMPANIES & 112,450 Applied Industrial Technologies,
Inc. ............................. 3,386,994 0.6
DISTRIBUTORS 182,800 Watsco, Inc. ....................... 5,131,196 0.8
------------ -----
8,518,190 1.4
- -----------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST--$500,162,230) 562,298,415 93.4
- -----------------------------------------------------------------------------------------------------------------
<Caption>
WARRANTS(J)
- -----------------------------------------------------------------------------------------------------------------
CAPITAL MARKETS 160,000 UBS AG (3/31/05)(i)................. 7,673,600 1.3
120,000 UBS AG (7/29/05)(i)................. 6,078,000 1.0
- -----------------------------------------------------------------------------------------------------------------
TOTAL WARRANTS
(COST--$13,810,862)................. 13,751,600 2.3
- -----------------------------------------------------------------------------------------------------------------
</Table>
263
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERCENT OF
BENEFICIAL INTEREST SHORT-TERM SECURITIES VALUE NET ASSETS
- -------------------------------------------------------------------------------------------------------------------------
$27,253,612 Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I(a)............ $ 27,253,612 4.5%
19,188,550 Merrill Lynch Liquidity Series, LLC
Money Market Series(a)(b)......... 19,188,550 3.2
- -------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$46,442,162) 46,442,162 7.7
- -------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$560,415,254)................ 622,492,177 103.4
LIABILITIES IN EXCESS OF OTHER
ASSETS.............................. (20,416,129) (3.4)
------------ -----
NET ASSETS.......................... $602,076,048 100.0%
============ =====
- -------------------------------------------------------------------------------------------------------------------------
</Table>
+ Non-income producing security.
++ For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management.
This definition may not apply for purposes of this report, which may
combine such industry sub-classifications for reporting ease.
(a) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- --------------------------------------------------------------------------------------
INTEREST/
NET DIVIDEND
AFFILIATE ACTIVITY INCOME
- --------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $ 1,940,469 $111,659
Merrill Lynch Liquidity Series, LLC Money Market Series..... $(10,981,213) $ 29,282
Merrill Lynch Premier Institutional Fund.................... (10,056,587) $ 8,371
- --------------------------------------------------------------------------------------
</Table>
(b) Security was purchased with the cash proceeds from securities loans.
(c) Represents ownership in Oil Services HOLDRs Trust. The Oil Services HOLDRs
Trust holds shares of common stock issued by 20 specified companies
generally considered to be involved in various segments of the oil service
industry.
(d) Represents ownership in Financial Select Sector SPDR Fund, registered in the
United States. The investment objective of the Financial Select Sector SPDR
Fund is to provide investment results that correspond to the performance of
The Financial Select Sector.
(e) iShares S&P MidCap 400 Index Fund is an exchange-traded Fund. The Fund seeks
investment results that correspond to the performance of the S&P MidCap 400
Index.
(f) iShares S&P SmallCap 600 Index Fund is an exchange-traded Fund. The Fund
seeks investment results that correspond to the performance of the S&P
SmallCap 600 Index.
(g) iShares S&P SmallCap 600/BARRA Value Index Fund is an exchange-traded Fund.
The Fund seeks investment results that correspond to the performance of the
S&P SmallCap 600/BARRA Value Index.
(h) Represents ownership in Energy Select Sector SPDR Fund, registered in the
United States. The investment objective of the Energy Select Sector SPDR
Fund is to provide investment results that correspond to the performance of
The Energy Select Sector Index.
(i) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(j) 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.
See Notes to Financial Statements.
264
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (including
securities loaned of $18,669,116) (identified
cost--$513,973,092)....................................... $576,050,015
Investments in affiliated securities, at value (identified
cost--$46,442,162)........................................ 46,442,162
Cash...................................................... 2,442,438
Receivables:
Securities sold........................................... $ 6,159,045
Capital shares sold....................................... 401,808
Dividends................................................. 312,711
Interest from affiliates.................................. 25,605
Securities lending--net................................... 7,660 6,906,829
-----------
Prepaid expenses............................................ 2,811
------------
Total assets................................................ 631,844,255
------------
- ------------------------------------------------------------------------------------------
LIABILITIES:
Collateral on securities loaned, at value................... 19,188,550
Payables:
Securities purchased...................................... 10,172,807
Capital shares redeemed................................... 304,530
Investment adviser........................................ 60,896
Other affiliates.......................................... 7,240
Distributor............................................... 2,971 10,548,444
-----------
Accrued expenses and other liabilities...................... 31,213
------------
Total liabilities........................................... 29,768,207
------------
- ------------------------------------------------------------------------------------------
NET ASSETS.................................................. $602,076,048
============
- ------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized......................................... $ 2,126,375
Class II Shares of Common Stock, $.10 par value, 100,000,000
shares authorized......................................... 66,977
Class III Shares of Common Stock, $.10 par value,
100,000,000 shares authorized............................. 25,936
Paid-in capital in excess of par............................ 479,420,800
Accumulated investment loss--net............................ $ (119,160)
Undistributed realized capital gains on investments--net.... 58,478,197
Unrealized appreciation on investments--net................. 62,076,923
-----------
Total accumulated earnings--net............................. 120,435,960
------------
NET ASSETS.................................................. $602,076,048
============
- ------------------------------------------------------------------------------------------
NET ASSET VALUE:
Class I--Based on net assets of $580,871,040 and 21,263,753
shares outstanding........................................ $ 27.32
============
Class II--Based on net assets of $18,252,199 and 669,774
shares outstanding........................................ $ 27.25
============
Class III--Based on net assets of $2,952,809 and 259,359
shares outstanding........................................ $ 11.39
============
- ------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
265
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends (net of $876 foreign withholding tax)............. $ 2,289,990
Interest from affiliates.................................... 111,659
Securities lending--net..................................... 37,653
------------
Total income................................................ 2,439,302
------------
- -----------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $2,295,905
Accounting services......................................... 117,017
Custodian fees.............................................. 40,217
Printing and shareholder reports............................ 27,202
Professional fees........................................... 20,470
Directors' fees and expenses................................ 16,790
Distribution fees--Class II................................. 13,647
Transfer agent fees--Class I................................ 2,303
Distribution fees--Class III................................ 1,335
Pricing services............................................ 590
Transfer agent fees--Class II............................... 71
Transfer agent fees--Class III.............................. 4
Other....................................................... 13,190
----------
Total expenses.............................................. 2,548,741
------------
Investment loss--net........................................ (109,439)
------------
- -----------------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS--NET:
Realized gain on investments--net........................... 71,100,319
Change in unrealized appreciation on investments--net....... (30,831,139)
------------
Total realized and unrealized gain on investments--net...... 40,269,180
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $ 40,159,741
============
- -----------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
266
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED, YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- ---------------------------------------------------------------------------------------------
OPERATIONS:
Investment income (loss)--net............................... $ (109,439) $ 366,794
Realized gain on investments--net........................... 71,100,319 234,795
Change in unrealized appreciation on investments--net....... (30,831,139) 188,228,092
------------ ------------
Net increase in net assets resulting from operations........ 40,159,741 188,829,681
------------ ------------
- ---------------------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... -- (377,389)
Class III................................................. -- (73)
Realized gain on investments--net:
Class I................................................... -- (3,895,251)
Class II.................................................. -- (133,507)
------------ ------------
Net decrease in net assets resulting from dividends and
distributions to shareholders............................. -- (4,406,220)
------------ ------------
- ---------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (57,727,250) (41,231,365)
------------ ------------
- ---------------------------------------------------------------------------------------------
NET ASSETS:
Total increase(decrease) in net assets...................... (17,567,509) 143,192,096
Beginning of period......................................... 619,643,557 476,451,461
------------ ------------
End of period*.............................................. $602,076,048 $619,643,557
============ ============
- ---------------------------------------------------------------------------------------------
* Accumulated investment loss--net/accumulated distributions
in excess of investment income--net....................... $ (119,160) $ (9,721)
============ ============
- ---------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
267
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS -----------------------------------------------------------
HAVE BEEN DERIVED FROM INFORMATION
PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,+
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................... $ 25.60 $ 18.09 $ 25.08 $ 20.78 $ 23.35
-------- -------- -------- -------- --------
Investment income (loss)--net***........................ --++ .02 (.02) .06 .07
Realized and unrealized gain (loss) on
investments--net...................................... 1.72 7.67 (5.84) 6.01 3.30
-------- -------- -------- -------- --------
Total from investment operations........................ 1.72 7.69 (5.86) 6.07 3.37
-------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net................................ -- (.02) -- (.06) (.07)
In excess of investment income--net................... -- -- -- -- --++
Realized gain on investments--net..................... -- (.16) (1.13) (1.71) (5.87)
-------- -------- -------- -------- --------
Total dividends and distributions....................... -- (.18) (1.13) (1.77) (5.94)
-------- -------- -------- -------- --------
Net asset value, end of period.......................... $ 27.32 $ 25.60 $ 18.09 $ 25.08 $ 20.78
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share...................... 6.72%++ 42.91% (23.76%) 29.94% 14.75%
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses................................................ .83%* .83% .84% .83% .81%
======== ======== ======== ======== ========
Investment income (loss)--net........................... (.03%)* .08% (.11%) .26% .28%
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)................ $580,871 $601,270 $460,279 $746,874 $591,631
======== ======== ======== ======== ========
Portfolio turnover...................................... 47.09% 64.35% 76.33% 64.99% 83.78%
======== ======== ======== ======== ========
- -----------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
++ Amount is less than $(.01) per share.
++ Aggregate total investment return.
See Notes to Financial Statements.
268
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
FINANCIAL HIGHLIGHTS (CONTINUED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS II
THE FOLLOWING PER SHARE DATA AND RATIOS ---------------------------------------------------------
HAVE BEEN DERIVED FROM INFORMATION
PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,+
JUNE 30, ------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................... $ 25.55 $ 18.08 $ 25.05 $ 20.77 $ 23.35
------- -------- -------- ------- -------
Investment income (loss)--net***....................... (.02) (.02) (.06) .02 .04
Realized and unrealized gain (loss) on
investments--net..................................... 1.72 7.65 (5.82) 6.01 3.29
------- -------- -------- ------- -------
Total from investment operations....................... 1.70 7.63 (5.88) 6.03 3.33
------- -------- -------- ------- -------
Less dividends and distributions:
Investment income--net............................... -- -- -- (.04) (.04)
In excess of investment income--net.................. -- -- -- -- --++
Realized gain on investments--net.................... -- (.16) (1.09) (1.71) (5.87)
------- -------- -------- ------- -------
Total dividends and distributions...................... -- (.16) (1.09) (1.75) (5.91)
------- -------- -------- ------- -------
Net asset value, end of period......................... $ 27.25 $ 25.55 $ 18.08 $ 25.05 $ 20.77
======= ======== ======== ======= =======
- ------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share..................... 6.65%++ 42.62% (23.86%) 29.72% 14.57%
======= ======== ======== ======= =======
- ------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................... .98%* .98% .99% .98% .96%
======= ======== ======== ======= =======
Investment income (loss)--net.......................... (.18%)* (.08%) (.26%) .09% .15%
======= ======== ======== ======= =======
- ------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)............... $18,252 $ 18,313 $ 16,172 $25,714 $ 9,603
======= ======== ======== ======= =======
Portfolio turnover..................................... 47.09% 64.35% 76.33% 64.99% 83.78%
======= ======== ======== ======= =======
- ------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Effective September 2, 2003, Class B Shares were redesignated Class II
Shares.
++ Amount is less than $(.01) per share.
++ Aggregate total investment return.
See Notes to Financial Statements.
269
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
FINANCIAL HIGHLIGHTS (CONCLUDED)
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS III
--------------------------------
FOR THE PERIOD
THE FOLLOWING PER SHARE DATA AND RATIOS FOR THE SIX NOVEMBER 18,
HAVE BEEN DERIVED FROM INFORMATION MONTHS ENDED 2003+ TO
PROVIDED IN THE FINANCIAL STATEMENTS. JUNE 30, DECEMBER 31,
INCREASE IN NET ASSET VALUE: 2004 2003
- ----------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........................ $ 10.68 $ 10.00
------- -------
Investment income (loss)--net***............................ (.01) .01
Realized and unrealized gain on investments--net............ .72 .68
------- -------
Total from investment operations............................ .71 .69
------- -------
Less dividends from investment income--net.................. -- (.01)
------- -------
Net asset value, end of period.............................. $ 11.39 $ 10.68
======= =======
- ----------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.......................... 6.65%++ 6.95%++
======= =======
- ----------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses.................................................... 1.08%* 1.08%*
======= =======
Investment income (loss)--net............................... (.23%)* .36%*
======= =======
- ----------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).................... $ 2,953 $ 61
======= =======
Portfolio turnover.......................................... 47.09% 64.35%
======= =======
- ----------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Commencement of operations.
++ Aggregate total investment return.
See Notes to Financial Statements.
270
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--SMALL CAP VALUE V.I. FUND
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies, that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Small Cap Value
V.I. Fund (the "Fund") is classified as "diversified," as defined in the
Investment Company Act of 1940, as amended. Class I Shares, Class II Shares and
Class III Shares have equal voting, dividend, liquidation and other rights,
except that only shares of the respective classes are entitled to vote on
matters concerning only that class. In addition, Class II Shares and Class III
Shares bear certain expenses related to the distribution of such shares. The
Fund's financial statements are prepared in conformity with U.S. generally
accepted accounting principles, which may require the use of management accruals
and estimates. Actual results may differ from these estimates. These unaudited
financial statements reflect all adjustments, which are, in the opinion of
management, necessary to present a fair statement of the results for the interim
period. All such adjustments are of a normal, recurring nature. Income, expenses
(other than expenses attributable to a specific class) and realized and
unrealized gains and losses on investments are allocated daily to each class
based on its relative net assets. The following is a summary of significant
accounting policies followed by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may
271
- --------------------------------------------------------------------------------
occur between the times at which they are determined and the close of business
on the NYSE that may not be reflected in the computation of the Fund's net asset
value. If events (for example, a company announcement, market volatility or a
natural disaster) occur during such periods that are expected to materially
affect the value of such securities, those securities may be valued at their
fair value as determined in good faith by the Company's Board of Directors or by
the Investment Adviser using a pricing service and/or procedures approved by the
Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- Options--The Fund may write covered call 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 received).
Written options are non-income producing investments.
(c) 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.
(d) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Interest income is recognized on the accrual basis.
(e) Dividends and distributions--Dividends and distributions paid by the Fund
are recorded on the ex-dividend dates.
(f) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
(g) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner. The Company has also entered into a Distribution
Agreement and Distribution Plan with FAM Distributors, Inc. ("FAMD" or the
"Distributor"), which is a wholly-owned subsidiary of Merrill Lynch Group, Inc.
MLIM is responsible for the management of the Company's funds and provides the
neces-
272
- --------------------------------------------------------------------------------
sary personnel, facilities, equipment and certain other services necessary to
the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .75% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Fund. There is no increase in the aggregate fees paid by the Fund for these
services.
Pursuant to the Distribution Plan adopted by the Company, in accordance with
Rule 12b-1 under the Investment Company Act of 1940, the Fund pays the
Distributor an ongoing distribution fee each month at the annual rate of .15% of
the average daily value of the Fund's Class II net assets and .25% of the
average daily value of the Fund's Class III net assets.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. As of June 30, 2004 the Fund lent securities with a value of
$1,630,980 to MLPF&S or its affiliates. Pursuant to that order, the Company also
has retained Merrill Lynch Investment Managers, LLC ("MLIM, LLC"), an affiliate
of MLIM, as the securities lending agent for a fee based on a share of the
returns on investment of cash collateral. MLIM, LLC may, on behalf of the
Company and the Fund, invest cash collateral received by the Fund for such
loans, among other things, in a private investment company managed by MLIM, LLC
or in registered money market funds advised by MLIM or its affiliates. For the
six months ended June 30, 2004, MLIM, LLC received $16,214 in securities lending
agent fees from the Fund.
For the six months ended June 30, 2004, MLPF&S earned $106,942 in commissions
on the execution of portfolio security transactions.
In addition, the Fund reimbursed MLIM $6,020 for certain accounting services
for the six months ended June 30, 2004.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $278,164,125 and $335,745,741, respectively.
Net realized gains for the six months ended June 30, 2004 and net unrealized
appreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Realized Unrealized
Gains Appreciation
- ------------------------------------------------------------------
Long-term investments................ $71,100,319 $62,076,923
----------- -----------
Total................................ $71,100,319 $62,076,923
=========== ===========
- ------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $55,944,586, of which $87,000,501 related to appreciated securities
and $31,055,915 related to depreciated securities. At June 30, 2004, the
aggregate cost of investments for federal income tax purposes was $566,547,591.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions was
$57,727,250 and $41,231,365 for the six months ended June 30, 2004 and for the
year ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- -------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- -------------------------------------------------------------------
Shares sold........................... 679,606 $ 18,115,352
Shares redeemed....................... (2,906,195) (77,383,504)
---------- ------------
Net decrease.......................... (2,226,589) $(59,268,152)
========== ============
- -------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold.......................... 1,734,814 $ 35,980,837
Shares issued to shareholders in
reinvestment of dividends and
distributions....................... 238,621 4,272,640
---------- ------------
Total issued......................... 1,973,435 40,253,477
Shares redeemed...................... (3,925,556) (77,852,996)
---------- ------------
Net decrease......................... (1,952,121) $(37,599,519)
========== ============
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- ---------------------------------------------------------------------
Class II Shares for the Six Months Ended
June 30, 2004 Shares Dollar Amount
- ---------------------------------------------------------------------
Shares sold........................... 3,617 $ 95,046
Shares redeemed....................... (50,498) (1,342,864)
---------- ------------
Net decrease.......................... (46,881) $ (1,247,818)
========== ============
- ---------------------------------------------------------------------
</Table>
273
- --------------------------------------------------------------------------------
<Table>
<Caption>
- -----------------------------------------------------------------
Class II Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold............................. 12,072 $ 237,732
Shares issued to shareholders in
reinvestment of dividends and
distributions.......................... 7,686 133,507
-------- -----------
Total issued............................ 19,758 371,239
Shares redeemed......................... (197,725) (4,062,711)
-------- -----------
Net decrease............................ (177,967) $(3,691,472)
======== ===========
- -----------------------------------------------------------------
</Table>
<Table>
<Caption>
- ------------------------------------------------------------------
Class III Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- ------------------------------------------------------------------
Shares sold............................. 255,973 $ 2,814,547
Shares redeemed......................... (2,313) (25,827)
-------- -----------
Net increase............................ 253,660 $ 2,788,720
======== ===========
- ------------------------------------------------------------------
</Table>
<Table>
<Caption>
- ---------------------------------------------------------------------
Class III Shares for the Period November 18, Dollar
2003+ to December 31, 2003 Shares Amount
- ---------------------------------------------------------------------
Shares sold............................... 5,694 $ 59,570
Shares issued to shareholders in
reinvestment of dividends................ 7 73
-------- -----------
Total issued.............................. 5,701 59,643
Shares redeemed........................... (2) (17)
-------- -----------
Net increase.............................. 5,699 $ 59,626
======== ===========
- ---------------------------------------------------------------------
</Table>
+ Commencement of operations.
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$5,415,240, all of which expires in 2011. This amount will be available to
offset like amounts of any future taxable gains.
7. SUBSEQUENT EVENT:
Effective July 26, 2004, the Fund changed its name to Value Opportunities V.I.
Fund of Merrill Lynch Variable Series Funds, Inc.
274
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
JUNE 30, 2004--SEMI-ANNUAL REPORT
- --------------------------------------------------------------------------------
DEAR SHAREHOLDER:
For the six months ended June 30, 2004, Utilities and Telecommunications V.I.
Fund's Class I Shares had a total return of +4.27%. This compares favorably to
the +3.80% return of the Standard & Poor's (S&P) Utilities Index and the +3.44%
return of the broader-based S&P 500 Index for the same period.
For about half of the six-month period, the influence of new money into
dividend-yielding stocks was fairly significant. Since Congress enacted
President Bush's proposed legislation to reduce the maximum income tax rate on
qualified dividends from 35% to 15%, we have seen an increase in demand for
companies that pay above-average dividends. For instance, the estimates are that
more than $9 billion of new money was raised between January and March 2004 for
closed-end funds that specialize in dividends or invest in utility stocks. Of
that estimated $9 billion, approximately $4 billion was raised in the month of
March alone. All of this has had a direct influence on the utility equity
market, particularly for integrated utility stocks. Moreover, we watched the
valuation of some of the higher-yielding electric utilities reach new highs in
the range of 15-16 times earnings compared to a historical range of about 11-13
times. Our belief was that these historically high valuation levels were
unsustainable given the underlying company growth rates in the 2%-4% range. Once
the demand for the securities began to diminish, we believed the stocks would
correct and trade closer to historically normal relationships. In fact, this
took place.
In the telecommunications space, the Fund's overall performance benefited from
the significant outperformance of the wireless sector, including our positions
in both AT&T Wireless Services Inc. and Sprint Corp. (PCS Group). In addition,
the rally in the European telecommunication services companies in early 2004
also benefited the Fund, as we captured some of the gains by reducing positions.
The remainder of the stocks held in the portfolio added further
diversification. More specifically, our holdings in a coal company and in some
natural gas companies have been making positive contributions given that
electric utilities need these resources to fuel their plants. In many cases,
fuel is a direct pass-through to the end consumer; therefore, the utility does
not have to absorb the cost of fuel. Other holdings in the Fund include local
natural gas distribution companies. They add dividend yields largely in the 3%
range but have growth of 3% or higher. These companies tend to be regulated and
can pass higher fuel costs on to customers.
PORTFOLIO ACTIVITY
In terms of portfolio diversification, there was basically no change in the
telecommunications arena. However, our weighting in electric utilities declined
and our exposure to the subsector of multi-utilities and unregulated power
increased. The media category decreased in importance and the oil and gas sector
increased in importance.
In the Fund's ten largest holdings, Public Service Enterprise Group
Incorporated was replaced with TXU Corporation. We reduced our exposure to
Public Service based solely on valuation, but retained a position in the company
given its above-average yield and longer-term positive fundamental outlook. We
increased our weighting in TXU as it became clearer that the company was
pursuing a new chief executive officer who we believe could have the ability to
move the company forward in the current environment.
The sale of Comcast Corporation reduced our exposure to the media sector. We
originally bought Comcast as a competitor to the large incumbent
telecommunications companies. New technology would have resulted in Comcast
being a strong competitor in the telecommunications space. Unfortunately, the
management of Comcast decided to pursue a strategy that involved being more
content-driven, as the company made an unsolicited bid for The Walt Disney
Company. We did not buy Comcast to own television networks or theme parks, so we
sold our shares at a modest gain.
The reduction in the Fund's exposure to electric utilities and the increase in
our position in multi-utilities and unregulated power were primarily the result
of our trimming positions in the more traditional electric utilities. The
approximately $9 billion that came into the higher-dividend-paying stocks
provided us with a good opportunity to sell into strength and reduce some
positions where weightings began to exceed our desired level for the Fund's
portfolio.
Overall, we believe the telecommunications service sector still offers the
potential for growth at reasonable valuation levels; thus, there was basically
no change in portfolio weighting during the period. As the economy improves and
people look for more access lines, whether wireless or wireline, the integrated
companies (those with both wireline and wireless) should benefit. The wireless
space is in a consolidation
275
- --------------------------------------------------------------------------------
phase in the United States and may be in the early stages of consolidation in
Europe and the United Kingdom. The bottom line is that pricing appears to be
more rational. New technologies that have the potential to compete with the
current wireline technology--cable television, wireless and power
lines--continue to evolve. Wireless remains the strongest competitor to
wireline. Wireless offers more convenience to customers, but wireline provides
more dependability and quality. Thus, activity in the telecommunication services
sector continues to evolve as opposed to revolutionize, and we remain
comfortable with the majority of our telecom holdings being large cap names and
with having the ability to finance new technologies in an effort to help to
level the playing field.
CURRENT POSITION
The portfolio was well diversified as of June 30, 2004, with more than 75
positions. We believe the Fund's holdings reflect our risk/reward analysis
across the subsectors of the utility and telecommunications sectors and provide
a fairly balanced portfolio. We maintain the Fund's largest weighting in
domestic electric utility stocks. Our emphasis has been on the lower-yielding
names that offer the potential for growth based on underlying fundamentals. We
also have emphasized diversity of fuel sources as we have seen both natural gas
and coal prices climb to new highs and, therefore, look for companies that have
a combination of fuels--nuclear, natural gas and coal (and, if possible, hydro).
Also attractive, in our view, are companies that have automatic fuel cost pass-
through to customers but, through careful planning, also are responsible enough
to reduce the risk of higher fuel costs to customers. Lastly, diversification
across regions also has been important, particularly in terms of regulatory
activity.
The telecommunication services sector was the second-largest weighting in the
portfolio during the period. The European telecom stocks, which exhibited some
positive momentum during the first couple of months in 2004, came under pressure
as investors overestimated potential returns. The calendar fourth quarter has
never been particularly attractive for the telecom space fundamentally, and this
past year proved no different. However, we now believe we are entering a more
favorable environment based on historical results and recent quarterly
financials. For that reason, we still believe the European telecom space should
regain momentum, and fundamentals appear to be intact. Consequently, we maintain
our current position.
Turning to the U.S. telecommunication services areas, we believe there is
enough going on in terms of regulation to create positive uncertainty and
potential opportunity. First, no one can ever predict with certainty how
Washington D.C. will respond on any issue during a presidential election year.
In our view, the United States cannot afford to have the backbone of the
wireline telecommunications system fail or to deteriorate to a level that makes
it unusable. Clearly, new technologies are presenting faster, better and cheaper
alternatives to the highly capital-intensive fixed line business that currently
exists. It will take time for these new technologies to reach all the markets,
particularly in rural areas. At some point, wireless revenues will exceed
wireline revenue, but we believe that is several years out. Thus, our stock
preference in the United States is for the integrated companies such as Verizon
Communications, SBC Communications Inc. and BellSouth Corporation.
IN CONCLUSION
We thank you for your continued investment in Utilities and Telecommunications
V.I. Fund of Merrill Lynch Variable Series Funds, Inc., and we look forward to
serving your future investment needs.
Sincerely,
- -s- Terry K. Glenn
Terry K. Glenn
President and Director
- -s- Kathleen M. Anderson
Kathleen M. Anderson
Vice President and Senior Portfolio Manager
July 12, 2004
276
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
AVERAGE ANNUAL TOTAL RETURN--CLASS I SHARES*
- --------------------------------------------------------------------------------
<Table>
<Caption>
PERIOD COVERED % RETURN
- --------------------------------------------------------------------------
One Year Ended 6/30/04 +12.82%
- --------------------------------------------------------------------------
Five Years Ended 6/30/04 - 1.00
- --------------------------------------------------------------------------
Ten Years Ended 6/30/04 + 7.71
- --------------------------------------------------------------------------
</Table>
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
RECENT PERFORMANCE RESULTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
6-MONTH 12-MONTH
AS OF JUNE 30, 2004 TOTAL RETURN TOTAL RETURN
- -----------------------------------------------------------------------------------------
Class I Shares* +4.27% +12.82%
- -----------------------------------------------------------------------------------------
S&P 500(R) Index** +3.44 +19.11
- -----------------------------------------------------------------------------------------
S&P Utilities Index*** +3.80 +11.49
- -----------------------------------------------------------------------------------------
</Table>
* Average annual and total investment returns are based on changes in net
asset values for the periods shown, and assume reinvestment of all dividends
and capital gains distributions at net asset value on the ex-dividend date.
Insurance-related fees and expenses are not reflected in these returns.
Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
** This unmanaged Index covers 500 industrial, utility, transportation and
financial companies of the U.S. markets (mostly NYSE issues), representing
about 75% of NYSE market capitalization and 30% of NYSE issues.
*** This unmanaged capitalization Index is comprised of all stocks designed to
measure the performance of electric and natural gas utilities within the S&P
500 Index.
Past results shown should not be considered a representation of future
performance.
S&P 500 is a registered trademark of the McGraw-Hilll Companies.
277
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY* HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
BELGIUM WIRELESS 3,700 +Mobistar SA........................ $ 230,482 0.5%
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN BELGIUM 230,482 0.5
- ----------------------------------------------------------------------------------------------------------------------
CANADA DIVERSIFIED 54,500 BCE Inc. ........................... 1,092,180 2.5
TELECOMMUNICATION
SERVICES
11,000 BCT.Telus Communications Inc. ...... 178,937 0.4
----------- -----
1,271,117 2.9
-----------------------------------------------------------------------------------------------------
OIL & GAS 7,700 EnCana Corp. ....................... 330,915 0.8
5,000 Talisman Energy Inc. ............... 108,700 0.2
----------- -----
439,615 1.0
-----------------------------------------------------------------------------------------------------
TELECOMMUNICATIONS 75 BCT.Telus Communications Inc. (A
Shares)........................... 1,126 0.0
-----------------------------------------------------------------------------------------------------
WIRELESS 14,400 +Stratos Global Corporation......... 109,980 0.3
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN CANADA 1,821,838 4.2
- ----------------------------------------------------------------------------------------------------------------------
FRANCE DIVERSIFIED 9,200 France Telecom SA................... 239,758 0.6
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 10,500 Suez SA............................. 218,577 0.5
UNREGULATED POWER 4,800 Veolia Environment.................. 135,428 0.3
----------- -----
354,005 0.8
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN FRANCE 593,763 1.4
- ----------------------------------------------------------------------------------------------------------------------
GERMANY DIVERSIFIED 72,100 +Deutsche Telekom AG (Registered
TELECOMMUNICATION Shares)........................... 1,266,684 2.9
SERVICES
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 12,000 E.On AG............................. 865,768 2.0
-----------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 6,900 RWE AG.............................. 324,462 0.8
UNREGULATED POWER
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN GERMANY 2,456,914 5.7
- ----------------------------------------------------------------------------------------------------------------------
HONG KONG ELECTRIC UTILITIES 206,000 +China Resources Power Holdings
Company Limited................... 116,208 0.3
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN HONG KONG 116,208 0.3
- ----------------------------------------------------------------------------------------------------------------------
ITALY DIVERSIFIED 163,393 Telecom Italia RNC.................. 360,808 0.8
TELECOMMUNICATION
SERVICES
106,288 Telecom Italia SpA.................. 330,401 0.8
----------- -----
691,209 1.6
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 18,400 Enel SpA............................ 147,526 0.3
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN ITALY 838,735 1.9
- ----------------------------------------------------------------------------------------------------------------------
JAPAN WIRELESS 100 NTT DoCoMo, Inc. ................... 178,711 0.4
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN JAPAN 178,711 0.4
- ----------------------------------------------------------------------------------------------------------------------
MEXICO DIVERSIFIED 12,000 Telefonos de Mexico SA 'L'
TELECOMMUNICATION (ADR)(a).......................... 399,240 0.9
SERVICES
-----------------------------------------------------------------------------------------------------
WIRELESS 5,900 America Movil SA de CV 'L'
TELECOMMUNICATION (ADR)(a).......................... 214,583 0.5
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN MEXICO 613,823 1.4
- ----------------------------------------------------------------------------------------------------------------------
PORTUGAL DIVERSIFIED 20,600 Portugal Telecom SA (Registered
TELECOMMUNICATION Shares)........................... 222,309 0.5
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN PORTUGAL 222,309 0.5
- ----------------------------------------------------------------------------------------------------------------------
</Table>
278
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONTINUED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY* HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
SPAIN DIVERSIFIED 66,100 Telefonica SA....................... $ 977,110 2.3%
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 23,500 Endesa SA........................... 452,886 1.1
63,000 Iberdrola SA........................ 1,329,859 3.1
----------- -----
1,782,745 4.2
-----------------------------------------------------------------------------------------------------
GAS UTILITIES 23,300 Enagas.............................. 252,580 0.6
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN SPAIN 3,012,435 7.1
- ----------------------------------------------------------------------------------------------------------------------
UNITED KINGDOM ELECTRIC UTILITIES 24,600 Scottish and Southern Energy PLC.... 304,031 0.7
91,300 ScottishPower PLC................... 660,220 1.5
----------- -----
964,251 2.2
-----------------------------------------------------------------------------------------------------
GAS UTILITIES 30,000 Centrica PLC........................ 122,139 0.3
-----------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 37,762 National Grid Group PLC............. 291,388 0.7
UNREGULATED POWER
-----------------------------------------------------------------------------------------------------
WIRELESS 33,900 Vodafone Group PLC (ADR)(a)......... 749,190 1.7
TELECOMMUNICATION
SERVICES
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
UNITED KINGDOM 2,126,968 4.9
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES DIVERSIFIED 16,300 ALLTEL Corporation.................. 825,106 1.9
TELECOMMUNICATION
SERVICES
13,020 AT&T Corporation.................... 190,483 0.4
48,500 BellSouth Corporation............... 1,271,670 2.9
13,800 CenturyTel, Inc. ................... 414,552 1.0
17,700 +Citizens Communications Company.... 214,170 0.5
50,300 SBC Communications Inc. ............ 1,219,775 2.8
18,100 Sprint Corporation.................. 318,560 0.7
45,900 Verizon Communications.............. 1,661,121 3.8
----------- -----
6,115,437 14.0
-----------------------------------------------------------------------------------------------------
ELECTRIC UTILITIES 9,300 Ameren Corporation.................. 399,528 0.9
23,300 American Electric Power Company,
Inc. ............................. 745,600 1.7
17,592 Cinergy Corp. ...................... 668,496 1.5
24,000 Cleco Corporation................... 431,520 1.0
5,800 DTE Energy Company.................. 235,132 0.6
23,300 Edison International................ 595,781 1.4
18,100 Entergy Corporation................. 1,013,781 2.3
36,800 Exelon Corporation.................. 1,225,072 2.8
5,700 FPL Group, Inc. .................... 364,515 0.8
24,500 FirstEnergy Corp. .................. 916,545 2.1
19,700 NSTAR............................... 943,236 2.2
3,900 OGE Energy Corp. ................... 99,333 0.2
7,500 +PG&E Corporation................... 209,550 0.5
23,800 PPL Corporation..................... 1,092,420 2.5
16,000 Pinnacle West Capital Corporation... 646,240 1.5
10,000 Progress Energy, Inc. .............. 440,500 1.0
23,800 The Southern Company................ 693,770 1.6
33,800 TXU Corporation..................... 1,369,238 3.2
9,900 Wisconsin Energy Corporation........ 322,839 0.8
----------- -----
12,413,096 28.6
-----------------------------------------------------------------------------------------------------
GAS UTILITIES 11,500 AGL Resources Inc. ................. 334,075 0.8
21,900 KeySpan Corporation................. 803,730 1.9
21,000 New Jersey Resources Corporation.... 873,180 2.0
6,700 NiSource Inc. ...................... 138,154 0.3
7,000 UGI Corporation..................... 224,700 0.5
----------- -----
2,373,839 5.5
-----------------------------------------------------------------------------------------------------
</Table>
279
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2004 (CONCLUDED) (IN U.S. DOLLARS)
- --------------------------------------------------------------------------------
<Table>
<Caption>
SHARES PERCENT OF
COUNTRY INDUSTRY* HELD COMMON STOCKS VALUE NET ASSETS
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES
(CONCLUDED)
MEDIA 13,700 +Cablevision Systems Corporation
(Class A)......................... $ 269,205 0.6%
-----------------------------------------------------------------------------------------------------
METALS & MINING 7,400 Peabody Energy Corporation.......... 414,326 1.0
-----------------------------------------------------------------------------------------------------
MULTI-UTILITIES & 29,500 Constellation Energy Group.......... 1,118,050 2.6
UNREGULATED POWER
23,000 Dominion Resources, Inc. ........... 1,450,840 3.4
11,600 Energy East Corporation............. 281,300 0.7
5,900 Equitable Resources, Inc. .......... 305,089 0.7
9,400 National Fuel Gas Company........... 235,000 0.5
10,700 ONEOK, Inc. ........................ 235,293 0.5
22,500 Public Service Enterprise Group
Incorporated...................... 900,675 2.1
8,400 Questar Corporation................. 324,576 0.7
14,200 SCANA Corporation................... 516,454 1.2
----------- -----
5,367,277 12.4
-----------------------------------------------------------------------------------------------------
OIL & GAS 2,400 Devon Energy Corporation............ 158,400 0.4
15,400 EOG Resources, Inc. ................ 919,534 2.1
3,800 Kinder Morgan, Inc. ................ 225,302 0.5
----------- -----
1,303,236 3.0
-----------------------------------------------------------------------------------------------------
WIRELESS 19,636 +AT&T Wireless Services, Inc. ...... 281,188 0.8
TELECOMMUNICATION
SERVICES
8,100 +NII Holdings Inc. (Class B)........ 272,889 0.6
6,200 +Western Wireless Corporation (Class
A)................................ 179,242 0.4
----------- -----
733,319 1.8
-----------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS IN THE
UNITED STATES 28,989,735 66.9
- ----------------------------------------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST--$34,040,597) 41,201,921 95.2
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
FACE
AMOUNT TRUST PREFERRED
- ----------------------------------------------------------------------------------------------------------------------
UNITED STATES MULTI-UTILITIES & US$357,550 AES Trust III, 6.75% due 10/15/2029
UNREGULATED POWER (Convertible)..................... 299,573 0.7
- ----------------------------------------------------------------------------------------------------------------------
TOTAL TRUST PREFERRED
(COST--$215,311) 299,573 0.7
- ----------------------------------------------------------------------------------------------------------------------
<Caption>
BENEFICIAL
INTEREST SHORT-TERM SECURITIES
- ----------------------------------------------------------------------------------------------------------------------
US$738,771 Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I(b)............ 738,771 1.7%
- ----------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM SECURITIES
(COST--$738,771) 738,771 1.7
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS
(COST--$34,994,679)................. 42,240,265 97.6
OTHER ASSETS LESS LIABILITIES....... 1,058,914 2.4
----------- -----
NET ASSETS.......................... $43,299,179 100.0%
=========== =====
- ----------------------------------------------------------------------------------------------------------------------
</Table>
+ Non-income producing security.
* For Fund compliance purposes, "Industry" means any one or more of the
industry sub-classifications used by one or more widely recognized market
indexes or ratings group indexes, and/or as defined by Fund management. This
definition may not apply for purposes of this report, which may combine such
industry sub-classifications for reporting ease.
(a) American Depository Receipts (ADR).
(b) Investments in companies considered to be an affiliate of the Fund (such
companies are defined as "Affiliated Companies" in Section 2(a)(3) of the
Investment Company Act of 1940) are as follows:
<Table>
<Caption>
- ------------------------------------------------------------------------------------
NET INTEREST
AFFILIATE ACTIVITY INCOME
- ------------------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC Cash Sweep Series I..... $(949,116) $10,826
- ------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
280
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
STATEMENT OF ASSETS AND LIABILITIES AS OF JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
ASSETS:
Investments in unaffiliated securities, at value (identified
cost--$34,255,908)........................................ $41,501,494
Investments in affiliated securities, at value (identified
cost--$738,771)........................................... 738,771
Cash........................................................ 10,351
Foreign cash (cost--$668)................................... 668
Receivables:
Securities sold........................................... $ 1,036,788
Dividends................................................. 90,978
Interest (including $1,095 from affiliates)............... 6,579 1,134,345
------------
Prepaid expenses and other assets........................... 3,099
-----------
Total assets................................................ 43,388,728
-----------
- ------------------------------------------------------------------------------------------
LIABILITIES:
Payables:
Securities purchased...................................... 82,722
Investment adviser........................................ 3,538
Capital shares redeemed................................... 1,989
Other affiliates.......................................... 1,300
------------
Total liabilities........................................... 89,549
-----------
NET ASSETS.................................................. $43,299,179
===========
- ------------------------------------------------------------------------------------------
NET ASSETS CONSIST OF:
Class I Shares of Common Stock, $.10 par value, 100,000,000
shares authorized+........................................ $ 566,895
Paid-in capital in excess of par............................ 47,044,520
Undistributed investment income--net........................ $ 336,979
Accumulated realized capital losses on investments and
foreign currency transactions--net........................ (11,893,342)
Unrealized appreciation on investments and foreign currency
transactions--net......................................... 7,244,127
------------
Total accumulated losses--net............................... (4,312,236)
-----------
NET ASSETS.................................................. $43,299,179
===========
- ------------------------------------------------------------------------------------------
NET ASSET VALUE:++
Class I--Based on net assets of $43,299,179 and 5,668,952
shares outstanding........................................ $ 7.64
===========
- ------------------------------------------------------------------------------------------
</Table>
+ The Fund is also authorized to issue 100,000,000 Class II Shares and
100,000,000 Class III Shares.
++ The Fund had no outstanding shares for Class II and Class III as of June 30,
2004.
See Notes to Financial Statements.
281
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004
- --------------------------------------------------------------------------------
<Table>
INVESTMENT INCOME:
Dividends (net of $29,901 foreign withholding tax).......... $ 753,109
Interest (including $10,826 from affiliates)................ 23,345
----------
Total income................................................ 776,454
----------
- -----------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees.................................... $135,339
Professional fees........................................... 13,613
Accounting services......................................... 8,496
Custodian fees.............................................. 6,322
Transfer agent fees......................................... 2,353
Printing and shareholder reports............................ 1,951
Pricing services............................................ 1,467
Directors' fees and expenses................................ 1,369
Other....................................................... 7,140
--------
Total expenses.............................................. 178,050
----------
Investment income--net...................................... 598,404
----------
- -----------------------------------------------------------------------------------
REALIZED & UNREALIZED GAIN (LOSS) ON INVESTMENTS & FOREIGN
CURRENCY TRANSACTIONS--NET:
Realized gain (loss) from:
Investments--net.......................................... 843,635
Foreign currency transactions--net........................ (10,063) 833,572
--------
Change in unrealized appreciation/depreciation on:
Investments--net.......................................... 502,867
Foreign currency transactions--net........................ (1,887) 500,980
-------- ----------
Total realized and unrealized gain on investments and
foreign currency transactions--net........................ 1,334,552
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........ $1,932,956
==========
- -----------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
282
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<Table>
<Caption>
FOR THE SIX FOR THE
MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31,
INCREASE (DECREASE) IN NET ASSETS: 2004 2003
- -----------------------------------------------------------------------------------------------
OPERATIONS:
Investment income--net...................................... $ 598,404 $ 1,329,682
Realized gain on investments and foreign currency
transactions--net......................................... 833,572 258,748
Change in unrealized appreciation/depreciation on
investments and foreign currency transactions--net........ 500,980 6,548,626
----------- -----------
Net increase in net assets resulting from operations........ 1,932,956 8,137,056
----------- -----------
- -----------------------------------------------------------------------------------------------
DIVIDENDS TO SHAREHOLDERS:
Investment income--net:
Class I................................................... (259,004) (1,317,612)
----------- -----------
Net decrease in net assets resulting from dividends to
shareholders.............................................. (259,004) (1,317,612)
----------- -----------
- -----------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share
transactions.............................................. (6,164,680) (5,068,702)
----------- -----------
- -----------------------------------------------------------------------------------------------
NET ASSETS:
Total increase (decrease) in net assets..................... (4,490,728) 1,750,742
Beginning of period......................................... 47,789,907 46,039,165
----------- -----------
End of period*.............................................. $43,299,179 $47,789,907
=========== ===========
- -----------------------------------------------------------------------------------------------
* Undistributed distributions in excess of investment
income--net............................................... $ 336,979 $ (2,421)
=========== ===========
- -----------------------------------------------------------------------------------------------
</Table>
See Notes to Financial Statements.
283
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
<Table>
<Caption>
CLASS I
THE FOLLOWING PER SHARE DATA AND RATIOS -----------------------------------------------------------
HAVE BEEN DERIVED FROM INFORMATION
PROVIDED IN THE FINANCIAL STATEMENTS. FOR THE SIX
MONTHS ENDED FOR THE YEAR ENDED DECEMBER 31,+
JUNE 30, --------------------------------------------
INCREASE (DECREASE) IN NET ASSET VALUE: 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................... $ 7.37 $ 6.32 $ 8.25 $ 10.31 $ 16.85
------- -------- -------- -------- --------
Investment income--net***.............................. .10 .20 .25 .31 .47
Realized and unrealized gain (loss) on investments and
foreign currency transactions--net................... .21 1.05 (1.76) (1.71) (.92)
------- -------- -------- -------- --------
Total from investment operations....................... .31 1.25 (1.51) (1.40) (.45)
------- -------- -------- -------- --------
Less dividends and distributions:
Investment income--net............................... (.04) (.20) (.26) (.33) (.50)
In excess of investment income--net.................. -- -- -- -- (.01)
Realized gain on investments--net.................... -- -- (.16) (.33) (5.58)
------- -------- -------- -------- --------
Total dividends and distributions...................... (.04) (.20) (.42) (.66) (6.09)
------- -------- -------- -------- --------
Net asset value, end of period......................... $ 7.64 $ 7.37 $ 6.32 $ 8.25 $ 10.31
======= ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share..................... 4.27%++ 20.19% (18.77%) (14.02%) (2.71%)
======= ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS:
Expenses............................................... .79%* .73% .75% .71% .69%
======= ======== ======== ======== ========
Investment income--net................................. 2.65%* 3.02% 3.50% 3.27% 3.00%
======= ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands)............... $43,299 $ 47,790 $ 46,039 $ 73,183 $106,330
======= ======== ======== ======== ========
Portfolio turnover..................................... 5.44% 20.19% 30.32% 34.59% 64.95%
======= ======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------
</Table>
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Based on average shares outstanding.
+ Effective September 2, 2003, Class A Shares were redesignated Class I
Shares.
++ Aggregate total investment return.
See Notes to Financial Statements.
284
- --------------------------------------------------------------------------------
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.--UTILITIES AND TELECOMMUNICATIONS V.I.
FUND
NOTES TO FINANCIALS STATEMENTS
- --------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES:
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-end
management investment company that is comprised of 16 separate funds. Each fund
offers three classes of shares to the Merrill Lynch Life Insurance Company, ML
Life Insurance Company of New York (indirect, wholly-owned subsidiaries of
Merrill Lynch & Co., Inc. ("ML & Co.")), and other insurance companies that are
not affiliated with ML & Co., for their separate accounts to fund benefits under
certain variable annuity and variable life insurance contracts. Utilities and
Telecommunications V.I. Fund (the "Fund") is classified as "diversified," as
defined in the Investment Company Act of 1940, as amended. Class I Shares, Class
II Shares and Class III Shares have equal voting, dividend, liquidation and
other rights, except that only shares of the respective classes are entitled to
vote on matters concerning only that class. In addition, Class II Shares and
Class III Shares bear certain expenses related to the distribution of such
shares. The Fund's financial statements are prepared in conformity with U.S.
generally accepted accounting principles, which may require the use of
management accruals and estimates. Actual results may differ from these
estimates. These unaudited financial statements reflect all adjustments, which
are, in the opinion of management, necessary to present a fair statement of the
results for the interim period. All such adjustments are of a normal, recurring
nature. The following is a summary of significant accounting policies followed
by the Fund.
(a) Valuation of investments--Equity securities that are held by the Fund that
are traded on stock exchanges or the Nasdaq National Market are valued at the
last sale price or official close price on the exchange, as of the close of
business on the day the securities are being valued or, lacking any sales, at
the last available bid price for long positions, and at the last available ask
price for short positions. In cases where equity securities are traded on more
than one exchange, the securities are valued on the exchange designated as the
primary market by or under the authority of the Board of Directors of the
Company. Long positions traded in the over-the-counter ("OTC") market, Nasdaq
Small Cap or Bulletin Board are valued at the last available bid price or yield
equivalent obtained from one or more dealers or pricing services approved by the
Board of Directors of the Company. Short positions traded in the OTC market are
valued at the last available ask price. Portfolio securities that are traded
both in the OTC market and on a stock exchange are valued according to the
broadest and most representative market.
Options written are valued at the last sale price in the case of
exchange-traded options or, in the case of options traded in the OTC market, the
last ask price. Options purchased are valued at their last sale price in the
case of exchange-traded options or, in the case of options traded in the OTC
market, the last bid price. Swap agreements are valued daily based upon
quotations from market makers. Financial futures contracts and options thereon,
which are traded on exchanges, are valued at their last sale price as of the
close of such exchanges. Obligations with remaining maturities of 60 days or
less are valued at amortized cost unless the Investment Adviser believes that
this method no longer produces fair valuations.
Repurchase agreements are valued at cost plus accrued interest. The Fund
employs pricing services to provide certain securities prices for the Fund.
Securities and assets for which market 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 Company, including valuations furnished by the
pricing services retained by the Fund, which may use a matrix system for
valuations. The procedures of a pricing service and its valuations are reviewed
by the officers of the Fund under the general supervision of the Company's Board
of Directors. Such valuations and procedures will be reviewed periodically by
the Board of Directors of the Company.
Generally, trading in foreign securities, as well as U.S. government
securities and money market instruments, is substantially completed each day at
various times prior to the close of business on the New York Stock Exchange
("NYSE"). The values of such securities used in computing the net asset value of
the Fund's shares are determined as of such times. Foreign currency exchange
rates also are generally determined prior to the close of business on the NYSE.
Occasionally, events affecting the values of such securities and such exchange
rates may occur between the times at which they are determined and the close of
business on the NYSE that may not be reflected in the computation of the Fund's
net asset value. If events (for example, a company announcement, market
volatility or a natural disaster) occur during such periods that are expected to
materially affect the value of such securities, those securities may be valued
at their fair value as determined in good
285
- --------------------------------------------------------------------------------
faith by the Company's Board of Directors or by the Investment Adviser using a
pricing service and/or procedures approved by the Company's Board of Directors.
(b) Derivative financial instruments--The Fund may engage in various portfolio
investment strategies both to increase the return of the Fund and to hedge, or
protect, its exposure to interest rate movements and movements in the securities
markets. Losses may arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
- Forward foreign exchange contracts--The Fund may enter into forward foreign
exchange contracts as a hedge against either specific transactions or portfolio
positions. The contract is marked-to-market daily and the change in market value
is recorded by the Fund as an unrealized gain or loss. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the value at the time it was opened and the value at the time it was closed.
- Options--The Fund may write call and put options and purchase 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.
- Financial futures contracts--The Fund may purchase or sell financial futures
contracts and options on such futures contracts. 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.
- Foreign currency options and futures--The Fund may also purchase or sell
listed or over-the-counter foreign currency options, foreign currency futures
and related options on foreign currency futures as a short or long hedge against
possible variations in foreign exchange rates. Such transactions may be effected
with respect to hedges on non-U.S. dollar-denominated securities owned by the
Fund, sold by the Fund but not yet delivered, or committed or anticipated to be
purchased by the Fund.
(c) 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 and liabilities expressed in
foreign currencies into U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(d) 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.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. Dividend income is recorded on the ex-dividend dates.
Dividends from foreign securities where the ex-dividend date may have passed are
subsequently recorded when the Fund has determined the ex-dividend date.
Interest income is recognized on the accrual basis.
(f) Dividends and distributions--Dividends from net investment income are
declared and paid quarterly. Distributions of capital gains are recorded on the
ex-dividend date.
(g) Expenses--Certain expenses have been allocated to the individual funds in
the Company on a pro rata basis based upon the respective aggregate net asset
value of each fund included in the Company.
286
- --------------------------------------------------------------------------------
(h) Securities lending--The Fund may lend securities to financial institutions
that provide cash or securities issued or guaranteed by the U.S. government as
collateral, which will be maintained at all times in an amount equal to at least
100% of the current market value of the loaned securities. The market value of
the loaned securities is determined at the close of business of the Fund and any
additional required collateral is delivered to the Fund on the next business
day. Where the Fund receives securities as collateral for the loaned securities,
it collects a fee from the borrower. The Fund typically receives the income on
the loaned securities, but does not receive the income on the collateral. Where
the Fund receives cash collateral, it may invest such collateral and retain the
amount earned on such investment, net of any amount rebated to the borrower.
Loans of securities are terminable at any time and the borrower, after notice,
is required to return borrowed securities within five business days. The Fund
may pay reasonable finder's, lending agent, administrative and custodial fees in
connection with its loans. In the event that the borrower defaults on its
obligation to return borrowed securities because of insolvency or for any other
reason, the Fund could experience delays and costs in gaining access to the
collateral. The Fund also could suffer a loss where the value of the collateral
falls below the market value of the borrowed securities, in the event of
borrower default or in the event of losses on investments made with cash
collateral.
2. INVESTMENT ADVISORY AGREEMENT AND TRANSACTIONS WITH AFFILIATES:
The Company has entered into an Investment Advisory Agreement with Merrill Lynch
Investment Managers, L.P. ("MLIM"). The general partner of MLIM is Princeton
Services, Inc. ("PSI"), an indirect, wholly-owned subsidiary of ML & Co., which
is the limited partner.
MLIM is responsible for the management of the Company's funds and provides the
necessary personnel, facilities, equipment and certain other services necessary
to the operations of the Fund. For such services, the Fund pays a monthly fee at
the annual rate of .60% of the average daily value of the Fund's net assets.
MLIM has entered into a Sub-Advisory Agreement with Merrill Lynch Asset
Management, U.K. Limited ("MLAM U.K."), an affiliate of MLIM, pursuant to which
MLAM U.K. provides investment advisory services to MLIM with respect to the
Fund. There is no increase in the aggregate fees paid by the Fund for these
services.
The Company has received an exemptive order from the Securities and Exchange
Commission permitting it to lend portfolio securities to Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("MLPF&S"), a subsidiary of ML & Co., or its
affiliates. Pursuant to that order, the Company also has retained Merrill Lynch
Investment Managers, LLC ("MLIM, LLC"), an affiliate of MLIM, as the securities
lending agent for a fee based on a share of the returns on investment of cash
collateral. MLIM, LLC may, on behalf of the Company and the Fund, invest cash
collateral received by the Fund for such loans, among other things, in a private
investment company managed by MLIM, LLC or in registered money market funds
advised by MLIM or its affiliates.
For the six months ended June 30, 2004, MLPF&S earned $1,817 in commissions on
the execution of portfolio security transactions.
In addition, the Fund reimbursed MLIM $435 for certain accounting services for
the six months ended June 30, 2004.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of ML & Co.,
is the Company's transfer agent.
FAM Distributors, Inc. ("FAMD"), which is a wholly-owned subsidiary of Merrill
Lynch Group, Inc., is the Fund's distributor.
Certain officers and/or directors of the Company are officers and/or directors
of MLIM, PSI, MLAM U.K., FDS, FAMD, and/or ML & Co.
3. INVESTMENTS:
Purchases and sales of investments, excluding short-term securities, for the six
months ended June 30, 2004 were $2,342,143 and $6,749,350, respectively.
Net realized gains/losses for the six months ended June 30, 2004 and net
unrealized appre-
287
- --------------------------------------------------------------------------------
ciation/depreciation as of June 30, 2004 were as follows:
<Table>
<Caption>
- ----------------------------------------------------------------------
Unrealized
Realized Appreciation/
Gains (Losses) Depreciation
- ----------------------------------------------------------------------
Long-term investments................. $843,635 $7,245,586
Foreign currency transactions......... (10,063) (1,459)
-------- ----------
Total................................. $833,572 $7,244,127
======== ==========
- ----------------------------------------------------------------------
</Table>
At June 30, 2004, net unrealized appreciation for federal income tax purposes
aggregated $7,220,149, of which $8,665,953 related to appreciated securities and
$1,445,804 related to depreciated securities. At June 30, 2004, the aggregate
cost of investments for federal income tax purposes was $35,020,116.
4. CAPITAL SHARE TRANSACTIONS:
Net decrease in net assets derived from capital share transactions were
$6,164,680 and $5,068,702 for the six months ended June 30, 2004 and the year
ended December 31, 2003, respectively.
Transactions in capital shares were as follows:
<Table>
<Caption>
- ------------------------------------------------------------------
Class I Shares for the Six Months Ended Dollar
June 30, 2004 Shares Amount
- ------------------------------------------------------------------
Shares sold........................... 386,915 $ 2,925,403
Shares issued to shareholders in
reinvestment of dividends............ 34,673 259,004
---------- -----------
Total issued.......................... 421,588 3,184,407
Shares redeemed....................... (1,235,339) (9,349,087)
---------- -----------
Net decrease.......................... (813,751) $(6,164,680)
========== ===========
- ------------------------------------------------------------------
</Table>
<Table>
<Caption>
- -----------------------------------------------------------------
Class I Shares for the Year Ended Dollar
December 31, 2003 Shares Amount
- -----------------------------------------------------------------
Shares sold........................... 427,830 $ 2,973,767
Shares issued to shareholders in
reinvestment of dividends and
distributions........................ 198,196 1,317,612
---------- -----------
Total issued.......................... 626,026 4,291,379
Shares redeemed....................... (1,430,670) (9,360,081)
---------- -----------
Net decrease.......................... (804,644) $(5,068,702)
========== ===========
- -----------------------------------------------------------------
</Table>
5. SHORT-TERM BORROWINGS:
The Fund, along with certain other funds managed by MLIM and its affiliates, is
a party to a $500,000,000 credit agreement with Bank One, N.A. and certain other
lenders. The Fund may borrow under the credit agreement to fund shareholder
redemptions and for other lawful purposes other than for leverage. The Fund may
borrow up to the maximum amount allowable under the Fund's current prospectus
and statement of additional information, subject to various other legal,
regulatory or contractual limits. The Fund pays a commitment fee of .09% per
annum based on the Fund's pro rata share of the unused portion of the credit
agreement. Amounts borrowed under the credit agreement bear interest at a rate
equal to, at each fund's election, the Federal Funds rate plus .50% or a base
rate as determined by Bank One, N.A. On November 28, 2003, the credit agreement
was renewed for one year under the same terms. The Fund did not borrow under the
credit agreement during the six months ended June 30, 2004.
6. COMMITMENTS:
At June 30, 2004, the Fund had entered into foreign exchange contracts, under
which it had agreed to purchase and sell various foreign currencies with
approximate values of $83,000 and $180,000, respectively.
7. CAPITAL LOSS CARRYFORWARD:
On December 31, 2003, the Fund had a net capital loss carryforward of
$12,701,478, of which $12,650,732 expires in 2010 and $50,746 expires in 2011.
This amount will be available to offset like amounts of any future taxable
gains.
8. DISTRIBUTION TO SHAREHOLDERS:
The Fund paid an ordinary income dividend in the amount of $.058381 per share on
July 27, 2004 to shareholders of record on July 21, 2004.
288
Item 2 - Code of Ethics - Not Applicable to this semi-annual report
Item 3 - Audit Committee Financial Expert - Not Applicable to this semi-annual
report
Item 4 - Principal Accountant Fees and Services - Not Applicable to this
semi-annual report
Item 5 - Audit Committee of Listed Registrants - Not Applicable
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies - Not Applicable
Item 8 - Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers - Not Applicable
Item 9 - Submission of Matters to a Vote of Security Holders - Not Applicable
Item 10 - Controls and Procedures
10(a) - The registrant's certifying officers have reasonably designed such
disclosure controls and procedures to ensure material information
relating to the registrant is made known to us by others particularly
during the period in which this report is being prepared. The
registrant's certifying officers have determined that the
registrant's disclosure controls and procedures are effective based
on our evaluation of these controls and procedures as of a date
within 90 days prior to the filing date of this report.
10(b) - There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the Act (17
CFR 270.30a-3(d)) that occurred during the last fiscal half-year of
the period covered by this report that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting.
Item 11 - Exhibits attached hereto
11(a)(1) - Code of Ethics - Not Applicable to this semi-annual report
11(a)(2) - Certifications - Attached hereto
11(a)(3) - Not Applicable
11(b) - Certifications - Attached hereto
Pursuant to the requirements of the Securities Exchange Act of 1934 and
the Investment Company Act of 1940, the registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Merrill Lynch Variable Series Funds, Inc.
By: /s/ Terry K. Glenn
------------------
Terry K. Glenn,
President of
Merrill Lynch Variable Series Funds, Inc.
Date: August 13, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934
and the Investment Company Act of 1940, this report has been signed
below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
By: /s/ Terry K. Glenn
------------------
Terry K. Glenn,
President of
Merrill Lynch Variable Series Funds, Inc.
Date: August 13, 2004
By: /s/ Donald C. Burke
------------------
Donald C. Burke,
President of
Merrill Lynch Variable Series Funds, Inc.
Date: August 13, 2004