UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT
INVESTMENT COMPANIES
Investment Company Act file number 811-08603
Name of Fund: Debt Strategies Fund, Inc.
Fund Address: P.O. Box 9011
Princeton, NJ 08543-9011
Name and address of agent for service: Robert C. Doll, Jr., Chief Executive
Officer, Debt Strategies Fund, 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: 02/28/05
Date of reporting period: 03/01/04 - 02/28/05
Item 1 - Report to Stockholders
Debt Strategies Fund, Inc.
Annual Report
February 28, 2005
Debt Strategies Fund, Inc.
The Benefits and Risks of Leveraging
Debt Strategies Fund, Inc. utilizes leverage through borrowings or issuance of
short-term debt securities or shares of Preferred Stock. The concept of
leveraging is based on the premise that the cost of assets to be obtained from
leverage will be based on short-term interest rates, which normally will be
lower than the income earned by the Fund on its longer-term portfolio
investments. To the extent that the total assets of the Fund (including the
assets obtained from leverage) are invested in higher-yielding portfolio
investments, the Fund's Common Stock shareholders will benefit from the
incremental yield.
Leverage creates risks for holders of Common Stock including the likelihood of
greater net asset value and market price volatility. In addition, there is the
risk that fluctuations in interest rates on borrowings (or in the dividend rates
on any Preferred Stock, if the Fund were to issue Preferred Stock) may reduce
the Common Stock's yield and negatively impact its net asset value and market
price. If the income derived from securities purchased with assets received from
leverage exceeds the cost of leverage, the Fund's net income will be greater
than if leverage had not been used. Conversely, if the income from the
securities purchased is not sufficient to cover the cost of leverage, the Fund's
net income will be less than if leverage had not been used, and therefore the
amount available for distribution to Common Stock shareholders will be reduced.
Portfolio Information as of February 28, 2005
Percent of
Ten Largest Holdings Net Assets
- --------------------------------------------------------------------------------
Charter Communications Operating LLC* ................................ 2.0%
Crown Castle International Corp.* .................................... 1.9
Kabel Deutschland GmbH ............................................... 1.8
XM Satellite Radio, Inc. ............................................. 1.7
Felcor Lodging LP .................................................... 1.7
Rainbow National Services LLC ........................................ 1.6
Playtex Products, Inc. ............................................... 1.5
United Rentals North America, Inc. ................................... 1.5
PolyOne Corp. ........................................................ 1.5
Levi Strauss & Co.* .................................................. 1.4
- --------------------------------------------------------------------------------
* Includes combined holdings.
Percent of
Five Largest Industries* Net Assets
- --------------------------------------------------------------------------------
Cable--U.S. ............................................... 17.4%
Chemicals ................................................. 15.8
Telecommunications ........................................ 9.8
Wireless Communications ................................... 8.7
Paper ..................................................... 7.2
- --------------------------------------------------------------------------------
* For Fund compliance purposes, "Industries" 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 industry sub-classifications for reporting ease. Industries are
shown as a percent of net assets.
- --------------------------------------------------------------------------------
Percent of
Quality Ratings by S&P/Moody's Total Investments
- --------------------------------------------------------------------------------
BBB/Baa ................................................. 2.0%
BB/Ba ................................................... 9.0
B/B ..................................................... 60.1
CCC/Caa ................................................. 13.9
CC/Ca ................................................... 0.6
NR (Not Rated) .......................................... 10.9
Other* .................................................. 3.5
- --------------------------------------------------------------------------------
* Includes portfolio holdings in common stocks, preferred stocks, warrants,
other interests and short-term investments.
2 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
A Letter From the President
Dear Shareholder
Financial markets broadly posted positive returns over the most recent reporting
period, with international equities providing some of the most impressive
results.
Total Returns as of February 28, 2005 6-month 12-month
=======================================================================================================
U.S. equities (Standard & Poor's 500 Index) + 9.99% + 6.98%
- -------------------------------------------------------------------------------------------------------
International equities (MSCI Europe Australasia Far East Index) +21.18 +18.68
- -------------------------------------------------------------------------------------------------------
Fixed income (Lehman Brothers Aggregate Bond Index) + 1.26 + 2.43
- -------------------------------------------------------------------------------------------------------
Tax-exempt fixed income (Lehman Brothers Municipal Bond Index) + 2.40 + 2.96
- -------------------------------------------------------------------------------------------------------
High yield bonds (Credit Suisse First Boston High Yield Index) + 7.53 +11.21
- -------------------------------------------------------------------------------------------------------
The U.S. economy has continued to show resilience in the face of the Federal
Reserve Board's (the Fed) continued interest rate hikes and, more recently,
higher oil prices. The Fed's measured tightening program recently brought the
federal funds rate to 2.75% en route to a more "neutral" short-term interest
rate target (relative to inflation). Since the U.S. presidential election,
progress has been monitored on many fronts in Washington, although concerns
remain about the structural problems of debt and deficits, as reflected by a
significant decline in the U.S. dollar.
U.S. equities ended 2004 in a strong rally, but remained in a fairly narrow
trading range for the first two months of 2005. Divergences were notable among
sectors, with energy emerging as a clear leader. On the positive side,
corporations have accelerated their hiring plans, capital spending remains
reasonably robust and merger-and-acquisition activity has increased. Offsetting
the positives are slowing corporate earnings growth, renewed energy price
concerns and the potential for an economic slowdown. International equities,
particularly in Asia, have benefited from higher economic growth rates (China
recorded growth of 9.3% in 2004), stronger currencies and relatively reasonable
valuations.
The major action in the bond market has been a flattening of the yield curve. As
short-term interest rates continued to rise, yields on the long end of the curve
remained relatively stable -- even declining at certain points since the Fed's
monetary tightening program began in June 2004. This phenomenon has been largely
attributed to continued foreign interest in U.S. bonds, which has served to
absorb much of the excess supply. By period-end, many believed long-term yields
were long overdue for a rise.
Looking ahead, the environment is likely to be a challenging one for investors,
with diversification and selectivity becoming increasingly important themes.
With this in mind, we encourage you to meet with your financial advisor to
review your goals and asset allocation and to rebalance your portfolio, as
necessary, to ensure it remains aligned with your objectives and risk tolerance.
As always, we thank you for trusting Merrill Lynch Investment Managers with your
investment assets, and we look forward to serving you in the months and years
ahead.
Sincerely,
/s/ Robert C. Doll, Jr.
Robert C. Doll, Jr.
President and Director
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 3
A Discussion With Your Fund's Portfolio Manager
The Fund's total return significantly exceeded that of its blended
benchmark for the fiscal year, primarily because of our overweight position in
high yield bonds and our active use of leverage.
How did the Fund perform during the fiscal year in light of the existing market
conditions?
For the 12-month period ended February 28, 2005, the Common Stock of Debt
Strategies Fund, Inc. had net annualized yields of 9.26% and 9.75%, based on a
year-end per share net asset value of $7.06 and a per share market price of
$6.71, respectively, and $.654 per share income dividends. Over the same period,
the total investment return on the Fund's Common Stock was +15.95%, based on a
change in per share net asset value from $6.71 to $7.06, and assuming
reinvestment of all distributions. The Fund's total return for the year
significantly exceeded the +8.25% return of its benchmark, which is an equal
blend of the Credit Suisse First Boston (CSFB) High Yield Index and the CSFB
Leveraged Loan Index.
For the six-month period ended February 28, 2005, the total investment return on
the Fund's Common Stock was +9.76%, based on a change in per share net asset
value from $6.74 to $7.06, and assuming reinvestment of all distributions. The
blended benchmark provided a return of +5.25% for the same six-month period.
For a description of the Fund's total investment return based on a change in the
per share market value of the Fund's Common Stock (as measured by the trading
price of the Fund's shares on the New York Stock Exchange), and assuming
reinvestment of dividends, please refer to the Financial Highlights section of
this report. As a closed-end fund, the Fund's shares may trade in the secondary
market at a premium or discount to the Fund's net asset value. As a result,
total investment returns based on changes in the market value of the Fund's
Common Stock can vary significantly from total investment returns based on
changes in the Fund's net asset value.
The high yield market closed out 2004 with an 11% return, far lower than the 29%
return recorded in 2003, but still quite respectable. High yield bond issuance
in 2004 totaled $131 billion, slightly down from $133 billion in 2003. As in
2003, when 79% of proceeds were used to refinance existing debt, some 69% of the
proceeds went for refinancing in 2004 as corporate treasurers continued to
exploit cheaper financing opportunities. While the yield on the 10-year Treasury
note (which is the typical reference rate for high yield bonds) has not changed
appreciably over the past two years, the required spread off of Treasury
securities for high yield bonds has narrowed significantly. This spread
compression has been the principal driver of the high yield bond rally, and has
presented these refinancing opportunities. The high yield market momentum has
slowed somewhat thus far in 2005, with a year-to-date return of +1.31% as of
February 28, 2005.
The market's appetite for risk was greater in 2004 than in 2003, as measured by
the major rating agencies. Issues rated B and lower accounted for 62% of 2004's
high yield bond volume compared to 63% for 2003, 54% for 2002 and 45% for 2001.
Moreover, CCC and split-CCC issuance was 7.2% in 2004 versus 3.0% in 2003 and
..4% in 2002. Despite this, credit measures remained relatively intact.
Debt/EBITDA (earnings before interest, taxes, depreciation and amortization) in
2003 was 4.9 times versus 5.0 times in 2004. Interest coverage in 2003 was 2.5
times versus 2.7 times in 2004. The anomaly of better interest coverage despite
higher leverage is explained by compression-driven lower spreads for high yield
bonds. Default rates continued to decline in 2004 to 1.27% versus 4.13% in 2003
and 15.41% in 2002. While 2002 saw the highest default rate ever, 2004 saw the
lowest since 1997, according to CSFB.
Conditions in the leveraged bank loan market were much the same as those
impacting high yield bonds. That is, strong demand has been leading to
compressed spreads, which has encouraged companies to refinance their bank debt.
This dynamic was even more pronounced in the bank loan market because, unlike
high yield bonds, bank loans generally lack call protection.
What factors contributed most to Fund performance?
The outperformance of the benchmark is attributed primarily to an overweight
bond position and our use of the Fund's leverage line. We use commercial
paper-based borrowings up to a maximum of 33% of the Fund's market value. The
average amount of Fund leverage during the six-month period was around 28%. (For
a complete discussion of the benefits and risks of leveraging, refer to page 2
of this report to shareholders.)
Specific credits that made significant contributions to Fund performance
included Viskase Cos., Inc., Vektura (also known as American Commercial Lines or
ACL) and GEO Specialty
4 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Chemicals, Inc. As a result of Chapter 11 proceedings, we received 1.4 million
common shares of Viskase, a company that manufactures cellulosic casings for the
meat processing industry. Over the past year, the market price of Viskase common
stock increased from $.41 to $3.00. The company has not filed public financial
statements since emergence from Chapter 11. The increase in the stock price has
been driven by the successful refinancing and extension of the term of the
company's debt in June, reductions in operating expenses and upgrades to certain
of its facilities.
ACL is a barge transportation company that filed Chapter 11 due to the impact of
depressed operating conditions in the inland waterways. Our $10 million bond
position (which we bought at 50 as a distressed investment) increased in price
from 28 to 64 during the year in response to both improving business conditions
and more aggressive actions by the debtor's board to develop a more favorable
business plan for unsecured creditors. We liquidated this position at 64.
GEO is a specialty chemical company that supplies functional chemicals to a
variety of markets, including the industrial water treatment, paints and
coatings, construction and electronics industries. Our $8.7 million bond
position rallied from 30 to 64 prior to the company's Chapter 11 filing in March
2004. We subsequently participated in financing the company's emergence from
Chapter 11 whereby we have a $10.6 million floating rate note position which
appreciated from 99 to 106.75. The strength of the market segments in which the
company participates has contributed to a favorable financial outlook for GEO.
Investments that detracted from performance included Pegasus Satellite
Communications, Inc. (PGTV), New World Pasta Co. (NWP) and Adelphia
Communications Corp. Two of the Fund's holdings in PGTV, a Direct TV
re-marketing company, collapsed during the year. Our $9.5 million senior note
position fell from 80 to 60, while our $3.5 million preferred position dropped
from 82 to 0. Our hopes for a favorable resolution of some longstanding
litigation following Newscorp's acquisition of Direct TV went unfulfilled. PGTV
filed Chapter 11 on June 2, 2004.
Our $28 million distressed investment in NWP (purchased at 17) declined in price
from 15 to 7 during the year. Operational difficulties, a high debt burden and
sluggish pasta sales combined to force a Chapter 11 filing in the second
quarter. The chief executive officer and chief financial officer were replaced
by a crisis management team from Alix Partners. The unsettled management
situation contributed to the bond's price decline during the year.
Our $7.5 million position in Adelphia convertible debt fell from 39 to 7.75
during the year. Adelphia is in the latter stages of a Chapter 11 restructuring
and has put its cable systems up for bid. Valuations are lower than we expected.
What changes were made to the portfolio during the period?
During the year, we completed a repositioning of the portfolio, moving from 78%
fixed rate and 22% floating rate investments to a 65% fixed rate and 35%
floating rate composition. In doing so, we have essentially lessened the
negative impact that rising interest rates would have on the portfolio's net
asset value.
Since June 2004, the Federal Reserve Board (the Fed) has raised interest rates
25 basis points (.25%) at each of its meetings, bringing the federal funds rate
from 1% to 2.75%. The consensus view is that the Fed will continue its measured
monetary tightening program until the target rate reaches a point of
"neutrality," which most have placed in the area of 3% to 4%. Although long-term
interest rates have been slow to follow short-term interest rates higher -- a
market phenomenon that even Fed Chairman Alan Greenspan has called a "conundrum"
- -- we continue to believe that rising long-term interest rates are the primary
threat to investors in the high yield market.
How would you characterize the Fund's position at the close of the period?
We would characterize our position at period-end as somewhat more defensive --
increasing our floating rate component while still focused on maintaining the
Fund's attractive yield. We also continue to be cautious and selective in adding
new positions, and intend to maintain our use of leverage within a target range
of 25% - 30%.
Kevin J. Booth
Vice President and Portfolio Manager
March 29, 2005
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 5
Schedule of Investments (in U.S. dollars)
Face
Industry+ Amount Corporate Debt Obligations Value
==========================================================================================================================
Aerospace & $ 5,000,000 Alliant Techsystems, Inc., 3% due 8/15/2024 (d)(k) $ 5,625,000
Defense--2.9% 875,000 K&F Acquisition, Inc., 7.75% due 11/15/2014 (d) 885,937
Titan Corp.:
2,000,000 8% due 5/15/2011 2,150,000
5,954,199 Term Loan B, due 6/30/2009* 6,038,861
7,120,000 Vought Aircraft Industries, Inc., 8% due 7/15/2011 7,191,200
-----------
21,890,998
==========================================================================================================================
Airlines--1.2% 4,377,562 American Airlines, Inc. Series 2001-1, 7.379% due 11/23/2017 2,942,364
5,875,000 Delta Air Lines, Inc., 2.875% due 2/18/2024 (d)(k) 3,032,969
3,300,000 Evergreen International Aviation, Inc., 12% due 5/15/2010 2,706,000
-----------
8,681,333
==========================================================================================================================
Automotive--3.5% 4,475,000 Cooper Standard Auto, 8.375% due 12/15/2014 (d) 4,228,875
2,700,000 Delco Remy International, Inc., 6.66% due 4/15/2009 (a) 2,754,000
1,550,000 Dura Operating Corp. Series D, 9% due 5/01/2009 1,433,750
3,500,000 Goodyear Tire & Rubber Tranche B Term Loan, due 3/31/2006* 3,543,750
4,467,296 Intermet Corp. Term Loan B, due 3/31/2009* 4,472,880
5,900,000 Metaldyne Corp., 11% due 6/15/2012 5,162,500
Tenneco Automotive, Inc.:
925,000 Series B, 10.25% due 7/15/2013 1,086,875
2,185,236 Term Loan B, due 12/12/2010* 2,228,030
1,114,764 Tranche B-1 Credit Linked, due 12/12/2010* 1,136,594
Venture Holdings Co. LLC (i):
4,450,000 12% due 6/01/2009 0
1,800,000 Series B, 9.50% due 7/01/2005 36,000
-----------
26,083,254
==========================================================================================================================
Broadcasting--2.9% 6,000,000 Granite Broadcasting Corp., 9.75% due 12/01/2010 5,745,000
770,000 Sinclair Broadcast Group, Inc., 4.875% due 7/15/2018 (k) 714,175
12,625,000 XM Satellite Radio, Inc., 8.243% due 5/01/2009 (a) 12,987,969
2,000,000 Young Broadcasting Inc., 10% due 3/01/2011 2,110,000
-----------
21,557,144
==========================================================================================================================
Cable-- 11,350,000 Kabel Deutschland GmbH, 10.625% due 7/01/2014 (d) 13,052,500
International--2.5% NTL Cable Plc (d):
4,700,000 7.66% due 10/15/2012 (a) 4,846,875
750,000 8.75% due 4/15/2014 853,125
-----------
18,752,500
==========================================================================================================================
Cable--U.S.--17.4% 7,500,000 Adelphia Communications Corp., 6% due 2/15/2006 (i)(k) 581,250
2,000,000 Atlantic Broadband Finance LLC, 9.375% due 1/15/2014 (d) 1,960,000
3,450,000 CSC Holdings, Inc., 7.25% due 7/15/2008 3,678,562
Century Cable Holdings LLC*:
7,000,000 Discretionary Term Loan, due 12/31/2009 6,973,750
10,000,000 Term Loan, due 6/30/2009 9,966,960
Charter Communications Holdings LLC:
3,750,000 10% due 4/01/2009 3,178,125
2,000,000 11.75% due 1/15/2010 1,805,000
2,000,000 11.125% due 1/15/2011 1,710,000
2,700,000 9.92% due 4/01/2011 2,200,500
3,000,000 10% due 5/15/2011 2,452,500
14,925,000 Charter Communications Operating LLC Tranche B Term Loan, due 4/07/2011* 14,994,655
Inmarsat Facility*:
4,584,272 Term Loan B, due 1/08/2011 4,608,830
4,595,046 Term Loan C, due 1/08/2012 4,635,910
7,920,000 Insight Midwest Holdings, LLC Term Loan B, due 12/31/2009* 8,068,500
2,500,000 Insight Midwest, LP, 9.75% due 10/01/2009 2,621,875
6 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Schedule of Investments (continued) (in U.S. dollars)
Face
Industry+ Amount Corporate Debt Obligations Value
==========================================================================================================================
Cable--U.S. Intelsat Bermuda Ltd. (d):
(concluded) $ 3,825,000 7.794% due 1/15/2012 (a) $ 3,930,187
3,375,000 8.25% due 1/15/2013 3,535,312
4,800,000 8.625% due 1/15/2015 5,124,000
2,500,000 Loral Cyberstar, Inc., 10% due 7/15/2006 (i) 1,859,375
5,432,561 Mallard Cablevision LLC & Sun Tel Communications Term Loan B, due 9/30/2008 (i)*10,865
2,350,000 Mediacom Broadband LLC, 11% due 7/15/2013 2,599,687
3,400,000 Mediacom LLC, 9.50% due 1/15/2013 3,544,500
New Skies Satellites:
1,613,739 BV Term Loan, due 5/04/2011* 1,630,549
3,500,000 NV, 7.438% due 11/01/2011 (a)(d) 3,670,625
3,700,000 NV, 9.125% due 11/01/2012 (d) 3,848,000
6,000,000 Olympus Cable Holdings, LLC Term Loan B, due 9/30/2010* 5,975,628
9,500,000 Pegasus Satellite Communications, Inc., 11.25% due 1/15/2010 (i) 5,700,000
10,000,000 Rainbow National Services LLC, 10.375% due 9/01/2014 (d) 11,900,000
10,350,000 Zeus Special Subsidiary Ltd., 9.25% due 2/01/2015 (c)(d) 6,908,625
-----------
129,673,770
==========================================================================================================================
Chemicals--14.8% 3,550,000 ArCo Chemical Co., 9.80% due 2/01/2020 4,118,000
2,320,000 BCP Caylux Holdings Luxembourg SCA, 9.625% due 6/15/2014 (d) 2,679,600
4,000,000 Compass Minerals International, Inc. Series B, 12% due 6/01/2013 (c) 3,360,000
Crompton Corp.:
8,800,000 8.71% due 8/01/2010 (a) 9,548,000
4,675,000 9.875% due 8/01/2012 5,282,750
10,640,000 GEO Speciality Chemicals, Inc., 11.064% due 12/31/2009 (k) 11,358,200
Huntsman International LLC:
1,900,000 9.875% due 3/01/2009 2,094,750
1,199,000 10.125% due 7/01/2009 1,260,449
3,588,678 Term Loan B, due 12/31/2010* 3,657,760
6,000,000 INVISTA, 9.25% due 5/01/2012 (d) 6,735,000
3,150,000 ISP Holdings, Inc. Series B, 10.625% due 12/15/2009 3,433,500
500,000 Innophos, Inc., 8.875% due 8/15/2014 (d) 537,500
Invista B.V. New Tranche*:
3,532,632 B-1 Term Loan, due 4/29/2011 3,592,246
1,593,838 B-2 Term Loan, due 4/29/2011 1,620,734
2,400,000 Millennium America, Inc., 7.625% due 11/15/2026 2,424,000
7,000,000 Omnova Solutions, Inc., 11.25% due 6/01/2010 7,490,000
7,575,917 PCI Chemicals Canada, Inc., 10% due 12/31/2008 8,106,231
2,668,253 Pinnacle Polymers (Epsilon Products) Term Loan, due 12/15/2006* 2,708,010
2,156,994 Pioneer Cos., Inc., 6.05% due 12/31/2006 (a) 2,275,629
9,500,000 PolyOne Corp., 10.625% due 5/15/2010 10,830,000
Rockwood Specialties Group, Inc.:
3,700,000 10.625% due 5/15/2011 4,199,500
450,000 7.50% due 11/15/2014 (d) 474,750
3,200,000 Tranche D Term Loan, due 12/10/2012* 3,254,858
1,656,000 Terra Capital, Inc., 11.50% due 6/01/2010 1,929,240
691,000 United Agri Products, 8.25% due 12/15/2011 (d) 746,280
6,500,000 Wellman, Inc. Second Lien Term Loan, due 2/10/2010* 6,849,375
-----------
110,566,362
==========================================================================================================================
Consumer-- 5,750,000 Sealy Mattress Co., 8.25% due 6/15/2014 6,023,125
Durables--2.4% 10,000,000 Simmons Bedding Co., 10% due 12/15/2014 (c)(d) 6,500,000
5,000,000 Simmons Co. Term Loan, due 6/19/2012* 5,093,750
-----------
17,616,875
==========================================================================================================================
Consumer-- 3,400,000 Chattem, Inc., 5.91% due 3/01/2010 (a) 3,468,000
Non-Durables--3.9% 2,000,000 General Binding Corp., 9.375% due 6/01/2008 1,980,000
9,875,000 Levi Strauss & Co. Tranche A Term Loan, due 9/29/2009* 10,637,844
4,000,000 North Atlantic Holding Co., Inc., 12.25% due 3/01/2014 (c) 880,000
10,500,000 Playtex Products, Inc., 9.375% due 6/01/2011 11,300,625
400,000 Riddell Bell Holdings, Inc., 8.375% due 10/01/2012 (d) 414,000
-----------
28,680,469
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 7
Schedule of Investments (continued) (in U.S. dollars)
Face
Industry+ Amount Corporate Debt Obligations Value
==========================================================================================================================
Diversified $ 2,000,000 Cadmus Communications Corp., 8.375% due 6/15/2014 $ 2,130,000
Media--2.8% Houghton Mifflin Co.:
775,000 9.875% due 2/01/2013 819,562
3,000,000 11.415% due 10/15/2013 (c)(d) 2,115,000
7,500,000 Liberty Media Corp., 0.75% due 3/30/2023 (k) 8,146,875
1,800,000 Loews Cineplex Entertainment Corp., 8.875% due 8/01/2008 (i) 0
2,675,000 Muzak Holdings, LLC, 13% due 3/15/2010 1,123,500
3,875,000 NBC Acquisition Corp., 11% due 3/15/2013 (c) 2,770,625
1,700,000 Nebraska Book Co., Inc., 8.625% due 3/15/2012 1,708,500
Universal City Florida Holding Co. I/II (d):
1,450,000 7.493% due 5/01/2010 (a) 1,518,875
375,000 8.375% due 5/01/2010 394,688
-----------
20,727,625
==========================================================================================================================
Energy--Exploration & Quest Cherokee, LLC*:
Production--0.5% 222,222 LC Facility, due 12/31/2008 222,778
1,500,000 Revolving Credit, due 7/22/2009 1,447,500
1,773,333 Term Loan B, due 7/22/2010 1,777,767
-----------
3,448,045
==========================================================================================================================
Energy--Other--5.6% 4,875,000 Aventine Renewable Energy Holdings, Inc., 9.01% due 12/15/2011 (a)(d) 5,021,250
Dresser, Inc.:
1,000,000 9.375% due 4/15/2011 1,080,000
1,148,861 Term Loan C, due 4/10/2009* 1,163,940
2,500,000 Term Loan Unsecured, due 2/25/2010* 2,543,750
2,325,000 Dresser-Rand Group, Inc., 7.375% due 11/01/2014 (d) 2,429,625
2,244,000 Energy Corp. of America Series A, 9.50% due 5/15/2007 2,241,195
Giant Industries, Inc.:
9,020,000 11% due 5/15/2012 10,463,200
3,525,000 8% due 5/15/2014 3,692,437
Star Gas Partners LP:
5,500,000 10.25% due 2/15/2013 5,018,750
3,000,000 10.25% due 2/15/2013 (d) 2,737,500
6,000,000 Trico Marine Services, Inc., 8.875% due 5/15/2012 (i) 5,400,000
-----------
41,791,647
==========================================================================================================================
Financial--2.4% 5,300,000 Fairfax Financial Holdings Ltd., 7.75% due 4/26/2012 5,538,500
1,500,000 Investcorp SA, 7.54%, due 10/21/2008 1,521,466
2,000,000 Pennant CBO Ltd., 13.43% due 3/14/2011 (d) 1,350,000
7,625,000 Refco Finance Holdings LLC, 9% due 8/01/2012 (d) 8,311,250
SKM-Libertyview CBO Ltd. Series 1A (d)(f)(i):
1,500,000 Class C1, 8.71% due 4/10/2011 900,000
1,000,000 Class D, 11.91% due 4/10/2011 80,000
-----------
17,701,216
==========================================================================================================================
Food & Drug--0.5% 4,500,000 Duane Reade Inc., 9.75% due 8/01/2011 4,005,000
==========================================================================================================================
Food/Tobacco--4.0% 1,119,217 Archibald Candy Corp., 10% due 11/01/2007 (i) 30,953
Commonwealth Brands, Inc. (d):
4,550,000 9.75% due 4/15/2008 4,868,500
8,000,000 10.625% due 9/01/2008 8,520,000
1,175,000 Doane Pet Care Co., 10.75% due 3/01/2010 1,248,437
3,825,000 Dole Food Co., Inc., 8.875% due 3/15/2011 4,140,562
3,855,421 Dr. Pepper Tranche B Term Loan, due 12/19/2010* 3,928,674
2,875,000 Gold Kist Inc., 10.25% due 3/15/2014 3,349,375
28,918,000 New World Pasta Co., 9.25% due 2/15/2009 (i) 2,024,260
4,800,000 Tabletop Holdings Inc., 12.25% due 5/15/2014 (c)(d) 1,920,000
-----------
30,030,761
==========================================================================================================================
8 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Schedule of Investments (continued) (in U.S. dollars)
Face
Industry+ Amount Corporate Debt Obligations Value
==========================================================================================================================
Gaming--2.0% $ 4,475,580 Buffington Harbor Parking Associates, LLC Term Loan B, due 7/01/2011* $ 4,475,580
4,000,000 Inn of the Mountain Gods Resort & Casino, 12% due 11/15/2010 4,740,000
2,000,000 Jacobs Entertainment, Inc., 11.875% due 2/01/2009 2,240,000
1,825,000 Majestic Star Casino LLC, 9.50% due 10/15/2010 1,932,219
1,725,000 Penn National Gaming, Inc., 6.75% due 3/01/2015 (d) 1,759,500
-----------
15,147,299
==========================================================================================================================
Health Care--6.9% 6,000,000 CDRV Investors, Inc., 9.75% due 1/01/2015 (c)(d) 3,720,000
5,000,000 Cinacalcet Royalty Corp., 8% due 3/30/2017 (d) 5,000,000
Elan Finance Plc (d):
4,825,000 6.49% due 11/15/2011 (a) 4,197,750
3,525,000 7.75% due 11/15/2011 3,137,250
Healthsouth Corp.:
2,500,000 8.50% due 2/01/2008 2,600,000
2,500,000 10.75% due 10/01/2008 2,631,250
5,000,000 7.625% due 6/01/2012 5,062,500
4,500,000 Term Loan A, due 1/16/2011* 5,023,125
3,416,811 Medpointe Capital Partners, LLC Tranche B Term Loan, due 9/30/2008* 3,433,895
5,000,000 Risperdal Consta Pharma, 7% due 1/01/2018 4,425,000
6,000,000 Tenet Healthcare Corp., 7.375% due 2/01/2013 5,685,000
1,400,000 VWR International, Inc., 8% due 4/15/2014 1,456,000
4,100,000 Vanguard Health Holding Co. I, LLC, 11.25% due 10/01/2015 (c) 2,982,750
2,325,000 Vanguard Health Holding Co. II, LLC, 9% due 10/01/2014 2,557,500
-----------
51,912,020
==========================================================================================================================
Housing--3.3% 421,312 Formica Holdings Corp., 7.87% due 6/10/2011 400,246
4,650,000 General Growth Properties, Inc. Tranche B Term Loan, due 11/12/2008* 4,727,939
Goodman Global Holding Co., Inc. (d):
1,025,000 5.76% due 6/15/2012 (a) 1,050,625
3,850,000 7.875% due 12/15/2012 3,763,375
6,637,500 Headwaters, Inc. Term Loan B, due 4/30/2011* 6,734,295
3,000,000 LNR Property Corp. Tranche B Term Loan, due 2/03/2008* 3,047,499
4,000,000 Lone Star Industries, 8.85% due 6/15/2005 (d) 4,032,252
1,000,000 U.S. Concrete, Inc., 8.375% due 4/01/2014 1,050,000
-----------
24,806,231
==========================================================================================================================
Information Amkor Technology, Inc.:
Technology--3.2% 3,650,000 9.25% due 2/15/2008 3,577,000
1,000,000 10.50% due 5/01/2009 942,500
5,000,000 Cypress Semiconductor Corp., 1.25% due 6/15/2008 (k) 5,675,000
4,725,000 Freescale Semiconductor, Inc., 5.41% due 7/15/2009 (a) 4,931,719
MagnaChip SemiConductor SA (d):
1,375,000 6.26% due 12/15/2011 (a) 1,416,250
1,050,000 8% due 12/15/2014 1,105,125
1,000,000 TTI Holding Corp., 8.875% due 3/01/2013 (d) 1,032,500
5,075,000 Viasystems, Inc., 10.50% due 1/15/2011 4,998,875
-----------
23,678,969
==========================================================================================================================
Leisure--2.3% 12,000,000 Felcor Lodging LP, 6.874% due 6/01/2011 (a) 12,735,000
2,000,000 True Temper Sports, Inc., 8.375% due 9/15/2011 1,925,000
Wyndham International, Inc.*:
1,481,382 Term Loan I, due 6/30/2006 1,489,869
1,014,098 Term Loan II, due 4/01/2006 1,018,535
-----------
17,168,404
==========================================================================================================================
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 9
Schedule of Investments (continued) (in U.S. dollars)
Face
Industry+ Amount Corporate Debt Obligations Value
==========================================================================================================================
Manufacturing-- $ 575,000 Aearo Co., 8.25% due 4/15/2012 $ 603,750
4.3% 2,500,000 CPI Holdco, Inc., 8.83% due 2/01/2015 (a)(d) 2,512,500
4,525,000 EaglePicher Industries, Inc., 9.75% due 9/01/2013 3,710,500
8,350,000 International Utility Structures, Inc., 10.75% due 2/01/2008 (i) 501,000
5,000,000 Invensys International Holdings Ltd. Second Lien Term Loan, due 12/04/2009* 5,146,875
5,875,000 Invensys Plc, 9.875% due 3/15/2011 (d) 6,345,000
3,300,000 Mueller Group, Inc., 10% due 5/01/2012 3,630,000
600,000 NMHG Holding Co., 10% due 5/15/2009 663,000
350,000 NSP Holdings LLC, 11.75% due 1/01/2012 (b)(d) 364,000
4,000,000 Propex Fabrics, Inc., 10% due 12/01/2012 (d) 4,040,000
3,000,000 Tyco International Group SA, 2.75% due 1/15/2018 (k) 4,443,750
-----------
31,960,375
==========================================================================================================================
Metal--Other--1.3% 1,100,000 IMCO Recycling Escrow, Inc., 9% due 11/15/2014 (d) 1,155,000
8,300,000 Massey Energy Co., 6.95% due 3/01/2007 8,673,500
-----------
9,828,500
==========================================================================================================================
Packaging--6.0% 9,625,000 Anchor Glass Container Corp., 11% due 2/15/2013 9,937,812
3,800,000 Consolidated Container Co. LLC, 10.75% due 6/15/2009 (c) 3,325,000
4,400,000 Crown European Holdings SA, 10.875% due 3/01/2013 5,225,000
1,100,000 Graham Packaging Co., Inc., 9.875% due 10/15/2014 (d) 1,185,250
6,959,471 Owens-Illinois Group Inc. French Tranche C-1 Term Loan, due 4/01/2008* 7,089,962
12,300,000 Pliant Corp, 13% due 6/01/2010 12,023,250
Tekni-Plex, Inc.:
2,000,000 12.75% due 6/15/2010 1,780,000
1,250,000 8.75% due 11/15/2013 (d) 1,225,000
2,575,000 Wise Metals Group LLC, 10.25% due 5/15/2012 2,626,500
-----------
44,417,774
==========================================================================================================================
Paper--7.0% 6,500,000 Abitibi-Consolidated, Inc., 5.99% due 6/15/2011 (a) 6,695,000
6,025,000 Ainsworth Lumber Co. Ltd., 6.30% due 10/01/2010 (a)(d) 6,205,750
1,437,182 Boise Cascade Holdings, LLC Tranche B Term Loan, due 10/28/2011* 1,465,297
Boise Cascade LLC (d):
500,000 5.535% due 10/15/2012 (a) 516,250
900,000 7.125% due 10/15/2014 951,750
7,600,000 Bowater, Inc., 5.49% due 3/15/2010 (a) 7,847,000
4,250,000 Georgia-Pacific Corp., 9.375% due 2/01/2013 4,914,062
2,000,000 Graphic Packaging International Corp., 9.50% due 8/15/2013 2,265,000
6,125,000 JSG Funding Plc, 7.75% due 4/01/2015 (d) 6,125,000
SP Newsprint Co.Tranche B*:
1,611,111 L/C, due 1/09/2010 1,631,250
863,889 Term Loan, due 1/09/2010 882,246
1,600,000 Smurfit-Stone Container Enterprises, Inc., 8.375% due 7/01/2012 1,732,000
3,000,000 Tembec Industries, Inc., 8.625% due 6/30/2009 3,007,500
7,281,000 Western Forest Products, Inc., 15% due 7/28/2009 (b) 7,937,296
-----------
52,175,401
==========================================================================================================================
Services--4.6% Allied Waste North America:
1,440,000 7.875% due 4/15/2013 1,504,800
6,250,000 Series B, 7.375% due 4/15/2014 6,000,000
2,000,000 Buhrmann US, Inc., 7.875% due 3/01/2015 (d) 2,015,000
3,200,000 Corrections Corp. of America, 9.875% due 5/01/2009 3,524,000
350,000 Great Lakes Dredge & Dock Corp., 7.75% due 12/15/2013 315,000
2,000,000 HydroChem Industrial Services, Inc., 9.25% due 2/15/2013 (d) 2,032,500
4,064,544 Outsourcing Solutions Inc. New Term Loan, due 12/03/2008* 4,079,786
10,825,000 United Rentals North America, Inc., 7.75% due 11/15/2013 (d) 10,852,063
3,970,000 Waste Services, Inc. Tranche B Term Loan, due 3/31/2011* 4,007,219
-----------
34,330,368
==========================================================================================================================
Steel--0.0% 7,711,830 Acme Metals, Inc. Term Loan, due 12/01/2005 (i)* 1
==========================================================================================================================
10 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Schedule of Investments (continued) (in U.S. dollars)
Face
Industry+ Amount Corporate Debt Obligations Value
==========================================================================================================================
Telecommuni- $ 5,000,000 ADC Telecommunications, Inc., 3.065% due 6/15/2013 (a)(k) $ 4,812,500
cations--9.7% 3,265,000 Alaska Communications Systems Holdings, Inc., 9.875% due 8/15/2011 3,534,362
7,500,000 Cincinnati Bell, Inc., 8.375% due 1/15/2014 7,753,125
1,986,667 Consolidated Communications, Inc. Term Loan C, due 10/14/2011* 2,006,533
6,000,000 LCI International, Inc., 7.25% due 6/15/2007 5,850,000
Qwest Capital Funding, Inc. (k):
2,000,000 6.375% due 7/15/2008 1,940,000
8,200,000 6.875% due 7/15/2028 6,990,500
7,900,000 Qwest Communications International, 6.294% due 2/15/2009 (a)(d) 8,058,000
Terremark Worldwide Inc (k):
4,475,000 9% due 6/15/2009 4,150,563
6,000,000 9% due 6/15/2009 (d) 5,565,000
Time Warner Telecom Holdings, Inc.:
7,000,000 6.794% due 2/15/2011 (a) 7,262,500
6,000,000 9.25% due 2/15/2014 (d) 6,180,000
8,000,000 Time Warner Telecom, Inc., 9.75% due 7/15/2008 8,180,000
-----------
72,283,083
==========================================================================================================================
Transportation--0.5% 2,950,000 Laidlaw International, Inc., 10.75% due 6/15/2011 3,381,437
==========================================================================================================================
Utilities--4.7% 789,000 The AES Corp., 8.50% due 11/01/2007 800,835
500,000 Calpine Canada Energy Finance Ulc, 8.50% due 5/01/2008 375,000
Calpine Corp.:
2,700,000 8.50% due 2/15/2011 1,917,000
7,880,000 Second Lien Term Loan, due 7/15/2007* 7,050,961
7,000,000 Centerpoint Energy, Inc., 3.75% due 5/15/2023 (k) 7,980,000
El Paso Corp.*:
1,500,000 Deposit Account, due 11/23/2009 1,525,899
2,490,000 Term Loan, due 11/23/2009 2,536,687
Sierra Pacific Resources:
3,200,000 8.75% due 5/15/2005 3,231,472
6,000,000 8.625% due 3/15/2014 6,630,000
1,576,000 TNP Enterprises, Inc. Term Loan, due 12/31/2006* 1,597,670
1,425,000 Williams Cos., Inc., 8.625% due 6/01/2010 1,556,813
-----------
35,202,337
==========================================================================================================================
Wireless 5,500,000 Alamosa Delaware, Inc., 8.50% due 1/31/2012 5,967,500
Communications-- 547,000 American Tower Corp., 9.375% due 2/01/2009 574,350
8.7% 5,940,000 Centennial Cellular Operating Co. Term Loan, due 2/09/2011* 6,043,950
Crown Castle International Corp.:
3,500,000 9.375% due 8/01/2011 3,885,000
13,000,000 7.50% due 12/01/2013 14,105,000
Dobson Cellular Systems, Inc. (d):
4,675,000 7.493% due 11/01/2011 (a) 4,932,125
1,750,000 8.375% due 11/01/2011 1,863,750
950,000 Horizon PCS, Inc., 11.375% due 7/15/2012 (d) 1,087,750
2,500,000 iPCS Escrow Co., 11.50% due 5/01/2012 2,900,000
3,775,000 MobiFon Holdings BV, 12.50% due 7/31/2010 4,501,688
1,600,000 Rural Cellular Corp., 7.51% due 3/15/2010 (a) 1,680,000
2,175,000 SBA Communications Corp., 8.50% due 12/01/2012 (d) 2,349,000
7,400,000 Spectrasite, Inc., 8.25% due 5/15/2010 7,955,000
6,600,000 US Unwired, Inc., 7.26% due 6/15/2010 (a) 6,897,000
-----------
64,742,113
- --------------------------------------------------------------------------------------------------------------------------
Total Investments in Corporate Debt Obligations
(Cost--$972,846,217)--131.8% 982,241,311
==========================================================================================================================
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 11
Schedule of Investments (continued) (in U.S. dollars)
Shares
Industry+ Held Common Stocks Value
==========================================================================================================================
Cable-- 245,382 Telewest Global, Inc. (j) $ 4,095,426
International--0.6%
==========================================================================================================================
Chemicals--1.0% 339,340 GEO Specialty Chemicals, Inc. (j) 5,090,100
93,826 Pioneer Cos., Inc. (j) 2,497,648
-----------
7,587,748
==========================================================================================================================
Financial--0.4% 35,000 Preferred Term Securities VI (d)(j) 2,765,000
==========================================================================================================================
Food/Tobacco--0.6% 1,428,423 Viskase Cos., Inc. (j) 4,285,269
==========================================================================================================================
Leisure--0.0% 27,787 Lodgian, Inc. (j) 333,444
==========================================================================================================================
Manufacturing--0.3% 724,291 ACP Holding Co. (d)(j) 1,376,153
509,720 High Voltage Engineering Corp. (j) 764,580
21,203 Thermadyne Holdings Corp. (j) 303,203
-----------
2,443,936
==========================================================================================================================
Paper--0.2% 211,149 Western Forest Products, Inc. (j) 1,357,043
==========================================================================================================================
Services--0.5% 89,976 Outsourcing Solutions Inc. (j) 4,048,920
==========================================================================================================================
Steel--0.0% 41,149 Acme Package Corp. Senior Holdings (j) 113,160
==========================================================================================================================
Telecommunications-- 59,534 IDT Corp. Class B (j) 912,061
0.1%
- --------------------------------------------------------------------------------------------------------------------------
Total Investments in Common Stocks (Cost--$29,130,048)--3.7% 27,942,007
==========================================================================================================================
Preferred Stocks
==========================================================================================================================
Automotive--0.7% 200,000 General Motors Corp. Series C (k) 4,896,000
==========================================================================================================================
Broadcasting--0.0% 40 Paxson Communications Corp. (b)(d)(k) 216,311
==========================================================================================================================
Cable--U.S.--0.0% 5,000 Adelphia Communications Corp. Series B 15,000
3,500 Pegasus Satellite Communications, Inc. Series B (i) 0
-----------
15,000
- --------------------------------------------------------------------------------------------------------------------------
Total Investments in Preferred Stocks (Cost--$7,984,374)--0.7% 5,127,311
==========================================================================================================================
Warrants (g)
==========================================================================================================================
Broadcasting--0.0% 15,000 Sirius Satellite Radio, Inc. (expires 5/15/2009) 7,500
==========================================================================================================================
Health Care--0.1% 126,761 HealthSouth Corp. (expires 1/23/2014) 316,903
==========================================================================================================================
Manufacturing--0.2% 652,739 ACP Holding Co. (expires 9/30/2013) 1,240,204
==========================================================================================================================
Paper--0.0% 18 Cellu Tissue Holdings, Inc. Series A (expires 9/28/2011) 0
7,000 MDP Acquisitions Plc (expires 10/01/2013) 70,000
-----------
70,000
==========================================================================================================================
Wireless 1,325 American Tower Corp. (expires 8/01/2008) 310,050
Communications--0.0%
- --------------------------------------------------------------------------------------------------------------------------
Total Investments in Warrants (Cost--$870,754)--0.3% 1,944,657
==========================================================================================================================
12 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Schedule of Investments (concluded) (in U.S. dollars)
Beneficial Interest/
Industry+ Shares Held Other Interests (e) Value
============================================================================================================================
Airlines--0.1% $ 2,641,443 US Airways Group, Inc. (Certificate of Beneficial Interest) $ 739,604
- ----------------------------------------------------------------------------------------------------------------------------
Automotive 3,614,601 Cambridge Industries, Inc. (Litigation Trust Certificates) (j) 36,146
Equipment--0.0%
- ----------------------------------------------------------------------------------------------------------------------------
Gaming--0.0% 15,140 Peninsula Gaming LLC (Convertible Membership Interest) (j) 90,842
- ----------------------------------------------------------------------------------------------------------------------------
Telecommunications-- 5,500,000 WilTel Communications Group, Inc. (Litigation Trust Certificates) (j) 55
0.0%
- ----------------------------------------------------------------------------------------------------------------------------
Total Investments in Other Interests (Cost--$804,491)--0.1% 866,647
============================================================================================================================
Beneficial
Interest Short-Term Securities
============================================================================================================================
$ 203,682 Merrill Lynch Liquidity Series, LLC Cash Sweep Series I (h) 203,682
- ----------------------------------------------------------------------------------------------------------------------------
Total Investments in Short-Term Securities (Cost--$203,682)--0.0% 203,682
============================================================================================================================
Total Investments (Cost--$1,011,839,566**)--136.6% 1,018,325,615
Liabilities in Excess of Other Assets--(36.6%) (273,069,534)
--------------
Net Assets--100.0% $ 745,256,081
==============
* 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. The base lending rates are generally (i)
the lending rate offered by one or more European banks, such as LIBOR
(London InterBank Offered Rate), (ii) the prime rate offered by one or
more U.S. banks or (iii) the certificate of deposit rate. Floating rate
corporate debt represents 26.5% of the Fund's net assets.
** The cost and unrealized appreciation (depreciation) of investments as of
February 28, 2005, as computed for federal income tax purposes, were as
follows:
Aggregate cost ...................................... $ 1,011,599,737
===============
Gross unrealized appreciation ....................... $ 72,613,793
Gross unrealized depreciation ....................... (65,887,915)
---------------
Net unrealized appreciation ......................... $ 6,725,878
===============
+ 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. These
industry classifications are unaudited.
(a) Floating rate note.
(b) Represents a pay-in-kind security which may pay interest/dividends in
additional face/shares.
(c) Represents a step bond; the interest rate shown reflects the effective
yield at the time of purchase.
(d) The security may be offered and sold to "qualified institutional buyers"
under Rule 144A of the Securities Act of 1933.
(e) Other interests represent beneficial interest in liquidation trusts and
other reorganization entities.
(f) 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.
(g) 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.
(h) 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) were as follows:
--------------------------------------------------------------------------
Net Interest
Affiliate Activity Income
--------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I $(735,749) $ 54,390
--------------------------------------------------------------------------
(i) Non-income producing security; issuer filed for bankruptcy or is in
default of interest/dividend payments.
(j) Non-income producing security.
(k) Convertible security.
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 13
Statement of Assets, Liabilities and Capital
As of February 28, 2005
==================================================================================================================================
Assets
- ----------------------------------------------------------------------------------------------------------------------------------
Investments in unaffiliated securities, at value (identified
cost--$1,011,635,884) ............................................. $ 1,018,121,933
Investments in affiliated securities, at value (identified
cost--$203,682) ................................................... 203,682
Cash ............................................................... 4,295,933
Receivables:
Interest (including $14 from affiliates) ........................ $ 14,977,926
Securities sold ................................................. 11,464,273
Commitment fees ................................................. 10,652 26,452,851
---------------
Prepaid expenses and other assets .................................. 225,154
---------------
Total assets ....................................................... 1,049,299,553
---------------
==================================================================================================================================
Liabilities
- ----------------------------------------------------------------------------------------------------------------------------------
Loans .............................................................. 298,400,000
Unfunded loan commitment ........................................... 33,692
Payables:
Securities purchased ............................................ 4,708,020
Investment adviser .............................................. 377,462
Dividends to shareholders ....................................... 343,266
Interest on loans ............................................... 92,122
Other affiliates ................................................ 44,462
Commitment fees ................................................. 5,785 5,571,117
---------------
Accrued expenses ................................................... 38,663
---------------
Total liabilities .................................................. 304,043,472
---------------
==================================================================================================================================
Net Assets
- ----------------------------------------------------------------------------------------------------------------------------------
Net Assets ......................................................... $ 745,256,081
===============
==================================================================================================================================
Capital
- ----------------------------------------------------------------------------------------------------------------------------------
Common Stock, $.10 par value, 200,000,000 shares authorized ........ $ 10,557,036
Paid-in capital in excess of par ................................... 1,063,890,539
Undistributed investment income--net ............................... $ 5,053,712
Accumulated realized capital losses--net ........................... (340,708,623)
Unrealized appreciation--net ....................................... 6,463,417
---------------
Total accumulated losses--net ...................................... (329,191,494)
---------------
Total capital--Equivalent to $7.06 per share based on 105,570,363
shares of Capital Stock outstanding (market price--$6.71) ......... $ 745,256,081
===============
See Notes to Financial Statements.
14 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Statement of Operations
For the Year Ended February 28, 2005
==================================================================================================================================
Investment Income
- ----------------------------------------------------------------------------------------------------------------------------------
Interest (including $54,390 from affiliates) ....................... $ 80,830,056
Dividends .......................................................... 1,704,602
Facility and other fees ............................................ 1,002,739
---------------
Total income ....................................................... 83,537,397
---------------
==================================================================================================================================
Expenses
- ----------------------------------------------------------------------------------------------------------------------------------
Investment advisory fees ........................................... $ 6,123,497
Loan interest expense .............................................. 5,812,935
Borrowing costs .................................................... 373,415
Accounting services ................................................ 236,271
Professional fees .................................................. 128,922
Transfer agent fees ................................................ 120,538
Listing fees ....................................................... 85,292
Printing and shareholder reports ................................... 62,546
Custodian fees ..................................................... 60,363
Directors' fees and expenses ....................................... 45,853
Pricing services ................................................... 24,673
Other .............................................................. 33,490
---------------
Total expenses ..................................................... 13,107,795
---------------
Investment income--net ............................................. 70,429,602
---------------
==================================================================================================================================
Realized & Unrealized Gain (Loss)--Net
- ----------------------------------------------------------------------------------------------------------------------------------
Realized loss on:
Investments--net ................................................ (431,257)
Foreign currency transactions--net .............................. (121,931) (553,188)
---------------
Changes in unrealized appreciation (depreciation) on:
Investments--net ................................................ 35,924,826
Unfunded corporate loans--net ................................... (15,512)
Foreign currency transactions--net .............................. 251 35,909,565
-----------------------------------
Total realized and unrealized gain--net ............................ 35,356,377
---------------
Net Increase in Net Assets Resulting from Operations ............... $ 105,785,979
===============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 15
Statements of Changes in Net Assets
For the For the
Year Ended Year Ended
February 28, February 29,
Increase (Decrease) in Net Assets: 2005 2004
==================================================================================================================================
Operations
- ----------------------------------------------------------------------------------------------------------------------------------
Investment income--net ............................................. $ 70,429,602 $ 78,995,576
Realized loss--net ................................................. (553,188) (35,622,531)
Change in unrealized appreciation (depreciation)--net .............. 35,909,565 181,822,398
-----------------------------------
Net increase in net assets resulting from operations ............... 105,785,979 225,195,443
-----------------------------------
==================================================================================================================================
Dividends to Shareholders
- ----------------------------------------------------------------------------------------------------------------------------------
Dividends to shareholders from investment income--net .............. (69,339,355) (82,761,761)
-----------------------------------
==================================================================================================================================
Capital Share Transactions
- ----------------------------------------------------------------------------------------------------------------------------------
Value of shares issued in reinvestment of dividends ................ 2,548,243 6,747,816
Recovery of previously expensed Common Stock offering costs ........ -- 11,432
-----------------------------------
Net increase in net assets resulting from capital share transactions 2,548,243 6,759,248
-----------------------------------
==================================================================================================================================
Net Assets
- ----------------------------------------------------------------------------------------------------------------------------------
Total increase in net assets ....................................... 38,994,867 149,192,930
Beginning of year .................................................. 706,261,214 557,068,284
-----------------------------------
End of year* ....................................................... $ 745,256,081 $ 706,261,214
===================================
* Undistributed investment income--net .......................... $ 5,053,712 $ 2,758,783
===================================
See Notes to Financial Statements.
16 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Statement of Cash Flows
For the Year Ended February 28, 2005
=====================================================================================================================
Cash Provided by Operating Activities
- ---------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations ........................ $ 105,785,979
Adjustments to reconcile net increase in net assets resulting from operations
to net cash provided by operating activities:
Increase in receivables .................................................. (171,239)
Increase in other assets ................................................. (69,695)
Increase in liabilities .................................................. 24,762
Realized and unrealized gain--net ........................................ (35,356,377)
Realized loss on foreign currency transactions--net ...................... (121,931)
Amortization of premium and discount ..................................... (8,628,458)
Proceeds from sales and paydowns of long-term securities .................... 596,258,036
Proceeds on other investment related transactions ........................... 3,195,052
Purchases of long-term securities ........................................... (620,263,193)
Purchases of short-term investments--net .................................... 735,749
-------------
Net cash provided by operating activities ................................... 41,388,685
-------------
=====================================================================================================================
Cash Used for Financing Activities
- ---------------------------------------------------------------------------------------------------------------------
Cash receipts from borrowings ............................................... 361,100,000
Cash payments on borrowings ................................................. (331,775,000)
Dividends paid to shareholders .............................................. (66,447,846)
-------------
Net cash used for financing activities ...................................... (37,122,846)
-------------
=====================================================================================================================
Cash
- ---------------------------------------------------------------------------------------------------------------------
Net increase in cash ........................................................ 4,265,839
Cash at beginning of year ................................................... 30,094
-------------
Cash at end of year ......................................................... $ 4,295,933
=============
=====================================================================================================================
Cash Flow Information
- ---------------------------------------------------------------------------------------------------------------------
Cash paid for interest ...................................................... $ 5,769,238
=============
=====================================================================================================================
Non-Cash Financing Activities
- ---------------------------------------------------------------------------------------------------------------------
Capital shares issued in reinvestment of dividends paid to shareholders ..... $ 2,548,243
=============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 17
Financial Highlights
For the For the For the Year Ended
Year Ended Year Ended February 28,
The following per share data and ratios have been derived February 28, February 29, ------------------------------------
from information provided in the financial statements. 2005 2004 2003 2002 2001
===================================================================================================================================
Per Share Operating Performance
- -----------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year ....... $ 6.71 $ 5.35 $ 6.03 $ 7.53 $ 8.60
----------------------------------------------------------------
Investment income--net** ................. .67 .75 .79 .92 .96
Realized and unrealized gain (loss)--net . .34 1.40 (.68) (1.49) (1.07)
----------------------------------------------------------------
Total from investment operations ......... 1.01 2.15 .11 (.57) (.11)
----------------------------------------------------------------
Less dividends from investment income--net (.66) (.79) (.79) (.93) (.96)
----------------------------------------------------------------
Recovery of previously expensed offering
costs (capital write-off) resulting from
the issuance of Common Stock ............ -- --+ -- --+ --
----------------------------------------------------------------
Net asset value, end of year ............. $ 7.06 $ 6.71 $ 5.35 $ 6.03 $ 7.53
================================================================
Market price per share, end of year ...... $ 6.71 $ 6.69 $ 5.99 $ 6.57 $ 7.15
================================================================
===================================================================================================================================
Total Investment Return*
- -----------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share ....... 15.95% 41.84% 2.04% (7.89%) .31%
================================================================
Based on market price per share .......... 10.53% 26.31% 4.85% 5.69% 13.97%
================================================================
===================================================================================================================================
Ratio to Average Net Assets
- -----------------------------------------------------------------------------------------------------------------------------------
Expenses, excluding interest expense ..... 1.02% 1.00% 1.07% 1.04% 1.20%
================================================================
Expenses ................................. 1.83% 1.53% 1.91% 2.59% 3.87%
================================================================
Investment income--net ................... 9.84% 12.22% 14.32% 13.69% 12.23%
================================================================
===================================================================================================================================
Leverage
- -----------------------------------------------------------------------------------------------------------------------------------
Amount of borrowings, end of year
(in thousands) .......................... $298,400 $269,075 $245,900 $273,600 $301,000
================================================================
Average amount of borrowings outstanding
during the year (in thousands) .......... $304,549 $239,315 $238,863 $280,460 $228,640
================================================================
Average amount of borrowings outstanding
per share during the year** ............. $ 2.89 $ 2.29 $ 2.31 $ 2.75 $ 3.07
================================================================
===================================================================================================================================
Supplemental Data
- -----------------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in thousands) ... $745,256 $706,261 $557,068 $620,043 $763,834
================================================================
Portfolio turnover ....................... 60.11% 70.43% 64.54% 49.58% 36.86%
================================================================
* Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
charges.
** Based on average shares outstanding.
+ Amount is less than $.01 per share.
See Notes to Financial Statements.
18 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Notes to Financial Statements
1. Significant Accounting Policies:
Debt Strategies Fund, Inc. (the "Fund") is registered under the Investment
Company Act of 1940, as amended, as a diversified, closed-end management
investment company. 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. The Fund determines and makes available for publication the net asset
value of its Common Stock on a daily basis. The Fund's Common Stock is listed on
the New York Stock Exchange ("NYSE") under the symbol DSU.
(a) Corporate debt obligations -- The Fund invests principally in debt
obligations of companies, including Corporate Loans made by banks and other
financial institutions and both privately and publicly offered corporate bonds
and notes. Because agents and intermediaries are primarily commercial banks and
other financial institutions, the Fund's investment in Corporate Loans could be
considered concentrated in financial institutions.
(b) Valuation of investments -- Corporate Loans are valued in accordance with
guidelines established by the Board of Directors. Corporate Loans are valued at
the mean between the last available bid and asked prices from one or more
brokers or dealers as obtained from Loan Pricing Corporation. For the limited
number of Corporate Loans for which no reliable price quotes are available, such
Corporate Loans will be valued by Loan Pricing Corporation through the use of
pricing matrixes to determine valuations. If the pricing service does not
provide a value for a Corporate Loan, the Investment Adviser will value the
Corporate Loan at fair value, which is intended to approximate market value.
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 on which such securities are traded, 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 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 the Fund. Long positions in securities
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 Fund. Short positions in securities traded in the OTC market are valued
at the last available asked 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. When the Fund writes an option, the amount of the
premium received is recorded on the books of the Fund as an asset and an
equivalent liability. The amount of the liability is subsequently valued to
reflect the current market value of the option written, based on 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 by the Fund 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. The value of swaps,
including interest rate swaps, caps and floors, will be determined by obtaining
dealer quotations. Other investments, including futures contracts and related
options, are stated at market value. 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 will
be valued at cost plus accrued interest. The Fund employs certain pricing
services to provide 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 Fund, 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 Board of Directors. Such valuations and procedures
will be reviewed periodically by the Board of Directors.
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 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 faith by the Board of Directors or by the Investment Adviser using a
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 19
Notes to Financial Statements (continued)
pricing service and/or procedures approved by the Board of Directors.
(c) 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.
o 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.
o 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.
o Options -- The Fund may write covered call and put options and purchase
call and put options. When the Fund writes an option, an amount equal to
the premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked-to-market to reflect the current market value of the option
written. When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or deducted
from) the basis of the security acquired or deducted from (or added to)
the proceeds of the security sold. When an option expires (or the Fund
enters into a closing transaction), the Fund realizes a gain or loss on
the option to the extent of the premiums received or paid (or gain or loss
to the extent the cost of the closing transaction exceeds the premium paid
or received).
Written and purchased options are non-income producing investments.
o 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
pre-determined 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. These periodic payments received or made by the Fund are
recorded in the accompanying Statement of Operations as realized gains or
losses, respectively. Gains or losses are also realized upon termination
of the swap agreements. Swaps are marked-to-market daily based on
dealer-supplied valuations and changes in value are recorded as unrealized
appreciation (depreciation). Risks include changes in the returns of the
underlying instruments, failure of the counterparties to perform under the
contracts' terms and the possible lack of liquidity with respect to the
swap agreements.
(d) Foreign currency transactions -- Transactions denominated in foreign
currencies are recorded at the exchange rate prevailing when recognized. Assets
and liabilities denominated in foreign currencies are valued at the exchange
rate at the end of the period. Foreign currency transactions are the result of
settling (realized) or valuing (unrealized) assets or liabilities expressed in
foreign currencies into U.S. dollars. Realized and unrealized gains or losses
from investments include the effects of foreign exchange rates on investments.
(e) Income taxes -- It is the Fund's policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of its taxable income to its shareholders.
Therefore, no federal income tax provision is required. Under the applicable
foreign tax law, a withholding tax may be imposed on interest, dividends and
capital gains at various rates.
(f) Security transactions and investment income -- Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined
on the
20 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Notes to Financial Statements (continued)
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.
(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.
(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.
(i) Reclassifications -- 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, $1,204,682 has been reclassified between accumulated net realized capital
losses and undistributed net investment income, and $263,491 has been
reclassified between paid-in capital in excess of par and accumulated net
realized capital losses as a result of permanent differences attributable to
foreign currency transactions, the reclassification of proceeds on sales of
securities in default, amortization methods on fixed income securities, and
expiration of capital loss carryforwards. These reclassifications have no effect
on net assets or net asset values per share.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with Fund Asset
Management, L.P. ("FAM"). The general partner of FAM is Princeton Services, Inc.
("PSI"), an indirect, wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML
& Co."), which is the limited partner. FAM has entered into a Sub-Advisory
Agreement with Merrill Lynch Asset Management U.K. Limited ("MLAM U.K."), an
affiliate of FAM, pursuant to which MLAM U.K. provides investment advisory
services to FAM with respect to the Fund. There is no increase in the aggregate
fees paid by the Fund for these services.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to perform the investment advisory function. For such services, the Fund pays a
monthly fee at an annual rate of .60% of the Fund's average weekly net assets
plus the proceeds of any outstanding borrowings used for leverage.
The Fund 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"), an affiliate of FAM, or its affiliates.
Pursuant to that order, the Fund also has retained Merrill Lynch Investment
Managers, LLC ("MLIM LLC"), an affiliate of FAM, 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 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 FAM or its
affiliates.
In addition, MLPF&S received $2,688 in commissions on the execution of portfolio
security transactions for the Fund for the year ended February 28, 2005.
For the year ended February 28, 2005, the Fund reimbursed FAM $15,616 for
certain accounting services.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, MLAM U.K., PSI, and/or ML & Co.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 21
Notes to Financial Statements (concluded)
3. Investments:
Purchases and sales (including paydowns) of investments, excluding short-term
securities, for the year ended February 28, 2005 were $605,589,733 and
$607,442,417, respectively.
4. Capital Share Transactions:
The Fund is authorized to issue 200,000,000 shares of Common Stock, par value
$.10 per share. Shares issued and outstanding during the years ended February
28, 2005 and February 29, 2004 increased by 374,356 and 1,056,734, respectively,
as a result of dividend reinvestment.
5. Unfunded Loan Interests:
As of February 28, 2005, the Fund had unfunded loan commitments of approximately
$1,209,000, which would be extended at the option of the borrower, pursuant to
the following loan agreements:
- --------------------------------------------------------------------------------
Unfunded
Commitment
Borrower (in Thousands)
- --------------------------------------------------------------------------------
Outsourcing Solutions, Inc. ................................ $ 209
Quest Cherokee, LLC ........................................ $1,000
- --------------------------------------------------------------------------------
6. Short-Term Borrowings:
The Fund has entered into a revolving credit and security agreement funded by a
commercial paper asset securitization program with Citicorp North America, Inc.
("Citicorp") as Agent, certain secondary backstop lenders, and certain asset
securitization conduits as lenders (the "Lenders"). The credit facility has a
maximum limit of $343,000,000. Under the Citicorp program, the conduits will
fund advances to the Fund through the issuance of highly rated commercial paper.
As security for its obligations to the Lenders under the revolving
securitization facility, the Fund has granted a security interest in
substantially all of its assets to and in favor of the Lenders. The interest
rate on the Fund's borrowings is based on the interest rate carried by the
commercial paper plus a program fee. The Fund pays additional borrowing costs
including a backstop commitment fee.
The weighted average annual interest rate was 1.91% and the average borrowing
was approximately $304,549,000 for the year ended February 28, 2005.
7. Distributions to Shareholders:
The Fund paid an ordinary income dividend in the amount of $.053000 per share on
March 31, 2005 to shareholders of record on March 15, 2005.
The tax character of distributions paid during the fiscal years ended February
28, 2005 and February 29, 2004 was as follows:
- --------------------------------------------------------------------------------
2/28/2005 2/29/2004
- --------------------------------------------------------------------------------
Distributions paid from:
Ordinary income ........................ $69,339,355 $82,761,761
------------------------------
Total taxable distributions .............. $69,339,355 $82,761,761
==============================
As of February 28, 2005, the components of accumulated losses on a tax basis
were as follows:
- -----------------------------------------------------------------------------
Undistributed ordinary income--net ..................... $ 5,559,423
Undistributed long-term capital gains--net ............. --
-------------
Total undistributed earnings--net ...................... 5,559,423
Capital loss carryforward .............................. (326,319,995)*
Unrealized losses--net ................................. (8,430,922)**
-------------
Total accumulated losses--net .......................... $(329,191,494)
=============
* On February 28, 2005, the Fund had a net capital loss carryforward of
$326,319,995, of which $12,067,388 expires in 2006, $27,376,921 expires in
2007, $51,234,056 expires in 2008, $21,442,332 expires in 2009,
$90,564,493 expires in 2010, $85,285,305 expires in 2011, $17,223,475
expires in 2012 and $21,126,025 expires in 2013. This amount will be
available to offset like amounts of any future taxable gains.
** The difference between book-basis and tax-basis net unrealized losses is
attributable primarily to the tax deferral of losses on wash sales, the
difference between book and tax amortization methods for premiums and
discounts on fixed income securities, book/tax differences in the accrual
of income on securities in default, the deferral of post-October capital
losses for tax purposes and other book/tax temporary differences.
22 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors of
Debt Strategies Fund, Inc.:
We have audited the accompanying statement of assets, liabilities and capital,
including the schedule of investments, of Debt Strategies Fund, Inc. as of
February 28, 2005, and the related statements of operations and cash flows for
the year then ended, the statements of changes in net assets for each of the two
years in the period then ended, and the financial highlights for each of the
five years in the period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of February 28, 2005, by correspondence with the
custodian and financial intermediaries; where replies were not received from
financial intermediaries, we performed other auditing procedures. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Debt
Strategies Fund, Inc. as of February 28, 2005, the results of its operations and
its cash flows for the year then ended, the changes in its net assets for each
of the two years in the period then ended, and its financial highlights for the
five years in the period then ended, in conformity with U.S. generally accepted
accounting principles.
Deloitte & Touche LLP
Princeton, New Jersey
April 22, 2005
Fund Certification (unaudited)
On September 17, 2004, the Fund filed its Chief Executive Officer Certification
for the prior year with the New York Stock Exchange pursuant to Section 303A.
12(a) of the New York Stock Exchange Corporate Governance Listing Standards.
The Fund's Chief Executive Officer and Chief Financial Officer Certifications
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 were filed with the
Fund's Form N-CSR and are available on the Securities and Exchange Commission's
Web site at http://www.sec.gov.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 23
Automatic Dividend Reinvestment Plan
The following description of the Fund's Automatic Dividend Reinvestment Plan
(the "Plan") is sent to you annually as required by federal securities laws.
Pursuant to the Fund's Plan, unless a holder of Common Stock otherwise elects,
all dividend and capital gains distributions will be automatically reinvested by
The Bank of New York (the "Plan Agent"), as agent for shareholders in
administering the Plan, in additional shares of Common Stock of the Fund.
Holders of Common Stock who elect not to participate in the Plan will receive
all distributions in cash paid by check mailed directly to the shareholder of
record (or, if the shares are held in street or other nominee name then to such
nominee) by The Bank of New York, as dividend paying agent. Such participants
may elect not to participate in the Plan and to receive all distributions of
dividends and capital gains in cash by sending written instructions to The Bank
of New York, as dividend paying agent, at the address set forth below.
Participation in the Plan is completely voluntary and may be terminated or
resumed at any time without penalty by written notice if received by the Plan
Agent not less than ten days prior to any dividend record date; otherwise such
termination will be effective with respect to any subsequently declared dividend
or distribution.
Whenever the Fund declares an income dividend or capital gains distribution
(collectively referred to as "dividends") payable either in shares or in cash,
non-participants in the Plan will receive cash and participants in the Plan will
receive the equivalent in shares of Common Stock. The shares will be acquired by
the Plan Agent for the participant's account, depending upon the circumstances
described below, either (i) through receipt of additional unissued but
authorized shares of Common Stock from the Fund ("newly issued shares") or (ii)
by purchase of outstanding shares of Common Stock on the open market
("open-market purchases") on the New York Stock Exchange or elsewhere. If, on
the payment date for the dividend, the net asset value per share of the Common
Stock is equal to or less than the market price per share of the Common Stock
plus estimated brokerage commissions (such conditions being referred to herein
as "market premium"), the Plan Agent will invest the dividend amount in newly
issued shares on behalf of the participant. The number of newly issued shares of
Common Stock to be credited to the participant's account will be determined by
dividing the dollar amount of the dividend by the net asset value per share on
the date the shares are issued, provided that the maximum discount from the then
current market price per share on the date of issuance may not exceed 5%. If, on
the dividend payment date, the net asset value per share is greater than the
market value (such condition being referred to herein as "market discount"), the
Plan Agent will invest the dividend amount in shares acquired on behalf of the
participant in open-market purchases.
In the event of a market discount on the dividend payment date, the Plan Agent
will have until the last business day before the next date on which the shares
trade on an "ex-dividend" basis or in no event more than 30 days after the
dividend payment date (the "last purchase date") to invest the dividend amount
in shares acquired in open-market purchases. It is contemplated that the Fund
will pay monthly income dividends. Therefore, the period during which
open-market purchases can be made will exist only from the payment date on the
dividend through the date before the next "ex-dividend" date, which typically
will be approximately ten days. If, before the Plan Agent has completed its
open-market purchases, the market price of a share of Common Stock exceeds the
net asset value per share, the average per share purchase price paid by the Plan
Agent may exceed the net asset value of the Fund's shares, resulting in the
acquisitions of fewer shares than if the dividend had been paid in newly issued
shares on the dividend payment date. Because of the foregoing difficulty with
respect to open-market purchases, the Plan provides that if the Plan Agent is
unable to invest the full dividend amount in open-market purchases during the
purchase period or if the market discount shifts to a market premium during the
purchase period, the Plan Agent will cease making open-market purchases and will
invest the uninvested portion of the dividend amount in newly issued shares at
the close of business on the last purchase date determined by dividing the
uninvested portion of the dividend by the net asset value per share.
The Plan Agent maintains all shareholders' accounts in the Plan and furnishes
written confirmation of all transactions in the account, including information
needed by shareholders for tax records. Shares in the account of each Plan
participant will be held by the Plan Agent in non-certificated form in the name
of the participant, and each shareholder's proxy will include those shares
purchased or received pursuant to the Plan. The Plan Agent will forward all
proxy solicitation materials to participants and vote proxies for shares held
pursuant to the Plan in accordance with the instructions of the participants.
24 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
In the case of shareholders such as banks, brokers or nominees which hold shares
of others who are the beneficial owners, the Plan Agent will administer the Plan
on the basis of the number of shares certified from time to time by the record
shareholders as representing the total amount registered in the record
shareholder's name and held for the account of beneficial owners who are to
participate in the Plan.
There will be no brokerage charges with respect to shares issued directly by the
Fund as a result of dividends or capital gains distributions payable either in
shares or in cash. However, each participant will pay a pro rata share of
brokerage commissions incurred with respect to the Plan Agent's open-market
purchases in connection with the reinvestment of dividends.
The automatic reinvestment of dividends and distributions will not relieve
participants of any federal, state or local income tax that may be payable (or
required to be withheld) on such dividends.
Shareholders participating in the Plan may receive benefits not available to
shareholders not participating in the Plan. If the market price plus commissions
of the Fund's shares is above the net asset value, participants in the Plan will
receive shares of the Fund at less than they could otherwise purchase them and
will have shares with a cash value greater than the value of any cash
distribution they would have received on their shares. If the market price plus
commissions is below the net asset value, participants will receive
distributions in shares with a net asset value greater than the value of any
cash distribution they would have received on their shares. However, there may
be insufficient shares available in the market to make distributions in shares
at prices below the net asset value. Also, since the Fund does not redeem
shares, the price on resale may be more or less than the net asset value.
The value of shares acquired pursuant to the Plan will generally be excluded
from gross income to the extent that the cash amount reinvested would be
excluded from gross income. If, when the Fund's shares are trading at a premium
over net asset value, the Fund issues shares pursuant to the Plan that have a
greater fair market value than the amount of cash reinvested, it is possible
that all or a portion of such discount (which may not exceed 5% of the fair
market value of the Fund's shares) could be viewed as a taxable distribution. If
the discount is viewed as a taxable distribution, it is also possible that the
taxable character of this discount would be allocable to all the shareholders,
including shareholders who do not participate in the Plan. Thus, shareholders
who do not participate in the Plan might be required to report as ordinary
income a portion of their distributions equal to their allocable share of the
discount.
Experience under the Plan may indicate that changes are desirable. Accordingly,
the Fund reserves the right to amend or terminate the Plan. There is no direct
service charge to participants in the Plan; however, the Fund reserves the right
to amend the Plan to include a service charge payable by the participants.
All correspondence concerning the Plan should be directed to the Plan Agent at
The Bank of New York, Church Street Station, P.O. Box 11258, New York, NY
10286-1258, Telephone: 800-432-8224.
Availability of Quarterly Schedule of Investments
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available on the SEC's Web site at
http://www.sec.gov. The Fund's Forms N-Q may also be reviewed and copied at the
SEC's Public Reference Room in Washington, DC. Information on the operation of
the Public Reference Room may be obtained by calling 1-800-SEC-0330.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 25
Officers and Directors
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
====================================================================================================================================
Interested Director
- ------------------------------------------------------------------------------------------------------------------------------------
Robert C. P.O. Box 9011 President 2005 to President of MLIM/FAM-advised funds since 2005; 114 Funds None
Doll, Jr.* Princeton, NJ and present President of MLIM and FAM since 2001; Co-Head 150 Portfolios
08543-9011 Director (Americas Region) thereof from 2000 to 2001 and
Age: 50 Senior Vice President from 1999 to 2001; President
and Director of Princeton Services, Inc. (Princeton
Services) since 2001; President of Princeton
Administrators, L.P. (Princeton Administrators) since
2001; Chief Investment Officer of Oppenheimer Funds,
Inc. in 1999 and Executive Vice President thereof from
1991 to 1999.
------------------------------------------------------------------------------------------------------------------------
* Mr. Doll is a director, trustee or member of an advisory board of certain other investment companies for which MLIM or
FAM acts as investment adviser. Mr. Doll is an "interested person," as described in the Investment Company Act, of the
Fund based on his current positions with MLIM, FAM, Princeton Services and Princeton Administrators, L.P. The
Director's term is unlimited. Directors serve until their resignation, removal or death, or until December 31 of the
year in which they turn 72. As Fund President, Mr. Doll serves at the pleasure of the Board of Directors.
====================================================================================================================================
Independent Directors*
- ------------------------------------------------------------------------------------------------------------------------------------
Ronald W. P.O. Box 9095 Director 1997 to Professor Emeritus of Finance, School of Business, 48 Funds None
Forbes Princeton, NJ present State University of New York at Albany since 2000 48 Portfolios
08543-9095 and Professor thereof from 1989 to 2000; Interna-
Age: 64 tional Consultant, Urban Institute from 1995 to 1999.
- ------------------------------------------------------------------------------------------------------------------------------------
Cynthia A. P.O. Box 9095 Director 1997 to Professor, Harvard Business School since 1989; 48 Funds Newell
Montgomery Princeton, NJ present Associate Professor, J.L. Kellogg Graduate School of 48 Portfolios Rubbermaid,
08543-9095 Management, Northwestern University from 1985 Inc.
Age: 52 to 1989; Associate Professor, Graduate School of (manufact-
Business Administration, University of Michigan uring)
from 1979 to 1985; Director, Harvard Business School
of Publishing since 2005.
- ------------------------------------------------------------------------------------------------------------------------------------
Jean Margo P.O. Box 9095 Director 2004 to Self-employed consultant since 2001; Counsel of 48 Funds None
Reid Princeton, NJ present lliance Capital Management (investment adviser) 48 Portfolios
08543-9095 in 2000; General Counsel, Director and Secretary of
Age: 59 Sanford C. Bernstein & Co., Inc. (investment adviser/
broker-dealer) from 1997 to 2000; Secretary, Sanford
C. Bernstein Fund, Inc. from 1994 to 2000; Director
and Secretary of SCB, Inc. since 1998; Director and
Secretary of SCB Partners, Inc. since 2000; Director
of Covenant House from 2001 to 2004.
- ------------------------------------------------------------------------------------------------------------------------------------
Roscoe S. P.O. Box 9095 Director 2000 to President, Middle East Institute from 1995 to 2001; 48 Funds None
Suddarth Princeton, NJ present Foreign Service Officer, United States Foreign 48 Portfolios
08543-9095 Service from 1961 to 1995; Career Minister, from
Age: 69 1989 to 1995; Deputy Inspector General, U.S.
Department of State from 1991 to 1994; U.S.
Ambassador to The Hashemite Kingdom of Jordan from
1987 to 1990.
- ------------------------------------------------------------------------------------------------------------------------------------
Richard R. P.O. Box 9095 Director 1997 to Professor of Finance from 1984 to 1995, Dean from 48 Funds Bowne &
West Princeton, NJ present 1984 to 1993 and since 1995 Dean Emeritus of 48 Portfolios Co., Inc.;
08543-9095 New York University Leonard N. Stern School of (financial
Age: 67 Business Administration. printers)
Vornado
Realty Trust;
(real estate
company)
Alexander's,
Inc. (real
estate
company)
26 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005
Officers and Directors (concluded)
Number of
Portfolios in Other Public
Position(s) Length of Fund Complex Directorships
Held with Time Overseen by Held by
Name Address & Age Fund Served Principal Occupation(s) During Past 5 Years Director Director
====================================================================================================================================
Independent Directors* (concluded)
- ------------------------------------------------------------------------------------------------------------------------------------
Edward D. P.O. Box 9095 Director 2000 to Self-employed financial consultant since 1994; 48 Funds None
Zinbarg Princeton, NJ present Executive Vice President of The Prudential 48 Portfolios
08543-9095 Insurance Company of America from 1988 to
Age: 70 1994; former Director of Prudential Reinsurance
Company and former Trustee of The Prudential
Foundation.
------------------------------------------------------------------------------------------------------------------------
* The Director's term is unlimited. Directors serve until their resignation, removal or death, or until December 31 of
the year in which they turn 72.
====================================================================================================================================
Fund Officers*
- ------------------------------------------------------------------------------------------------------------------------------------
Donald C. P.O. Box 9011 Vice 1997 to First Vice President of MLIM and FAM since 1997 and Treasurer thereof since 1999;
Burke Princeton, NJ President present Senior Vice President and Treasurer of Princeton Services since 1999 and Director
08543-9011 and and since 2004; Vice President of FAMD since 1999; Vice President of MLIMand FAM from
Age: 44 Treasurer 1999 to 1990 to 1997; Director of Taxation of MLIM from 1990 to 2001; Vice President,
present Treasurer and Secretary of the IQ Funds since 2004.
- ------------------------------------------------------------------------------------------------------------------------------------
Kevin J. P.O. Box 9011 Vice 2001 to Director (Global Fixed Income) of MLIM since 2000; Vice President of MLIM from
Booth Princeton, NJ President present 1994 to 2000.
08543-9011
Age: 50
- ------------------------------------------------------------------------------------------------------------------------------------
Jeffrey P.O. Box 9011 Chief 2004 to Chief Compliance Officer of the IQ Funds since 2004; Chief Compliance Officer of
Hiller Princeton, NJ Compliance present the MLIM/FAM-advised funds and First Vice President and Chief Compliance Officer of
08543-9011 Officer MLIM (Americas Region) since 2004; Global Director of Compliance at Morgan Stanley
Age: 53 Investment Management from 2002 to 2004; Managing Director and Global Director of
Compliance at Citigroup Asset Management from 2000 to 2002; Chief Compliance
Officer at Soros Fund Management in 2000; Chief Compliance Officer at Prudential
Financial from 1995 to 2000; Senior Counsel in the Commission's Division of
Enforcement in Washington, D.C. from 1990 to 1995.
- ------------------------------------------------------------------------------------------------------------------------------------
Alice A. P.O. Box 9011 Secretary 2004 to Director (Legal Advisory) of MLIM since 2002; Vice President of MLIM from 1999 to
Pellegrino Princeton, NJ present 2002; Attorney associated with MLIM since 1997; Secretary of MLIM, FAM, FAMD and
08543-9011 Princeton Services since 2004.
Age: 44
------------------------------------------------------------------------------------------------------------------------
* Officers of the Fund serve at the pleasure of the Board of Directors.
- ------------------------------------------------------------------------------------------------------------------------------------
Custodian
The Bank of New York
100 Church Street
New York, NY 10286
Transfer Agent
The Bank of New York
101 Barclay Street -- 11 East
New York, NY 10286
NYSE Symbol
DSU
- --------------------------------------------------------------------------------
Effective January 1, 2005, Terry K. Glenn, President and Director and Kevin A.
Ryan, Director of Debt Strategies Fund, Inc. retired. The Fund's Board of
Directors wishes Messrs. Glenn and Ryan well in their retirements.
Effective January 1, 2005, Robert C. Doll, Jr. became President and Director of
the Fund.
- --------------------------------------------------------------------------------
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2005 27
[LOGO] Merrill Lynch Investment Managers
www.mlim.ml.com
- --------------------------------------------------------------------------------
Mercury Advisors
A Division of Merrill Lynch Investment Managers
www.mercury.ml.com
Debt Strategies Fund, Inc. seeks to provide current income by investing
primarily in a diversified portfolio of U.S. companies' debt instruments,
including corporate loans, that are rated in the lower rating categories of the
established rating services (Baa or lower by Moody's Investors Service, Inc. or
BBB or lower by Standard & Poor's) or unrated debt instruments of comparable
quality.
This report, including the financial information herein, is transmitted to
shareholders of Debt Strategies Fund, Inc. for their information. It is not a
prospectus. Past performance results shown in this report should not be
considered a representation of future performance. The Fund leverages its Common
Stock to provide Common Stock shareholders with a potentially higher rate of
return. Leverage creates risk for Common Stock shareholders, including the
likelihood of greater volatility of net asset value and market price of Common
Stock shares, and the risk that fluctuations in short-term interest rates may
reduce the Common Stock's yield. Statements and other information herein are as
dated and are subject to change.
A description of the policies and procedures that the Fund uses 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)
at www.mutualfunds.ml.com; and (3) on the Securities and Exchange Commission's
Web site at http://www.sec.gov. Information about how the Fund voted proxies
relating to securities held in the Fund's portfolio 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.
Debt Strategies Fund, Inc.
Box 9011
Princeton, NJ 08543-9011
#DEBT -- 2/05
Item 2 - Code of Ethics - The registrant has adopted a code of ethics, as of the
end of the period covered by this report, that applies to the
registrant's principal executive officer, principal financial officer
and principal accounting officer, or persons performing similar
functions. A copy of the code of ethics is available without charge
upon request by calling toll-free 1-800-MER-FUND (1-800-637-3863).
Item 3 - Audit Committee Financial Expert - The registrant's board of directors
has determined that (i) the registrant has the following audit
committee financial experts serving on its audit committee and (ii)
each audit committee financial expert is independent: (1) Ronald W.
Forbes, (2) Richard R. West, and (3) Edward D. Zinbarg.
Item 4 - Principal Accountant Fees and Services
(a) Audit Fees - Fiscal Year Ending February 28, 2005 - $43,000
Fiscal Year Ending February 29, 2004 - $38,900
(b) Audit-Related Fees - Fiscal Year Ending February 28, 2005 - $7,500
Fiscal Year Ending February 29, 2004 - $7,500
The nature of the services include assurance and related services
reasonably related to the performance of the audit of financial
statements not included in Audit Fees.
(c) Tax Fees - Fiscal Year Ending February 28, 2005 - $5,700
Fiscal Year Ending February 29, 2004 - $5,200
The nature of the services include tax compliance, tax advice and tax
planning.
(d) All Other Fees - Fiscal Year Ending February 28, 2005 - $0
Fiscal Year Ending February 29, 2004 - $0
(e)(1) The registrant's audit committee (the "Committee") has adopted
policies and procedures with regard to the pre-approval of services.
Audit, audit-related and tax compliance services provided to the
registrant on an annual basis require specific pre-approval by the
Committee. The Committee also must approve other non-audit services
provided to the registrant and those non-audit services provided to the
registrant's affiliated service providers that relate directly to the
operations and the financial reporting of the registrant. Certain of
these non-audit services that the Committee believes are a) consistent
with the SEC's auditor independence rules and b) routine and recurring
services that will not impair the independence of the independent
accountants may be approved by the Committee without consideration on a
specific case-by-case basis ("general pre-approval"). However, such
services will only be deemed pre-approved provided that any individual
project does not exceed $5,000 attributable to the registrant or
$50,000 for all of the registrants the Committee oversees. Any proposed
services exceeding the pre-approved cost levels will require specific
pre-approval by the Committee, as will any other services not subject
to general pre-approval (e.g., unanticipated but permissible services).
The Committee is informed of each service approved subject to general
pre-approval at the next regularly scheduled in-person board meeting.
(e)(2) 0%
(f) Not Applicable
(g) Fiscal Year Ending February 28, 2005 - $11,046,527
Fiscal Year Ending February 29, 2004 - $18,176,900
(h) The registrant's audit committee has considered and determined that
the provision of non-audit services that were rendered to the
registrant's investment adviser and any entity controlling, controlled
by, or under common control with the investment adviser that provides
ongoing services to the registrant that were not pre-approved pursuant
to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible
with maintaining the principal accountant's independence.
Regulation S-X Rule 2-01(c)(7)(ii) - $945,000, 0%
Item 5 - Audit Committee of Listed Registrants - The following individuals are
members of the registrant's separately-designated standing audit
committee established in accordance with Section 3(a)(58)(A) of the
Exchange Act (15 U.S.C. 78c(a)(58)(A)):
Ronald W. Forbes
Cynthia A. Montgomery
Jean Margo Reid (as of August 20, 2004)
Kevin A. Ryan (retired as of December 31, 2004)
Roscoe S. Suddarth
Richard R. West
Edward D. Zinbarg
Item 6 - Schedule of Investments - Not Applicable
Item 7 - Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies -
Proxy Voting Policies and Procedures
Each Fund's Board of Directors/Trustees has delegated to Merrill Lynch
Investment Managers, L.P. and/or Fund Asset Management, L.P. (the
"Investment Adviser") authority to vote all proxies relating to the
Fund's portfolio securities. The Investment Adviser has adopted
policies and procedures ("Proxy Voting Procedures") with respect to the
voting of proxies related to the portfolio securities held in the
account of one or more of its clients, including a Fund. Pursuant to
these Proxy Voting Procedures, the Investment Adviser's primary
objective when voting proxies is to make proxy voting decisions solely
in the best interests of each Fund and its shareholders, and to act in
a manner that the Investment Adviser believes is most likely to enhance
the economic value of the securities held by the Fund. The Proxy Voting
Procedures are designed to ensure that that the Investment Adviser
considers the interests of its clients, including the Funds, and not
the interests of the Investment Adviser, when voting proxies and that
real (or perceived) material conflicts that may arise between the
Investment Adviser's interest and those of the Investment Adviser's
clients are properly addressed and resolved.
In order to implement the Proxy Voting Procedures, the Investment
Adviser has formed a Proxy Voting Committee (the "Committee"). The
Committee is comprised of the Investment Adviser's Chief Investment
Officer (the "CIO"), one or more other senior investment professionals
appointed by the CIO, portfolio managers and investment analysts
appointed by the CIO and any other personnel the CIO deems appropriate.
The Committee will also include two non-voting representatives from the
Investment Adviser's Legal department appointed by the Investment
Adviser's General Counsel. The Committee's membership shall be limited
to full-time employees of the Investment Adviser. No person with any
investment banking, trading, retail brokerage or research
responsibilities for the Investment Adviser's affiliates may serve as a
member of the Committee or participate in its decision making (except
to the extent such person is asked by the Committee to present
information to the Committee, on the same basis as other interested
knowledgeable parties not affiliated with the Investment Adviser might
be asked to do so). The Committee determines how to vote the proxies of
all clients, including a Fund, that have delegated proxy voting
authority to the Investment Adviser and seeks to ensure that all votes
are consistent with the best interests of those clients and are free
from unwarranted and inappropriate influences. The Committee
establishes general proxy voting policies for the Investment Adviser
and is responsible for determining how those policies are applied to
specific proxy votes, in light of each issuer's unique structure,
management, strategic options and, in certain circumstances, probable
economic and other anticipated consequences of alternate actions. In so
doing, the Committee may determine to vote a particular proxy in a
manner contrary to its generally stated policies. In addition, the
Committee will be responsible for ensuring that all reporting and
recordkeeping requirements related to proxy voting are fulfilled.
The Committee may determine that the subject matter of a recurring
proxy issue is not suitable for general voting policies and requires a
case-by-case determination. In such cases, the Committee may elect not
to adopt a specific voting policy applicable to that issue. The
Investment Adviser believes that certain proxy voting issues require
investment analysis - such as approval of mergers and other significant
corporate transactions - akin to investment decisions, and are,
therefore, not suitable for general guidelines. The Committee may elect
to adopt a common position for the Investment Adviser on certain proxy
votes that are akin to investment decisions, or determine to permit the
portfolio manager to make individual decisions on how best to maximize
economic value for a Fund (similar to normal buy/sell investment
decisions made by such portfolio managers). While it is expected that
the Investment Adviser will generally seek to vote proxies over which
the Investment Adviser exercises voting authority in a uniform manner
for all the Investment Adviser's clients, the Committee, in conjunction
with a Fund's portfolio manager, may determine that the Fund's specific
circumstances require that its proxies be voted differently.
To assist the Investment Adviser in voting proxies, the Committee has
retained Institutional Shareholder Services ("ISS"). ISS is an
independent adviser that specializes in providing a variety of
fiduciary-level proxy-related services to institutional investment
managers, plan sponsors, custodians, consultants, and other
institutional investors. The services provided to the Investment
Adviser by ISS include in-depth research, voting recommendations
(although the Investment Adviser is not obligated to follow such
recommendations), vote execution, and recordkeeping. ISS will also
assist the Fund in fulfilling its reporting and recordkeeping
obligations under the Investment Company Act.
The Investment Adviser's Proxy Voting Procedures also address special
circumstances that can arise in connection with proxy voting. For
instance, under the Proxy Voting Procedures, the Investment Adviser
generally will not seek to vote proxies related to portfolio securities
that are on loan, although it may do so under certain circumstances. In
addition, the Investment Adviser will vote proxies related to
securities of foreign issuers only on a best efforts basis and may
elect not to vote at all in certain countries where the Committee
determines that the costs associated with voting generally outweigh the
benefits. The Committee may at any time override these general policies
if it determines that such action is in the best interests of a Fund.
From time to time, the Investment Adviser may be required to vote proxies in
respect of an issuer where an affiliate of the Investment Adviser (each, an
"Affiliate"), or a money management or other client of the Investment Adviser
(each, a "Client") is involved. The Proxy Voting Procedures and the Investment
Adviser's adherence to those procedures are designed to address such conflicts
of interest. The Committee intends to strictly adhere to the Proxy Voting
Procedures in all proxy matters, including matters involving Affiliates and
Clients. If, however, an issue representing a non-routine matter that is
material to an Affiliate or a widely known Client is involved such that the
Committee does not reasonably believe it is able to follow its guidelines (or if
the particular proxy matter is not addressed by the guidelines) and vote
impartially, the Committee may, in its discretion for the purposes of ensuring
that an independent determination is reached, retain an independent fiduciary to
advise the Committee on how to vote or to cast votes on behalf of the Investment
Adviser's clients.
In the event that the Committee determines not to retain an independent
fiduciary, or it does not follow the advice of such an independent
fiduciary, the powers of the Committee shall pass to a subcommittee,
appointed by the CIO (with advice from the Secretary of the Committee),
consisting solely of Committee members selected by the CIO. The CIO
shall appoint to the subcommittee, where appropriate, only persons
whose job responsibilities do not include contact with the Client and
whose job evaluations would not be affected by the Investment Adviser's
relationship with the Client (or failure to retain such relationship).
The subcommittee shall determine whether and how to vote all proxies on
behalf of the Investment Adviser's clients or, if the proxy matter is,
in their judgment, akin to an investment decision, to defer to the
applicable portfolio managers, provided that, if the subcommittee
determines to alter the Investment Adviser's normal voting guidelines
or, on matters where the Investment Adviser's policy is case-by-case,
does not follow the voting recommendation of any proxy voting service
or other independent fiduciary that may be retained to provide research
or advice to the Investment Adviser on that matter, no proxies relating
to the Client may be voted unless the Secretary, or in the Secretary's
absence, the Assistant Secretary of the Committee concurs that the
subcommittee's determination is consistent with the Investment
Adviser's fiduciary duties
In addition to the general principles outlined above, the Investment
Adviser has adopted voting guidelines with respect to certain recurring
proxy issues that are not expected to involve unusual circumstances.
These policies are guidelines only, and the Investment Adviser may
elect to vote differently from the recommendation set forth in a voting
guideline if the Committee determines that it is in a Fund's best
interest to do so. In addition, the guidelines may be reviewed at any
time upon the request of a Committee member and may be amended or
deleted upon the vote of a majority of Committee members present at a
Committee meeting at which there is a quorum.
The Investment Adviser has adopted specific voting guidelines with
respect to the following proxy issues:
o Proposals related to the composition of the Board of Directors of issuers
other than investment companies. As a general matter, the Committee
believes that a company's Board of Directors (rather than shareholders) is
most likely to have access to important, nonpublic information regarding a
company's business and prospects, and is therefore best-positioned to set
corporate policy and oversee management. The Committee, therefore,
believes that the foundation of good corporate governance is the election
of qualified, independent corporate directors who are likely to diligently
represent the interests of shareholders and oversee management of the
corporation in a manner that will seek to maximize shareholder value over
time. In individual cases, the Committee may look at a nominee's history
of representing shareholder interests as a director of other companies or
other factors, to the extent the Committee deems relevant.
o Proposals related to the selection of an issuer's independent auditors. As
a general matter, the Committee believes that corporate auditors have a
responsibility to represent the interests of shareholders and provide an
independent view on the propriety of financial reporting decisions of
corporate management. While the Committee will generally defer to a
corporation's choice of auditor, in individual cases, the Committee may
look at an auditors' history of representing shareholder interests as
auditor of other companies, to the extent the Committee deems relevant.
o Proposals related to management compensation and employee benefits. As a
general matter, the Committee favors disclosure of an issuer's
compensation and benefit policies and opposes excessive compensation, but
believes that compensation matters are normally best determined by an
issuer's board of directors, rather than shareholders. Proposals to
"micro-manage" an issuer's compensation practices or to set arbitrary
restrictions on compensation or benefits will, therefore, generally not be
supported.
o Proposals related to requests, principally from management, for approval
of amendments that would alter an issuer's capital structure. As a general
matter, the Committee will support requests that enhance the rights of
common shareholders and oppose requests that appear to be unreasonably
dilutive.
o Proposals related to requests for approval of amendments to an issuer's
charter or by-laws. As a general matter, the Committee opposes poison pill
provisions.
o Routine proposals related to requests regarding the formalities of
corporate meetings.
o Proposals related to proxy issues associated solely with holdings of
investment company shares. As with other types of companies, the Committee
believes that a fund's Board of Directors (rather than its shareholders)
is best-positioned to set fund policy and oversee management. However, the
Committee opposes granting Boards of Directors authority over certain
matters, such as changes to a fund's investment objective, that the
Investment Company Act envisions will be approved directly by
shareholders.
o Proposals related to limiting corporate conduct in some manner that
relates to the shareholder's environmental or social concerns. The
Committee generally believes that annual shareholder meetings are
inappropriate forums for discussion of larger social issues, and opposes
shareholder resolutions "micromanaging" corporate conduct or requesting
release of information that would not help a shareholder evaluate an
investment in the corporation as an economic matter. While the Committee
is generally supportive of proposals to require corporate disclosure of
matters that seem relevant and material to the economic interests of
shareholders, the Committee is generally not supportive of proposals to
require disclosure of corporate matters for other purposes.
Item 8 - Portfolio Managers of Closed-End Management Investment Companies - Not
Applicable at this time
Item 9 - Purchases of Equity Securities by Closed-End Management Investment
Company and Affiliated Purchasers - Not Applicable
Item 10 - Submission of Matters to a Vote of Security Holders - Not Applicable
Item 11 - Controls and Procedures
11(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.
11(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 second 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 12 - Exhibits attached hereto
12(a)(1) - Code of Ethics - See Item 2
12(a)(2) - Certifications - Attached hereto
12(a)(3) - Not Applicable
12(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.
Debt Strategies Fund, Inc.
By: /s/ Robert C. Doll, Jr.
------------------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Debt Strategies Fund, Inc.
Date: April 22, 2005
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/ Robert C. Doll, Jr.
------------------------------------
Robert C. Doll, Jr.,
Chief Executive Officer of
Debt Strategies Fund, Inc.
Date: April 22, 2005
By: /s/ Donald C. Burke
------------------------------------
Donald C. Burke,
Chief Financial Officer of
Debt Strategies Fund, Inc.
Date: April 22, 2005