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: 02/28/06
Date of reporting period: 03/01/05 - 02/28/06
Item 1 - Report to Stockholders
Annual Report
February 28, 2006
Debt Strategies Fund, Inc.
Debt Strategies Fund, Inc.
Announcement to Shareholders
On February 15, 2006, BlackRock, Inc. ("BlackRock") and Merrill Lynch & Co.,
Inc. ("Merrill Lynch") entered into an agreement to contribute Merrill Lynch's
investment management business, Merrill Lynch Investment Managers, L.P. and
certain affiliates (including Fund Asset Management, L.P. and Merrill Lynch
Investment Managers International Limited), to BlackRock to create a new
independent company that will be one of the world's largest asset management
firms with nearly $1 trillion in assets under management (based on combined
assets under management as of December 31, 2005). The transaction is expected to
close in the third quarter of 2006, at which time the new company will operate
under the BlackRock name. If approved by the Fund's Board of Directors and Fund
Shareholders, the combined company that results from the transaction is expected
to become the investment adviser of the Fund.
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.
2 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
A Letter From the President
Dear Shareholder
Financial markets began 2006 with a return to volatility following a fairly
uninspiring 2005. For the six- and 12-month periods ended February 28, 2006,
most major market indexes landed in positive territory:
Total Returns as of February 28, 2006 6-month 12-month
===============================================================================================
U.S. equities (Standard & Poor's 500 Index) + 5.93% + 8.40%
-----------------------------------------------------------------------------------------------
Small cap U.S. equities (Russell 2000 Index) +10.24 +16.59
-----------------------------------------------------------------------------------------------
International equities (MSCI Europe, Australasia, Far East Index) +15.14 +17.41
-----------------------------------------------------------------------------------------------
Fixed income (Lehman Brothers Aggregate Bond Index) - 0.11 + 2.74
-----------------------------------------------------------------------------------------------
Tax-exempt fixed income (Lehman Brothers Municipal Bond Index) + 0.99 + 3.87
-----------------------------------------------------------------------------------------------
High yield bonds (Credit Suisse High Yield Index) + 1.89 + 3.27
-----------------------------------------------------------------------------------------------
The Federal Reserve Board (the Fed) increased interest rates 200 basis points
(2.00%) over the past 12 months, bringing the target federal funds rate to 4.5%.
Notably, Ben Bernanke replaced Alan Greenspan as Fed chairman in January, a
month after the central bank removed the critical word "measured" from the
description of its rate-hiking program. Still, most observers expect at least
one more interest rate hike before the Fed pauses in its tightening campaign.
U.S. economic growth, which came in at 4.1% in the third quarter of 2005, fell
to 1.6% in the fourth quarter. Growth is expected to reaccelerate in the first
quarter of 2006, although the economy is likely to feel some pressure in the
quarters ahead as the consumer sector seems to be softening. Capital spending by
businesses, however, appears relatively strong. Overall corporate health,
including strong company balance sheets, helped prompt robust
dividend-distribution, share-buyback and merger-and-acquisition activity in
2005, a trend that has continued in 2006. This, as well as reasonably good
company earnings and low core inflation, has been supportive of U.S. stocks
despite the headwinds of rising interest rates and high energy prices. Many
international equity markets have fared even better, thanks in part to higher
economic growth rates and low inflation.
In the U.S. bond market, short-term interest rates continued to move higher as
longer-term interest rates advanced more moderately. After flattening
dramatically in 2005, the Treasury curve recently has been toying with bouts of
inversion, whereby short-term yields have surpassed long-term yields. At
period-end, the six-month Treasury bill offered the highest yield on the curve
at 4.74%.
Amid the uncertainty inherent in the financial markets, we encourage you to
review your goals periodically with your financial advisor and to make portfolio
changes, as needed. For timely "food for thought" for investors, we also invite
you to visit Shareholder magazine at www.mlim.ml.com/shareholdermagazine. As
always, we thank you for trusting Merrill Lynch Investment Managers with your
investment assets, and we look forward to continuing to serve your investment
needs.
Sincerely,
/s/ Robert C. Doll, Jr.
Robert C. Doll, Jr.
President and Director
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 3
A Discussion With Your Fund's Portfolio Manager
The Fund provided competitive returns and an attractive yield during the
fiscal year as we continued to use our credit-driven investment process to
maintain a well-diversified portfolio.
How did the Fund perform during the fiscal year in light of the existing market
conditions?
For the 12-month period ended February 28, 2006, the Common Stock of Debt
Strategies Fund, Inc. had net annualized yields of 9.65% and 9.53%, based on a
year-end per share net asset value of $6.69 and a per share market price of
$6.77, respectively, and $.645 per share income dividends. Over the same period,
the total investment return on the Fund's Common Stock was +4.57%, based on a
change in per share net asset value from $7.06 to $6.69, and assuming
reinvestment of all distributions. The Fund's total return for the period kept
in line with the +4.62% return of its benchmark, which is an equal blend of the
Credit Suisse High Yield Index and the Credit Suisse Leveraged Loan Index.
For the six-month period ended February 28, 2006, the total investment return on
the Fund's Common Stock was +3.61%, based on a change in per share net asset
value from $6.79 to $6.69, and assuming reinvestment of all distributions. The
blended benchmark returned +2.46% for the same 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 was quite volatile during the 12 months ended February 28,
2006. In spring 2005, we saw the downgrades of both Ford Motor Co.'s and General
Motors Corp.'s debt to junk bond status. Uncertainty regarding the absolute
volume of bonds that would constitute "fallen angels" (that is, bonds that move
from investment grade to junk bond status) and the impact of the downgrades on
the high yield index caused some investors in the asset class to head for the
sidelines. This led to price weakness and spread widening, particularly among
the lower-rated junk bond categories. The market gained perspective on the auto
downgrades, rallied through late spring and summer, but retreated in the fall
following the bankruptcy filing of auto-parts maker Delphi Automotive Systems.
For this 12-month reporting period, the Credit Suisse High Yield Index returned
a relatively modest +3.27%.
In contrast, the bank loan market, as represented by the Credit Suisse Leveraged
Loan Index, remained solid during the fiscal year, posting a return of +5.96%
for the 12 months ended February 28, 2006. This is primarily attributable to the
senior secured status of bank loans, which made them less vulnerable to credit
concerns when compared to high yield bonds. Another factor contributing to the
strong performance of leveraged loans is collateralized loan obligations (CLOs),
which now hold more than 60% of the leveraged loan market. As the financing for
these structured products has become less expensive, so too has the spread
required in the leveraged loan space to make this model work. We are seeing
leveraged loan spreads at historically tight levels. The prospect for further
spread tightening relies primarily on the cost of CLO financing going forward.
What factors most influenced Fund performance?
Specific credits that contributed most to performance during the past year
included Winstar Communications, High Voltage Engineering Corp. (HVE) and Trico
Marine Services, Inc. The Fund had participated in a DIP (debtor-in-possession)
financing for Winstar back in 2001. We wrote off $3 million that went unpaid
following the conversion of the case from a Chapter 11 reorganization to a
Chapter 7 liquidation. However, there was an open litigation proceeding against
Lucent Technologies Inc. wherein the judge recently (in January 2006) ruled in
favor of Winstar. We reinstated this position in the portfolio at $4.1 million,
which represents the market bid for the DIP loan plus accrued interest.
Our 501,000 common equity share position in HVE rallied from $1.50 to $9.00 per
share during the period. The price of this equity, which we received in 2004 in
a Chapter 11 reorganization, had been under pressure as the company faced
daunting liquidity issues arising from overextended working capital positions.
Subsequently, the company's principal division, Robicon Corp., was sold to
Siemens AG at a surprisingly strong multiple, which propelled the stock upward.
We liquidated this position in August.
4 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Finally, our $6 million bond position in marine oil service company Trico was
converted to equity via a Chapter 11 reorganization in 2005. The Fund received
shares which rose in price from $16.63 to $29.13 per share. This move reflects
the strong momentum across the entire energy spectrum in the current price
environment.
Investments that detracted most from Fund performance included Pliant
Corporation, GEO Specialty Chemicals, Inc. and Refco Finance Holdings LLC. Our
$12.3 million position in Pliant, a flexible plastic packaging corporation,
collapsed from 98 to 27 during the year. An already difficult financial position
arising from high resin prices worsened following the August and September
hurricanes. Resin suppliers put Pliant on order allocation (that is, rationing),
and then subsequently withdrew trade support. Pliant's liquidity position became
untenable, leading to a Chapter 11 filing on January 4, 2006.
The Fund holds $9.8 million in bonds and 339,000 shares of common stock of GEO,
a specialty chemicals company that services niche markets in electronics, paints
and coatings, construction, water treatment and rubber additives. In 2005, high
energy costs and raw material inflation hurt the company's profit margins as
costs rose faster than prices. This caused the bonds to decline in price from
$106.75 to $86.00, while the share price of the equity declined from $15.00 to
$4.50. This trend has abated recently, and we believe 2006 should prove to be a
key turnaround year for the company.
Financial services company Refco filed for Chapter 11 reorganization following
the announcement that the company had discovered that it was owed a debt of
approximately $430 million by an entity controlled by the company's CEO. The
value of our Refco bonds, which were marked at $108.75 on September 30, 2005,
plunged sharply. We liquidated our $7.6 million position at an average price of
$50.00.
What changes were made to the portfolio during the period?
We continued to shorten the portfolio's duration, thereby limiting the price
sensitivity to rising long-term interest rates, by investing in floating rate
notes and bank loans. The Fund is currently at a roughly 60% fixed rate/40%
floating rate composition. We intend to aim for a 50% fixed/50% floating make-up
in 2006. We think this makes sense given the flat yield curve and our conviction
that the probability of rising long-term rates far outweighs that of declining
long-term rates.
How would you characterize the Fund's position at the close of the period?
We are on target for a 50% fixed rate/50% floating rate allocation in 2006. Our
investment approach will continue to be credit-driven, with the aim of
maintaining a well-diversified investment portfolio. We also intend to maintain
our use of leverage within a target range of 25% - 30%.
Kevin J. Booth
Vice President and Portfolio Manager
March 8, 2006
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 5
Portfolio Information
As of February 28, 2006
Percent of
Ten Largest Holdings Net Assets
--------------------------------------------------------------------------------
Anchor Glass Container Corp.* ............................. 2.6%
Nova Chemicals Corp. ...................................... 2.6
Sungard Data Systems, Inc.* ............................... 2.3
Charter Communications Operating LLC ...................... 2.1
PolyOne Corp.* ............................................ 2.0
Time Warner Telecom Holdings, Inc.* ....................... 1.9
NewPage Corp.* ............................................ 1.9
Sirius Satellite Radio, Inc.* ............................. 1.8
FelCor Lodging LP* ........................................ 1.8
Intelsat Bermuda Ltd.* .................................... 1.7
--------------------------------------------------------------------------------
* Includes combined holdings.
Percent of
Five Largest Industries Net Assets
--------------------------------------------------------------------------------
Cable -- U.S. ............................................. 15.6%
Chemicals ................................................. 14.8
Paper ..................................................... 8.5
Information Technology .................................... 8.1
Telecommunications ........................................ 7.2
--------------------------------------------------------------------------------
For Fund compliance purposes, the Fund's industry classifications refer to
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.
Quality Ratings by Percent of
S&P/Moody's Total Investments
--------------------------------------------------------------------------------
A/A ....................................................... 0.7%
BBB/Baa ................................................... 1.0
BB/Ba ..................................................... 8.6
B/B ....................................................... 61.5
CCC/Caa ................................................... 13.0
CC/Ca ..................................................... 0.2
D ......................................................... 1.5
NR (Not Rated) ............................................ 10.4
Other* .................................................... 3.1
--------------------------------------------------------------------------------
* Includes portfolio holdings in common stocks, preferred stocks, warrants,
rights and other interests.
6 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Schedule of Investments (in U.S. dollars)
Face
Amount Corporate Bonds Value
====================================================================================
Aerospace & Defense--4.2%
$ 5,000,000 Alliant Techsystems, Inc., 3%
due 8/15/2024 (d)(k) $ 5,775,000
7,500,000 L-3 Communications Corp., 3%
due 8/01/2035 (d)(k) 7,696,875
9,765,000 Standard Aero Holdings, Inc., 8.25%
due 9/01/2014 8,593,200
8,120,000 Vought Aircraft Industries, Inc., 8% due 7/15/2011 7,612,500
-------------
29,677,575
====================================================================================
Automotive--2.8%
700,000 Advanced Accessory Systems LLC, 10.75%
due 6/15/2011 556,500
3,150,000 Cooper-Standard Automotive, Inc., 8.375%
due 12/15/2014 2,441,250
2,700,000 Delco Remy International, Inc., 8.60%
due 4/15/2009 (a) 2,538,000
4,625,000 Exide Technologies, 10.50% due 3/15/2013 (d) 3,665,312
5,000,000 General Motors Acceptance Corporation,
5.50% due 1/16/2007 (a) 4,868,070
6,050,000 Metaldyne Corp., 11% due 6/15/2012 4,719,000
925,000 Tenneco Automotive, Inc. Series B,10.25%
due 7/15/2013 1,024,438
Venture Holdings Co. LLC:
4,450,000 12% due 6/01/2009 (i) 0
1,800,000 Series B, 9.50% due 7/01/2005 (f) 2,250
-------------
19,814,820
====================================================================================
Broadcasting--7.1%
5,000,000 Canadian Satellite Radio Holdings, Inc.,
12.75% due 2/15/2014 (d) 5,100,000
1,354,286 Emmis Communications Corp., 10.366%
due 6/15/2012 (a) 1,354,286
6,000,000 Granite Broadcasting Corp., 9.75%
due 12/01/2010 5,430,000
1,100,000 LIN Television Corp. Series B, 6.50%
due 5/15/2013 1,043,625
Paxson Communications Corp. (a)(d):
2,800,000 7.777% due 1/15/2012 2,800,000
5,625,000 10.777% due 1/15/2013 5,442,188
3,235,000 Sinclair Broadcast Group, Inc. Class A,
4.875% due 7/15/2018 (k) 2,802,319
13,300,000 Sirius Satellite Radio, Inc., 9.625% due 8/01/2013 13,034,000
11,250,000 XM Satellite Radio, Inc., 9.75%
due 5/01/2009 (a) 11,404,688
2,000,000 Young Broadcasting Inc., 10% due 3/01/2011 1,787,500
-------------
50,198,606
====================================================================================
Cable--International--1.2%
750,000 NTL Cable Plc, 8.75% due 4/15/2014 765,000
New Skies Satellites NV:
3,500,000 9.573% due 11/01/2011 (a)(d) 3,613,750
3,700,000 9.125% due 11/01/2012 3,977,500
-------------
8,356,250
====================================================================================
Cable--U.S.--8.1%
7,500,000 Adelphia Communications Corp., 6%
due 2/15/2006 (f)(k) 187,500
3,450,000 CSC Holdings, Inc., 7.25% due 7/15/2008 3,493,125
4,225,000 Cablevision Systems Corp. Series B, 8.716%
due 4/01/2009 (a) 4,367,594
Charter Communications Holdings LLC:
3,750,000 10% due 4/01/2009 2,887,500
2,000,000 11.75% due 1/15/2010 1,400,000
2,000,000 11.125% due 1/15/2011 1,070,000
2,700,000 9.92% due 4/01/2011 1,377,000
3,000,000 10% due 5/15/2011 1,500,000
2,500,000 Insight Midwest, LP, 9.75% due 10/01/2009 2,581,250
Intelsat Bermuda Ltd. (d):
3,825,000 9.609% due 1/15/2012 (a) 3,901,500
3,375,000 8.25% due 1/15/2013 3,450,937
4,800,000 8.625% due 1/15/2015 4,980,000
1,023,000 Loral Spacecom Corp., 14% due 10/15/2015 (b) 1,222,485
2,350,000 Mediacom Broadband LLC, 11% due 7/15/2013 2,514,500
3,875,000 Mediacom LLC, 9.50% due 1/15/2013 3,875,000
10,000,000 Rainbow National Services LLC, 10.375%
due 9/01/2014 (d) 11,312,500
10,350,000 Zeus Special Subsidiary Ltd., 9.25%
due 2/01/2015 (c)(d) 7,089,750
-------------
57,210,641
====================================================================================
Chemicals--12.6%
3,550,000 ArCo Chemical Co., 9.80% due 2/01/2020 3,905,000
4,000,000 Compass Minerals International, Inc. Series B,
12% due 6/01/2013 (c) 3,560,000
9,783,000 GEO Specialty Chemicals, Inc., 13.036%
due 12/31/2009 (k) 8,413,380
Huntsman International, LLC:
1,900,000 9.875% due 3/01/2009 1,990,250
1,199,000 10.125% due 7/01/2009 1,228,975
1,500,000 Innophos, Inc., 8.875% due 8/15/2014 (d) 1,545,000
6,000,000 Invista B.V., 9.25% due 5/01/2012 (d) 6,375,000
2,400,000 Millennium America, Inc., 7.625%
due 11/15/2026 2,160,000
18,000,000 Nova Chemicals Corp., 7.561%
due 11/15/2013 (a) 18,360,000
10,000,000 Omnova Solutions, Inc., 11.25% due 6/01/2010 10,525,000
5,025,101 PCI Chemicals Canada, Inc., 10% due 12/31/2008 5,263,793
PolyOne Corp.:
2,500,000 6.89% due 9/22/2008 2,393,750
10,700,000 10.625% due 5/15/2010 11,475,750
Rockwood Specialties Group, Inc.:
2,612,000 10.625% due 5/15/2011 2,873,200
450,000 7.50% due 11/15/2014 454,500
6,000,000 Tronox Worldwide LLC, 9.50% due 12/01/2012 (d) 6,270,000
2,000,000 VeraSun Energy Corp., 9.875% due 12/15/2012 (d) 2,130,000
-------------
88,923,598
====================================================================================
Consumer--Durables--2.4%
10,750,000 Sealy Mattress Co., 8.25% due 6/15/2014 11,233,750
10,000,000 Simmons Co., 10.207% due 12/15/2014 (c) 6,000,000
-------------
17,233,750
====================================================================================
Consumer--Non-Durables--1.4%
9,000,000 Hines Nurseries, Inc., 10.25% due 10/01/2011 8,988,750
4,000,000 North Atlantic Holding Co., Inc., 12.25%
due 3/01/2014 (c) 840,000
-------------
9,828,750
====================================================================================
Diversified Media--3.9%
2,350,000 AMC Entertainment, Inc., 11% due 2/01/2016 (d) 2,364,688
2,000,000 Cadmus Communications Corp., 8.375%
due 6/15/2014 2,030,000
7,500,000 Liberty Media Corp., 0.75% due 3/30/2023 (k) 8,025,000
1,800,000 Loews Cineplex Entertainment Corp., 8.875%
due 8/01/2008 (i) 0
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 7
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Corporate Bonds Value
====================================================================================
Diversified Media (concluded)
$ 2,675,000 Muzak Holdings, LLC, 13% due 3/15/2010 $ 464,781
3,875,000 NBC Acquisition Corp., 11% due 3/15/2013 (c) 2,751,250
RH Donnelley Corp. (d):
1,200,000 6.875% due 1/15/2013 1,128,000
2,725,000 8.875% due 1/15/2016 2,844,219
2,375,000 Series A-2, 6.875% due 1/15/2013 2,232,500
Universal City Florida Holding Co. I:
375,000 8.375% due 5/01/2010 374,063
5,300,000 9.43% due 5/01/2010 (a) 5,379,500
-------------
27,594,001
====================================================================================
Energy--Exploration & Production--1.2%
3,000,000 Chaparral Energy, Inc., 8.50%
due 12/01/2015 (d) 3,172,500
5,500,000 Compton Petroleum Finance Corp.,
7.625% due 12/01/2013 5,623,750
-------------
8,796,250
====================================================================================
Energy--Other--3.3%
6,150,000 Aventine Renewable Energy Holdings, Inc.,
10.491% due 12/15/2011 (a)(d) 6,488,250
1,000,000 Dresser, Inc., 9.375% due 4/15/2011 1,050,000
2,045,000 Dresser-Rand Group, Inc., 7.375%
due 11/01/2014 (d) 2,126,800
6,950,000 SemGroup LP, 8.75% due 11/15/2015 (d) 7,193,250
6,250,000 Star Gas Partners LP, 10.25% due 2/15/2013 6,328,125
-------------
23,186,425
====================================================================================
Financial--1.0%
5,743,690 Archimedes Funding III Ltd., 5.50%
due 11/29/2011 (a)(d) 4,250,331
1,500,000 Investcorp SA, 7.54% due 10/21/2008 1,521,027
2,000,000 Pennant CBO Ltd., 13.43% due 3/14/2011 (d) 1,240,000
-------------
7,011,358
====================================================================================
Food & Drug--0.2%
1,000,000 Stripes Acquisition LLC, 10.625%
due 12/15/2013 (d) 1,045,000
====================================================================================
Food & Tobacco--0.4%
842,946 Archibald Candy Corp., 10% due 11/01/2007 (i) 53,687
1,175,000 Doane Pet Care Co., 10.75% due 3/01/2010 1,264,594
28,918,000 New World Pasta Co., 9.25% due 2/15/2009 (i) 1,735,080
-------------
3,053,361
====================================================================================
Gaming--3.7%
Galaxy Entertainment Finance Co. Ltd. (d):
9,250,000 9.655% due 12/15/2010 (a) 9,550,625
1,250,000 9.875% due 12/15/2012 1,293,750
5,250,000 Inn of the Mountain Gods Resort & Casino,
12% due 11/15/2010 5,545,312
2,000,000 Jacobs Entertainment, Inc., 11.875%
due 2/01/2009 2,110,000
3,275,000 Little Traverse Bay Bands of Odawa Indians,
10.25% due 2/15/2014 (d) 3,234,062
1,725,000 Penn National Gaming, Inc., 6.75%
due 3/01/2015 1,733,625
3,000,000 Tunica-Biloxi Gaming Authority, 9%
due 11/15/2015 (d) 3,075,000
-------------
26,542,374
====================================================================================
Health Care--4.2%
3,525,000 CDRV Investors, Inc., 9.75% due 1/01/2015 (c) 2,414,625
5,000,000 Cinacalcet Royalty Corp., 8% due 3/30/2017 (d) 5,150,000
Elan Finance Plc:
3,525,000 7.75% due 11/15/2011 3,278,250
4,825,000 8.749% due 11/15/2011 (a) 4,668,187
5,000,000 Risperdal Consta Pharma, 7% due 1/01/2018 4,550,000
6,000,000 Tenet Healthcare Corp., 7.375% due 2/01/2013 5,505,000
1,400,000 VWR International, Inc., 8% due 4/15/2014 1,400,000
4,100,000 Vanguard Health Holding Co. I, LLC, 11.25%
due 10/01/2015 (c) 3,034,000
-------------
30,000,062
====================================================================================
Housing--2.9%
Compression Polymers Corp. (d):
2,000,000 11.44% due 7/01/2012 (a) 2,000,000
1,300,000 10.50% due 7/01/2013 1,306,500
460,013 Formica Holdings Corp., 8.76% due 6/10/2011 437,012
Goodman Global Holding Co., Inc. (d):
3,190,000 7.491% due 6/15/2012 (a) 3,245,825
8,200,000 7.875% due 12/15/2012 8,015,500
2,500,000 Nortek, Inc., 8.50% due 9/01/2014 2,493,750
2,250,000 Stanley-Martin Communities, 9.75%
due 8/15/2015 (d) 2,013,750
700,000 US Concrete, Inc., 8.375% due 4/01/2014 717,500
-------------
20,229,837
====================================================================================
Information Technology--7.2%
Activant Solutions, Inc. (a)(d):
1,600,000 10.53% due 4/01/2010 1,640,000
4,500,000 13.036% due 10/01/2011 (b) 4,612,500
6,950,000 Amkor Technology, Inc., 9.25% due 2/15/2008 7,054,250
5,000,000 Cypress Semiconductor Corp., 1.25%
due 6/15/2008 (k) 6,462,500
4,725,000 Freescale Semiconductor, Inc., 7.35%
due 7/15/2009 (a) 4,843,125
MagnaChip Semiconductor SA:
1,375,000 7.741% due 12/15/2011 (a) 1,395,625
1,050,000 8% due 12/15/2014 1,013,250
Sungard Data Systems, Inc. (d):
7,075,000 9.125% due 8/15/2013 7,526,031
3,825,000 9.431% due 8/15/2013 (a) 4,035,375
4,818,000 10.25% due 8/15/2015 5,052,878
2,925,000 Telcordia Technologies Inc., 10%
due 3/15/2013 (d) 2,691,000
5,075,000 Viasystems, Inc., 10.50% due 1/15/2011 4,872,000
-------------
51,198,534
====================================================================================
Leisure--2.0%
12,000,000 FelCor Lodging LP, 8.83% due 6/01/2011 (a) 12,480,000
2,000,000 True Temper Sports, Inc., 8.375% due 9/15/2011 1,800,000
-------------
14,280,000
====================================================================================
Manufacturing--4.6%
4,000,000 CPI Holdco, Inc., 10.561% due 2/01/2015 (a)(d) 4,140,000
2,000,000 Chart Industries, Inc., 9.125% due 10/15/2015 (d) 2,070,000
4,525,000 EaglePicher Inc., 9.75% due 9/01/2013 (i) 3,144,875
5,875,000 Invensys Plc, 9.875% due 3/15/2011 (d) 6,080,625
4,899,000 Medis Technologies Ltd., 6% due 7/15/2010 (d)(k) 5,388,900
7,725,000 Mueller Group, Inc., 10% due 5/01/2012 8,458,875
600,000 NMHG Holding Co., 10% due 5/15/2009 633,000
3,000,000 Propex Fabrics, Inc., 10% due 12/01/2012 2,670,000
-------------
32,586,275
====================================================================================
8 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Corporate Bonds Value
====================================================================================
Metal--Other--2.8%
$ 1,100,000 Aleris International, Inc., 9% due 11/15/2014 $ 1,160,500
5,000,000 Indalex Holding Corp., 11.50% due 2/01/2014 (d) 4,900,000
8,500,000 James River Coal Co., 9.375% due 6/01/2012 8,861,250
4,550,000 RathGibson, Inc., 11.25% due 2/15/2014 (d) 4,606,875
-------------
19,528,625
====================================================================================
Packaging--4.2%
Anchor Glass Container Corp.:
9,053,000 11.491% due 9/30/2006 9,234,060
11,905,000 11.497% due 2/15/2013 (i) 9,524,000
1,100,000 Graham Packing Co., Inc., 9.875% due 10/15/2014 1,116,500
20,525,000 Pliant Corp., 13% due 6/01/2010 (i) 5,028,625
6,575,000 Wise Metals Group LLC, 10.25% due 5/15/2012 5,029,875
-------------
29,933,060
====================================================================================
Paper--8.5%
6,500,000 Abitibi-Consolidated, Inc., 7.991%
due 6/15/2011 (a) 6,321,250
6,025,000 Ainsworth Lumber Co. Ltd., 8.277%
due 10/01/2010 (a) 5,964,750
Boise Cascade LLC:
2,150,000 7.475% due 10/15/2012 (a) 2,139,250
900,000 7.125% due 10/15/2014 855,000
7,600,000 Bowater, Inc., 7.491% due 3/15/2010 (a) 7,600,000
3,775,000 Domtar, Inc., 7.125% due 8/15/2015 3,161,562
2,000,000 Graphic Packaging International Corp.,
9.50% due 8/15/2013 1,900,000
JSG Funding Plc:
2,000,000 9.625% due 10/01/2012 2,095,000
6,125,000 7.75% due 4/01/2015 5,573,750
NewPage Corp.:
8,000,000 10.93% due 5/01/2012 (a) 8,400,000
4,725,000 12% due 5/01/2013 4,843,125
1,600,000 Smurfit-Stone Container Enterprises, Inc.,
8.375% due 7/01/2012 1,568,000
3,450,000 Tembec Industries, Inc., 8.625% due 6/30/2009 1,914,750
7,281,000 Western Forest Products, Inc., 15%
due 7/28/2009 (b)(d) 8,085,621
-------------
60,422,058
====================================================================================
Retail--1.6%
Neiman-Marcus Group, Inc. (d):
6,000,000 9% due 10/15/2015 6,337,500
5,000,000 10.375% due 10/15/2015 5,262,500
-------------
11,600,000
====================================================================================
Service--4.3%
1,440,000 Allied Waste North America, Inc., 7.875%
due 4/15/2013 1,497,600
2,000,000 Buhrmann US, Inc., 7.875% due 3/01/2015 1,995,000
1,250,000 Corrections Corp. of America, 6.75%
due 1/31/2014 1,271,875
7,500,000 HydroChem Industrial Services, Inc., 9.25%
due 2/15/2013 (d) 7,425,000
3,000,000 Neff Rental LLC, 11.25% due 6/15/2012 (d) 3,255,000
14,825,000 United Rentals North America, Inc., 7.75%
due 11/15/2013 (d) 14,880,594
-------------
30,325,069
====================================================================================
Telecommunications--6.6%
5,000,000 ADC Telecommunications, Inc., 5.045%
due 6/15/2013 (a)(k) 5,431,250
7,500,000 Cincinnati Bell, Inc., 8.375% due 1/15/2014 7,575,000
7,900,000 Qwest Communications International, Inc.,
8.249% due 2/15/2009 (a) 8,067,875
2,675,000 Qwest Corp., 7.741% due 6/15/2013 (a)(d) 2,922,438
Terremark Worldwide, Inc. (k):
4,475,000 9% due 6/15/2009 3,982,750
6,000,000 9% due 6/15/2009 (d) 5,340,000
Time Warner Telecom Holdings, Inc.:
7,000,000 8.749% due 2/15/2011 (a) 7,148,750
6,000,000 9.25% due 2/15/2014 6,472,500
-------------
46,940,563
====================================================================================
Thrifts & Mortgage Finance--0.1%
SKM-LibertyView CBO Ltd. Series 1A (d)(i):
1,500,000 Class C1, 8.71% due 4/10/2011 525,000
1,000,000 Class D,11.91% due 4/10/2011 15,000
-------------
540,000
====================================================================================
Transportation--0.9%
3,000,000 Progress Rail Services Corp., 7.75%
due 4/01/2012 (d) 3,071,250
3,500,000 Titan Petrochemicals Group Ltd., 8.50%
due 3/18/2012 (d) 3,307,500
-------------
6,378,750
====================================================================================
Utility--2.0%
4,142,000 Centerpoint Energy, Inc. Series B, 3.75%
due 5/15/2023 (k) 4,856,495
NRG Energy, Inc.:
4,475,000 7.25% due 2/01/2014 4,586,875
3,025,000 7.375% due 2/01/2016 3,115,750
1,425,000 Williams Cos., Inc., 8.625% due 6/01/2010 1,508,719
-------------
14,067,839
====================================================================================
Wireless Communications--2.5%
Dobson Cellular Systems:
1,750,000 8.375% due 11/01/2011 1,855,000
4,675,000 9.43% due 11/01/2011 (a) 4,862,000
2,500,000 iPCS Escrow Co., 11.50% due 5/01/2012 2,868,750
1,600,000 Rural Cellular Corp., 8.991% due 3/15/2010 (a) 1,632,000
6,600,000 US Unwired, Inc., 8.741% due 6/15/2010 (a) 6,798,000
-------------
18,015,750
------------------------------------------------------------------------------------
Total Corporate Bonds
(Cost--$795,078,523)--107.9% 764,519,181
====================================================================================
Floating Rate Loan Interests**
====================================================================================
Airlines--0.4%
1,000,000 Delta Air Lines, Inc. Term Loan B, 11.01%
due 3/27/2008 1,039,750
1,750,000 United Air Lines Term Loan B, 8.625%
due 2/01/2012 1,782,375
-------------
2,822,125
====================================================================================
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 9
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Floating Rate Loan Interests** Value
====================================================================================
Automotive--1.6%
$ 7,775,042 Delphi Automotive Systems Term Loan B,
13% due 6/14/2011 $ 8,208,337
Tenneco Automotive, Inc.:
2,185,236 Term Loan B, 7.02% due 12/12/2010 2,219,380
959,936 Tranche B-1 Credit Linked Deposit,
6.82% due 12/12/2010 974,935
-------------
11,402,652
====================================================================================
Cable--U.S.--6.7%
10,000,000 Adelphia Communications Corp. Term Loan B,
9.50% due 6/30/2009 9,829,170
7,000,000 Century Cable Holdings LLC Discretionary
Term Loan, 10.50% due 12/31/2009 6,860,000
14,756,654 Charter Communications Operating LLC Tranche B
Term Loan, 7.86% - 7.92% due 4/07/2011 14,943,281
7,840,000 Insight Midwest Holdings LLC Term Loan C,
6.563% due 12/31/2009 7,958,494
667,652 New Skies Satellites, BV Term Loan,
6.75% due 5/04/2011 672,239
Olympus Cable Holdings LLC:
6,000,000 Term Loan B, 9.50% due 9/30/2010 5,910,534
1,500,000 Tranche 2 Term Loan A, 9.50% due 6/30/2010 1,469,883
-------------
47,643,601
====================================================================================
Chemicals--2.0%
2,946,952 Huntsman ICI Holdings Term Loan B, 6.32%
due 8/16/2012 2,967,672
3,168,000 Rockwood Specialties Group, Inc. Tranche D
Term Loan, 6.668% due 12/10/2012 3,212,552
8,000,000 Wellman, Inc. Second Lien Term Loan, 11.43%
due 2/10/2010 8,210,000
-------------
14,390,224
====================================================================================
Consumer--Durables--0.7%
5,000,000 Simmons Co. Term Loan, 8.50% due 6/19/2012 5,067,970
====================================================================================
Consumer--Non-Durables--1.4%
9,775,000 Levi Strauss & Co. Tranche A Term Loan,
11.445% - 11.525% due 9/29/2009 10,034,653
====================================================================================
Energy--Other--0.8%
Dresser, Inc.:
377,915 Term Loan C, 7.11% due 4/10/2009 384,528
2,500,000 Term Loan Unsecured, 7.99% due 2/25/2010 2,568,750
3,000,000 Scorpion Drilling Ltd. Second Lien Term Loan,
12.07% due 5/05/2015 3,097,500
-------------
6,050,778
====================================================================================
Financial--0.4%
2,716,310 LNR Property Corp. Tranche B Term Loan,
7.75% due 2/03/2008 2,744,323
====================================================================================
Food & Tobacco--1.1%
1,000,000 Bolthouse Farms, Inc. Second Lien Term Loan,
10.07% due 12/01/2013 1,026,250
2,967,500 Commonwealth Brands Term Loan, 7%
due 12/22/2012 3,006,448
3,564,111 Dr. Pepper/Seven Up Bottling Group, Inc.
Term Loan B, 6.57% due 12/19/2010 3,617,573
-------------
7,650,271
====================================================================================
Health Care--1.2%
4,500,000 HealthSouth Corp. Term Loan A, 10.375%
due 1/16/2011 5,156,249
3,032,204 Medpointe Healthcare Inc. Tranche B Term Loan,
9.86% due 9/30/2008 3,032,204
-------------
8,188,453
====================================================================================
Housing--2.0%
4,672,338 Headwaters, Inc. Term Loan B-1,
6.43% - 6.86% due 4/30/2011 4,711,272
10,000,000 Stile U.S. Acquisition Corp. Bridge Loan,
10.884% due 4/06/2015 9,250,000
-------------
13,961,272
====================================================================================
Information Technology--0.9%
3,080,000 Fidelity National Information Solutions, Inc.
Term Loan B, 6.32% due 3/09/2013 3,105,385
3,349,688 Telcordia Technologies, Inc. Term Loan,
7.22% - 7.31% due 9/15/2012 3,318,284
-------------
6,423,669
====================================================================================
Manufacturing--0.7%
5,000,000 Invensys International Holdings Ltd. Second Lien
Term Loan, 9.431% due 12/04/2009 5,112,500
====================================================================================
Metal--Other--1.2%
Euramax International Plc:
1,989,474 Second Lien Term Loan, 11.544%
due 6/29/2013 1,914,868
2,551,265 Tranche 3 Term Loan B, 7.241%
due 6/29/2012 2,557,643
4,010,526 Tranche 4 Second Lien Term Loan,
11.544% due 6/29/2013 3,860,132
-------------
8,332,643
====================================================================================
Packaging--1.0%
6,774,814 Owens-Illinois Group, Inc. Tranche Term Loan C,
6.39% due 4/01/2008 6,819,277
====================================================================================
Service--0.7%
Waste Services, Inc. Term Loan B:
3,930,000 7.61% - 7.82% due 3/31/2011 3,981,581
1,125,000 7.83% due 3/31/2011 1,139,063
-------------
5,120,644
====================================================================================
Steel--0.0%
7,711,830 Acme Metals, Inc., Term Loan, 11.75% - 12.25%
due 12/01/2005 (f) 0
====================================================================================
Telecommunications--0.6%
3,161,871 Winstar Communications Debtor In Possession,
6.366% due 12/31/2006 (i) 4,149,957
====================================================================================
Utility--1.3%
5,000,000 Covanta Energy Corp. Second Lien Term Loan,
10.019% - 10.081% due 6/24/2013 5,093,750
El Paso Corp.:
1,500,000 Deposit Account, 4.29% due 11/23/2009 1,516,041
2,450,000 Term Loan, 7.313% due 11/23/2009 2,481,475
-------------
9,091,266
====================================================================================
10 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Schedule of Investments (continued) (in U.S. dollars)
Face
Amount Floating Rate Loan Interests** Value
====================================================================================
Wireless Communications--0.8%
$ 5,500,000 Centennial Cellular Operating Co. Term Loan,
6.45% - 7.23% due 2/09/2011 $ 5,580,971
------------------------------------------------------------------------------------
Total Floating Rate Loan Interests
(Cost--$178,416,556)--25.5% 180,587,249
====================================================================================
Shares
Held Common Stocks
====================================================================================
Cable--U.S.--0.6%
141,880 Loral Space & Communications Ltd. (j) 3,826,504
====================================================================================
Chemicals--0.2%
339,340 GEO Specialty Chemicals, Inc. (j) 1,527,030
====================================================================================
Energy--Other--0.5%
118,013 Trico Marine Services, Inc. (j) 3,437,719
====================================================================================
Financial--0.3%
35,000 Preferred Term Securities VI (d) 2,345,000
====================================================================================
Food & Tobacco--0.6%
1,428,423 Viskase Cos., Inc. (j) 4,285,269
====================================================================================
Leisure--0.1%
27,787 Lodgian, Inc. (j) 348,449
====================================================================================
Manufacturing--0.2%
724,291 ACP Holding Co. (d)(j) 1,267,509
====================================================================================
Paper--0.0%
211,149 Western Forest Products, Inc. (j) 315,439
====================================================================================
Service--0.5%
90,876 Outsourcing Solutions Inc. (j) 3,453,279
====================================================================================
Steel--0.0%
41,149 Acme Package Corp. Senior Holdings (j)(l) 0
------------------------------------------------------------------------------------
Total Common Stocks
(Cost--$18,251,855)--3.0% 20,806,198
====================================================================================
Preferred Stocks
====================================================================================
Automotive--0.5%
200,000 General Motors Corp. Series C, 6.25% (d)(k) 3,320,000
====================================================================================
Broadcasting--0.0%
2 Paxson Communications Corp., 9.75% (b)(d)(k) 11,851
====================================================================================
Cable--U.S.--0.2%
5,000 Adelphia Communications Corp. Series B, 13% (j) 1,250
8,953 Loral Spacecom Corp. Series A, 12% (d)(j) 1,772,694
-------------
1,773,944
------------------------------------------------------------------------------------
Total Preferred Stocks
(Cost--$7,130,285)--0.7% 5,105,795
====================================================================================
Warrants (g)
====================================================================================
Broadcasting--0.0%
15,000 Sirius Satellite Radio, Inc. (expires 5/15/2009) 7,500
====================================================================================
Health Care--0.0%
126,761 HealthSouth Corp. (expires 1/16/2014) 316,903
====================================================================================
Manufacturing--0.2%
652,738 ACP Holding Co. (expires 9/30/2013) 1,142,293
====================================================================================
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 Communications--0.1%
1,325 American Tower Corp. (expires 8/01/2008) 593,905
------------------------------------------------------------------------------------
Total Warrants
(Cost--$870,754)--0.3% 2,130,601
====================================================================================
Rights
====================================================================================
Paper--0.0%
211,149 Western Forest Products, Inc. (h) 3,711
------------------------------------------------------------------------------------
Total Rights
(Cost--$0)--0.0% 3,711
====================================================================================
Beneficial
Interest Other Interests (e)
====================================================================================
Airlines--0.2%
$ 2,641,443 US Airways Group, Inc. (Certificate of
Beneficial Interest) 1,162,235
====================================================================================
Automotive--0.0%
3,614,601 Cambridge Industries, Inc. (Litigation Trust
Certificates) (j) 36,146
====================================================================================
Cable--U.S.--0.1%
6,375,000 Loral Cyberstar Escrow (j) 64
9,500,000 Pegasus Satellite Communications, Inc.
(Litigation Trust Certificates) (j) 961,875
-------------
961,939
------------------------------------------------------------------------------------
Total Other Interests
(Cost--$2,153,867)--0.3% 2,160,320
====================================================================================
Total Investments (Cost--$1,001,901,840*)--137.7% 975,313,055
Liabilities in Excess of Other Assets--(37.7%) (266,902,114)
-------------
Net Assets--100.0% $ 708,410,941
=============
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 11
Schedule of Investments (concluded) (in U.S. dollars)
* The cost and unrealized appreciation (depreciation) of investments as of
February 28, 2006, as computed for federal income tax purposes, were as
follows:
Aggregate cost ............................. $ 1,001,645,143
===============
Gross unrealized appreciation .............. $ 42,565,951
Gross unrealized depreciation .............. (68,898,039)
---------------
Net unrealized depreciation ................ $ (26,332,088)
===============
** Floating rate loan interests in which the Fund invests generally pay
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.
(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) As a result of bankruptcy proceedings, the company did not repay the
principal amount of the security upon maturity and is non-income
producing.
(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) The rights may be exercised until 3/09/2006.
(i) Non-income producing security; issuer filed for bankruptcy or is in
default of interest payments.
(j) Non-income producing security.
(k) Convertible security.
(l) Restricted securities as to resale, representing 0.0% of net assets, were
as follows:
--------------------------------------------------------------------------
Acquisition
Issue Date Cost Value
--------------------------------------------------------------------------
Acme Package Corp.
Senior Holdings 11/25/2002 -- --
--------------------------------------------------------------------------
o For Fund compliance purposes, the Fund's industry classifications refer to
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. These industry
classifications are unaudited.
o Investments in companies considered to be an affiliate of the Fund, for
purposes of Section 2(a)(3) of the Investment Company Act of 1940, were as
follows:
--------------------------------------------------------------------------
Net
Affiliate Activity Interest
--------------------------------------------------------------------------
Merrill Lynch Liquidity Series, LLC
Cash Sweep Series I $ (203,682) $ 43,977
--------------------------------------------------------------------------
o Swaps outstanding as of February 28, 2006 were as follows:
Notional Unrealized
Amount Depreciation
--------------------------------------------------------------------------------
Sold credit default protection on General Motors
Corp. and receive 5%
Broker, Citibank N.A.
Expires December 2006 $8,000,000 $ (78,639)
Sold credit default protection on General Motors
Corp. and receive 5%
Broker, Lehman Brothers Special Finance
Expires December 2006 $7,000,000 (30,125)
--------------------------------------------------------------------------------
Total $(108,764)
=========
See Notes to Financial Statements.
12 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Statement of Assets, Liabilities and Capital
As of February 28, 2006
===================================================================================================================================
Assets
-----------------------------------------------------------------------------------------------------------------------------------
Investments in unaffiliated securities, at value
(identified cost--$1,001,901,840) ................................. $ 975,313,055
Unfunded loan commitment ........................................... 14,062
Receivables:
Interest ........................................................ $ 15,521,089
Securities sold ................................................. 2,603,934
Swaps ........................................................... 147,916
Principal paydowns .............................................. 33,532
Commitment fees ................................................. 3,174 18,309,645
-------------
Prepaid expenses and other assets .................................. 53,273
-------------
Total assets ....................................................... 993,690,035
-------------
===================================================================================================================================
Liabilities
-----------------------------------------------------------------------------------------------------------------------------------
Loans .............................................................. 259,900,000
Unrealized depreciation on swaps ................................... 108,764
Swap premiums received ............................................. 840,000
Bank overdraft ..................................................... 7,047,466
Payables:
Securities purchased ............................................ 16,733,348
Investment adviser .............................................. 372,196
Interest on loans ............................................... 141,360
Other affiliates ................................................ 6,020 17,252,924
-------------
Accrued expenses ................................................... 129,940
-------------
Total liabilities .................................................. 285,279,094
-------------
===================================================================================================================================
Net Assets
-----------------------------------------------------------------------------------------------------------------------------------
Net assets ......................................................... $ 708,410,941
=============
===================================================================================================================================
Capital
-----------------------------------------------------------------------------------------------------------------------------------
Common Stock, $.10 par value, 200,000,000 shares authorized ........ $ 10,582,322
Paid-in capital in excess of par ................................... 1,053,466,024
Undistributed investment income--net ............................... $ 5,020,714
Accumulated realized capital losses--net ........................... (333,974,632)
Unrealized depreciation--net ....................................... (26,683,487)
-------------
Total accumulated losses--net ...................................... (355,637,405)
-------------
Total capital--Equivalent to $6.69 per share based on
105,823,219 shares of capital stock outstanding
(market price--$6.77) ............................................. $ 708,410,941
=============
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 13
Statement of Operations
For the Year Ended February 28, 2006
===================================================================================================================================
Investment Income
-----------------------------------------------------------------------------------------------------------------------------------
Interest (including $43,977 from affiliates) ....................... $ 83,229,068
Dividends .......................................................... 1,249,691
Facility and other fees ............................................ 1,016,039
-------------
Total income ....................................................... 85,494,798
-------------
===================================================================================================================================
Expenses
-----------------------------------------------------------------------------------------------------------------------------------
Loan interest expense .............................................. $ 11,314,912
Investment advisory fees ........................................... 5,978,234
Borrowing costs .................................................... 397,430
Accounting services ................................................ 236,241
Professional fees .................................................. 114,160
Transfer agent fees ................................................ 112,693
Listing fees ....................................................... 76,885
Printing and shareholder reports ................................... 58,936
Custodian fees ..................................................... 54,103
Directors' fees and expenses ....................................... 44,375
Pricing services ................................................... 25,540
Other .............................................................. 44,631
-------------
Total expenses ..................................................... 18,458,140
-------------
Investment income--net ............................................. 67,036,658
-------------
===================================================================================================================================
Realized & Unrealized Gain (Loss)--Net
-----------------------------------------------------------------------------------------------------------------------------------
Realized gain (loss) on:
Investments--net ................................................ (4,739,365)
Swaps--net ...................................................... 518,749 (4,220,616)
-------------
Change in unrealized appreciation/depreciation on:
Investments--net ................................................ (33,074,834)
Swaps--net ...................................................... (108,764)
Unfunded corporate loans--net ................................... 36,694 (33,146,904)
-----------------------------------
Total realized and unrealized loss--net ............................ (37,367,520)
-------------
Net Increase in Net Assets Resulting from Operations ............... $ 29,669,138
=============
See Notes to Financial Statements.
14 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Statements of Changes in Net Assets
For the Year Ended
February 28,
-----------------------------------
Increase (Decrease) in Net Assets: 2006 2005
===================================================================================================================================
Operations
-----------------------------------------------------------------------------------------------------------------------------------
Investment income--net ............................................. $ 67,036,658 $ 70,429,602
Realized loss--net ................................................. (4,220,616) (553,188)
Change in unrealized appreciation/depreciation--net ................ (33,146,904) 35,909,565
-----------------------------------
Net increase in net assets resulting from operations ............... 29,669,138 105,785,979
-----------------------------------
===================================================================================================================================
Dividends to Shareholders
-----------------------------------------------------------------------------------------------------------------------------------
Dividends to shareholders from investment income--net .............. (68,179,612) (69,339,355)
-----------------------------------
===================================================================================================================================
Capital Share Transactions
-----------------------------------------------------------------------------------------------------------------------------------
Value of shares issued to Common Stock shareholders in
reinvestment of dividends ......................................... 1,665,334 2,548,243
-----------------------------------
Net increase in net assets resulting from capital share
transactions ...................................................... 1,665,334 2,548,243
-----------------------------------
===================================================================================================================================
Net Assets
-----------------------------------------------------------------------------------------------------------------------------------
Total increase (decrease) in net assets ............................ (36,845,140) 38,994,867
Beginning of year .................................................. 745,256,081 706,261,214
-----------------------------------
End of year* ....................................................... $ 708,410,941 $ 745,256,081
===================================
* Undistributed investment income--net .......................... $ 5,020,714 $ 5,053,712
===================================
See Notes to Financial Statements.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 15
Statement of Cash Flows
For the Year Ended February 28, 2006
===================================================================================================================================
Cash Provided by Operating Activities
-----------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets resulting from operations .................................. $ 29,669,138
Adjustments to reconcile net increase in net assets
resulting from operations to net cash
provided by operating activities:
Increase in receivables ............................................................ (683,601)
Decrease in prepaid expenses and other assets ...................................... 171,881
Increase in other liabilities ...................................................... 57,330
Realized and unrealized loss--net .................................................. 37,367,520
Amortization of premium and discount ............................................... (5,217,713)
Proceeds from sales and paydowns of long-term securities .............................. 465,069,146
Other investment related transactions ................................................. 6,018,118
Purchases of long-term securities ..................................................... (438,641,356)
Proceeds from sales of short-term investments--net .................................... 203,682
-------------
Net cash provided by operating activities ............................................. 94,014,145
-------------
===================================================================================================================================
Cash Used for Financing Activities
-----------------------------------------------------------------------------------------------------------------------------------
Cash receipts from borrowings ......................................................... 386,300,000
Cash payments on borrowings ........................................................... (424,800,000)
Dividends paid to shareholders ........................................................ (66,857,544)
Increase in bank overdraft ............................................................ 7,047,466
-------------
Net cash used for financing activities ................................................ (98,310,078)
-------------
===================================================================================================================================
Cash
-----------------------------------------------------------------------------------------------------------------------------------
Net decrease in cash .................................................................. (4,295,933)
Cash at beginning of year ............................................................. 4,295,933
-------------
Cash at end of year ................................................................... $ --
=============
===================================================================================================================================
Cash Flow Information
-----------------------------------------------------------------------------------------------------------------------------------
Cash paid for interest ................................................................ $ 11,265,674
=============
===================================================================================================================================
Non-Cash Financing Activities
-----------------------------------------------------------------------------------------------------------------------------------
Capital shares issued on reinvestment of dividends to shareholders .................... $ 1,665,334
=============
See Notes to Financial Statements.
16 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Financial Highlights
For the Year Ended For the For the Year Ended
February 28, Year Ended February 28,
The following per share data and ratios have been derived ------------------ February 29, ------------------
from information provided in the financial statements. 2006 2005 2004 2003 2002
==================================================================================================================================
Per Share Operating Performance
----------------------------------------------------------------------------------------------------------------------------------
Net asset value, beginning of year ...................... $ 7.06 $ 6.71 $ 5.35 $ 6.03 $ 7.53
------------------------------------------------------
Investment income--net** ................................ .63 .67 .75 .79 .92
Realized and unrealized gain (loss)--net ................ (.35) .34 1.40 (.68) (1.49)
------------------------------------------------------
Total from investment operations ........................ .28 1.01 2.15 .11 (.57)
------------------------------------------------------
Less dividends from investment income--net .............. (.65) (.66) (.79) (.79) (.93)
------------------------------------------------------
Recovery of previously expensed offering costs
(capital write-off) resulting from the issuance of
Common Stock ......................................... -- -- --+ -- --+
------------------------------------------------------
Net asset value, end of year ............................ $ 6.69 $ 7.06 $ 6.71 $ 5.35 $ 6.03
======================================================
Market price per share, end of year ..................... $ 6.77 $ 6.71 $ 6.69 $ 5.99 $ 6.57
======================================================
==================================================================================================================================
Total Investment Return*
----------------------------------------------------------------------------------------------------------------------------------
Based on net asset value per share ...................... 4.57% 15.95% 41.84% 2.04% (7.89%)
======================================================
Based on market price per share ......................... 11.34% 10.53% 26.31% 4.85% 5.69%
======================================================
==================================================================================================================================
Ratios to Average Net Assets
----------------------------------------------------------------------------------------------------------------------------------
Expenses, excluding interest expense .................... 1.02% 1.02% 1.00% 1.07% 1.04%
======================================================
Expenses ................................................ 2.63% 1.83% 1.53% 1.91% 2.59%
======================================================
Investment income--net .................................. 9.55% 9.84% 12.22% 14.32% 13.69%
======================================================
==================================================================================================================================
Leverage
----------------------------------------------------------------------------------------------------------------------------------
Amount of borrowings, end of year (in thousands) ........ $259,900 $298,400 $269,075 $245,900 $273,600
======================================================
Average amount of borrowings outstanding during the year
(in thousands) ......................................... $294,371 $304,549 $239,315 $238,863 $280,460
======================================================
Average amount of borrowings outstanding per share during
the year** ............................................. $ 2.79 $ 2.89 $ 2.29 $ 2.31 $ 2.75
======================================================
==================================================================================================================================
Supplemental Data
----------------------------------------------------------------------------------------------------------------------------------
Net assets, end of year (in thousands) .................. $708,411 $745,256 $706,261 $557,068 $620,043
======================================================
Portfolio turnover ...................................... 45.67% 60.11% 70.43% 64.54% 49.58%
======================================================
* 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.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 17
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 shares are
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 floating rate 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 floating rate loans could
be considered concentrated in financial institutions.
(b) Valuation of investments -- Floating rate loans are valued in accordance
with guidelines established by the Board of Directors. Floating rate 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 floating rate loans for which no reliable price quotes are
available, such floating rate 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 floating rate loans, Fund Asset Management,
L.P. ("FAM") will value the floating rate loans at fair value, which is intended
to approximate market value.
Debt securities are traded primarily in the over-the-counter ("OTC") markets and
are valued at the last available bid price in the OTC markets or on the basis of
values as obtained by a pricing service. Pricing services use valuation matrixes
that incorporate both dealer-supplied valuations and valuation models. The
procedures of the pricing service and its valuations are reviewed by the
officers of the Fund under the general direction of the Board of Directors. Such
valuations and procedures will be reviewed periodically by the Board of
Directors of the Fund.
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 asked 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 Directors of the Fund. Long
positions in securities traded in the 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 asked 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. Swap
agreements are valued based upon quoted fair valuations received daily by the
Fund from a pricing service or counterparty. 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
FAM believes that this method no longer produces fair valuations. Repurchase
agreements will be valued at cost plus accrued interest.
Generally, trading in foreign securities, as well as U.S. Government securities,
money market instruments and certain fixed income securities, 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
18 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Notes to Financial Statements (continued)
value as determined in good faith by the Board of Directors or by FAM using a
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 OTC 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 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.
The Fund invests in foreign securities, which may involve a number of risk
factors and special considerations not present with investments in securities of
U.S. corporations.
(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.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 19
Notes to Financial Statements (continued)
(f) Security transactions and investment income -- Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Realized gains and losses on security transactions are determined on the
identified cost basis. 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) Bank overdraft -- The Fund recorded a bank overdraft, which resulted from
management estimates of available cash.
(j) 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, $12,067,388 has been reclassified between paid-in capital in excess of par
and accumulated net realized capital losses, $1,112,781 has been reclassified
between accumulated net realized capital losses and undistributed net investment
income and $2,825 has been reclassified between undistributed net investment
income and paid-in capital in excess of par as a result of permanent differences
attributable to expiration of capital loss carryforwards, securities in default
and amortization methods on fixed income securities. These reclassifications
have no effect on net assets or net asset value per share.
2. Investment Advisory Agreement and Transactions with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM. The general
partner of FAM is Princeton Services, Inc. ("PSI"), an indirect, wholly-owned
subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the limited
partner.
FAM is responsible for the management of the Fund's portfolio and provides the
necessary personnel, facilities, equipment and certain other services necessary
to perform the investment advisory function. For such services, the Fund pays a
monthly fee at an annual rate of .60% of the Fund's average weekly net assets
plus the proceeds of any outstanding borrowings used for leverage.
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, 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.
For the year ended February 28, 2006, the Fund reimbursed FAM $16,996 for
certain accounting services.
Certain officers and/or directors of the Fund are officers and/or directors of
FAM, PSI, ML & Co., and/or MLIM, LLC.
In February 2006, ML & Co. and BlackRock, Inc. entered into an agreement to
merge ML & Co.'s investment management business, including FAM, with the
investment management business of BlackRock, Inc. The transaction is expected to
close in the third quarter of 2006.
20 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Notes to Financial Statements (concluded)
3. Investments:
Purchases and sales (including paydowns) of investments, excluding short-term
securities, for the year ended February 28, 2006 were $450,666,684 and
$456,242,339, respectively.
4. Capital Share Transactions:
The Fund is authorized to issue 200,000,000 shares of Common Stock, par value
$.10 per share. The Board of Directors is authorized, however, to classify and
reclassify any unissued shares of capital stock without approval of the holders
of Common Stock.
Shares issued and outstanding during the years ended February 28, 2006 and
February 28, 2005 increased by 252,856 and 374,356, respectively, as a result of
dividend reinvestment.
5. Unfunded Corporate Loans:
As of February 28, 2006, the Fund had unfunded loan commitments of $1,375,000,
which would be extended at the option of the borrower, pursuant to the following
loan agreements.
(in Thousands)
--------------------------------------------------------------------------------
Unfunded
Borrower Commitment Value
--------------------------------------------------------------------------------
United Air Lines ........................... $ 250 $ 250
Waste Services, Inc. ....................... $1,125 $1,139
--------------------------------------------------------------------------------
6. Short-Term Borrowings:
On May 24, 2005, the Fund renewed its revolving credit and security agreement
funded by a commercial paper asset securitization program with Citigroup North
America, Inc. ("Citigroup") as Agent, certain secondary backstop lenders, and
certain asset securitization conduits as lenders (the "Lenders"). The agreement
was renewed for one year and has a maximum limit of $370,000,000. Under the
Citigroup 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 3.84% and the average borrowing
was approximately $294,371,000 for the year ended February 28, 2006.
7. Distributions to Shareholders:
The Fund paid an ordinary income dividend in the amount of $.053000 per share on
March 31, 2006 to shareholders of record on March 14, 2006.
The tax character of distributions paid during the fiscal years ended February
28, 2006 and February 28, 2005 was as follows:
--------------------------------------------------------------------------------
2/28/2006 2/28/2005
--------------------------------------------------------------------------------
Distributions paid from:
Ordinary income ........................ $68,179,612 $69,339,355
------------------------------
Total taxable distributions .............. $68,179,612 $69,339,355
==============================
As of February 28, 2006, the components of accumulated losses on a tax basis
were as follows:
-----------------------------------------------------------------------------
Undistributed ordinary income--net ..................... $ 5,720,274
Undistributed long-term capital gains--net ............. --
-------------
Total undistributed earnings--net ...................... 5,720,274
Capital loss carryforward .............................. (334,486,594)*
Unrealized losses--net ................................. (26,871,085)**
-------------
Total accumulated losses--net .......................... $(355,637,405)
=============
* On February 28, 2006, the Fund had a net capital loss carryforward of
$334,486,594, of which $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, $21,126,025
expires in 2013 and $20,233,987 expires in 2014. 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 and other book/tax temporary
differences.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 21
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, 2006, 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, 2006, 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, 2006, 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 24, 2006
Fund Certification (unaudited)
In September 2005, 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.
Important Tax Information
The following information is provided with respect to the ordinary income
distributions paid by Debt Strategies Fund, Inc. for the fiscal year ended
February 28, 2006:
Interest-Related Dividends for Non-U.S. Residents
--------------------------------------------------------------------------------
Month Paid: March 2005 ........................................... 0.53%*
April 2005 - January 2006 ............................ 87.93%*
February 2006 ........................................ 86.63%*
--------------------------------------------------------------------------------
* Represents the portion of the taxable ordinary income dividends eligible
for exemption from U.S. withholding tax for nonresident aliens and foreign
corporations.
22 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
Automatic Dividend Reinvestment Plan
How the Plan Works -- The Fund offers a Dividend Reinvestment Plan (the "Plan")
under which income and capital gains dividends paid by the Fund are
automatically reinvested in additional shares of Common Stock of the Fund. The
Plan is administered on behalf of the sharehold- ers by The Bank of New York
(the "Plan Agent"). Under the Plan, whenever the Fund declares a dividend,
participants in the Plan will receive the equivalent in shares of Common Stock
of the Fund. The Plan Agent will acquire the shares for the participant's
account either (i) through receipt of additional unissued but authorized shares
of the Fund ("newly issued shares") or (ii) by purchase of outstanding shares of
Common Stock on the open market on the New York Stock Exchange or elsewhere. If,
on the dividend payment date, the Fund's net asset value per share is equal to
or less than the market price per share plus estimated brokerage commissions (a
condition often referred to as a "market premium"), the Plan Agent will invest
the dividend amount in newly issued shares. If the Fund's net asset value per
share is greater than the market price per share (a condition often referred to
as a "market discount"), the Plan Agent will invest the dividend amount by
purchasing on the open market additional shares. If the Plan Agent is unable to
invest the full dividend amount in open market purchases, or if the market
discount shifts to a market premium during the purchase period, the Plan Agent
will invest any uninvested portion in newly issued shares. The shares acquired
are credited to each shareholder's account. The amount credited is determined by
dividing the dollar amount of the dividend by either (i) when the shares are
newly issued, the net asset value per share on the date the shares are issued or
(ii) when shares are purchased in the open market, the average purchase price
per share.
Participation in the Plan -- Participation in the Plan is automatic, that is, a
shareholder is automatically enrolled in the Plan when he or she purchases
shares of Common Stock of the Fund unless the shareholder specifically elects
not to participate in the Plan. Shareholders who elect not to participate will
receive all dividend distributions in cash. Shareholders who do not wish to
participate in the Plan must advise the Plan Agent in writing (at the address
set forth below) that they elect not to participate in the Plan. Participation
in the Plan is completely voluntary and may be terminated or resumed at any time
without penalty by writing to the Plan Agent.
Benefits of the Plan -- The Plan provides an easy, convenient way for
shareholders to make additional, regular investments in the Fund. The Plan
promotes a long-term strategy of investing at a lower cost. All shares acquired
pursuant to the Plan receive voting rights. In addition, 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 for less than they could otherwise
purchase them and with a cash value greater than the value of any cash
distribution they would have received. However, there may not be enough 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.
Plan Fees -- There are no enrollment fees or brokerage fees for participating in
the Plan. The Plan Agent's service fees for handling the reinvestment of
distributions are paid for by the Fund. However, brokerage commissions may be
incurred when the Fund purchases shares on the open market and shareholders will
pay a pro rata share of any such commissions.
Tax Implications -- 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. Therefore, income and
capital gains may still be realized even though shareholders do not receive
cash. Participation in the Plan generally will not effect the tax-exempt status
of exempt interest dividends paid by the Fund. If, when the Fund's shares are
trading at a market premium, 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 the discount from the market value (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.
Contact Information -- All correspondence concerning the Plan, including any
questions about 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.
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 23
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 the MLIM/FAM-advised funds since 2005; 131 Funds None
Doll, Jr.* Princeton, NJ and present President of MLIM and FAM since 2001; Co-Head 177 Portfolios
08543-9011 Director (Americas Region) thereof from 2000 to 2001 and
Age: 51 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 defined in the Investment Company
Act, of the Fund based on his positions with MLIM, FAM, Princeton Services and Princeton Administrators. 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, 49 Funds None
Forbes** Princeton, NJ present State University of New York at Albany since 2000 50 Portfolios
08543-9095 and Professor thereof from 1989 to 2000; Interna-
Age: 65 tional Consultant, Urban Institute, Washington, D.C.
from 1995 to 1999.
------------------------------------------------------------------------------------------------------------------------------------
Cynthia A. P.O. Box 9095 Director 1997 to Professor, Harvard Business School since 1989; 49 Funds Newell
Montgomery Princeton, NJ present Associate Professor, J.L. Kellogg Graduate School of 50 Portfolios Rubbermaid,
08543-9095 Management, Northwestern University from 1985 Inc.
Age: 53 to 1989; Associate Professor, Graduate School of (manufac-
Business Administration, University of Michigan turing)
from 1979 to 1985; Director, Harvard Business School
of Publishing since 2005; Director, McLean Hospital
since 2005.
------------------------------------------------------------------------------------------------------------------------------------
Jean Margo P.O. Box 9095 Director 2004 to Self-employed consultant since 2001; Counsel of 49 Funds None
Reid Princeton, NJ present Alliance Capital Management (investment adviser) 50 Portfolios
08543-9095 in 2000; General Counsel, Director and Secretary of
Age: 60 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; and
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; 49 Funds None
Suddarth Princeton, NJ present Foreign Service Officer, United States Foreign 50 Portfolios
08543-9095 Service, from 1961 to 1995 and Career Minister, from
Age: 70 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.
------------------------------------------------------------------------------------------------------------------------------------
24 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
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
====================================================================================================================================
Interested Director* (concluded)
------------------------------------------------------------------------------------------------------------------------------------
Richard R. P.O. Box 9095 Director 1997 to Professor of Finance from 1984 to 1995, Dean from 49 Funds Bowne &
West Princeton, NJ present 1984 to 1993 and since 1995 Dean Emeritus of 50 Portfolios Co., Inc.,
08543-9095 New York University's Leonard N. Stern School of (financial
Age: 68 Business Administration. printers);
Vornado
Realty Trust,
(real estate
company);
Alexander's,
Inc. (real
estate
company)
------------------------------------------------------------------------------------------------------------------------------------
Edward D. P.O. Box 9095 Director 2000 to Self-employed financial consultant since 1994; 49 Funds None
Zinbarg Princeton, NJ present Executive Vice President of the Prudential 50 Portfolios
08543-9095 Insurance Company of America from 1988 to
Age: 71 1994; former Director of Prudential Reinsurance
Company and former Trustee of the Prudential
Foundation.
------------------------------------------------------------------------------------------------------------------------
* Directors serve until their resignation, removal or death, or until December 31 of the year in which they turn 72.
** Chairman of the Board of Directors and the Audit Committee.
====================================================================================================================================
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 FAM Distributors, Inc. ("FAMD") since 1999 and
Age: 45 Treasurer 1999 to Director since 2004; Vice President of MLIMand FAM from 1990 to 1997; Director of
present Taxation of MLIM from 1990 to 2001; Vice President, 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 2005; Vice President of MLIM from
Booth Princeton, NJ President present 2000 to 2005; Vice President at Chase Securities, Inc. from 1993 to 2000.
08543-9011
Age: 51
------------------------------------------------------------------------------------------------------------------------------------
Jeffrey P.O. Box 9011 Chief 2004 to Chief Compliance Officer of the MLIM/FAM-advised funds and First Vice President and
Hiller Princeton, NJ Compliance present Chief Compliance Officer of MLIM (Americas Region) since 2004; Chief Compliance
08543-9011 Officer Officer of the IQ Funds since 2004; Global Director of Compliance at Morgan Stanley
Age: 54 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 Securities and
Exchange 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: 45
------------------------------------------------------------------------------------------------------------------------
* 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
DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006 25
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.
Electronic Delivery
The Fund offers electronic delivery of communications to its shareholders. In
order to receive this service, you must register your account and provide us
with e-mail information. To sign up for this service, simply access this Web
site at http://www.icsdelivery.com/live and follow the instructions. When you
visit this site, you will obtain a personal identification number (PIN). You
will need this PIN should you wish to update your e-mail address, choose to
discontinue this service and/or make any other changes to the service. This
service is not available for certain retirement accounts at this time.
26 DEBT STRATEGIES FUND, INC. FEBRUARY 28, 2006
[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 1-800-637-3863; (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 -- 2/06
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, 2006 - $45,500
Fiscal Year Ending February 28, 2005 - $43,000
(b) Audit-Related Fees - Fiscal Year Ending February 28, 2006 - $8,000
Fiscal Year Ending February 28, 2005 - $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, 2006 - $6,000
Fiscal Year Ending February 28, 2005 - $5,700
The nature of the services include tax compliance, tax advice and tax
planning.
(d) All Other Fees - Fiscal Year Ending February 28, 2006 - $0
Fiscal Year Ending February 28, 2005 - $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, 2006 - $4,944,454
Fiscal Year Ending February 28, 2005 - $11,046,527
(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) - $1,227,000, 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
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 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 - as
of February 28, 2006.
(a)(1) Mr. Kevin J. Booth is primarily responsible for the day-to-day
management of the registrant's portfolio ("Portfolio Manager").
Mr. Booth has been a Managing Director of the Investment Adviser
since 2006 and was previously a Director at the Investment
Adviser. He has been a portfolio manager and Vice President of
the Fund since 2005. He has more than eleven years of investment
experience, including the analysis and management of senior
floating rate loans and the use of leverage techniques to manage
portfolios. Mr. Booth joined MLIM in 1991 and has core
experience in bank loans, high yield and distressed investing.
(a)(2) As of February 28, 2006:
(iii) Number of Other Accounts and
(ii) Number of Other Accounts Managed Assets for Which Advisory Fee is
and Assets by Account Type Performance-Based
Other Other
(i) Name of Registered Other Pooled Registered Other Pooled
Portfolio Investment Investment Other Investment Investment Other
Manager Companies Vehicles Accounts Companies Vehicles Accounts
--------------- -----------
Kevin J. Booth 2 1 0 0 0 0
$ 557,672,860 $ 1,660,762,375 $ 0 $ 0 $ 0 $ 0
(iv) Potential Material Conflicts of Interest
Real, potential or apparent conflicts of interest may arise when a
portfolio manager has day-to-day portfolio management responsibilities with
respect to more than one fund or account, including the following:
Certain investments may be appropriate for the Fund and also for other
clients advised by the Investment. Adviser and its affiliates, including other
client accounts managed by the Fund's portfolio management team. Investment
decisions for the Fund and other clients are made with a view to achieving their
respective investment objectives and after consideration of such factors as
their current holdings, availability of cash for investment and the size of
their investments generally. Frequently, a particular security may be bought or
sold for only one client or in different amounts and at different times for more
than one but less than all clients. Likewise, because clients of the Investment
Adviser and its affiliates may have differing investment strategies, a
particular security may be bought for one or more clients when one or more other
clients are selling the security. The investment results for the Fund may differ
from the results achieved by other clients of the Investment Adviser and its
affiliates and results among clients may differ. In addition, purchases or sales
of the same security may be made for two or more clients on the same day. In
such event, such transactions will be allocated among the clients in a manner
believed by the Investment Adviser and its affiliates to be equitable to each.
The Investment Adviser will not determine allocations based on whether it
receives a performance based fee from the client. In some cases, the allocation
procedure could have an adverse effect on the price or amount of the securities
purchased or sold by the Fund. Purchase and sale orders for the Fund may be
combined with those of other clients of the Investment Adviser and its
affiliates in the interest of achieving the most favorable net results to the
Fund.
To the extent that the Fund's portfolio management team has
responsibilities for managing accounts in addition to the Fund, a portfolio
manager will need to divide his time and attention among relevant accounts.
In some cases, a real, potential or apparent conflict may also arise where
(i) the Investment Adviser may have an incentive, such as a performance based
fee, in managing one account and not with respect to other accounts it manages
or (ii) where a member of the Fund's portfolio management team owns an interest
in one fund or account he or she manages and not another.
(a)(3) As of February 28, 2006:
Portfolio Manager Compensation
The Portfolio Manager Compensation Program of MLIM and its affiliates,
including the Investment Adviser (collectively, "MLIM"), is critical to MLIM's
ability to attract and retain the most talented asset management professionals.
This program ensures that compensation is aligned with maximizing investment
returns and it provides a competitive pay opportunity for competitive
performance.
Compensation Program
The elements of total compensation for MLIM portfolio managers are a fixed
base salary, annual performance-based cash and stock compensation (cash and
stock bonus) and other benefits. MLIM has balanced these components of pay to
provide portfolio managers with a powerful incentive to achieve consistently
superior investment performance. By design, portfolio manager compensation
levels fluctuate -- both up and down -- with the relative investment performance
of the portfolios that they manage.
Base Salary
Under the MLIM approach, like that of many asset management firms, base
salaries that are fixed on an annual basis represent a relatively small portion
of a portfolio manager's total compensation. This approach serves to enhance the
motivational value of the performance-based (and therefore variable)
compensation elements of the compensation program.
Performance-Based Compensation
MLIM believes that the best interests of investors are served by
recruiting and retaining exceptional asset management talent and managing their
compensation within a consistent and disciplined framework that emphasizes pay
for performance in the context of an intensely competitive market for talent.
To that end, portfolio manager incentive compensation for MLIM and its
affiliates is based on a formulaic compensation program. MLIM's formulaic
portfolio manager compensation program includes: investment performance relative
to general closed-end, non-leveraged, fixed income funds over 1-, 3-, and 5-year
performance periods and a measure of operational efficiency. Portfolio managers
are compensated based on the pre-tax performance of the products they manage. A
discretionary element of portfolio manager compensation may include
consideration of: financial results of MLIM, expense control, profit margins,
strategic planning and implementation, quality of client service, market share,
corporate reputation, capital allocation, compliance and risk control,
leadership, workforce diversity, technology and innovation. MLIM and its
affiliates also consider the extent to which individuals exemplify and foster
Merrill Lynch's principles of client focus, respect for the individual,
teamwork, responsible citizenship and integrity. All factors are considered
collectively by MLIM management.
Cash Bonus
Performance-based compensation is distributed to portfolio managers in a
combination of cash and stock. Typically, the cash bonus, when combined with
base salary, represents more than 60% of total compensation for portfolio
managers.
Stock Bonus
A portion of the dollar value of the total annual performance-based bonus
is paid in restricted shares of Merrill Lynch & Co., Inc. (herein, the
"Company") stock. Paying a portion of annual bonuses in stock puts compensation
earned by a portfolio manager for a given year "at risk" based on the Company's
ability to sustain and improve its performance over future periods. The ultimate
value of stock bonuses is dependent on future Company stock price performance.
As such, the stock bonus aligns each portfolio manager's financial interests
with those of the Company shareholders and encourages a balance between
short-term goals and long-term strategic objectives. Management strongly
believes that providing a significant portion of competitive performance-based
compensation in stock is in the best interests of investors and shareholders.
This approach ensures that portfolio managers participate as shareholders in
both the "downside risk" and "upside opportunity" of the Company's performance.
Portfolio managers therefore have a direct incentive to protect the Company's
reputation for integrity.
Other Compensation Programs
Portfolio managers who meet relative investment performance and financial
management objectives during a performance year are eligible to participate in a
deferred cash program. Awards under this program are in the form of deferred
cash that may be benchmarked to a menu of MLIM mutual funds (including their own
fund) during a five-year vesting period. The deferred cash program aligns the
interests of participating portfolio managers with the investment results of
MLIM products and promotes continuity of successful portfolio management teams.
Other Benefits
Portfolio managers are also eligible to participate in broad-based plans
offered generally to the Company's employees, including broad-based retirement,
401(k), health, and other employee benefit plans.
(a)(4) Beneficial Ownership of Securities. As of February 28, 2006, Mr.
Booth beneficially owns stock issued by the Fund in the range of
$100,001 - $500,000.
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 20, 2006
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 20, 2006
By: /s/ Donald C. Burke
---------------------------
Donald C. Burke,
Chief Financial Officer of
Debt Strategies Fund, Inc.
Date: April 20, 2006