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: 811-04020
Morgan Stanley California Tax-Free Income Fund
(Exact name of registrant as specified in charter)
1221 Avenue of the Americas, New York, New York 10020
(Address of principal executive offices) (Zip code)
Ronald E. Robison
1221 Avenue of the Americas, New York, New York 10020
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-762-4000
Date of fiscal year end: December 31, 2004
Date of reporting period: June 30, 2004
Item 1 - Report to Shareholders
Welcome, Shareholder:
In this report, you'll learn about how your investment in Morgan Stanley
California Tax-Free Income Fund performed during the semiannual period. We will
provide an overview of the market conditions, and discuss some of the factors
that affected performance during the reporting period. In addition, this report
includes the Fund's financial statements and a list of Fund investments.
This material must be preceded or accompanied by a prospectus for the fund being
offered. Market forecasts provided in this report may not necessarily come to
pass. There is no assurance that the Fund will achieve its investment objective.
The Fund is subject to market risk, which is the possibility that market values
of securities owned by the Fund will decline and, therefore, the value of the
Fund's shares may be less than what you paid for them. Accordingly, you can lose
money investing in this Fund.
FUND REPORT
For the six-month period ended June 30, 2004
TOTAL RETURN FOR THE SIX-MONTH PERIOD ENDED JUNE 30, 2004
<Table>
<Caption>
LEHMAN LIPPER CA
BROTHERS MUNICIPAL
MUNICIPAL DEBT FUNDS
CLASS A CLASS B CLASS C CLASS D BOND INDEX(1) INDEX(2)
-0.80% -0.83% -1.07% -0.71% -0.68% -0.78%
</Table>
The performance of the Fund's four share classes varies because each has
different expenses. The Fund's total return figures assume the reinvestment of
all distributions but do not reflect the deduction of any applicable sales
charges. Such costs would lower performance. Past performance is no guarantee of
future results. See Performance Summary for standardized performance
information.
MARKET CONDITIONS
During the first six months of 2004, an array of positive indicators confirmed
the strength of the U.S. economic recovery. Not only was solid growth recorded
but the long-awaited improvement in employment became apparent. Unfortunately,
the strengthening economy also brought the specter of higher inflation. While a
year ago the Federal Reserve was actively prepared to fight price deflation, by
early this spring it had begun to signal a change in policy. The fixed-income
markets reacted to these events by sending interest rates higher. Finally, on
June 30, 2004, the Federal Reserve Board ended the easiest monetary policy in
decades by raising its short-term borrowing rate for the first time in four
years.
The changing outlook also affected the municipal market. By the end of June,
yields on intermediate and long-term tax-exempt bonds had increased to their
highest levels in nearly a year. Bond prices, which move in the opposite
direction of interest rates, fell accordingly. Rising interest rates have
historically resulted in reduced issuance of municipal securities. In keeping
with this pattern, the year-to-date volume of $188 billion was 9 percent below
last year's record level. Much of the decline can be attributed to June, when
issuance fell 29 percent. Of the major states, only California had an increase
in volume.
On the demand side, higher yields attracted retail investors who began to
reinvest upcoming coupon payments and maturities. The ratio of municipal yields
to Treasury yields -- a gauge of the relative performance of the two
markets -- also remained stable. The ratio of 30-year insured municipals to
Treasuries averaged 96 percent for the quarter, and the 10-year ratio averaged
89 percent of Treasuries. This relationship continued to attract buying activity
by nontraditional investors including hedge funds and arbitrage accounts.
The California municipal market entered the period in the doldrums, with the
state's general debt carrying the lowest investment-grade rating of any state
from Moody's and Standard & Poor's. The market took a turn for the better with
the widely publicized election of Arnold Schwarzenegger as governor, then
improved further as the new governor successfully implemented new policy
initiatives aimed at easing the state's fiscal woes. Key among these measures
was a $7.9 billion economic recovery package, part of a total of $11 billion in
deficit financing intended to raise further capital to cover the state's budget
shortfalls. Yield spreads between California and national issues declined
measurably for all maturities.
2
PERFORMANCE ANALYSIS
Morgan Stanley California Tax-Free Income Fund underperformed the Lehman
Brothers Municipal Bond Index, and its Class A, B and C shares underperformed
the Lipper California Municipal Debt Funds Index for the six-month period ending
June 30, 2004. However, the Fund's Class D shares did slightly outperform the
Lipper Index. In the rising-interest-rate environment, the Fund benefited by
maintaining a shorter than benchmark portfolio duration* to reduce volatility.
In part, the lower duration reflected a mix of holdings that included
higher-coupon bonds priced to various call dates. These bonds are generally
considered defensive in nature. New purchases were focused in the 15- to 20-year
range. In keeping with our long-term strategy, we managed the Fund with a bias
toward high-quality investments. As indicated, nearly 75 percent of the bonds in
the portfolio at the close of the review period were rated either AA or AAA. The
Fund was well diversified, with 63 individual credits in 14 municipal sectors.
* A measure of the sensitivity of a bond's price to changes in interest rates,
expressed in years. Each year of duration represents an expected 1 percent
change in the price of a bond for every 1 percent change in interest rates.
The longer a bond's duration, the greater the effect of interest-rate
movements on its price. Typically, funds with shorter durations perform better
in rising-interest-rate environments, while funds with longer durations
perform better when rates decline.
3
<Table>
<Caption>
TOP FIVE SECTORS
Water & Sewer 18.0%
Transportation 17.4
General Obligation 14.8
Refunded 9.1
Electric 7.9
</Table>
<Table>
<Caption>
LONG-TERM CREDIT ANALYSIS
Aaa/AAA 72.5%
Aa/AA 4.0
A/A 14.2
Baa/BBB 7.6
Ba/BB or Less 1.7
</Table>
Data as of June 30, 2004. Subject to change daily. All percentages for Top Five
Sectors are as a percentage of net assets and all percentages for Long-Term
Credit Analysis are as a percentage of total long-term investments. Provided for
informational purposes only and should not be deemed a recommendation to buy or
sell the securities mentioned. Morgan Stanley is a full-service securities firm
engaged in securities trading and brokerage activities, investment banking,
research and analysis, financing and financial advisory services.
INVESTMENT STRATEGY
The fund will normally invest at least 80% of its net assets in securities that
pay interest exempt from federal and California state income taxes. The fund's
"Investment Manager," Morgan Stanley Investment Advisors Inc., generally invests
the fund's assets in investment grade, California municipal obligations.
Municipal obligations are bonds, notes or short-term commercial paper issued by
state governments, local governments or their respective agencies.
4
DISTRIBUTION BY MATURITY
(% of Long-Term Portfolio) As of June 30, 2004
WEIGHTED AVERAGE MATURITY: 15 YEARS
<Table>
1-5 12
5-10 7
10-20 63
20-30 16
30+ Years 2
</Table>
Portfolio structure is subject to change.
5
CALL AND COST (BOOK) YIELD STRUCTURE
(Based on Long-Term Portfolio) As of June 30, 2004
YEARS BONDS CALLABLE -- WEIGHTED AVERAGE CALL PROTECTION: 6 YEARS
<Table>
2004(a) 8
2005 6
2006 6
2007 7
2008 13
2009 4
2010 2
2011 18
2012 9
2013 9
2014+ 18
</Table>
COST (BOOK) YIELD(B) -- WEIGHTED AVERAGE BOOK YIELD: 5.6%
<Table>
2004(a) 6.1
2005 7.7
2006 6.1
2007 6.2
2008 5.4
2009 5.2
2010 6.1
2011 5
2012 5.1
2013 5
2014+ 5.6
</Table>
(a) May include issues callable in previous years.
(b) Cost or "book" yield is the annual income earned on a portfolio investment
based on its original purchase price before the Fund's operating expenses.
For example, the Fund is earning a book yield of 6.1% on 8% of the
long-term portfolio that is callable in 2004.
Portfolio structure is subject to change.
6
PERFORMANCE SUMMARY
AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED JUNE 30, 2004
<Table>
<Caption>
CLASS A SHARES* CLASS B SHARES ** CLASS C SHARES(+) CLASS D SHARES(++)
(Since 07/28/97) (Since 07/11/84) (Since 07/28/97) (Since 07/28/97)
SYMBOL CLFAX CLFBX CLFCX CLFDX
1 YEAR 0.64%(3) 0.67%(3) 0.11%(3) 0.78%(3)
(3.64)(4) (4.12)(4) (0.85)(4) --
5 YEARS 4.99(3) 4.87(3) 4.42(3) 5.19(3)
4.09(4) 4.54(4) 4.42(4) --
10 YEARS -- 5.21(3) -- --
-- 5.21(4) -- --
SINCE INCEPTION 4.57(3) 7.11(3) 4.08(3) 4.82(3)
3.91(4) 7.11(4) 4.08(4) --
</Table>
Past performance is no guarantee of future results and current performance may
be lower or higher than the figures shown. For more up-to-date information,
including month-end performance figures, please visit morganstanley.com or speak
with your financial advisor. Investment returns and principal value will
fluctuate and fund shares, when redeemed, may be worth more or less than their
original cost. The table does not reflect the deduction of taxes that a
shareholder would pay on fund distributions or the redemption of fund shares.
Performance for Class A, Class B, Class C, and Class D shares will vary due to
differences in sales charges and expenses.
* The maximum front-end sales charge for Class A is 4.25%.
** The maximum contingent deferred sales charge (CDSC) for Class B is 5.0%. The
CDSC declines to 0% after six years.
+ The maximum contingent deferred sales charge for Class C is 1% for shares
redeemed within one year of purchase.
++ Class D has no sales charge.
(1) The Lehman Brothers Municipal Bond Index tracks the performance of
municipal bonds rated at least Baa or BBB by Moody's Investors Service,
Inc. or Standard Poor's Corporation, respectively and with maturities of 2
years or greater. Indexes are unmanaged and their returns do not include
any sales charges or fees. Such costs would lower performance. It is not
possible to invest directly in an index.
(2) The Lipper California Municipal Debt Funds Index is an equally weighted
performance index of the largest qualifying funds (based on net assets) in
the Lipper California Municipal Debt Funds classification. The Index, which
is adjusted for capital gains distributions and income dividends, is
unmanaged and should not be considered an investment. There are currently
30 funds represented in this Index.
(3) Figure shown assumes reinvestment of all distributions and does not reflect
the deduction of any sales charges.
(4) Figure shown assumes reinvestment of all distributions and the deduction of
the maximum applicable sales charge. See the Fund's current prospectus for
complete details on fees and sales charges.
7
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2004 (UNAUDITED)
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
California Tax-Exempt Municipal Bonds (92.4%)
General Obligation (14.8%)
California,
$ 5,000 Ser 1990................................................ 7.00% 08/01/07 $ 5,613,100
5,000 Ser 1990................................................ 7.00 08/01/08 5,738,900
2,000 Veterans Ser AT......................................... 9.50 02/01/10 2,581,040
10,000 Refg Ser 2002........................................... 5.25 02/01/11 10,870,900
2,400 Veterans Ser BH (AMT) (FSA)............................. 5.40 12/01/16 2,481,552
5,000 Various Purpose dtd 04/01/93 (FSA)...................... 5.50 04/01/19 5,087,950
5,000 Various Purpose dtd 04/01/02............................ 6.00 04/01/19 5,536,300
10,000 Various Purpose Ser 1996 (Ambac)........................ 5.25 06/01/21 10,298,100
Los Angeles Community College District,
5,000 2001 Ser A (MBIA)....................................... 5.50 08/01/20 5,360,450
5,000 2001 Ser A (MBIA)....................................... 5.50 08/01/21 5,338,400
Los Angeles Unified School District,
5,000 2003 Ser A (FSA)........................................ 5.25 07/01/20 5,254,300
10,000 1997 Ser B (FGIC)....................................... 5.00 07/01/23 10,085,100
6,500 North Orange County Community College District, 2002 Ser A
(MBIA).................................................. 5.375 08/01/21 6,877,845
5,000 Placentia - Yorba Linda United School District, 2002 Ser A
(FGIC).................................................. 5.00 08/01/26 4,989,850
Puerto Rico,
8,000 Public Improvement Ser 1999............................. 4.75 07/01/23 7,643,040
3,000 Public Improvement Ser 1998 (Secondary MBIA)............ 4.875 07/01/23 3,017,040
------------
- --------
96,773,867
91,900
------------
- --------
Educational Facilities Revenue (1.5%)
5,000 California Educational Facilities Authority, University of
San Diego Ser 1998 (Ambac).............................. 5.00 10/01/22 5,066,550
5,000 University California, Ser 2003 Q (FSA)................... 5.00 09/01/24 5,027,050
------------
- --------
10,093,600
10,000
------------
- --------
Electric Revenue (7.9%)
10,000 California State Department of Water Resources, Power
Supply Ser 2002 A....................................... 5.375 05/01/21 10,369,300
25,000 Los Angeles Department of Water & Power, 2001 Ser A
(FSA)................................................... 5.25 07/01/22 25,820,000
Southern California Public Power Authority,
1,750 Transmission Refg Ser 1988 (FGIC)....................... 0.00 07/01/06 1,667,855
3,500 Mead-Adelanto 1994 A (Ambac)............................ 8.88++ 07/01/15 4,014,080
2,500 Mead-Phoenix 1994 Ser A (Ambac)......................... 8.88++ 07/01/15 2,867,200
2,750 Transmission Refg Ser 2002 A (FSA)...................... 5.25 07/01/18 2,916,348
</Table>
8
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2004 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Puerto Rico Electric Power Authority,
$ 2,000 Power Ser II (MBIA)..................................... 5.375% 07/01/19 $ 2,160,620
2,000 Power Ser X............................................. 5.50 07/01/25 2,042,360
------------
- --------
51,857,763
49,500
------------
- --------
Hospital Revenue (7.4%)
8,000 Antelope Valley Healthcare District, Refg Ser 1997 A
(FSA)................................................... 5.20 01/01/20 8,199,760
California Health Facilities Financing Authority,
3,000 Scripps Memorial Hospitals Ser 1992 A (MBIA)............ 6.375 10/01/22 3,030,420
2,500 Sutter/CHS Ser 1996 A (MBIA)............................ 5.875 08/15/16 2,708,525
5,000 California Infrastructure & Economic Development Bank,
Kaiser Assistance Ser 2001 A............................ 5.55 08/01/31 5,006,100
2,000 California Statewide Communities Development Authority,
Cedars-Sinai Medical Center Ser 1992 COPs............... 6.50 08/01/12 2,214,800
14,000 Duarte, City of Hope National Medical Center Ser 1999 A
COPs.................................................... 5.25 04/01/19 14,034,300
7,500 Madera County, Valley Children's Hospital Ser 1995 COPs
(MBIA).................................................. 6.50 03/15/15 8,868,750
4,000 Rancho Mirage Joint Powers Financing Authority, Eisenhower
Medical Center Ser 1997 A COPs (MBIA)................... 5.25 07/01/17 4,215,160
------------
- --------
48,277,815
46,000
------------
- --------
Industrial Development/Pollution Control Revenue (2.4%)
California Pollution Control Financing Authority,
5,000 San Diego Gas & Electric Co 1996 Ser A.................. 5.90 06/01/14 5,236,350
10,000 Southern California Edison Co 1992 Ser B (AMT).......... 6.40 12/01/24 10,094,000
------------
- --------
15,330,350
15,000
------------
- --------
Mortgage Revenue - Multi-Family (0.3%)
2,000 California Housing Finance Agency, Rental II 1992 Ser B... 6.70 08/01/15 2,002,200
------------
- --------
Mortgage Revenue - Single Family (0.4%)
1,435 California Housing Finance Agency, 1995 Ser B-2 (AMT)..... 6.30 08/01/24 1,480,160
California Rural Home Financing Authority,
570 Home 1997 Ser D-CL 5 (AMT).............................. 6.70 05/01/29 581,850
490 1997 Ser A-2 (AMT)...................................... 7.00 09/01/29 493,175
270 Home 1998 Ser A (AMT)................................... 6.35 12/01/29 276,037
------------
- --------
2,831,222
2,765
------------
- --------
Public Facilities Revenue (5.1%)
4,000 Anaheim Public Financing Authority, 1997 Ser C (FSA)...... 6.00 09/01/16 4,614,160
California Public Works Board,
10,000 Department of Corrections 2004 Ser E (XLCA)............. 5.00 06/01/18 10,367,800
10,000 Department of Corrections Refg 1993 Ser A (Ambac)....... 5.00 12/01/19 10,406,400
</Table>
9
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2004 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
$ 4,000 Sacramento City Financing Authority, 2002 Ser A (FSA)..... 5.25% 12/01/17 $ 4,267,960
5,000 Puerto Rico Public Buildings Authority, 2002 Ser D
(Ambac)................................................. 0.00# 07/01/31 3,374,450
------------
- --------
33,030,770
33,000
------------
- --------
Recreational Facilities Revenue (0.6%)
2,000 California State University, Fresno Event Center Sr Ser
2002.................................................... 6.00 07/01/26 2,021,720
2,000 San Diego County, San Diego Natural History Museum COPs... 5.70 02/01/28 1,690,200
------------
- --------
3,711,920
4,000
------------
- --------
Tax Allocation Revenue (5.9%)
1,500 Fontana Public Finance Authority, Ser 2003 A (Ambac)...... 5.375 09/01/25 1,547,190
Long Beach Bond Finance Authority,
3,205 Downtown North Long Beach 2002 Ser A (Ambac)............ 5.375 08/01/19 3,392,076
2,380 Downtown North Long Beach 2002 Ser A (Ambac)............ 5.375 08/01/20 2,509,043
20,000 Long Beach Financing Authority, Ser 1992 (Ambac).......... 6.00 11/01/17 23,080,600
8,000 San Jose Redevelopment Agency, Ser 1999 (Ambac)........... 4.75 08/01/23 7,789,120
------------
- --------
38,318,029
35,085
------------
- --------
Transportation Facilities Revenue (17.4%)
10,000 Alameda Corridor Transportation Authority, Sr Lien Ser
1999 A (MBIA)........................................... 5.25 10/01/21 10,377,800
4,000 Bay Area Toll Authority, San Francisco Bay Area Toll
Bridge 2001 Ser D....................................... 5.00 04/01/18 4,145,480
3,000 California Infrastructure and Economic Development Bank,
Bay Area Toll Bridges Seismic Retrofit First Lien Ser
2003 A (FSA)............................................ 5.25 07/01/21 3,134,550
Foothill/Eastern Transportation Corridor Agency,
5,000 Toll Road Ser 1999 (MBIA)............................... 5.125 01/15/19 5,182,000
14,000 Toll Road Ser 1999...................................... 0.00## 01/15/23 10,552,220
Long Beach,
5,000 Harbor Refg Ser 1998 A (AMT) (FGIC)..................... 6.00 05/15/17 5,599,100
3,000 Harbor Refg Ser 1998 A (AMT) (FGIC)..................... 6.00 05/15/19 3,364,110
10,000 Harbor Ser 1995 (AMT) (MBIA)............................ 5.25 05/15/25 10,016,500
5,000 Orange County, Airport Refg Ser 1997 (AMT) (MBIA)......... 5.50 07/01/11 5,352,450
Port of Oakland,
5,200 Ser 2002 M (FGIC)....................................... 5.25 11/01/19 5,487,872
2,000 Ser 2002 M (FGIC)....................................... 5.25 11/01/20 2,086,940
5,000 San Diego County Regional Transportation Commission, Sales
Tax 1994 Ser A (FGIC)................................... 4.75 04/01/08 5,356,800
5,000 San Francisco Airports Commission, San Francisco Int'l
Airport Second Ser Refg Issue 27B (FGIC)................ 5.125 05/01/26 5,013,950
San Francisco Bay Area Rapid Transit District,
795 Sales Tax Ser 1995 (FGIC)............................... 5.50 07/01/15 826,514
9,500 Sales Tax Ser 1998 (Ambac).............................. 4.75 07/01/23 9,319,310
</Table>
10
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2004 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
San Joaquin Hills Transportation Corridor Agency,
$ 6,000 Toll Road Refg Ser 1997 A (MBIA)........................ 0.00% 01/15/15 $ 3,652,260
10,000 Toll Road Senior Lien Ser 1993.......................... 5.00 01/01/33 8,585,500
10,000 San Jose, Airport Ser 2001 A (FGIC)....................... 5.00 03/01/25 9,990,400
6,000 Puerto Rico Highway & Transportation Authority, Ser 1998
A....................................................... 4.75 07/01/38 5,508,900
------------
- --------
113,552,656
118,495
------------
- --------
Water & Sewer Revenue (18.0%)
20,000 California Department of Water Resources, Central Valley
Ser Y (FGIC)............................................ 5.00 12/01/25 20,063,400
4,000 Corona Public Financing Authority, Water Ser 1998
(FGIC).................................................. 4.75 09/01/23 3,913,520
10,000 East Bay Municipal Utility District, Water Ser 2001
(MBIA).................................................. 5.00 06/01/26 9,979,800
8,000 Eastern Municipal Water District, Water & Sewer Refg Ser
1998 A COPs (FGIC)...................................... 4.75 07/01/23 7,770,800
20,000 Los Angeles, Wastewater Refg Ser 2003 B (FSA)............. 5.00 06/01/22 20,337,399
5,000 Los Angeles Department of Water & Power, Water 2001 Ser
A....................................................... 5.125 07/01/41 4,931,400
3,195 Metropolitan Water District of Southern California, 2004
Ser A................................................... 5.00 07/01/26 3,171,836
10,000 Sacramento Financing Authority, Water & Capital Impr 2001
Ser A (Ambac)........................................... 5.00 12/01/26 9,979,500
10,000 San Diego Public Facilities Authority, Sewer Ser 1993 A... 5.25 05/15/20 10,053,300
San Francisco Public Utilities Commission,
5,650 Water 2002 Ser A (MBIA)................................. 5.00 11/01/20 5,786,956
10,000 Water 1996 Ser A........................................ 5.00 11/01/21 10,059,300
6,000 Santa Margarita/Dana Point Authority, Ser 2004 A
(Ambac)................................................. 5.00 08/01/20 6,160,020
5,000 West Basin Municipal Water District, Refg Ser 2003 A COPs
(MBIA).................................................. 5.00 08/01/30 4,910,400
------------
- --------
117,117,631
116,845
------------
- --------
Other Revenue (1.6%)
10,000 California, Economic Recovery Ser 2004 A.................. 5.00 07/01/16 10,416,300
------------
- --------
Refunded (9.1%)
Foothill/Eastern Transportation Corridor Agency,
15,000 Toll Road Sr Lien Ser 1995 A............................ 6.00 01/01/07+ 16,313,700
4,000 Toll Road Sr Lien Ser 1995 A............................ 0.00### 01/01/10+ 4,675,480
Los Angeles Convention & Exhibition Center Authority,
10,000 Ser 1985 COPs........................................... 9.00 12/01/05+ 10,998,100
14,000 Ser 1985 COPs........................................... 9.00 12/01/05+ 15,397,340
6,000 San Diego County Water Authority, Ser 1991 B COPs
(MBIA).................................................. 11.22++ 04/27/06+ 7,101,900
5,250 Southern California Public Power Authority, Transmission
Refg Ser 1988 A (FGIC) (ETM)............................ 0.00 07/01/06 5,018,423
------------
- --------
59,504,943
54,250
------------
- --------
588,840 Total California Tax-Exempt Municipal Bonds (Cost $575,621,071).............. 602,819,066
------------
- --------
</Table>
11
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2004 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Short-Term California Tax-Exempt Municipal Obligations (6.0%)
$ 8,500 California Department of Water Resources, Power Supply Ser
B (Demand 07/01/04)..................................... 1.08*% 05/01/22 $ 8,500,000
2,500 California Health Facilities Financing Authority,
Adventist Health System/West 1998 Ser B (MBIA) (Demand
07/01/04)............................................... 1.08* 09/01/15 2,500,000
8,000 Castaic Lake Water Agency, Refg Ser 1994 A COPs (MBIA)
(Called for Redemption 08/01/04)........................ 6.00 08/01/18 8,191,840
9,500 Newport Beach, Hoag Memorial/Presbyterian Hospital Ser
1992 (Demand 07/01/04).................................. 1.04* 10/01/22 9,500,000
10,575 Pleasanton Joint Powers Financing Authority, Reassessment
1993 Ser A.............................................. 6.15 09/02/04+ 10,763,764
------------
- --------
39,075 Total Short-Term California Tax-Exempt Municipal Obligations (Cost
$38,813,344)................................................................. 39,455,604
------------
- --------
</Table>
<Table>
$627,915 Total Investments (Cost $614,434,415) (a)............................ 98.4% 642,274,670
========
Other Assets in Excess of Liabilities................................ 1.6 10,107,932
----- ------------
Net Assets........................................................... 100.0% $652,382,602
===== ============
</Table>
- ---------------------
<Table>
AMT Alternative Minimum Tax.
COPs Certificates of Participation.
ETM Escrowed to maturity.
* Current coupon of variable rate demand obligation.
# Currently a zero coupon security; will convert to 5.45% on
07/01/12.
## Currently a zero coupon security; will convert to 5.85% on
07/15/09.
### Currently a zero coupon security; will convert to 7.15% on
01/01/05.
+ Prerefunded to call date shown.
++ Current coupon rate for inverse floating rate municipal
obligations. This rate resets periodically as the auction
rate on the related security changes. Positions in inverse
floating rate municipal obligations have a total value of
$13,983,180 which represents 2.1% of net assets.
(a) The aggregate cost for federal income tax purposes is
$614,021,565. The aggregate gross unrealized appreciation is
$30,325,959 and the aggregate gross unrealized depreciation
is $2,072,854, resulting in net unrealized appreciation of
$28,253,105.
Bond Insurance:
- ---------------
Ambac Ambac Assurance Corporation.
FGIC Financial Guaranty Insurance Company.
FSA Financial Security Assurance Inc.
MBIA Municipal Bond Investors Assurance Corporation.
XLCA XL Capital Assurance Inc.
</Table>
12
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
June 30, 2004 (unaudited)
<Table>
Assets:
Investments in securities, at value
(cost $614,434,415)....................................... $642,274,670
Cash........................................................ 205,476
Receivable for:
Interest................................................ 9,039,417
Investments sold........................................ 1,888,043
Shares of beneficial interest sold...................... 143,416
Prepaid expenses and other assets........................... 60,514
------------
Total Assets............................................ 653,611,536
------------
Liabilities:
Payable for:
Distribution fee........................................ 393,490
Investment management fee............................... 320,349
Shares of beneficial interest redeemed.................. 254,569
Dividends and distributions to shareholders............. 158,088
Accrued expenses and other payables......................... 102,438
------------
Total Liabilities....................................... 1,228,934
------------
Net Assets.............................................. $652,382,602
============
Composition of Net Assets:
Paid-in-capital............................................. $619,922,026
Net unrealized appreciation................................. 27,840,255
Accumulated undistributed net investment income............. 743,452
Accumulated undistributed net realized gain................. 3,876,869
------------
Net Assets.............................................. $652,382,602
============
Class A Shares:
Net Assets.................................................. $16,151,821
Shares Outstanding (unlimited authorized, $.01 par value)... 1,322,439
Net Asset Value Per Share............................... $12.21
============
Maximum Offering Price Per Share,
(net asset value plus 4.44% of net asset value)....... $12.75
============
Class B Shares:
Net Assets.................................................. $549,144,553
Shares Outstanding (unlimited authorized, $.01 par value)... 44,701,968
Net Asset Value Per Share............................... $12.28
============
Class C Shares:
Net Assets.................................................. $27,254,331
Shares Outstanding (unlimited authorized, $.01 par value)... 2,219,635
Net Asset Value Per Share............................... $12.28
============
Class D Shares:
Net Assets.................................................. $59,831,897
Shares Outstanding (unlimited authorized, $.01 par value)... 4,886,920
Net Asset Value Per Share............................... $12.24
============
</Table>
13
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended June 30, 2004 (unaudited)
<Table>
Net Investment Income:
Interest Income............................................. $ 17,730,658
------------
Expenses
Distribution fee (Class A shares)........................... 13,234
Distribution fee (Class B shares)........................... 1,880,436
Distribution fee (Class C shares)........................... 101,728
Investment management fee................................... 1,859,955
Transfer agent fees and expenses............................ 104,435
Shareholder reports and notices............................. 34,342
Professional fees........................................... 31,044
Custodian fees.............................................. 14,844
Trustees' fees and expenses................................. 8,636
Other....................................................... 21,016
------------
Total Expenses.......................................... 4,069,670
Less: expense offset........................................ (14,578)
Less: distribution fee rebate (Class B shares).............. (1,379,167)
------------
Net Expenses............................................ 2,675,925
------------
Net Investment Income................................... 15,054,733
------------
Net Realized and Unrealized Gain (Loss):
Net realized gain........................................... 4,377,654
Net change in unrealized appreciation....................... (24,664,700)
------------
Net Loss................................................ (20,287,046)
------------
Net Decrease................................................ $ (5,232,313)
============
</Table>
14
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
FINANCIAL STATEMENTS continued
Statement of Changes in Net Assets
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JUNE 30, 2004 DECEMBER 31, 2003
------------- -----------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 15,054,733 $ 32,313,322
Net realized gain........................................... 4,377,654 4,612,431
Net change in unrealized appreciation....................... (24,664,700) (6,374,894)
------------ ------------
Net Increase (Decrease)................................. (5,232,313) 30,550,859
------------ ------------
Dividends and Distributions to Shareholders from:
Net investment income
Class A shares.......................................... (382,536) (732,776)
Class B shares.......................................... (12,409,460) (27,255,860)
Class C shares.......................................... (516,416) (1,010,881)
Class D shares.......................................... (1,448,062) (3,233,583)
Net realized gain
Class A shares.......................................... (1,982) (118,724)
Class B shares.......................................... (67,006) (4,075,235)
Class C shares.......................................... (3,325) (179,557)
Class D shares.......................................... (7,323) (450,944)
------------ ------------
Total Dividends and Distributions....................... (14,836,110) (37,057,560)
------------ ------------
Net decrease from transactions in shares of beneficial
interest.................................................. (37,286,920) (87,733,702)
------------ ------------
Net Decrease............................................ (57,355,343) (94,240,403)
Net Assets:
Beginning of period......................................... 709,737,945 803,978,348
------------ ------------
End of Period
(Including accumulated undistributed net investment income
of $743,452 and $445,193, respectively)..................... $652,382,602 $709,737,945
============ ============
</Table>
15
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2004 (UNAUDITED)
1. Organization and Accounting Policies
Morgan Stanley California Tax-Free Income Fund (the "Fund") is registered under
the Investment Company Act of 1940, as amended (the "Act"), as a diversified,
open-end management investment company. The Fund's investment objective is to
provide a high level of current income which is exempt from federal and
California income tax, consistent with the preservation of capital. The Fund was
organized as a Massachusetts business trust on April 9, 1984 and commenced
operations on July 11, 1984. On July 28, 1997, the Fund converted to a multiple
class share structure.
The Fund offers Class A shares, Class B shares, Class C shares and Class D
shares. The four classes are substantially the same except that most Class A
shares are subject to a sales charge imposed at the time of purchase and some
Class A shares, and most Class B shares and Class C shares are subject to a
contingent deferred sales charge imposed on shares redeemed within one year, six
years and one year, respectively. Class D shares are not subject to a sales
charge. Additionally, Class A shares, Class B shares and Class C shares incur
distribution expenses.
The following is a summary of significant accounting policies:
A. Valuation of Investments -- (1) portfolio securities are valued by an outside
independent pricing service approved by the Trustees. The pricing service uses
both a computerized grid matrix of tax-exempt securities and evaluations by its
staff, in each case based on information concerning market transactions and
quotations from dealers which reflect the mean between the last reported bid and
asked price. The portfolio securities are thus valued by reference to a
combination of transactions and quotations for the same or other securities
believed to be comparable in quality, coupon, maturity, type of issue, call
provisions, trading characteristics and other features deemed to be relevant.
The Trustees believe that timely and reliable market quotations are generally
not readily available for purposes of valuing tax-exempt securities and that the
valuations supplied by the pricing service are more likely to approximate the
fair value of such securities; (2) futures are valued at the latest sale price
on the commodities exchange on which they trade unless it is determined that
such price does not reflect their market value, in which case they will be
valued at their fair value as determined in good faith under procedures
established by and under the supervision of the Trustees; and (3) short-term
debt securities having a maturity date of more than sixty days at time of
purchase are valued on a mark-to-market basis until sixty days prior to maturity
and thereafter at amortized cost based on their value on the 61st day.
Short-term debt securities having a maturity date of sixty days or less at the
time of purchase are valued at amortized cost.
B. Accounting for Investments -- Security transactions are accounted for on the
trade date (date the order to buy or sell is executed). Realized gains and
losses on security transactions are determined
16
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2004 (UNAUDITED) continued
by the identified cost method. Discounts are accreted and premiums are amortized
over the life of the respective securities. Interest income is accrued daily.
C. Multiple Class Allocations -- Investment income, expenses (other than
distribution fees), and realized and unrealized gains and losses are allocated
to each class of shares based upon the relative net asset value on the date such
items are recognized. Distribution fees are charged directly to the respective
class.
D. Futures Contracts -- A futures contract is an agreement between two parties
to buy and sell financial instruments or contracts based on financial indices at
a set price on a future date. Upon entering into such a contract, the Fund is
required to pledge to the broker cash, U.S. Government securities or other
liquid portfolio securities equal to the minimum initial margin requirements of
the applicable futures exchange. 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 the value of the contract. Such receipts or payments known as
variation margin are recorded by the Fund as unrealized gains and losses. Upon
closing of the contract, the Fund realizes a 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.
E. Federal Income Tax Policy -- 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 and nontaxable
income to its shareholders. Accordingly, no federal income tax provision is
required.
F. Dividends and Distributions to Shareholders -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
G. Use of Estimates -- The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures.
Actual results could differ from those estimates.
2. Investment Management Agreement
Pursuant to an Investment Management Agreement with Morgan Stanley Investment
Advisors Inc. (the "Investment Manager") the Fund pays the Investment Manager a
management fee, accrued daily and payable monthly, by applying the following
annual rates to the Fund's net assets determined as of the close of each
business day: 0.55% to the portion of daily net assets not exceeding $500
million; 0.525% to the portion of daily net assets exceeding $500 million but
not exceeding $750 million; 0.50% to the portion of daily net assets exceeding
$750 million but not exceeding $1 billion;
17
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2004 (UNAUDITED) continued
0.475% to the portion of daily net assets exceeding $1 billion but not exceeding
$1.25 billion; and 0.45% to the portion of daily net assets in excess of $1.25
billion.
3. Plan of Distribution
Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the
"Distributor"), an affiliate of the Investment Manager. The Fund has adopted a
Plan of Distribution (the "Plan") pursuant to Rule 12b-1 under the Act. The Plan
provides that the Fund will pay the Distributor a fee which is accrued daily and
paid monthly at the following annual rates: (i) Class A -- up to 0.25% of the
average daily net assets of Class A; (ii) Class B -- up to 0.75% of the lesser
of: (a) the average daily aggregate gross sales of the Class B shares since the
inception of the Fund (not including reinvestment of dividend or capital gain
distributions) less the average daily aggregate net asset value of the Class B
shares redeemed since the Fund's inception upon which a contingent deferred
sales charge has been imposed or waived; or (b) the average daily net assets of
Class B; and (iii) Class C -- up to 0.75% of the average daily net assets of
Class C.
In the case of Class B shares, provided that the Plan continues in effect, any
cumulative expenses incurred by the Distributor but not yet recovered may be
recovered through the payment of future distribution fees from the Fund pursuant
to the Plan and contingent deferred sales charges paid by investors upon
redemption of Class B shares. Although there is no legal obligation for the Fund
to pay expenses incurred in excess of payments made to the Distributor under the
Plan and the proceeds of contingent deferred sales charges paid by investors
upon redemption of shares, if for any reason the Plan is terminated, the
Trustees will consider at that time the manner in which to treat such expenses.
The Distributor has advised the Fund that there were no excess expenses as of
June 30, 2004.
For the period January 1, 2004 through April 30, 2004, the Distributor rebated a
portion of the distribution fees paid by the Fund on Class B shares in the
amount of $1,379,167.
In the case of Class A shares and Class C shares, expenses incurred pursuant to
the Plan in any calendar year in excess of 0.25% or 0.75% of the average daily
net assets of Class A or Class C, respectively, will not be reimbursed by the
Fund through payments in any subsequent year, except that expenses representing
a gross sales credit to Morgan Stanley Financial Advisors or other selected
broker-dealer representatives may be reimbursed in the subsequent calendar year.
For the six months ended June 30, 2004, the distribution fee was accrued for
Class A shares and Class C shares at the annual rate of 0.15% and 0.75%,
respectively.
The Distributor has informed the Fund that for the six months ended June 30,
2004, it received contingent deferred sales charges from certain redemptions of
the Fund's Class B shares and
18
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2004 (UNAUDITED) continued
Class C shares of $184,602 and $1,212, respectively and received $28,811 in
front-end sales charges from sales of the Fund's Class A shares. The respective
shareholders pay such charges which are not an expense of the Fund.
4. Security Transactions and Transactions with Affiliates
The cost of purchases and proceeds from sales of portfolio securities, excluding
short-term investments, for the six months ended June 30, 2004 aggregated
$47,928,620 and $107,201,042, respectively.
Morgan Stanley Trust, an affiliate of the Investment Manager and Distributor, is
the Fund's transfer agent. At June 30, 2004, the Fund had transfer agent fees
and expenses payable of approximately $4,200.
The Fund has an unfunded noncontributory defined benefit pension plan covering
certain independent Trustees of the Fund who will have served as independent
Trustees for at least five years at the time of retirement. Benefits under this
plan are based on factors which include years of service and compensation.
Aggregate pension costs for the six months ended June 30, 2004 included in
Trustees' fees and expenses in the Statement of Operations amounted to $3,691.
At June 30, 2004, the Fund had an accrued pension liability of $59,663 which is
included in accrued expenses in the Statement of Assets and Liabilities. On
December 2, 2003, the Trustees voted to close the plan to new participants and
eliminate the future benefits growth due to increases to compensation after July
31, 2003.
Effective April 1, 2004, the Fund began an unfunded Deferred Compensation Plan
(the "Compensation Plan") which allows each independent Trustee to defer payment
of all, or a portion, of the fees he receives for serving on the Board of
Trustees. Each eligible Trustee generally may elect to have the deferred amounts
credited with a return equal to the total return on one or more of the Morgan
Stanley funds that are offered as investment options under the Compensation
Plan. Appreciation/depreciation and distributions received from these
investments are recorded with an offsetting increase/decrease in the deferred
compensation obligation and do not affect the net asset value of the Fund.
5. Expense Offset
The expense offset represents a reduction of the custodian fees for earnings on
cash balances maintained by the Fund.
19
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2004 (UNAUDITED) continued
6. Risks Relating to Certain Financial Instruments
The Fund may invest a portion of its assets in residual interest bonds, which
are inverse floating rate municipal obligations. The prices of these securities
are subject to greater market fluctuations during periods of changing prevailing
interest rates than are comparable fixed rate obligations.
To hedge against adverse interest rate changes, the Fund may invest in financial
futures contracts or municipal bond index futures contracts ("futures
contracts").
These futures contracts involve elements of market risk in excess of the amount
reflected in the Statement of Assets and Liabilities. The Fund bears the risk of
an unfavorable change in the value of the underlying securities. Risks may also
arise upon entering into these contracts from the potential inability of the
counterparties to meet the terms of their contracts.
7. Federal Income Tax Status
The amount of dividends and distributions from net investment income and net
realized capital gains are determined in accordance with federal income tax
regulations which may differ from generally accepted accounting principles.
These "book/tax" differences are either considered temporary or permanent in
nature. To the extent these differences are permanent in nature, such amounts
are reclassified within the capital accounts based on their federal tax-basis
treatment; temporary differences do not require reclassification. Dividends and
distributions which exceed net investment income and net realized capital gains
for tax purposes are reported as distributions of paid-in-capital.
As of December 31, 2003, the Fund had temporary book/tax differences primarily
attributable to capital loss deferrals on wash sales and book amortization of
discounts on debt securities.
8. Legal Matters
The Investment Manager, certain affiliates of the Investment Manager, certain
officers of such affiliates and certain investment companies advised by the
Investment Manager or its affiliates, including the Fund, are named as
defendants in a number of similar class action complaints which were recently
consolidated. This consolidated action also names as defendants certain
individual Trustees and Directors of the Morgan Stanley funds. The consolidated
amended complaint generally alleges that defendants, including the Fund,
violated their statutory disclosure obligations and fiduciary duties by failing
properly to disclose (i) that the Investment Manager and certain affiliates of
the Investment Manager allegedly offered economic incentives to brokers and
others to recommend the funds advised by the Investment Manager or its
affiliates to investors rather than funds managed by other companies, and (ii)
that the funds advised by the Investment Manager or its affiliates, including
the Fund, allegedly paid excessive commissions to brokers in return for their
efforts to
20
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2004 (UNAUDITED) continued
recommend these funds to investors. The complaint seeks, among other things,
unspecified compensatory damages, rescissionary damages, fees and costs. The
defendants have moved to dismiss the action and intend to otherwise vigorously
defend it. While the Fund believes that it has meritorious defenses, the
ultimate outcome of this matter is not presently determinable at this early
stage of the litigation, and no provision has been made in the Fund's financial
statements for the effect, if any, of this matter.
9. Shares of Beneficial Interest
Transactions in shares of beneficial interest were as follows:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JUNE 30, 2004 DECEMBER 31, 2003
------------------------- --------------------------
(unaudited)
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ---------- -------------
CLASS A SHARES
Sold............................................. 219,395 $ 2,788,396 798,027 $ 10,035,431
Reinvestment of dividends and distributions...... 10,897 135,052 24,442 307,515
Redeemed......................................... (293,113) (3,614,978) (1,076,242) (13,544,718)
---------- ------------ ---------- -------------
Net decrease - Class A........................... (62,821) (691,530) (253,773) (3,201,772)
---------- ------------ ---------- -------------
CLASS B SHARES
Sold............................................. 627,490 7,901,575 2,241,508 28,434,334
Reinvestment of dividends and distributions...... 493,443 6,160,921 1,276,233 16,142,176
Redeemed......................................... (3,835,687) (47,892,765) (9,610,206) (121,340,302)
---------- ------------ ---------- -------------
Net decrease - Class B........................... (2,714,754) (33,830,269) (6,092,465) (76,763,792)
---------- ------------ ---------- -------------
CLASS C SHARES
Sold............................................. 268,797 3,401,158 871,904 11,075,117
Reinvestment of dividends and distributions...... 26,075 325,358 59,793 756,188
Redeemed......................................... (165,232) (2,071,718) (868,360) (10,970,699)
---------- ------------ ---------- -------------
Net increase - Class C........................... 129,640 1,654,798 63,337 860,606
---------- ------------ ---------- -------------
CLASS D SHARES
Sold............................................. 182,797 2,294,475 885,580 11,217,139
Reinvestment of dividends and distributions...... 58,854 733,011 151,366 1,909,249
Redeemed......................................... (599,714) (7,447,405) (1,718,245) (21,755,132)
---------- ------------ ---------- -------------
Net decrease - Class D........................... (358,063) (4,419,919) (681,299) (8,628,744)
---------- ------------ ---------- -------------
Net decrease in Fund............................. (3,005,998) $(37,286,920) (6,964,200) $ (87,733,702)
========== ============ ========== =============
</Table>
21
Morgan Stanley California Tax-Free Income Fund
FINANCIAL HIGHLIGHTS
Selected ratios and per share data for a share of beneficial interest
outstanding throughout each period:
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31,
MONTHS ENDED --------------------------------------------------------------------
JUNE 30, 2004 2003 2002 2001 2000 1999
------------- -------- -------- -------- -------- --------
(unaudited)
Class A Shares
Selected Per Share Data:
Net asset value, beginning of
period............................. $12.58 $12.68 $12.34 $12.49 $11.67 $12.75
------ ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income........... 0.28 0.55 0.57 0.57 0.58 0.58
Net realized and unrealized gain
(loss).......................... (0.38) (0.01) 0.44 (0.10) 0.82 (1.06)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations......................... (0.10) 0.54 1.01 0.47 1.40 (0.48)
------ ------ ------ ------ ------ ------
Less dividends and distributions
from:
Net investment income........... (0.27) (0.55) (0.57) (0.58) (0.58) (0.58)
Net realized gain............... 0.00++ (0.09) (0.10) (0.04) -- (0.02)
------ ------ ------ ------ ------ ------
Total dividends and distributions... (0.27) (0.64) (0.67) (0.62) (0.58) (0.60)
------ ------ ------ ------ ------ ------
Net asset value, end of period...... $12.21 $12.58 $12.68 $12.34 $12.49 $11.67
====== ====== ====== ====== ====== ======
Total Return+....................... (0.80)%(1) 4.31% 8.37% 3.90% 12.17% (3.91)%
Ratios to Average Net Assets(3):
Expenses (before expense offset).... 0.76 %(2) 0.78% 0.80% 0.80% 0.83% 0.78%(4)
Net investment income............... 4.42 %(2) 4.34% 4.53% 4.62% 4.80% 4.70%
Supplemental Data:
Net assets, end of period, in
thousands.......................... $16,152 $17,422 $20,775 $17,147 $12,336 $6,253
Portfolio turnover rate............. 7 %(1) 11% 12% 13% 4% 5%
</Table>
- ---------------------
<Table>
+ Does not reflect the deduction of sales charge. Calculated
based on the net asset value as of the last business day of
the period.
++ Distribution of $0.002 per share.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall fund ratios for investment income and
non-class specific expenses.
(4) Does not reflect the effect of expense offset of 0.01%.
</Table>
22
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31,
MONTHS ENDED ---------------------------------------------------------------------
JUNE 30, 2004 2003 2002 2001 2000 1999
------------- --------- --------- --------- --------- ---------
(unaudited)
Class B Shares
Selected Per Share Data:
Net asset value, beginning of
period............................ $12.65 $12.75 $12.42 $12.57 $11.73 $12.81
------ ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income.......... 0.27 0.55 0.56 0.55 0.57 0.57
Net realized and unrealized
gain (loss).................... (0.37) (0.02) 0.42 (0.11) 0.84 (1.06)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations........................ (0.10) 0.53 0.98 0.44 1.41 (0.49)
------ ------ ------ ------ ------ ------
Less dividends and distributions
from:
Net investment income.......... (0.27) (0.54) (0.55) (0.55) (0.57) (0.57)
Net realized gain.............. 0.00++ (0.09) (0.10) (0.04) -- (0.02)
------ ------ ------ ------ ------ ------
Total dividends and
distributions..................... (0.27) (0.63) (0.65) (0.59) (0.57) (0.59)
------ ------ ------ ------ ------ ------
Net asset value, end of period..... $12.28 $12.65 $12.75 $12.42 $12.57 $11.73
====== ====== ====== ====== ====== ======
Total Return+...................... (0.83)%(1) 4.27% 8.13% 3.56% 12.29% (3.99)%
Ratios to Average Net Assets(3)(5):
Expenses (before expense offset)... 0.78 %(2) 0.83% 0.93% 1.04% 0.93% 0.91%(4)
Net investment income.............. 4.40 %(2) 4.29% 4.40% 4.38% 4.70% 4.57%
Supplemental Data:
Net assets, end of period, in
thousands......................... $549,145 $599,737 $682,046 $696,481 $732,668 $761,548
Portfolio turnover rate............ 7 %(1) 11% 12% 13% 4% 5%
</Table>
- ---------------------
<Table>
+ Does not reflect the deduction of sales charge. Calculated based on the net asset value as of the last business day
of the period.
++ Distribution of $0.002 per share.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall fund ratios for investment income and non-class specific expenses.
(4) Does not reflect the effect of expense offset of 0.01%.
(5) If the Fund had borne all of its expenses that were reimbursed by the Distributor, the annualized expense and net
investment income ratios would have been as follows:
EXPENSE NET INVESTMENT
PERIOD ENDED RATIO INCOME RATIO
----------------- ---- ----
June 30, 2004 1.26% 3.92%
December 31, 2003 1.35 3.77
December 31, 2002 1.35 3.98
December 31, 2001 1.34 4.06
December 31, 2000 1.34 4.29
December 31, 1999 1.34 4.14
</Table>
23
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31,
MONTHS ENDED --------------------------------------------------------------------
JUNE 30, 2004 2003 2002 2001 2000 1999
------------- -------- -------- -------- -------- --------
(unaudited)
Class C Shares
Selected Per Share Data:
Net asset value, beginning of
period............................. $12.65 $12.74 $12.42 $12.57 $11.73 $ 12.81
------ ------ ------ ------ ------ -------
Income (loss) from investment
operations:
Net investment income........... 0.24 0.48 0.50 0.51 0.52 0.51
Net realized and unrealized gain
(loss).......................... (0.37) 0.00 0.42 (0.11) 0.84 (1.06)
------ ------ ------ ------ ------ -------
Total income (loss) from investment
operations......................... (0.13) 0.48 0.92 0.40 1.36 (0.55)
------ ------ ------ ------ ------ -------
Less dividends and distributions
from:
Net investment income........... (0.24) (0.48) (0.50) (0.51) (0.52) (0.51)
Net realized gain............... 0.00++ (0.09) (0.10) (0.04) -- (0.02)
------ ------ ------ ------ ------ -------
Total dividends and distributions... (0.24) (0.57) (0.60) (0.55) (0.52) (0.53)
------ ------ ------ ------ ------ -------
Net asset value, end of period...... $12.28 $12.65 $12.74 $12.42 $12.57 $ 11.73
====== ====== ====== ====== ====== =======
Total Return+....................... (1.07)%(1) 3.80% 7.59% 3.33% 11.74% (4.41)%
Ratios to Average Net Assets(3):
Expenses (before expense offset).... 1.36 %(2) 1.35% 1.35% 1.34% 1.34% 1.34%(4)
Net investment income............... 3.82 %(2) 3.77% 3.98% 4.09% 4.29% 4.14%
Supplemental Data:
Net assets, end of period, in
thousands.......................... $27,254 $26,435 $25,825 $16,745 $14,534 $13,099
Portfolio turnover rate............. 7 %(1) 11% 12% 13% 4% 5%
</Table>
- ---------------------
<Table>
+ Does not reflect the deduction of sales charge. Calculated
based on the net asset value as of the last business day of
the period.
++ Distribution of $0.002 per share.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall fund ratios for investment income and
non-class specific expenses.
(4) Does not reflect the effect of expense offset of 0.01%.
</Table>
24
See Notes to Financial Statements
Morgan Stanley California Tax-Free Income Fund
FINANCIAL HIGHLIGHTS continued
<Table>
<Caption>
FOR THE SIX FOR THE YEAR ENDED DECEMBER 31,
MONTHS ENDED --------------------------------------------------------------------
JUNE 30, 2004 2003 2002 2001 2000 1999
------------- -------- -------- -------- -------- --------
(unaudited)
Class D Shares
Selected Per Share Data:
Net asset value, beginning of
period............................. $12.61 $12.71 $12.39 $12.53 $11.71 $12.78
------ ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income........... 0.29 0.57 0.60 0.60 0.61 0.60
Net realized and unrealized gain
(loss).......................... (0.38) (0.01) 0.41 (0.10) 0.82 (1.05)
------ ------ ------ ------ ------ ------
Total income (loss) from investment
operations......................... (0.09) 0.56 1.01 0.50 1.43 (0.45)
------ ------ ------ ------ ------ ------
Less dividends and distributions
from:
Net investment income........... (0.28) (0.57) (0.59) (0.60) (0.61) (0.60)
Net realized gain............... 0.00++ (0.09) (0.10) (0.04) -- (0.02)
------ ------ ------ ------ ------ ------
Total dividends and distributions... (0.28) (0.66) (0.69) (0.64) (0.61) (0.62)
------ ------ ------ ------ ------ ------
Net asset value, end of period...... $12.24 $12.61 $12.71 $12.39 $12.53 $11.71
====== ====== ====== ====== ====== ======
Total Return+....................... (0.71)%(1) 4.50% 8.41% 4.12% 12.50% (3.63)%
Ratios to Average Net Assets(3):
Expenses (before expense offset).... 0.61 %(2) 0.60% 0.60% 0.59% 0.59% 0.59%(4)
Net investment income............... 4.57 %(2) 4.52% 4.73% 4.84% 5.04% 4.89%
Supplemental Data:
Net assets, end of period, in
thousands.......................... $59,832 $66,143 $75,332 $83,638 $95,132 $1,021
Portfolio turnover rate............. 7 %(1) 11% 12% 13% 4% 5%
</Table>
- ---------------------
<Table>
+ Calculated based on the net asset value as of the last
business day of the period.
++ Distribution of $0.002 per share.
(1) Not annualized.
(2) Annualized.
(3) Reflects overall fund ratios for investment income and
non-class specific expenses.
(4) Does not reflect the effect of expense offset of 0.01%.
</Table>
25
See Notes to Financial Statements
(This Page Intentionally Left Blank)
(This Page Intentionally Left Blank)
TRUSTEES
Michael Bozic
Charles A. Fiumefreddo
Edwin J. Garn
Wayne E. Hedien
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael E. Nugent
Fergus Reid
OFFICERS
Charles A. Fiumefreddo
Chairman of the Board
Mitchell M. Merin
President
Ronald E. Robison
Executive Vice President and Principal Executive Officer
Barry Fink
Vice President
Joseph J. McAlinden
Vice President
Stefanie V. Chang
Vice President
Francis J. Smith
Treasurer and Chief Financial Officer
Thomas F. Caloia
Vice President
Mary E. Mullin
Secretary
TRANSFER AGENT
Morgan Stanley Trust
Harborside Financial Center, Plaza Two
Jersey City, New Jersey 07311
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
Two World Financial Center
New York, New York 10281
INVESTMENT MANAGER
Morgan Stanley Investment Advisors Inc.
1221 Avenue of the Americas
New York, New York 10020
The financial statements included herein have been taken from the records of the
Fund without examination by the independent auditors and accordingly they do not
express an opinion thereon.
This report is submitted for the general information of shareholders of the
Fund. For more detailed information about the Fund, its fees and expenses and
other pertinent information, please read its Prospectus. The Fund's Statement of
Additional Information contains additional information about the Fund, including
its trustees. It is available, without charge, by calling (800) 869-NEWS.
This report is not authorized for distribution to prospective investors in the
Fund unless preceded or accompanied by an effective Prospectus. Read the
Prospectus carefully before investing.
Investments and services offered through Morgan Stanley DW Inc., member SIPC.
Morgan Stanley Distributors Inc., member NASD.
(c) 2004 Morgan Stanley
[MORGAN STANLEY LOGO]
MORGAN STANLEY FUNDS
Morgan Stanley
California Tax-Free
Income Fund
Semiannual Report
June 30, 2004
[MORGAN STANLEY LOGO]
37900RPT-RA04-00481P-Y06/04
Item 2. Code of Ethics.
Not applicable for semiannual reports.
Item 3. Audit Committee Financial Expert.
Not applicable for semiannual reports.
Item 4. Principal Accountant Fees and Services
Not applicable for semiannual reports.
Item 5. Audit Committee of Listed Registrants.
Not applicable for semiannual reports.
Item 6. [Reserved.]
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Not applicable for semiannual reports.
Item 8. [Reserved.]
Item 9 - Controls and Procedures
(a) The Fund's principal executive officer and principal financial officer have
concluded that the Fund's disclosure controls and procedures are sufficient to
ensure that information required to be disclosed by the Fund in this Form N-CSR
was recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, based
upon such officers' evaluation of these controls and procedures as of a date
within 90 days of the filing date of the report.
There were no significant changes or corrective actions with regard to
significant deficiencies or material weaknesses in the Fund's internal controls
or in other factors that could significantly affect the Fund's internal controls
subsequent to the date of their evaluation.
(b) There were no changes in the registrant's internal control over financial
reporting that occurred during the registrant's most recent fiscal half-year
(the registrant's second fiscal half-year in the case of an annual report) that
has materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
Item 10 Exhibits
(a) Code of Ethics - Not applicable for semiannual reports.
(b) A separate certification for each principal executive officer and principal
financial officer of the registrant are attached hereto as part of EX-99.CERT.
2
SIGNATURES
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.
Morgan Stanley California Tax-Free Income Fund
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
August 19, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934
and the Investment Company Act of 1940, this report has been signed by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
/s/ Ronald E. Robison
Ronald E. Robison
Principal Executive Officer
August 19, 2004
/s/ Francis Smith
Francis Smith
Principal Financial Officer
August 19, 2004
3