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, 2005
Date of reporting period: June 30, 2005
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. PLEASE SEE THE PROSPECTUS FOR MORE COMPLETE
INFORMATION ON INVESTMENT RISKS.
FUND REPORT
For the six months ended June 30, 2005
TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2005
<Table>
<Caption>
LEHMAN LIPPER CA
BROTHERS MUNICIPAL
MUNICIPAL DEBT FUNDS
CLASS A CLASS B CLASS C CLASS D BOND INDEX(1) INDEX(2)
2.85% 2.98% 2.64% 2.93% 2.89% 3.29%
</Table>
THE PERFORMANCE OF THE FUND'S FOUR SHARE CLASSES VARIES BECAUSE EACH HAS
DIFFERENT EXPENSES. THE FUND'S TOTAL RETURNS ASSUME THE REINVESTMENT OF ALL
DISTRIBUTIONS BUT DO NOT REFLECT THE DEDUCTION OF ANY APPLICABLE SALES CHARGES.
SUCH COSTS WOULD LOWER PERFORMANCE. SEE PERFORMANCE SUMMARY FOR STANDARDIZED
PERFORMANCE AND BENCHMARK INFORMATION.
BECAUSE CLASS B SHARES INCURRED LOWER EXPENSES UNDER THE 12B-1 PLAN THAN DID
CLASS A SHARES FOR THE FISCAL PERIOD ENDED JUNE 30, 2005, THE TOTAL OPERATING
EXPENSE RATIO FOR CLASS B SHARES WAS LOWER AND, AS A RESULT, THE PERFORMANCE OF
CLASS B SHARES WAS HIGHER THAN THAT OF THE CLASS A SHARES. THERE CAN BE NO
ASSURANCE THAT THIS WILL CONTINUE TO OCCUR IN THE FUTURE AS THE MAXIMUM FEES
PAYABLE BY CLASS B SHARES UNDER THE 12B-1 PLAN ARE HIGHER THAN THOSE PAYABLE BY
CLASS A SHARES.
MARKET CONDITIONS
Consumer spending and business investment helped the U.S. economy expand at a
solid pace during the six-month period ending June 30, 2005. However, the
direction of some economic indicators, including job growth, remained uneven and
caused uncertainty about the strength of the economy. Consequently, interest
rates fluctuated, moving higher when reports were strong and lower when data was
weaker than anticipated. The first quarter of 2005 saw generally rising interest
rates. By April, however, the themes of low inflation and slow growth were again
prevalent and interest rates fell through the end of June.
Throughout the period, the Federal Open Market Committee (the "Fed") reaffirmed
its pledge to raise the federal funds target rate at a "measured" pace.
Continuing the policy shift begun in June 2004, the Fed increased the federal
funds target rate four times during the first half of 2005, in 25 basis point
increments. These moves brought the federal funds target rate to 3.25 percent at
the end of the reporting period.
Against this setting, the municipal bond market followed the taxable market and
the yields of long-term tax-exempt issues increased in the first quarter. The
course changed in the second quarter, as the market rallied and yields fell to
near-record lows. Persistent investor demand for income sustained the momentum
of this long-term bond rally. Meanwhile, the yields of shorter maturity
bonds -- which were more directly influenced by the Fed's actions -- rose. As a
result, the municipal yield curve continued to flatten and the yield spread (or
differential between one-year rates and 30-year rates) narrowed. Investors'
quest for yield favored lower-quality investment grade bonds over high-grade
issues, keeping quality spreads tight.
Led by a surge in refundings, municipal issuers continued to rush to the market
in the first six months of 2005. New issue volume increased by nine percent to
$206 billion, a record for the first six months of a calendar year. Refundings
increased to 35 percent of total issuance, up from 24 percent in 2004. Bonds
backed by insurance dominated issuance and increased their market penetration to
60 percent. California issuers represented 13 percent of the new underwriting
volume in 2005.
2
On the demand side, the municipal-to-Treasury yield ratio, which gauges relative
performance between the two markets, was attractive for tax-exempt bonds. As a
result, institutional investors (such as arbitrage accounts and hedge funds)
that normally focus on taxable bond sectors supported municipals by "crossing
over" to purchase bonds. However, retail investors were deterred by the absolute
level of rates and largely remained on the sidelines for most of the period.
California's economy demonstrated sustained improvement. Residential real-estate
markets showed continued strength and unemployment edged downward. On the fiscal
front, strong personal and corporate income tax growth helped stabilize the
credit outlook.
PERFORMANCE ANALYSIS
Morgan Stanley California Tax-Free Income Fund Class A and Class C shares
underperformed the Lehman Brothers Municipal Bond Index and its Class B and D
shares outperformed this Index for the six-month period ending June 30, 2005,
assuming no deduction of applicable sales charges. The Fund underperformed the
Lipper California Municipal Debt Funds Index for the same period.
During the period, the Fund maintained a conservative strategy in anticipation
of continued Fed tightening and higher interest rates. As a result, the Fund's
overall duration* (a measure of interest rate sensitivity) was managed to be
lower than its benchmark. The Fund's option adjusted duration was 6.8 years at
the end of June. This positioning helped performance early in the period when
rates rose into April, but hindered total returns when rates declined later in
the period. Lower rates also led municipal issuers to refinance outstanding
debt. The prerefunding of several of the Fund's holdings had a positive impact
on performance. The Fund continued to maintain a high average credit quality,
with 90 percent of assets in bonds rated A or higher at the close of the
reporting period. As credit spreads tightened, this high grade orientation had
an adverse impact on performance. The Fund's net assets of $611 million were
well diversified across 71 credits in 13 long-term 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.
There is no guarantee that any sectors mentioned will continue to perform well
or that securities in such sectors will be held by the Fund in the future.
3
<Table>
<Caption>
TOP FIVE SECTORS
Water & Sewer 20.6%
Transportation 17.3
General Obligations 11.9
Hospital 10.6
Tax Allocation 9.3
</Table>
<Table>
<Caption>
LONG-TERM CREDIT ANALYSIS
Aaa/AAA 71.3%
Aa/AA 3.9
A/A 14.9
Baa/BBB 8.3
Ba/BB or less 1.6
</Table>
Data as of June 30, 2005. Subject to change daily. All percentages for top five
sectors are as a percentage of net assets. All percentages for long-term credit
analysis are as a percentage of total long-term investments. These data are
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 PERCENT OF ITS NET ASSETS IN
SECURITIES THAT PAY INTEREST EXEMPT FROM FEDERAL AND CALIFORNIA STATE INCOME
TAXES. THE FUND'S "INVESTMENT ADVISER," 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.
FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS
EACH MORGAN STANLEY FUND PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN
ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE FUND'S SECOND
AND FOURTH FISCAL QUARTERS BY FILING THE SCHEDULE ELECTRONICALLY WITH THE
SECURITIES AND EXCHANGE COMMISSION (SEC). THE SEMIANNUAL REPORTS ARE FILED ON
FORM N-CSRS AND THE ANNUAL REPORTS ARE FILED ON FORM N-CSR. MORGAN STANLEY ALSO
DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO FUND SHAREHOLDERS AND MAKES THESE
REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, WWW.MORGANSTANLEY.COM. EACH MORGAN
STANLEY FUND ALSO FILES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS WITH THE SEC
FOR THE FUND'S FIRST AND THIRD FISCAL QUARTERS ON FORM N-Q. MORGAN STANLEY DOES
NOT DELIVER THE REPORTS FOR THE FIRST AND THIRD FISCAL QUARTERS TO SHAREHOLDERS,
NOR ARE THE REPORTS POSTED TO THE MORGAN STANLEY PUBLIC WEB SITE. YOU MAY,
HOWEVER, OBTAIN THE FORM N-Q FILINGS (AS WELL AS THE FORM N-CSR AND N-CSRS
FILINGS) BY ACCESSING THE SEC'S WEB SITE, HTTP://WWW.SEC.GOV. YOU MAY ALSO
REVIEW AND COPY THEM AT THE SEC'S PUBLIC REFERENCE ROOM IN WASHINGTON, DC.
INFORMATION ON THE OPERATION OF THE SEC'S PUBLIC REFERENCE ROOM MAY BE OBTAINED
BY
4
CALLING THE SEC AT (800) SEC-0330. YOU CAN ALSO REQUEST COPIES OF THESE
MATERIALS, UPON PAYMENT OF A DUPLICATING FEE, BY ELECTRONIC REQUEST AT THE SEC'S
E-MAIL ADDRESS (PUBLICINFO@SEC.GOV) OR BY WRITING THE PUBLIC REFERENCE SECTION
OF THE SEC, WASHINGTON, DC 20549-0102.
HOUSEHOLDING NOTICE
TO REDUCE PRINTING AND MAILING COSTS, THE FUND ATTEMPTS TO ELIMINATE DUPLICATE
MAILINGS TO THE SAME ADDRESS. THE FUND DELIVERS A SINGLE COPY OF CERTAIN
SHAREHOLDER DOCUMENTS, INCLUDING SHAREHOLDER REPORTS, PROSPECTUSES AND PROXY
MATERIALS, TO INVESTORS WITH THE SAME LAST NAME WHO RESIDE AT THE SAME ADDRESS.
YOUR PARTICIPATION IN THIS PROGRAM WILL CONTINUE FOR AN UNLIMITED PERIOD OF TIME
UNLESS YOU INSTRUCT US OTHERWISE. YOU CAN REQUEST MULTIPLE COPIES OF THESE
DOCUMENTS BY CALLING (800) 350-6414, 8:00 A.M. TO 8:00 P.M., ET. ONCE OUR
CUSTOMER SERVICE CENTER HAS RECEIVED YOUR INSTRUCTIONS, WE WILL BEGIN SENDING
INDIVIDUAL COPIES FOR EACH ACCOUNT WITHIN 30 DAYS.
5
DISTRIBUTION BY MATURITY
(% of Long-Term Portfolio) As of June 30, 2005
WEIGHTED AVERAGE MATURITY: 17 YEARS(A)
<Table>
1-5 7
6-10 7
11-15 26
16-20 38
21-25 10
26-30 7
30+ 5
</Table>
(a) Where applicable maturities reflect mandatory tenders, puts and call dates.
Portfolio structure is subject to change.
6
CALL AND COST (BOOK) YIELD STRUCTURE
(Based on Long-Term Portfolio) As of June 30, 2005
YEARS BONDS CALLABLE -- WEIGHTED AVERAGE CALL PROTECTION: 6 YEARS
<Table>
2005(a) 5
2006 5
2007 7
2008 12
2009 4
2010 2
2011 16
2012 11
2013 11
2014 6
2015+ 21
</Table>
COST (BOOK) YIELD(B) -- WEIGHTED AVERAGE BOOK YIELD: 5.3%
<Table>
2005(a) 6.1
2006 6.0
2007 6.2
2008 5.3
2009 5.2
2010 6.0
2011 5.1
2012 4.9
2013 4.9
2014 5.0
2015+ 5.4
</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 5% of the
long-term portfolio that is callable in 2005.
Portfolio structure is subject to change.
7
PERFORMANCE SUMMARY
AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED JUNE 30, 2005
<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 8.10%(3) 8.23%(3) 7.50%(3) 8.31%(3)
3.50(4) 3.23(4) 6.50(4) --
5 YEARS 6.12(3) 6.02(3) 5.51(3) 6.29(3)
5.20(4) 5.70(4) 5.51(4) --
10 YEARS -- 5.37(3) -- --
-- 5.37(4) -- --
SINCE INCEPTION 5.01(3) 7.16(3) 4.51(3) 5.26(3)
4.43(4) 7.16(4) 4.51(4) --
</Table>
Performance data quoted represents past performance, which is no guarantee of
future results and current performance may be lower or higher than the figures
shown. For the most recent month-end performance figures, please visit
www.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.
8
EXPENSE EXAMPLE
As a shareholder of the Fund, you incur two types of costs: (1) transaction
costs, including sales charges (loads) on purchase payments and redemption fees;
and (2) ongoing costs, including management fees; distribution and service
(12b-1) fees; and other Fund expenses. This example is intended to help you
understand your ongoing costs (in dollars) of investing in the Fund and to
compare these costs with the ongoing costs of investing in other mutual funds.
The example is based on an investment of $1,000 invested at the beginning of the
period and held for the entire period 01/01/05 - 06/30/05.
ACTUAL EXPENSES
The first line of the table below provides information about actual account
values and actual expenses. You may use the information in this line, together
with the amount you invested, to estimate the expenses that you paid over the
period. Simply divide your account value by $1,000 (for example, an $8,600
account value divided by $1,000 = 8.6), then multiply the result by the number
in the first line under the heading entitled "Expenses Paid During Period" to
estimate the expenses you paid on your account during this period.
HYPOTHETICAL EXAMPLE FOR COMPARISON PURPOSES
The second line of the table below provides information about hypothetical
expenses based on the Fund's actual expense ratio and an assumed rate of return
of 5% per year before expenses, which is not the Fund's actual return. The
hypothetical account values and expenses may not be used to estimate the actual
ending account balance or expenses you paid for the period. You may use this
information to compare the ongoing cost of investing in the Fund and other
funds. To do so, compare this 5% hypothetical example with the 5% hypothetical
examples that appear in the shareholder reports of the other funds.
Please note that the expenses shown in the table are meant to highlight your
ongoing costs only and do not reflect any transactional costs, such as sales
charges (loads) and redemption fees. Therefore, the second line of the table is
useful in comparing ongoing costs, and will not help you determine the relative
total cost of owning different funds. In addition, if these transactional costs
were included, your costs would have been higher.
<Table>
<Caption>
BEGINNING ENDING EXPENSES PAID
ACCOUNT VALUE ACCOUNT VALUE DURING PERIOD *
------------- ------------- ---------------
01/01/05 -
01/01/05 06/30/05 06/30/05
------------- ------------- ---------------
CLASS A
Actual (2.85% return)....................................... $1,000.00 $1,028.50 $4.28
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,020.63 $4.26
CLASS B
Actual (2.98% return)....................................... $1,000.00 $1,029.80 $3.37
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,021.52 $3.36
CLASS C
Actual (2.64% return)....................................... $1,000.00 $1,026.40 $6.78
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,018.10 $6.76
CLASS D
Actual (2.93% return)....................................... $1,000.00 $1,029.30 $3.07
Hypothetical (5% annual return before expenses)............. $1,000.00 $1,021.77 $3.06
</Table>
- ------------------
* Expenses are equal to the Fund's annualized expense ratio of 0.85%, 0.67%,
1.35% and 0.61% respectively, multiplied by the average account value over
the period, multiplied by 181/365 (to reflect the one-half year period).
9
INVESTMENT ADVISORY AGREEMENT APPROVAL
NATURE, EXTENT AND QUALITY OF SERVICES
The Board reviewed and considered the nature and extent of the investment
advisory services provided by the Investment Adviser under the Advisory
Agreement, including portfolio management, investment research and fixed income
securities trading. The Board also reviewed and considered the nature and extent
of the non-advisory, administrative services provided by the Fund's
Administrator under the Administration Agreement, including accounting,
clerical, bookkeeping, compliance, business management and planning, and the
provision of supplies, office space and utilities. (The Investment Adviser and
the Administrator together are referred to as the "Adviser" and the Advisory and
Administration Agreements together are referred to as the "Management
Agreement.") The Board also compared the nature of the services provided by the
Adviser with similar services provided by non-affiliated advisers as reported to
the Board by Lipper Inc. ("Lipper").
The Board reviewed and considered the qualifications of the portfolio managers,
the senior administrative managers and other key personnel of the Adviser who
provide the administrative and investment advisory services to the Fund. The
Board determined that the Adviser's portfolio managers and key personnel are
well qualified by education and/or training and experience to perform the
services in an efficient and professional manner. The Board concluded that the
nature and extent of the advisory and administrative services provided were
necessary and appropriate for the conduct of the business and investment
activities of the Fund. The Board also concluded that the overall quality of the
advisory and administrative services was satisfactory.
PERFORMANCE RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the Fund's performance for the one-, three- and five-year
periods ended November 30, 2004, as shown in reports provided by Lipper (the
"Lipper Reports"), compared to the performance of comparable funds selected by
Lipper (the "performance peer group"), and noted that the Fund's performance was
lower than, but close to, its performance peer group average for all three
periods. The Board concluded that the Fund's performance was satisfactory.
FEES RELATIVE TO OTHER FUNDS MANAGED BY THE ADVISER WITH COMPARABLE INVESTMENT
STRATEGIES
The Board reviewed the advisory and administrative fees (together, the
"management fee") paid by the Fund under the Management Agreement. The Board
noted that the rate was comparable to the management fee rates charged by the
Adviser to any other funds it manages with investment strategies comparable to
those of the Fund.
10
FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the management fee rate and total expense ratio of the Fund.
The Board noted that: (i) the Fund's management fee rate was higher than the
average management fee rate for funds, selected by Lipper (the "expense peer
group"), managed by other advisers, with investment strategies comparable to
those of the Fund, as shown in the Lipper Report for this Fund; and (ii) the
Fund's total expense ratio was also higher than the average total expense ratio
of the funds included in the Fund's expense peer group. The Board and the
Adviser discussed the Fund's management fee and total expense ratio and the
Adviser agreed to impose a cap of 0.60% on the Fund's total expenses, excluding
brokerage and 12b-1 fees, which would have the effect of reducing the management
fee and/or other expenses of the Fund. The Board concluded that with the
proposed cap the Fund's management fee and total expense ratio would be
competitive with those its expense peer group.
BREAKPOINTS AND ECONOMIES OF SCALE
The Board reviewed the structure of the Fund's management fee schedule under the
Management Agreement and noted that it includes breakpoints. The Board also
reviewed the level of the Fund's management fee and noted that the fee, as a
percentage of the Fund's net assets, would decrease as net assets increase
because the management fee includes breakpoints. The Board concluded that the
Fund's management fee would reflect economies of scale as assets increase.
PROFITABILITY OF ADVISER AND AFFILIATES
The Board considered and reviewed information concerning the costs incurred and
profits realized by the Adviser and its affiliates during the last two years
from their relationship with the Fund and the Morgan Stanley Fund Complex and
reviewed with the Controller of the Adviser the cost allocation methodology used
to determine the Adviser's profitability. Based on their review of the
information they received, the Board concluded that the profits earned by the
Adviser and its affiliates were not excessive in light of the advisory,
administrative and other services provided to the Fund.
FALL-OUT BENEFITS
The Board considered so-called "fall-out benefits" derived by the Adviser and
its affiliates from their relationship with the Fund and the Morgan Stanley Fund
Complex, such as "float" benefits derived from handling of checks for purchases
and redemptions of Fund shares through a broker-dealer affiliate of the Adviser.
The Board also considered that a broker-dealer affiliate of the Adviser receives
from the Fund 12b-1 fees for distribution and shareholder services. The Board
concluded that the float benefits were relatively small and that the 12b-1 fees
were competitive with those of other broker-dealer affiliates of investment
advisers.
11
SOFT DOLLAR BENEFITS
The Board considered whether the Adviser realizes any benefits from commissions
paid to brokers who execute securities transactions for the Fund ("soft
dollars"). The Board noted that the Fund invests only in fixed income
securities, which do not generate soft dollars.
ADVISER FINANCIALLY SOUND AND FINANCIALLY CAPABLE OF MEETING THE FUND'S NEEDS
The Board considered whether the Adviser is financially sound and has the
resources necessary to perform its obligations under the Management Agreement.
The Board noted that the Adviser's operations remain profitable, although
increased expenses in recent years have reduced the Adviser's profitability. The
Board concluded that the Adviser has the financial resources necessary to
fulfill its obligations under the Management Agreement.
HISTORICAL RELATIONSHIP BETWEEN THE FUND AND THE ADVISER
The Board also reviewed and considered the historical relationship between the
Fund and the Adviser, including the organizational structure of the Adviser, the
policies and procedures formulated and adopted by the Adviser for managing the
Fund's operations and the Board's confidence in the competence and integrity of
the senior managers and key personnel of the Adviser. The Board concluded that
it is beneficial for the Fund to continue its relationship with the Adviser.
OTHER FACTORS AND CURRENT TRENDS
The Board considered the controls and procedures adopted and implemented by the
Adviser and monitored by the Fund's Chief Compliance Officer and concluded that
the conduct of business by the Adviser indicates a good faith effort on its part
to adhere to high ethical standards in the conduct of the Fund's business.
GENERAL CONCLUSION
After considering and weighing all of the above factors, the Board concluded it
would be in the best interest of the Fund and its shareholders to approve
renewal of the Management Agreement for another year.
12
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED)
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
California Tax-Exempt Municipal Bonds (97.4%)
General Obligation (11.9%)
California,
$ 5,000 Ser 1990................................................ 7.00% 08/01/07 $ 5,418,450
5,000 Ser 1990................................................ 7.00 08/01/08 5,591,750
8,310 Ser 1996 (Ambac)........................................ 5.25 06/01/21 8,556,724
535 Various Purpose Dtd 04/01/93 (FSA)...................... 5.50 04/01/19 538,622
5,000 Various Purpose Dtd 04/01/02............................ 6.00 04/01/19 6,034,800
2,000 Veterans Ser AT......................................... 9.50 02/01/10 2,518,780
2,400 Veterans Ser BH (AMT) (FSA)............................. 5.40 12/01/16 2,548,152
3,000 Huntington Beach Union High School District, Ser 2004
(FSA)................................................... 5.00 08/01/27 3,220,650
5,000 Los Angeles, Ser 2004 A (MBIA)............................ 5.00 09/01/24 5,378,400
Los Angeles Unified School District,
5,000 2003 Ser A (FSA)........................................ 5.25 07/01/20 5,572,900
10,000 1997 Ser B (FGIC)....................................... 5.00 07/01/23 10,546,400
5,000 Placentia - Yorba Linda United School District, 2002
Election Ser A (FGIC)................................... 5.00 08/01/26 5,294,650
Puerto Rico,
8,000 Public Impr Ser 1999.................................... 4.75 07/01/23 8,135,280
3,000 Public Impr Ser 1999 (Secondary MBIA)................... 4.875 07/01/23 3,135,780
------------
- --------
72,491,338
67,245
------------
- --------
Educational Facilities Revenue (4.7%)
California Educational Facilities Authority,
2,000 California College of the Arts Ser 2005................. 5.00 06/01/35 2,020,960
3,000 Mills College Ser 2005 A................................ 5.00 09/01/29 3,153,660
2,000 Mills College Ser 2005 A................................ 5.00 09/01/34 2,079,600
3,000 Pitzer College Ser 2005 A............................... 5.00 04/01/35 3,108,990
4,240 University of Redlands 2005 Ser A (WI).................. 5.00 10/01/35 4,415,833
5,000 University of San Diego Ser 1998 (Ambac)................ 5.00 10/01/22 5,290,500
University California,
5,000 Ser 2003 Q (FSA)........................................ 5.00 09/01/24 5,308,450
3,000 Ser 2005 F (FSA) (WI)................................... 4.75 05/15/26 3,113,160
------------
- --------
28,491,153
27,240
------------
- --------
</Table>
See Notes to Financial Statements
13
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Electric Revenue (8.3%)
$ 10,000 California Department of Water Resources, Power Supply Ser
2002 A.................................................. 5.375% 05/01/21 $ 10,950,700
25,000 Los Angeles Department of Water & Power, 2001 Ser A
(FSA)................................................... 5.25 07/01/22 27,054,750
Southern California Public Power Authority,
3,500 Mead-Adelanto 1994 A (Ambac)............................ 7.67++ 07/01/15 4,351,515
2,500 Mead-Phoenix 1994 Ser A (Ambac)......................... 7.67++ 07/01/15 3,108,225
2,750 Transmission Refg Ser 2002 A (FSA)...................... 5.25 07/01/18 3,042,105
2,000 Puerto Rico Electric Power Authority, Power Ser II
(MBIA).................................................. 5.375 07/01/19 2,255,440
------------
- --------
50,762,735
45,750
------------
- --------
Hospital Revenue (10.6%)
8,000 Antelope Valley Healthcare District, Refg Ser 1997 A
(FSA)................................................... 5.20 01/01/20 8,483,760
California Health Facilities Financing Authority,
3,000 Scripps Memorial Hospitals Ser 1992 A (MBIA)............ 6.375 10/01/22 3,026,670
2,500 Sutter/CHS Ser 1996 A (MBIA)............................ 5.875 08/15/16 2,632,125
5,000 California Infrastructure & Economic Development Bank,
Kaiser Assistance Ser 2001 A............................ 5.55 08/01/31 5,372,850
California Statewide Communities Development Authority,
1,805 Cedars-Sinai Medical Center Ser 1992 COPs............... 6.50 08/01/12 1,991,150
3,000 Daughters of Charity Health Ser 2005 A.................. 5.25 07/01/30 3,189,570
2,500 Daughters of Charity Health Ser 2005 A.................. 5.25 07/01/35 2,652,800
1,630 Huntington Memorial Hospital Ser 2005................... 5.00 07/01/27 1,707,784
14,000 Duarte, City of Hope National Medical Center Ser 1999 A
COPs.................................................... 5.25 04/01/19 14,448,420
7,500 Madera County, Valley Children's Hospital Ser 1995 COPs
(MBIA).................................................. 6.50 03/15/15 9,033,300
4,000 Rancho Mirage Joint Powers Financing Authority, Eisenhower
Medical Center Ser 1997 A COPs (MBIA)................... 5.25 07/01/17 4,251,080
7,890 University California, UCLA Medical Center Ser 2004 A
(Ambac)................................................. 5.00 05/15/39 8,285,920
------------
- --------
65,075,429
60,825
------------
- --------
Industrial Development/Pollution Control Revenue (2.6%)
California Pollution Control Financing Authority,
5,000 San Diego Gas & Electric Co 1996 Ser A.................. 5.90 06/01/14 5,770,700
10,000 Southern California Edison Co 1992 Ser B (AMT).......... 6.40 12/01/24 10,155,000
------------
- --------
15,925,700
15,000
------------
- --------
Mortgage Revenue - Multi-Family (0.3%)
1,780 California Housing Finance Agency, Rental II 1992 Ser B... 6.70 08/01/15 1,794,098
------------
- --------
</Table>
See Notes to Financial Statements
14
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Mortgage Revenue - Single Family (0.2%)
$ 890 California Housing Finance Agency, 1995 Ser B-2 (AMT)..... 6.30% 08/01/24 $ 911,075
California Rural Home Financing Authority,
185 Home 1997 Ser D-CL 5 (AMT).............................. 6.70 05/01/29 187,433
180 1997 Ser A-2 (AMT)...................................... 7.00 09/01/29 181,443
160 Home 1998 Ser A (AMT)................................... 6.35 12/01/29 164,706
------------
- --------
1,444,657
1,415
------------
- --------
Public Facilities Revenue (5.2%)
4,000 Anaheim Public Financing Authority, 1997 Ser C (FSA)...... 6.00 09/01/16 4,797,080
California Public Works Board,
2,000 Butterfield State Office 2005 Ser A..................... 5.25 06/01/30 2,167,180
5,000 Department of Corrections 2004 Ser E (XLCA)............. 5.00 06/01/18 5,432,400
10,000 Department of Corrections Refg 1993 Ser A (Ambac)....... 5.00 12/01/19 11,068,800
4,000 Sacramento City Financing Authority, 2002 Ser A (FSA)..... 5.25 12/01/17 4,435,880
5,000 Puerto Rico Public Buildings Authority, 2002 Ser D
(Ambac)................................................. 0.00# 07/01/31 3,893,250
------------
- --------
31,794,590
30,000
------------
- --------
Tax Allocation Revenue (9.3%)
2,000 Capistrano Unified School District, Community Facilities
District #98-2, Ledera Special Tax Ser 2005 (FGIC)...... 5.00 09/01/29 2,157,840
1,500 Fontana Public Finance Authority, Ser 2003 A (Ambac)...... 5.375 09/01/25 1,637,880
Long Beach Bond Finance Authority,
3,205 Downtown North Long Beach 2002 Ser A (Ambac)............ 5.375 08/01/19 3,569,569
2,380 Downtown North Long Beach 2002 Ser A (Ambac)............ 5.375 08/01/20 2,612,431
5,000 Redevelopment Housing & Gas Utility 2005 Ser A
(Ambac)................................................. 5.00 08/01/40 5,239,550
20,000 Long Beach Financing Authority, Ser 1992 (Ambac).......... 6.00 11/01/17 23,835,600
4,000 Rancho Mirage Redevelopment Agency Ser 2003 A (MBIA)...... 5.00 04/01/33 4,216,400
San Jose Redevelopment Agency,
8,000 Ser 1999 (Ambac)........................................ 4.75 08/01/23 8,164,880
3,000 Merged Area (MBIA)...................................... 5.00 08/01/32 3,133,680
2,000 San Marcos Public Facilities Authority, Project Areas #2 &
#3 2005 Ser C (Ambac)................................... 5.00 08/01/38 2,145,460
------------
- --------
56,713,290
51,085
------------
- --------
</Table>
See Notes to Financial Statements
15
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Transportation Facilities Revenue (17.3%)
$ 10,000 Alameda Corridor Transportation Authority, Sr Lien Ser
1999 A (MBIA)........................................... 5.25% 10/01/21 $ 10,812,900
4,000 Bay Area Toll Authority, San Francisco Bay Area Toll
Bridge 2001 Ser D....................................... 5.00 04/01/18 4,326,240
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 3,343,740
Foothill/Eastern Transportation Corridor Agency,
5,000 Toll Road Ser 1999 (MBIA)............................... 5.125 01/15/19 5,419,450
14,000 Toll Road Ser 1999...................................... 0.00## 01/15/23 12,079,620
Long Beach,
5,000 Harbor Refg Ser 1998 A (AMT) (FGIC)..................... 5.00 05/15/15 5,431,700
5,000 Harbor Refg Ser 1998 A (AMT) (FGIC)..................... 6.00 05/15/17 5,898,750
2,750 Harbor Refg Ser 2005 A (AMT) (MBIA)..................... 5.00 05/15/23 2,911,370
2,500 Harbor Refg Ser 2005 A (AMT) (MBIA)..................... 5.00 05/15/25 2,638,450
5,000 Orange County, Airport Refg Ser 1997 (AMT) (MBIA)......... 5.50 07/01/11 5,321,800
Port of Oakland,
5,200 Ser 2002 M (FGIC)....................................... 5.25 11/01/19 5,775,172
2,000 Ser 2002 M (FGIC)....................................... 5.25 11/01/20 2,190,740
5,000 San Francisco Airports Commission, San Francisco Int'l
Airport Second Ser Refg Issue 27B (FGIC)................ 5.125 05/01/26 5,259,350
San Francisco Bay Area Rapid Transit District,
795 Sales Tax Ser 1995 (FGIC)............................... 5.50 07/01/15 804,762
9,500 Sales Tax Ser 1998 (Ambac).............................. 4.75 07/01/23 9,808,275
San Joaquin Hills Transportation Corridor Agency,
6,000 Toll Road Refg Ser 1997 A (MBIA)........................ 0.00 01/15/15 4,104,900
10,000 Toll Road Senior Lien Ser 1993.......................... 5.00 01/01/33 9,275,300
10,000 San Jose, Airport Ser 2001 A (FGIC)....................... 5.00 03/01/25 10,448,100
------------
- --------
105,850,619
104,745
------------
- --------
</Table>
See Notes to Financial Statements
16
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Water & Sewer Revenue (20.6%)
$ 20,000 California Department of Water Resources, Center Valley
Ser Y (FGIC)............................................ 5.00% 12/01/25 $ 21,493,000
4,000 Corona Public Financing Authority, Water Ser 1998
(FGIC).................................................. 4.75 09/01/23 4,131,840
10,000 East Bay Municipal Utility District, Water Ser 2001
(MBIA).................................................. 5.00 06/01/26 10,503,300
8,000 Eastern Municipal Water District, Water & Sewer Refg Ser
1998 A COPs (FGIC)...................................... 4.75 07/01/23 8,184,000
1,500 Hesperia Community Redevelopment Agency, Ser 2005 A
(XLCA).................................................. 5.00 09/01/35 1,591,380
Los Angeles Department of Water & Power,
5,000 Water 2001 Ser A........................................ 5.125 07/01/41 5,222,650
5,000 2003 Ser A (FGIC)....................................... 5.00 07/01/43 5,231,850
20,000 Los Angeles Wastewater, Refg Ser 2003 B (FSA)............. 5.00 06/01/22 21,724,400
10,000 Sacramento Financing Authority, Water & Capital Impr 2001
Ser A (Ambac)........................................... 5.00 02/01/26 10,503,300
5,000 San Diego County Water Authority, Ser 2004 A (FSA)........ 5.00 05/01/29 5,371,450
10,000 San Diego Public Facilities Authority, Sewer Ser 1993 A... 5.25 05/15/20 10,065,600
San Francisco Public Utilities Commission,
5,650 Water 2002 Ser A (MBIA)................................. 5.00 11/01/20 6,076,518
10,000 Water 1996 Ser A........................................ 5.00 11/01/21 10,264,600
5,000 West Basin Municipal Water District, Refg Ser 2003 A COPs
(MBIA).................................................. 5.00 08/01/30 5,294,500
------------
- --------
125,658,388
119,150
------------
- --------
Other Revenue (2.6%)
10,000 California Economic Recovery, Ser 2004 A.................. 5.00 07/01/16 10,836,800
5,000 Puerto Rico Infrastructure Financing Authority, Ser 2005
B....................................................... 5.00 07/01/41 5,285,000
------------
- --------
16,121,800
15,000
------------
- --------
Refunded (3.8%)
2,000 California State University, Fresno Event Center Sr Ser
2002.................................................... 6.00 07/01/12+ 2,340,820
15,000 Foothill/Eastern Transportation Corridor Agency, Toll Road
Sr Lien Ser 1995 A...................................... 6.00 01/01/07+ 15,745,800
5,250 Southern California Public Power Authority, Transmission
Refg Ser 1988 A (FGIC) (ETM)............................ 0.00 07/01/06 5,115,757
------------
- --------
23,202,377
22,250
------------
- --------
561,485 Total California Tax-Exempt Municipal Bonds (Cost $552,516,240).............. 595,326,174
------------
- --------
</Table>
See Notes to Financial Statements
17
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2005 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ---------------------------------------------------------------------------------------------------------
Short-Term California Tax-Exempt Municipal Obligations (2.6%)
$ 600 California Statewide Community Development Authority, John
Muir/ Mt Diablo Health Ser 1997 COPs (Demand
07/01/05)............................................... 2.23*% 12/01/18 $ 600,000
7,200 Irvine, Assessment District #97-17 Ser A (Demand
07/01/05)............................................... 2.20* 09/02/29 7,200,000
1,100 Los Angeles Department of Water & Power, 2001 Ser B SubSer
B-6 (Demand 07/01/05)................................... 2.21* 07/01/34 1,100,000
650 Newport Beach, Hoag Memorial Presbyterian Hospital 1992
Ser (Demand 07/01/05)................................... 2.24* 10/01/22 650,000
6,000 San Diego County Water Authority, Ser 1991 B COPs CARs
(MBIA).................................................. 10.02++ 04/27/06+ 6,585,540
------------
- --------
15,550 Total Short-Term California Tax-Exempt Municipal Obligations (Cost
$15,529,044)................................................................. 16,135,540
------------
- --------
</Table>
<Table>
$577,035 Total Investments (Cost $568,045,284)(a)(b).......................... 100.0% 611,461,714
========
Other Assets in Excess of Liabilities................................ 0.0 318
----- ------------
Net Assets........................................................... 100.0% $611,462,032
===== ============
</Table>
- ---------------------
<Table>
AMT Alternative Minimum Tax.
CARs Complementary Auction Rate Certificates.
COPs Certificates of Participation.
ETM Escrowed to maturity.
WI Securities purchased on a when-issued basis.
* 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.
+ 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
$14,045,280 which represents 2.3% of net assets.
(a) Securities have been designated as collateral in an amount
equal to $7,498,369 in connection with securities purchased
on a when-issued basis.
(b) The aggregate cost for federal income tax purposes
approximates the aggregate cost for book purposes. The
aggregate gross unrealized appreciation is $43,857,826 and
the aggregate gross unrealized depreciation is $43,113,
resulting in net unrealized appreciation of $43,814,713.
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>
See Notes to Financial Statements
18
Morgan Stanley California Tax-Free Income Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
June 30, 2005 (unaudited)
<Table>
Assets:
Investments in securities, at value
(cost $568,045,284).................... $611,461,714
Cash.................................... 1,748,655
Receivable for:
Interest............................ 8,134,575
Shares of beneficial interest
sold............................... 45,402
Investments sold.................... 10,233
Receivable from affiliate............... 87,656
Prepaid expenses and other assets....... 34,056
------------
Total Assets........................ 621,522,291
------------
Liabilities:
Payable for:
Investments purchased............... 9,062,049
Shares of beneficial interest
redeemed........................... 284,334
Investment advisory fee............. 225,520
Distribution fee.................... 200,947
Dividends to shareholders........... 137,940
Administration fee.................. 40,248
Accrued expenses and other payables..... 109,221
------------
Total Liabilities................... 10,060,259
------------
Net Assets.......................... $611,462,032
============
Composition of Net Assets:
Paid-in-capital......................... $561,576,262
Net unrealized appreciation............. 43,416,430
Accumulated undistributed net investment
income................................. 460,694
Accumulated undistributed net realized
gain................................... 6,008,646
------------
Net Assets.......................... $611,462,032
============
Class A Shares:
Net Assets.............................. $345,103,231
Shares Outstanding (unlimited
authorized, $.01 par value)............ 27,505,984
Net Asset Value Per Share........... $12.55
============
Maximum Offering Price Per Share,
(net asset value plus 4.44% of net
asset value)........................ $13.11
============
Class B Shares:
Net Assets.............................. $182,437,631
Shares Outstanding (unlimited
authorized, $.01 par value)............ 14,451,368
Net Asset Value Per Share........... $12.62
============
Class C Shares:
Net Assets.............................. $26,751,515
Shares Outstanding (unlimited
authorized, $.01 par value)............ 2,119,918
Net Asset Value Per Share........... $12.62
============
Class D Shares:
Net Assets.............................. $57,169,655
Shares Outstanding (unlimited
authorized, $.01 par value)............ 4,543,314
Net Asset Value Per Share........... $12.58
============
</Table>
Statement of Operations
For the six months ended June 30, 2005 (unaudited)
<Table>
Net Investment Income:
Interest Income....................... $15,487,671
-----------
Expenses
Investment advisory fee............... 1,427,337
Administration fee.................... 245,456
Distribution fee (Class A shares)..... 167,923
Distribution fee (Class B shares)..... 108,057
Distribution fee (Class C shares)..... 99,040
Transfer agent fees and expenses...... 100,940
Shareholder reports and notices....... 37,798
Professional fees..................... 27,840
Custodian fees........................ 18,318
Trustees' fees and expenses........... 7,540
Other................................. 25,959
-----------
Total Expenses.................... 2,266,208
Less: amounts waived.................. (8,635)
Less: expense offset.................. (17,549)
-----------
Net Expenses...................... 2,240,024
-----------
Net Investment Income............. 13,247,647
-----------
Net Realized and Unrealized Gain
(Loss):
Net realized gain..................... 6,284,388
Net change in unrealized
appreciation........................ (1,689,084)
-----------
Net Gain.......................... 4,595,304
-----------
Net Increase.......................... $17,842,951
===========
</Table>
See Notes to Financial Statements
19
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, 2005 DECEMBER 31, 2004
------------- -----------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income....................................... $ 13,247,647 $ 28,753,186
Net realized gain........................................... 6,284,388 5,439,032
Net change in unrealized appreciation....................... (1,689,084) (7,399,441)
------------ ------------
Net Increase............................................ 17,842,951 26,792,777
------------ ------------
Dividends and Distributions to Shareholders from:
Net investment income
Class A shares.......................................... (2,920,883) (760,362)
Class B shares.......................................... (8,540,023) (24,171,667)
Class C shares.......................................... (492,771) (1,021,650)
Class D shares.......................................... (1,262,582) (2,765,747)
Net realized gain
Class A shares.......................................... -- (163,452)
Class B shares.......................................... -- (4,452,125)
Class C shares.......................................... -- (232,466)
Class D shares.......................................... -- (495,229)
------------ ------------
Total Dividends and Distributions....................... (13,216,259) (34,062,698)
------------ ------------
Net decrease from transactions in shares of beneficial
interest.................................................. (24,311,993) (71,320,691)
------------ ------------
Net Decrease............................................ (19,685,301) (78,590,612)
Net Assets:
Beginning of period......................................... 631,147,333 709,737,945
------------ ------------
End of Period
(Including accumulated undistributed net investment income
of $460,694 and $429,306, respectively)..................... $611,462,032 $631,147,333
============ ============
</Table>
See Notes to Financial Statements
20
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (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 eighteen
months, 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
21
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (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 Advisory/Administration Agreements
Pursuant to an Investment Advisory Agreement with Morgan Stanley Investment
Advisors Inc. (the "Investment Adviser") the Fund pays the Investment Adviser an
advisory 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: 0.47% to the portion of the daily net assets not exceeding $500
million; 0.445% to the portion of the daily net assets exceeding $500 million
but not exceeding $750 million; 0.42% to the portion of the daily net assets
exceeding $750 million but not
22
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) continued
exceeding $1 billion; 0.395% to the portion of the daily net assets exceeding $1
billion but not exceeding $1.25 billion; and 0.37% to the portion of the daily
net assets in excess of $1.25 billion.
Pursuant to an Administration Agreement with Morgan Stanley Services Company
Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Fund
pays an administration fee, accrued daily and payable monthly, by applying the
annual rate of 0.08% to the fund's daily net assets.
Effective June 1, 2005, the Investment Adviser has agreed to cap the Fund's
operating expenses (except for brokerage and 12b-1 fees) by assuming the Fund's
"other expenses" and/or waiving the Fund's advisory fees, and the Administrator
has agreed to waive the Fund's administrative fees, to the extent such operating
expenses exceed 0.60% of the average daily net assets of the Fund on an
annualized basis. These voluntary assumptions/waivers may be discontinued at any
time.
3. Plan of Distribution
Shares of the Fund are distributed by Morgan Stanley Distributors Inc. (the
"Distributor"), an affiliate of the Investment Adviser and Administrator. 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 expenses as of June 30,
2005.
For the six months ended June 30, 2005, the distribution fee was accrued for
Class B shares at the annual rate of 0.06%. At June 30, 2005, included in the
Statement of Assets and Liabilities, is a receivable from affiliate of $87,656
which represents payments by the Distributor.
23
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) continued
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, 2005, the distribution fee was accrued for
Class A shares and Class C shares at the annual rate of 0.24% and 0.74%,
respectively.
The Distributor has informed the Fund that for the six months ended June 30,
2005, it received contingent deferred sales charges from certain redemptions of
the Fund's Class B shares and Class C shares of $112,312 and $925, respectively
and received $76,683 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, 2005 aggregated
$74,885,900 and $82,883,953, respectively. Included in the aforementioned
transactions is a purchase of $5,416,400 and a sale of $5,343,350 with another
Morgan Stanley fund including a net realized gain of $443,891.
Morgan Stanley Trust, an affiliate of the Investment Adviser, Administrator and
Distributor, is the Fund's transfer agent.
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, 2005 included in
Trustees' fees and expenses in the Statement of Operations amounted to $3,662.
At June 30, 2005, the Fund had an accrued pension liability of $61,151 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.
The Fund has 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
24
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) continued
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.
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, 2004, the Fund had temporary book/tax differences primarily
attributable to capital loss deferrals on wash sales and book amortization of
discounts on debt securities.
25
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) continued
8. 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, 2005 DECEMBER 31, 2004
---------------------------- --------------------------
(unaudited)
SHARES AMOUNT SHARES AMOUNT
----------- -------------- ---------- -------------
CLASS A SHARES
Sold.......................................... 314,145 $ 3,919,214 559,337 $ 7,038,418
Conversion from Class B....................... 26,119,832 324,441,882 -- --
Reinvestment of dividends and distributions... 118,345 1,480,307 28,186 350,747
Redeemed...................................... (587,865) (7,345,296) (431,256) (5,340,734)
----------- -------------- ---------- -------------
Net increase - Class A........................ 25,964,457 322,496,107 156,267 2,048,431
----------- -------------- ---------- -------------
CLASS B SHARES
Sold.......................................... 398,468 4,992,099 1,325,952 16,676,138
Conversion to Class A......................... (25,973,192) (324,441,882) -- --
Reinvestment of dividends and distributions... 300,253 3,749,937 1,188,509 14,881,743
Redeemed...................................... (2,273,549) (28,474,063) (7,931,795) (99,245,593)
----------- -------------- ---------- -------------
Net decrease - Class B........................ (27,548,020) (344,173,909) (5,417,334) (67,687,712)
----------- -------------- ---------- -------------
CLASS C SHARES
Sold.......................................... 92,101 1,156,216 382,653 4,832,637
Reinvestment of dividends and distributions... 23,658 296,076 65,456 819,425
Redeemed...................................... (193,098) (2,427,330) (340,847) (4,273,996)
----------- -------------- ---------- -------------
Net increase (decrease) - Class C............. (77,339) (975,038) 107,262 1,378,066
----------- -------------- ---------- -------------
CLASS D SHARES
Sold.......................................... 105,438 1,318,909 274,779 3,446,290
Reinvestment of dividends and distributions... 52,178 651,475 139,106 1,737,213
Redeemed...................................... (290,616) (3,629,537) (982,554) (12,242,979)
----------- -------------- ---------- -------------
Net decrease - Class D........................ (133,000) (1,659,153) (568,669) (7,059,476)
----------- -------------- ---------- -------------
Net decrease in Fund.......................... (1,793,902) $ (24,311,993) (5,722,474) $ (71,320,691)
=========== ============== ========== =============
</Table>
9. Legal Matters
The Investment Adviser, certain affiliates of the Investment Adviser, certain
officers of such affiliates and certain investment companies advised by the
Investment Adviser or its affiliates, including the Fund, are named as
defendants in a consolidated class action. 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 Adviser
and certain affiliates of the Investment Adviser allegedly offered economic
incentives to brokers and others to recommend the funds advised by the
Investment Adviser or its
26
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2005 (UNAUDITED) continued
affiliates to investors rather than funds managed by other companies, and (ii)
that the funds advised by the Investment Adviser or its affiliates, including
the Fund, allegedly paid excessive commissions to brokers in return for their
efforts to 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. On March 10, 2005, Plaintiffs sought leave to supplement
their complaint to assert claims on behalf of other investors. While the Fund
and Adviser believe that each 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.
27
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, 2005 2004 2003 2002 2001 2000
------------- ------- ------- ------- ------- -------
(unaudited)
Class A Shares
Selected Per Share Data:
Net asset value, beginning of period............ $12.46 $12.58 $12.68 $12.34 $12.49 $11.67
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income....................... 0.26 0.54 0.55 0.57 0.57 0.58
Net realized and unrealized gain (loss)..... 0.09 (0.02) (0.01) 0.44 (0.10) 0.82
------ ------ ------ ------ ------ ------
Total income from investment operations......... 0.35 0.52 0.54 1.01 0.47 1.40
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income....................... (0.26) (0.53) (0.55) (0.57) (0.58) (0.58)
Net realized gain........................... -- (0.11) (0.09) (0.10) (0.04) --
------ ------ ------ ------ ------ ------
Total dividends and distributions............... (0.26) (0.64) (0.64) (0.67) (0.62) (0.58)
------ ------ ------ ------ ------ ------
Net asset value, end of period.................. $12.55 $12.46 $12.58 $12.68 $12.34 $12.49
====== ====== ====== ====== ====== ======
Total Return+................................... 2.85%(2) 4.26% 4.31% 8.37% 3.90% 12.17%
Ratios to Average Net Assets(1):
Expenses (before expense offset)................ 0.85%(3)(4) 0.81% 0.78% 0.80% 0.80% 0.83%
Net investment income........................... 4.20%(3)(4) 4.29% 4.34% 4.53% 4.62% 4.80%
Supplemental Data:
Net assets, end of period, in thousands......... $345,103 $19,203 $17,422 $20,775 $17,147 $12,336
Portfolio turnover rate......................... 12%(2) 10% 11% 12% 13% 4%
</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.
(1) Reflects overall fund ratios for investment income and
non-class specific expenses.
(2) Not annualized.
(3) Annualized.
(4) If the Investment Adviser and Administrator had not "capped"
all expenses (except for distribution fees) at 0.60% of its
daily net assets for the period June 1, 2005 through June
30, 2005, the annualized expense and net investment income
ratios would have been 0.86% and 4.19%, respectively.
</Table>
See Notes to Financial Statements
28
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, 2005 2004 2003 2002 2001 2000
------------- -------- -------- -------- -------- --------
(unaudited)
Class B Shares
Selected Per Share Data:
Net asset value, beginning of period....... $12.52 $12.65 $12.75 $12.42 $12.57 $11.73
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income.................. 0.27 0.54 0.55 0.56 0.55 0.57
Net realized and unrealized gain
(loss)................................. 0.10 (0.02) (0.02) 0.42 (0.11) 0.84
------ ------ ------ ------ ------ ------
Total income from investment operations.... 0.37 0.52 0.53 0.98 0.44 1.41
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income.................. (0.27) (0.54) (0.54) (0.55) (0.55) (0.57)
Net realized gain...................... -- (0.11) (0.09) (0.10) (0.04) --
------ ------ ------ ------ ------ ------
Total dividends and distributions.......... (0.27) (0.65) (0.63) (0.65) (0.59) (0.57)
------ ------ ------ ------ ------ ------
Net asset value, end of period............. $12.62 $12.52 $12.65 $12.75 $12.42 $12.57
====== ====== ====== ====== ====== ======
Total Return+.............................. 2.98%(2) 4.22% 4.27% 8.13% 3.56% 12.29%
Ratios to Average Net Assets(1)(4):
Expenses (before expense offset)........... 0.67%(3)(5) 0.78% 0.83% 0.93% 1.04% 0.93%
Net investment income...................... 4.38%(3)(5) 4.32% 4.29% 4.40% 4.38% 4.70%
Supplemental Data:
Net assets, end of period, in thousands.... $182,438 $526,026 $599,737 $682,046 $696,481 $732,668
Portfolio turnover rate.................... 12%(2) 10% 11% 12% 13% 4%
</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.
(1) Reflects overall fund ratios for investment income and non-class specific expenses.
(2) Not annualized.
(3) Annualized.
(4) 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
----------------- ---- ----
December 31, 2004 1.03% 4.07%
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
(5) If the Investment Adviser and Administrator had not "capped" all expenses (except for distribution fees) at 0.60% of
its daily net assets for the period June 1, 2005 through June 30, 2005, the annualized expenses and net investment
income ratios would have been 0.68% and 4.37%, respectively.
</Table>
See Notes to Financial Statements
29
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, 2005 2004 2003 2002 2001 2000
------------- ------- ------- ------- ------- -------
(unaudited)
Class C Shares
Selected Per Share Data:
Net asset value, beginning of period............ $12.52 $12.65 $12.74 $12.42 $12.57 $11.73
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income....................... 0.23 0.47 0.48 0.50 0.51 0.52
Net realized and unrealized gain (loss)..... 0.10 (0.02) 0.00 0.42 (0.11) 0.84
------ ------ ------ ------ ------ ------
Total income from investment operations......... 0.33 0.45 0.48 0.92 0.40 1.36
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income....................... (0.23) (0.47) (0.48) (0.50) (0.51) (0.52)
Net realized gain........................... -- (0.11) (0.09) (0.10) (0.04) --
------ ------ ------ ------ ------ ------
Total dividends and distributions............... (0.23) (0.58) (0.57) (0.60) (0.55) (0.52)
------ ------ ------ ------ ------ ------
Net asset value, end of period.................. $12.62 $12.52 $12.65 $12.74 $12.42 $12.57
====== ====== ====== ====== ====== ======
Total Return+................................... 2.64%(2) 3.61% 3.80% 7.59% 3.33% 11.74%
Ratios to Average Net Assets(1):
Expenses (before expense offset)................ 1.35%(3)(4) 1.36% 1.35% 1.35% 1.34% 1.34%
Net investment income........................... 3.70%(3)(4) 3.74% 3.77% 3.98% 4.09% 4.29%
Supplemental Data:
Net assets, end of period, in thousands......... $26,751 $27,519 $26,435 $25,825 $16,745 $14,534
Portfolio turnover rate......................... 12%(2) 10% 11% 12% 13% 4%
</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.
(1) Reflects overall fund ratios for investment income and
non-class specific expenses.
(2) Not annualized.
(3) Annualized.
(4) If the Investment Adviser and Administrator had not "capped"
all expenses (except for distribution fees) at 0.60% of its
daily net assets for the period June 1, 2005 through June
30, 2005, the annualized expense and net investment income
ratios would have been 1.36% and 3.69%, respectively.
</Table>
See Notes to Financial Statements
30
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, 2005 2004 2003 2002 2001 2000
------------- ------- ------- ------- ------- -------
(unaudited)
Class D Shares
Selected Per Share Data:
Net asset value, beginning of period............ $12.49 $12.61 $12.71 $12.39 $12.53 $11.71
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income....................... 0.28 0.56 0.57 0.60 0.60 0.61
Net realized and unrealized gain (loss)..... 0.08 (0.01) (0.01) 0.41 (0.10) 0.82
------ ------ ------ ------ ------ ------
Total income from investment operations......... 0.36 0.55 0.56 1.01 0.50 1.43
------ ------ ------ ------ ------ ------
Less dividends and distributions from:
Net investment income....................... (0.27) (0.56) (0.57) (0.59) (0.60) (0.61)
Net realized gain........................... -- (0.11) (0.09) (0.10) (0.04) --
------ ------ ------ ------ ------ ------
Total dividends and distributions............... (0.27) (0.67) (0.66) (0.69) (0.64) (0.61)
------ ------ ------ ------ ------ ------
Net asset value, end of period.................. $12.58 $12.49 $12.61 $12.71 $12.39 $12.53
====== ====== ====== ====== ====== ======
Total Return+................................... 2.93%(2) 4.48% 4.50% 8.41% 4.12% 12.50%
Ratios to Average Net Assets(1):
Expenses (before expense offset)................ 0.61%(3)(4) 0.61% 0.60% 0.60% 0.59% 0.59%
Net investment income........................... 4.44%(3)(4) 4.49% 4.52% 4.73% 4.84% 5.04%
Supplemental Data:
Net assets, end of period, in thousands......... $57,170 $58,399 $66,143 $75,332 $83,638 $95,132
Portfolio turnover rate......................... 12%(2) 10% 11% 12% 13% 4%
</Table>
- ---------------------
<Table>
+ Calculated based on the net asset value as of the last
business day of the period.
(1) Reflects overall fund ratios for investment income and
non-class specific expenses.
(2) Not annualized.
(3) Annualized.
(4) If the Investment Adviser and Administrator had not "capped"
all expenses (except for distribution fees) at 0.60% of its
daily net assets for the period June 1, 2005 through June
30, 2005, the annualized expense and net investment income
ratios would have been 0.62% and 4.43%, respectively.
</Table>
See Notes to Financial Statements
31
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
Joseph J. McAlinden
Vice President
Barry Fink
Vice President
Amy R. Doberman
Vice President
Carsten Otto
Chief Compliance Officer
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 ADVISER
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 the 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) 2005 Morgan Stanley
[MORGAN STANLEY LOGO]
MORGAN STANLEY FUNDS
Morgan Stanley
California Tax-Free
Income Fund
Semiannual Report
June 30, 2005
[MORGAN STANLEY LOGO]
37900RPT RA05-00655P-Y06/05
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.
Refer to Item 1.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End
Management Investment Companies.
Not applicable for semiannual reports.
Item 8. Portfolio Managers of Closed-End Management Investment Companies
Applicable only to reports filed by closed-end funds.
Item 9. Closed-End Fund Repurchases
Applicable to reports filed by closed-end funds.
Item 10. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 11. 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.
(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 12. 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 23, 2005
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 23, 2005
/s/ Francis Smith
- -------------------------------------
Francis Smith
Principal Financial Officer
August 23, 2005
3