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)
522 Fifth Avenue, New York, New York 10036
(Address of principal executive offices) (Zip code)
Ronald E. Robison
522 Fifth Avenue, New York, New York 10036
(Name and address of agent for service)
Registrant's telephone number, including area code: 212-296-6990
Date of fiscal year end: December 31, 2008
Date of reporting period: June 30, 2008
Item 1 - Report to Shareholders
<Table>
INVESTMENT MANAGEMENT [MORGAN STANLEY LOGO]
</Table>
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, 2008
TOTAL RETURN FOR THE 6 MONTHS ENDED JUNE 30, 2008
<Table>
<Caption>
LIPPER
LEHMAN CALIFORNIA
BROTHERS MUNICIPAL
CALIFORNIA DEBT
EXEMPT FUNDS
CLASS A CLASS B CLASS C CLASS I(+) INDEX(1) INDEX(2)
-0.88% -0.89% -1.10% -0.75% -0.19% -1.00%
</Table>
+ Formerly Class D shares. Renamed Class I shares effective March 31, 2008.
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.
MARKET CONDITIONS
The fixed income market was tremendously volatile throughout the six-month
reporting period. In the first quarter of 2008, credit and liquidity remained
constrained, the housing market continued to weaken and fears of an economic
recession emerged, all of which took a toll on investor confidence. As a result,
investors shunned risky assets in favor of the relatively safe haven of high-
quality government securities, fueling the performance of U.S. Treasuries while
driving spreads in other sectors considerably wider.
The Federal Reserve (the "Fed") stepped in several times during the quarter to
help boost liquidity and the economy, reducing the target federal funds rates by
225 basis points while also taking the unprecedented steps of granting primary
brokerage firms access to its discount window, loosening its collateral
requirements, and extending loans of Treasury securities in exchange for lower
quality, less liquid securities. In what was decidedly the biggest headline
event, the Fed facilitated JPMorgan Chase's purchase of troubled Bear
Stearns -- once the country's fifth largest investment bank -- in mid-March,
which was viewed by many as necessary to avoid serious market repercussions had
the firm failed.
Early in the second quarter, market liquidity began to improve and investor
appetite for risk returned, spurring a rebound in spread sector performance that
lasted through mid-June. Citing the need to maintain a balance between
supporting the economy while limiting inflationary pressures, the Fed held the
target federal funds rate steady at 2.0 percent in June, where it had stood
since the last rate cut in April. In the final weeks of the quarter, the market
retreated again as investors paused to consider new credit concerns in the
market as well as the possibility that the Fed might begin to raise rates in
order to fight inflation. As a result, for the overall period Treasuries
outperformed all other sectors of the fixed income market.
After a difficult first quarter, the municipal bond market regained ground
versus Treasuries in April and May as investors recognized the relative
"cheapness" of municipals versus taxable products. However, some of that
outperformance was given back late in the quarter. Overall, investment-grade
municipal bonds outperformed high-yield municipals. Investment-grade municipals
also outperformed their taxable counterparts. As of period end, municipal yields
remained higher than at the start of the year, except on the front end of the
yield curve. The California municipal market underperformed the broad municipal
market for the period. The state continues to struggle with a growing budget
deficit and deteriorating housing
2
market. California remained one of the largest issuers of municipal bonds in the
country, with the majority of new issuance occurring in the development and
energy sectors.
PERFORMANCE ANALYSIS
All share classes of Morgan Stanley California Tax-Free Income Fund
underperformed the Lehman Brothers California Exempt Index, while Class A, B and
I shares outperformed and Class C shares underperformed the Lipper California
Municipal Debt Funds Index for the six months ended June 30, 2008, assuming no
deduction of applicable sales charges.
Over the course of the period, we added to the Fund's holdings in zero-coupon
municipal bonds as they have become cheaper relative to their coupon-bearing
counterparts. Unfortunately, zero-coupon issues underperformed during the period
and holdings here held back performance. Overweight exposures to the
hospital/life care and tobacco sectors also hindered performance as spreads in
both sectors widened, causing their performance to wane.
Other positions, however, were additive to performance. An overweight to the
public utility sector, particularly water and sewer bonds, enhanced returns as
the flight to quality that took place during the early part of the period helped
boost the performance of the more solid infrastructure sectors such as these.
Given the outperformance of the higher-rated segment of the municipal market,
the Fund's overall emphasis on higher-quality securities was also additive.
The Fund's yield-curve positioning was beneficial as well. We underweighted
longer-dated issues and overweighted intermediate-dated issues through the use
of interest rate swaps. This strategy helped enhance returns as the spread
between intermediate- and long-dated yields widened in the first quarter of the
year.
There is no guarantee that any sectors mentioned will continue to perform as
discussed herein or that securities in such sectors will be held by the Fund in
the future.
3
<Table>
<Caption>
TOP FIVE SECTORS AS OF 06/30/08
Appropriation 16.2%
Water/Sewer 15.9
Education 9.8
General obligation 9.7
Hospital 9.6
</Table>
<Table>
<Caption>
LONG-TERM CREDIT ANALYSIS AS OF 06/30/08
Aaa/AAA 39.8%
Aa/AA 24.6
A/A 18.9
Baa/BBB 14.5
Ba/BB or Less 2.2
</Table>
Subject to change daily. Provided for informational purposes only and should not
be deemed as a recommendation to buy or sell the securities mentioned or
securities in the sectors shown above. Top five sectors are as a percentage of
total investments. Long-term credit analysis are as a percentage of long-term
investments. Securities are classified by sectors that represent broad groupings
of related industries. 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. Rating allocations based
upon ratings as issued by Standard and Poor's and Moody's, respectively.
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. THE SEMIANNUAL REPORTS AND THE ANNUAL REPORTS ARE
FILED ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC) ON FORM
N-CSRS AND FORM N-CSR, RESPECTIVELY. 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.
4
INFORMATION ON THE OPERATION OF THE SEC'S PUBLIC REFERENCE ROOM MAY BE OBTAINED
BY 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) 869-NEWS, 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
PERFORMANCE SUMMARY
AVERAGE ANNUAL TOTAL RETURNS -- PERIOD ENDED JUNE 30, 2008
CLASS A SHARES* CLASS B SHARES** CLASS C SHARES+ CLASS I SHARES++
(since 07/28/97) (since 07/11/84) (since 07/28/97) (since 07/28/97)
SYMBOL CLFAX CLFBX CLFCX CLFDX
1 YEAR 0.98% (3) 0.94% (3) 0.50% (3) 1.16% (3)
(3.31) (4) (3.89) (4) (0.47) (4) --
5 YEARS 2.89 (3) 2.99 (3) 2.37 (3) 3.12 (3)
2.00 (4) 2.67 (4) 2.37 (4) --
10 YEARS 4.03 (3) 4.03 (3) 3.52 (3) 4.29 (3)
3.58 (4) 4.03 (4) 3.52 (4) --
SINCE INCEPTION 4.16 (3) 6.51 (3) 3.66 (3) 4.41 (3)
3.75 (4) 6.51 (4) 3.66 (4) --
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 most recent month-end performance figures, please visit
www.morganstanley.com/msim 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
I 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. For periods greater than eight years,
returns do not reflect conversion to Class A shares eight years after the
end of the calendar month in which shares were purchased. The conversion
feature is currently suspended because the total annual operating expense
ratio of Class B is currently lower than that of Class A. See "Conversion
Feature" for Class B shares in "Share Class Arrangements" of the Prospectus
for more information.
+ The maximum contingent deferred sales charge for Class C is 1.0% for shares
redeemed within one year of purchase.
++ Class I (formerly Class D) has no sales charge.
(1) The Lehman Brothers California Exempt Index tracks the performance of
California issued 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. The Index is unmanaged and its
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. The Fund is in the Lipper California
Municipal Debt Funds classification as of the date of this report.
(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.
6
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 advisory 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 01/01/08 - 06/30/08.
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@
------------- ------------- --------------
01/01/08 -
01/01/08 06/30/08 06/30/08
------------- ------------- --------------
CLASS A
Actual (-0.88% return)........................ $1,000.00 $ 991.20 $4.26
Hypothetical (5% annual return before
expenses)................................... $1,000.00 $1,020.59 $4.32
CLASS B
Actual (-0.89% return)........................ $1,000.00 $ 991.10 $4.11
Hypothetical (5% annual return before
expenses)................................... $1,000.00 $1,020.74 $4.17
CLASS C
Actual (-1.10% return)........................ $1,000.00 $ 989.00 $6.73
Hypothetical (5% annual return before
expenses)................................... $1,000.00 $1,018.10 $6.82
CLASS I@@
Actual (-0.75% return)........................ $1,000.00 $ 992.50 $3.02
Hypothetical (5% annual return before
expenses)................................... $1,000.00 $1,021.83 $3.07
</Table>
- ---------
@ Expenses are equal to the Fund's annualized expense ratios of 0.86%, 0.83%,
1.36% and 0.61% for Class A, Class B, Class C and Class I shares,
respectively, multiplied by the average account value over the period,
multiplied by 182/366 (to reflect the one-half year period). If the Fund
had borne all of its expenses, the annualized expense ratios would have
been 0.90%, 0.87%, 1.40% and 0.65% for Class A, Class B, Class C and Class
I shares, respectively. Currently, the Distributor has agreed to waive the
12b-1 fee on Class B shares to the extent it exceeds 0.24% of the average
daily net assets of such shares on an annualized basis. The Distributor may
discontinue this waiver in the future.
@@ Formerly Class D shares. Renamed Class I shares effective March 31, 2008.
7
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 at the Investment Adviser's
expense. (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 advisory and administrative 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
On a regular basis, the Board reviews the performance of all funds in the Morgan
Stanley Fund Complex, including the Fund, compared to their peers, paying
specific attention to the underperforming funds. In addition, the Board
specifically reviewed the Fund's performance for the one-, three- and five-year
periods ended December 31, 2007, as shown in a report provided by Lipper (the
"Lipper Report"), compared to the performance of comparable funds selected by
Lipper (the "performance peer group"). The Board also discussed with the Adviser
the performance goals and the actual results achieved in managing the Fund. The
Board concluded that the Fund's performance was competitive with that of its
performance peer group.
FEES RELATIVE TO OTHER PROPRIETARY FUNDS MANAGED BY THE ADVISER WITH COMPARABLE
INVESTMENT STRATEGIES
The Board noted that the Adviser did not manage any other proprietary funds with
investment strategies comparable to those of the Fund.
8
FEES AND EXPENSES RELATIVE TO COMPARABLE FUNDS MANAGED BY OTHER ADVISERS
The Board reviewed the advisory and administrative fee (together, the
"management fee") rate and total expense ratio of the Fund as compared to the
average management fee rate and average total expense ratio 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. The
Board noted that the management fee was lower and total expense ratio was higher
but close to the expense peer group average. The Board concluded that the Fund's
management fee rate and total expense ratio were competitive with those of 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 THE ADVISER AND AFFILIATES
The Board considered information concerning the costs incurred and profits
realized by the Adviser and affiliates during the last year from their
relationship with the Fund and during the last two years from their relationship
with the Morgan Stanley Fund Complex and reviewed with the Adviser the cost
allocation methodology used to determine the profitability of the Adviser and
affiliates. Based on its review of the information it received, the Board
concluded that the profits earned by the Adviser and 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
affiliates from their relationship with the Fund and the Morgan Stanley Fund
Complex, such as sales charges on sales of Class A shares and "float" benefits
derived from handling of checks for purchases and sales 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 the sales charges and 12b-1 fees were
competitive with those of other broker-dealers.
9
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 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
that it would be in the best interest of the Fund and its shareholders to
approve renewal of the Management Agreement for another year.
10
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2008 (UNAUDITED)
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------
Tax-Exempt Municipal Bonds (98.0%)
California (94.4%)
$ 750 Alameda County Joint Powers Authority, 2008
Ser A (FSA Insd)......................... 5.00% 12/01/25 $ 779,677
1,325 Alameda County Joint Powers Authority, 2008
Ser A (FSA Insd)......................... 5.00 12/01/26 1,372,276
1,590 Alvord Unified School District, 2007
Election, Ser 2008 A (FSA Insd).......... 5.00 08/01/28 1,643,392
4,000 Anaheim Public Financing Authority, 1997
Ser C (FSA Insd)......................... 6.00 09/01/16 4,542,160
8,000 Antelope Valley Healthcare District, Refg
Ser 1997 A (FSA Insd).................... 5.20 01/01/20 8,171,520
5,000 California County Tobacco Securitization
Agency, Los Angeles County Securitization
Corp Ser 2006............................ 0.00(a) 06/01/28 3,600,600
19,730 California Department of Water Resources,
Center Valley Ser Y (FGIC Insd).......... 5.00 12/01/25 20,142,752
2,000 California Educational Facilities
Authority, California College of Arts Ser
2005..................................... 5.00 06/01/35 1,738,040
3,000 California Educational Facilities
Authority, Mills College Ser 2005 A...... 5.00 09/01/29 2,972,730
2,000 California Educational Facilities
Authority, Pitzer College Ser 2005 A..... 5.00 04/01/35 1,936,780
2,000 California Educational Facilities
Authority, University of Redlands Ser
2005 A................................... 5.00 10/01/35 1,925,000
5,000 California Educational Facilities
Authority, University of San Diego Ser
1998 (AMBAC Insd)........................ 5.00 10/01/22 5,045,200
4,000 California Health Facilities Financing
Authority, Cedars-Sinai Medical Center
Ser 2005................................. 5.00 11/15/27 3,950,880
5,000 California Health Facilities Financing
Authority, Cedars-Sinai Medical Center
Ser 2005................................. 5.00 11/15/34 4,750,450
2,000 California Health Facilities Financing
Authority, Kaiser Permanente Ser 2006 A.. 5.25 04/01/39 1,928,920
2,000 California Infrastructure & Economic
Development Bank, California Science
Center Foundation Phase II Ser 2006 B
(FGIC Insd).............................. 5.00 05/01/31 1,931,200
5,000 California Infrastructure & Economic
Development Bank, Kaiser Hospital Ser
2001 A................................... 5.55 08/01/31 5,054,600
1,000 California Municipal Finance Authority,
American Heritage Education Foundation
Ser 2006 A............................... 5.25 06/01/26 918,800
5,000 California Pollution Control Finance
Authority, San Diego Gas & Electric Co
1996 Ser A............................... 5.90 06/01/14 5,247,450
2,000 California Public Works Board, Butterfield
State Office 2005 Ser A.................. 5.25 06/01/30 2,019,540
10,000 California Public Works Board, Department
of Corrections Refg 1993 Ser A (AMBAC
Insd).................................... 5.00 12/01/19 10,285,600
495 California State, Ser 1993 (FSA Insd)...... 5.50 04/01/19 498,208
5,000 California Statewide Communities
Development Authority, Adventist
Healthwest 2005 Ser A.................... 5.00 03/01/30 4,795,300
1,260 California Statewide Communities
Development Authority, Cedars-Sinai
Medical Center Ser 1992 (COPs)........... 6.50 08/01/12 1,338,460
</Table>
See Notes to Financial Statements
11
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2008 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------
$ 3,000 California Statewide Communities
Development Authority, Daughters of
Charity Health Ser 2005 A................ 5.25 % 07/01/30 $ 2,814,060
2,650 California, Ser 1996 (AMBAC Insd).......... 5.25 06/01/21 2,656,625
5,000 California, Various Purpose Dtd 04/01/02... 6.00 04/01/19 5,647,050
2,000 California, Veterans Ser AT................ 9.50 02/01/10 2,202,460
14,000 Duarte, City of Hope National Medical
Center Ser 1999 A (COPs)................. 5.25 04/01/19 14,077,140
8,000 Eastern Municipal Water District, Water &
Sewer Refg Ser 1998 A (COPs) (FGIC
Insd).................................... 4.75 07/01/23 8,004,560
9,445 Fontana Unified School District, Election
of 2006, Ser B (FSA Insd)................ 0.00 02/01/33 2,530,127
1,500 Fontana Public Financing Authority, Ser
2003 A (AMBAC Insd)...................... 5.375 09/01/25 1,550,160
14,000 Foothill/Eastern Transportation Corridor
Agency, Toll Road Ser 1999............... 0.00(a) 01/15/23 13,130,460
5,000 Foothill/Eastern Transportation Corridor
Agency, Toll Road Ser 1999 (MBIA Insd)... 5.125 01/15/19 5,047,050
10,000 Golden State Tobacco Securitization
Corporation, Asset Backed Ser 2007 A-1... 5.75 06/01/47 8,510,300
3,000 Golden State Tobacco Securitization
Corporation, Enhanced Asset Backed Ser
2005 A................................... 5.00 06/01/45 2,759,520
4,000 Golden State Tobacco Securitization
Corporation, Enhanced Asset Backed Ser
2007 A-1................................. 5.125 06/01/47 3,057,080
6,750 Grossmont Union High School District,
Election of 2004, Ser 2006 (MBIA Insd)... 0.00 08/01/24 2,960,415
3,000 Huntington Beach Union High School
District, Ser 2004 (FSA Insd)............ 5.00 08/01/27 3,058,170
2,000 Independent Cities Lease Financing
Authority, San Juan Mobile Estates Ser
2006 A................................... 5.125 05/15/41 1,748,680
780 Indio Redevelopment Agency, Tax Allocation
Ser 2008 A............................... 5.25 08/15/27 771,599
470 Indio Redevelopment Agency, Tax Allocation
Ser 2008 A............................... 5.25 08/15/28 461,380
2,100 Kern County Water Agency Improvement
District No. 4, Ser 2008 A (COPs) (AGC
Insd).................................... 5.00 05/01/28 2,144,058
5,000 Loma Linda, Loma Linda University Medical
Center Ser 2005 A........................ 5.00 12/01/20 4,927,100
20,000 Long Beach Financing Authority, Ser 1992
(AMBAC Insd)............................. 6.00 11/01/17 22,054,800
20,000 Los Angeles Department of Water & Power,
Ser 2001-A (FSA Insd).................... 5.25 07/01/22 20,815,600
5,000 Los Angeles Department of Water & Power,
Ser 2001 A............................... 5.125 07/01/41 5,032,450
3,000 Los Angeles Municipal Improvement
Corporation, Police Headquarters Ser
2006 - A (FGIC Insd)..................... 4.75 01/01/31 2,810,820
20,000 Los Angeles Wastewater, Refg Ser 2003 B
(FSA Insd) (c)........................... 5.00 06/01/22 20,592,600
5,000 Los Angeles, Ser 2004 (MBIA Insd).......... 5.00 09/01/24 5,146,650
7,500 Madera County, Valley Children's Hospital
Ser 1995 (COPs) (MBIA Insd).............. 6.50 03/15/15 8,311,575
850 Oakland Joint Powers Financing Authority,
Oakland Administration Buildings Refg
2008 Ser B (AGC Insd).................... 5.00 08/01/25 870,264
1,215 Oakland Joint Powers Financing Authority,
Oakland Administration Buildings Refg
2008 Ser B (AGC Insd).................... 5.00 08/01/26 1,239,069
</Table>
See Notes to Financial Statements
12
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2008 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------
$ 2,155 Placer County Water Agency, Refg Ser 2008
(COPs) (FSA Insd)........................ 4.75 % 07/01/29 $ 2,124,011
2,530 Poway Uniform School District Public
Financing Authority, Ser 2007 (AMBAC
Insd).................................... 4.625 09/15/42 2,318,340
3,100 Redding Electric System, 2008 Ser A (COPs)
(FSA Insd)............................... 5.00 06/01/27 3,180,352
2,515 Roseville Joint Union High School District,
Election of 2004, Ser 2007 C (FSA Insd).. 0.00 08/01/24 1,118,697
1,970 Roseville Joint Union High School District,
Election of 2004, Ser 2007 C (FSA Insd).. 0.00 08/01/25 828,267
1,350 Roseville Joint Union High School District,
Election of 2004, Ser 2007 C (FSA Insd).. 0.00 08/01/26 534,600
2,000 San Diego County, Burnham Institute for
Medical Research Ser 2006 (COPs)......... 5.00 09/01/34 1,760,160
2,080 San Diego County Water Authority, Ser 2008
A (COPs) (FSA Insd)...................... 5.00 05/01/28 2,143,440
5,000 San Francisco Airports Commission, San
Francisco Int'l Airport Second Ser Refg
Issue 27 B (FGIC Insd)................... 5.125 05/01/26 5,043,600
9,500 San Francisco Bay Area Rapid Transit
District, Sales Tax Ser 1998 (AMBAC
Insd).................................... 4.75 07/01/23 9,557,665
4,000 San Francisco City & County, City Buildings
Ser 2007 A (COPs) (FGIC Insd)............ 4.50 09/01/37 3,554,320
5,000 San Francisco City & County, Laguna Honda
Hospital (FSA Insd) (d).................. 5.00 06/15/30 5,127,440
4,000 San Francisco Public Utilities Commission,
Water 2002 Ser A (MBIA Insd)............. 5.00 11/01/20 4,080,120
6,000 San Joaquin Hills Transportation Corridor
Agency, Toll Road Refg Ser 1997 A (MBIA
Insd).................................... 0.00 01/15/15 4,432,680
10,000 San Joaquin Hills Transportation Corridor
Agency, Toll Road Senior Lien Ser 1993... 5.00 01/01/33 8,537,100
10,000 San Jose Airport, Ser 2001 A (FGIC Insd)... 5.00 03/01/25 10,068,800
1,385 Santa Monica Community College District,
2002 Election 2007 Ser A (FGIC Insd)..... 0.00 08/01/22 668,276
1,385 Santa Monica Community College District,
2002 Election 2007 Ser A (FGIC Insd)..... 0.00 08/01/23 629,482
1,385 Santa Monica Community College District,
2002 Election 2007 Ser A (FGIC Insd)..... 0.00 08/01/24 593,403
1,380 Santa Monica Community College District,
2002 Election 2007 Ser A (FGIC Insd)..... 0.00 08/01/25 556,361
1,745 School Facilities Financing Authority,
Grant Joint Union High School District
Ser 2008 A (FSA Insd).................... 0.00 08/01/30 548,419
2,040 School Facilities Financing Authority,
Grant Joint Union High School District
Ser 2008 A (FSA Insd).................... 0.00 08/01/31 607,022
6,395 School Facilities Financing Authority,
Grant Joint Union High School District
Ser 2008 A (FSA Insd).................... 0.00 08/01/32 1,801,344
4,770 School Facilities Financing Authority,
Grant Joint Union High School District
Ser 2008 A (FSA Insd).................... 0.00 08/01/33 1,268,534
</Table>
See Notes to Financial Statements
13
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2008 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN COUPON MATURITY
THOUSANDS RATE DATE VALUE
- ------------------------------------------------------------------------------------------
$ 3,500 Southern California Public Power Authority,
Mead-Adelanto 1994 Ser A (AMBAC Insd).... 6.42(e)% 07/01/15 $ 4,098,675
2,500 Southern California Public Power Authority,
Mead-Phoenix 1994 Ser A (AMBAC Insd)..... 6.27(e) 07/01/15 2,927,625
2,750 Southern California Public Power Authority,
Transmission Refg Ser 2002 A (FSA Insd).. 5.25 07/01/18 2,884,805
5,000 Tobacco Securitization Authority of
Northern California, Sacramento County
Tobacco Securitization Corporation Ser
2005 A-1................................. 5.50 06/01/45 4,084,950
4,000 Tobacco Securitization Authority of
Northern California, Sacramento County
Tobacco Securitization Corporation Ser
2006 A-1................................. 5.00 06/01/37 3,148,440
2,050 Tustin Unified School District, School
Facilities Improvement District No 2002-
1, 2002 Election Ser 2008 C (FSA Insd)... 5.00 06/01/28 2,112,997
10,000 University of California, Ser 2007 J (FSA
Insd).................................... 4.50 05/15/31 9,479,300
10,000 University of California, Ser 2007 J (FSA
Insd).................................... 4.50 05/15/35 9,334,700
5,000 West Basin Municipal Water District, Refg
Ser 2003 A (COPs) (MBIA Insd)............ 5.00 08/01/30 4,993,150
4,685 Yosemite Community College District,
Election of 2004 Ser 2008 C (FSA Insd)... 0.00 08/01/24 2,083,935
------------
387,752,367
------------
Puerto Rico (3.6%)
1,635 Puerto Rico Commonwealth, Ser 1998......... 4.75 07/01/08(b) 1,651,481
6,365 Puerto Rico Commonwealth, Ser 1998......... 4.75 07/01/23 5,986,983
3,680 Puerto Rico Public Buildings Authority,
2002 Ser D (AMBAC Insd).................. 0.00(a) 07/01/17(b) 3,289,662
1,320 Puerto Rico Public Buildings Authority,
2002 Ser D (AMBAC Insd).................. 0.00(a) 07/01/31 1,105,883
3,000 Puerto Rico, Public Improvement Ser 1999
(Secondary MBIA Insd).................... 4.875 07/01/08(b) 3,030,270
------------
15,064,279
------------
Total Tax-Exempt Municipal Bonds (Cost $400,415,491)............ 402,816,646
------------
Short-Term California Tax-Exempt Municipal
Obligations (1.8%)
780 California Housing Finance Agency
Multifamily Housing, Ser 2000 D (Demand
07/01/08)................................ 2.85(f) 02/01/31 780,000
1,700 California Infrastructure & Economic
Development Bank, The J. Paul Getty Trust
Ser 2004 B (Demand 07/01/08)............. 1.45(f) 10/01/23 1,700,000
4,000 Metropolitan Water District of Southern
California, Ser 2000 B-3 (Demand
07/01/08)................................ 2.16(f) 07/01/35 4,000,000
1,000 Tustin Improvement Bond Act of 1915,
Reassessment District No. 95-2 Ser 1996 A
(Demand 07/01/08)........................ 1.60(f) 09/02/13 1,000,000
------------
Total Short-Term California Tax-Exempt Municipal Obligations
(Cost $7,480,000)............................................... 7,480,000
------------
Total Investments (Cost $407,895,491)........................... 410,296,646
------------
</Table>
See Notes to Financial Statements
14
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2008 (UNAUDITED) continued
<Table>
<Caption>
PRINCIPAL
AMOUNT IN
THOUSANDS VALUE
- ------------------------------------------------------------------------------------------
Floating Rate Note and Dealer Trust
Obligation Related to Security Held (-0.7%)
$(3,000) Note with interest rate of 1.53% at June
30, 2008 and contractual maturity of
collateral at 06/15/30 (See Note 1D) (g)
(Cost $(3,000,000))...................... $ (3,000,000)
------------
Total Net Investments (Cost $404,895,491) (h) (i).... 99.1% 407,296,646
Other Assets In Excess of Liabilities................ 0.9 3,571,983
-------- ------------
Net Assets........................................... 100.0% $410,868,629
======== ============
</Table>
- ----------
<Table>
<Caption>
COPs Certificates of Participation.
(a) Security is a "step-up" bond where the coupon increases on a
predetermined future date.
(b) Prerefunded to call date shown.
(c) A portion of this security has been physically segregated in
connection with open futures and swap contracts in the amount of
$382,786.
(d) Underlying security related to inverse floaters entered into by the
Fund (See Note 1D).
(e) Current coupon rate for an inverse floating rate municipal
obligation (See Note 6). This rate resets periodically as the
auction rate on the related security changes. Position in an
inverse floating rate municipal obligation has a total value of
$7,026,300 which represents 1.7% of net assets.
(f) Current coupon of variable rate demand obligation.
(g) Floating rate note and dealer trust obligation related to security
held. The interest shown reflects the rate in effect at June 30,
2008.
(h) Securities have been designated as collateral in the amount equal to
$81,059,158 in connection with open futures and swap contracts.
(i) The aggregate cost for federal income tax purposes approximates the
aggregate cost for book purposes. The aggregate gross unrealized
appreciation is $11,588,409 and the aggregate gross unrealized
depreciation is $8,943,010 resulting in net unrealized appreciation
of $2,645,399.
<Caption>
Bond Insurance:
- ---------------
AGC Assured Guaranty Corporation.
AMBAC AMBAC Assurance Corporation.
FGIC Financial Guaranty Insurance Company.
FSA Financial Security Assurance Inc.
MBIA Municipal Bond Investors Assurance Corporation.
</Table>
See Notes to Financial Statements
15
Morgan Stanley California Tax-Free Income Fund
PORTFOLIO OF INVESTMENTS - JUNE 30, 2008 (UNAUDITED) continued
FUTURES CONTRACTS OPEN AT JUNE 30, 2008:
<Table>
<Caption>
UNREALIZED
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE APPRECIATION
CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE (DEPRECIATION)
- -------------------------------------------------------------------------------------------------
416 Long Swap Future 5 Year
September 2008 $ 44,642,000 $ (72,669)
213 Long Swap Future 10 Year
September 2008 23,420,017 124,984
1 Long U.S. Treasury Note Future 2 Year
September 2008 211,203 1,279
149 Short U.S. Treasury Note Future 10 Year
September 2008 (16,974,360) (69,336)
204 Short U.S. Treasury Bond Future 20 Year
September 2008 (23,581,125) (355,957)
280 Short U.S. Treasury Note Future 5 Year
September 2008 (30,955,313) (10,823)
---------
Net Unrealized Depreciation......................... $(382,522)
=========
</Table>
INTEREST RATE SWAP CONTRACTS OPEN AT JUNE 30, 2008:
<Table>
<Caption>
NOTIONAL UNREALIZED
AMOUNT PAYMENTS RECEIVED TERMINATION APPRECIATION
COUNTERPARTY (000'S) MADE BY FUND BY FUND DATE (DEPRECIATION)
- ------------------------------------------------------------------------------------------------------------------------
JPMorgan Chase Bank $28,810 Floating Rate 0.00% # Fixed Rate 5.385% February 14, 2018 $ 215,787
Bank of America N.A. 7,198 Floating Rate 0.00 # Fixed Rate 5.580 February 28, 2018 103,291
Bank of America N.A. 8,240 Floating Rate 0.00 # Fixed Rate 5.070 April 14, 2018 (35,597)
Bank of America N.A. 7,540 Floating Rate 0.00 # Fixed Rate 4.982 April 15, 2018 (56,022)
Merrill Lynch & Co. 10,060 Floating Rate 0.00 # Fixed Rate 5.000 April 15, 2018 (68,509)
JPMorgan Chase Bank 36,680 Fixed Rate 5.831 Floating Rate 0.00 # February 14, 2023 (473,906)
Bank of America N.A. 9,073 Fixed Rate 5.990 Floating Rate 0.00 # February 28, 2023 (156,509)
Bank of America N.A. 10,550 Fixed Rate 5.470 Floating Rate 0.00 # April 14, 2023 (29,645)
Bank of America N.A. 9,170 Fixed Rate 5.380 Floating Rate 0.00 # April 15, 2023 (3,118)
Merrill Lynch & Co. 12,880 Fixed Rate 5.395 Floating Rate 0.00 # April 15, 2023 (9,660)
---------
Net Unrealized Depreciation................................................... $(513,888)
=========
</Table>
- ----------
<Table>
<Caption>
# Floating rate represents USD-3 months LIBOR.
</Table>
See Notes to Financial Statements
16
Morgan Stanley California Tax-Free Income Fund
FINANCIAL STATEMENTS
Statement of Assets and Liabilities
June 30, 2008 (unaudited)
<Table>
Assets:
Investments in securities, at value (cost $407,895,491)......... $410,296,646
Cash............................................................ 76,070
Unrealized appreciation on open swap contracts.................. 319,078
Receivable for:
Interest..................................................... 4,911,988
Shares of beneficial interest sold........................... 440,122
Variation margin............................................. 103,671
Receivable from Distributor..................................... 315,979
Prepaid expenses and other assets............................... 32,720
------------
Total Assets................................................. 416,496,274
------------
Liabilities:
Floating rate note and dealer trust obligation.................. 3,000,000
Unrealized depreciation on open swap contracts.................. 832,966
Payable for:
Shares of beneficial interest redeemed....................... 1,054,150
Distribution fee............................................. 224,330
Dividends to shareholders.................................... 195,222
Investment advisory fee...................................... 155,090
Administration fee........................................... 28,211
Transfer agent fee........................................... 7,891
Accrued expenses and other payables............................. 129,785
------------
Total Liabilities............................................ 5,627,645
------------
Net Assets................................................... $410,868,629
============
Composition of Net Assets:
Paid-in-capital................................................. $405,615,640
Net unrealized appreciation..................................... 1,504,745
Accumulated undistributed net investment income................. 384,849
Accumulated undistributed net realized gain..................... 3,363,395
------------
Net Assets................................................... $410,868,629
============
Class A Shares:
Net Assets...................................................... $ 25,639,018
Shares Outstanding (unlimited authorized, $.01 par value)....... 2,234,096
Net Asset Value Per Share.................................... $11.48
======
Maximum Offering Price Per Share,
(net asset value plus 4.44% of net asset value).............. $11.99
======
Class B Shares:
Net Assets...................................................... $318,709,111
Shares Outstanding (unlimited authorized, $.01 par value)....... 27,589,518
Net Asset Value Per Share.................................... $11.55
======
Class C Shares:
Net Assets...................................................... $ 20,726,862
Shares Outstanding (unlimited authorized, $.01 par value)....... 1,795,087
Net Asset Value Per Share.................................... $11.55
======
Class I Shares: @@
Net Assets...................................................... $ 45,793,638
Shares Outstanding (unlimited authorized, $.01 par value)....... 3,978,052
Net Asset Value Per Share.................................... $11.51
======
</Table>
- ---------
@@ Formerly Class D shares. Renamed Class I shares effective March 31, 2008.
See Notes to Financial Statements
17
Morgan Stanley California Tax-Free Income Fund
FINANCIAL STATEMENTS continued
Statement of Operations
For the six months ended June 30, 2008 (unaudited)
<Table>
Net Investment Income:
Interest Income................................................. $ 10,727,562
------------
Expenses
Investment advisory fee......................................... 1,002,786
Distribution fee (Class A shares)............................... 31,262
Distribution fee (Class B shares)............................... 363,936
Distribution fee (Class C shares)............................... 84,195
Administration fee.............................................. 170,687
Transfer agent fees and expenses................................ 71,977
Shareholder reports and notices................................. 38,199
Professional fees............................................... 34,804
Custodian fees.................................................. 21,123
Registration fees............................................... 6,598
Trustees' fees and expenses..................................... 6,586
Interest and residual trust expenses............................ 98
Other........................................................... 26,134
------------
Total Expenses............................................... 1,858,385
Less: amounts waived/reimbursed................................. (78,131)
Less: expense offset............................................ (20,611)
------------
Net Expenses................................................. 1,759,643
------------
Net Investment Income........................................ 8,967,919
------------
Realized and Unrealized Gain (Loss):
Realized Gain (Loss) on:
Investments..................................................... 4,103,265
Futures contracts............................................... (858,470)
Swap contracts.................................................. (142,589)
------------
Net Realized Gain............................................ 3,102,206
------------
Change in Unrealized Appreciation/Depreciation on:
Investments..................................................... (14,963,652)
Futures contracts............................................... (117,614)
Swap contracts.................................................. (513,888)
------------
Net Change in Unrealized Appreciation/Depreciation........... (15,595,154)
------------
Net Loss..................................................... (12,492,948)
------------
Net Decrease.................................................... $ (3,525,029)
============
</Table>
See Notes to Financial Statements
18
Morgan Stanley California Tax-Free Income Fund
FINANCIAL STATEMENTS continued
Statements of Changes in Net Assets
<Table>
<Caption>
FOR THE SIX FOR THE YEAR
MONTHS ENDED ENDED
JUNE 30, 2008 DECEMBER 31, 2007
------------- -----------------
(unaudited)
Increase (Decrease) in Net Assets:
Operations:
Net investment income.............................. $ 8,967,919 $ 19,586,718
Net realized gain.................................. 3,102,206 959,407
Net change in unrealized
appreciation/depreciation........................ (15,595,154) (13,209,931)
------------ ------------
Net Increase (Decrease)......................... (3,525,029) 7,336,194
------------ ------------
Dividends and Distributions to Shareholders from:
Net investment income
Class A shares.................................. (520,197) (4,607,758)
Class B shares.................................. (7,100,050) (11,856,006)
Class C shares.................................. (411,368) (834,721)
Class I shares@@................................ (1,043,325) (2,230,782)
Net realized gain
Class A shares.................................. (20,879) (62,447)
Class B shares.................................. (263,071) (847,603)
Class C shares.................................. (17,155) (53,295)
Class I shares@@................................ (37,773) (118,103)
------------ ------------
Total Dividends and Distributions............... (9,413,818) (20,610,715)
------------ ------------
Net decrease from transactions in shares of
beneficial interest.............................. (17,267,398) (54,500,585)
------------ ------------
Net Decrease.................................... (30,206,245) (67,775,106)
Net Assets:
Beginning of period................................ 441,074,874 508,849,980
------------ ------------
End of Period
(Including accumulated undistributed net investment
income of $384,849 and $491,870, respectively)... $410,868,629 $441,074,874
============ ============
</Table>
- ----------
@@ Formerly Class D shares. Renamed Class I shares effective March 31, 2008.
See Notes to Financial Statements
19
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (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 I
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 I shares are not subject to
a sales charge. Additionally, Class A shares, Class B shares and Class C shares
incur distribution expenses. Effective March 31, 2008, Class D shares were
renamed Class I shares.
The Fund will assess a 2% redemption fee on Class A shares, Class B shares,
Class C shares, and Class I shares, which is paid directly to the Fund, for
shares redeemed or exchanged within seven days of purchase, subject to certain
exceptions. The redemption fee is designed to protect the Fund and its remaining
shareholders from the effects of short-term trading.
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; (3) interest rate
swaps are mark-to-market daily based upon quotations from market makers; and
20
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (UNAUDITED) continued
(4) 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 by the identified cost method.
Discounts are accreted and premiums are amortized over the life of the
respective securities and are included in interest income. 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. Floating Rate Note and Dealer Trust Obligation Related to Security
Held -- The Fund enters into transactions in which it transfers to a Dealer
Trust ("Dealer Trust"), fixed rate bonds in exchange for cash and residual
interests in the Dealer Trust's assets and cash flows, which are in the form of
inverse floating rate investments. The Dealer Trust funds the purchases of the
fixed rate bonds by issuing floating rate notes to third parties and allowing
the Fund to retain residual interest in the bonds. The Fund enters into
shortfall agreements with the Dealer Trust which commit the Fund to pay the
Dealer Trust, in certain circumstances, the difference between the liquidation
value of the fixed rate bonds held by the Dealer Trust and the liquidation value
of the floating rate notes held by third parties, as well as any shortfalls in
interest cash flows. The residual interests held by the Fund (inverse floating
rate investments) include the right of the Fund (1) to cause the holders of the
floating rate notes to tender their notes at par at the next interest rate reset
date, and (2) to transfer the municipal bond from the Dealer Trust to the Fund,
thereby collapsing the Dealer Trust. The Fund accounts for the transfer of bonds
to the Dealer Trust as secured borrowings, with the securities transferred
remaining in the Fund's investment assets, and the related floating rate notes
reflected as Fund liabilities under the caption "Floating rate note and dealer
trust obligation" on the Statement of Assets and Liabilities. The Fund records
the interest income from the fixed rate bonds under the caption "Interest
Income" and records the expenses related to floating rate note obligations and
any administrative expenses of the Dealer Trust under the caption "Interest and
residual trust expenses" on the Statement of Operations. The note issued by the
Dealer Trust has an interest rate that resets weekly and the floating rate note
holders have the option to tender their notes to the Dealer Trust for redemption
at par at each reset date. At June 30, 2008, Fund investments with a value of
$5,127,440 are held by the Dealer Trust and serve as collateral for the
$3,000,000 in floating rate
21
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (UNAUDITED) continued
note obligations outstanding at that date. Contractual maturity of the floating
rate note obligation and interest rate in effect at June 30, 2008 are presented
in the Portfolio of Investments.
E. 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.
F. Interest Rate Swaps -- Interest rate swaps involve the exchange of
commitments to pay and receive interest based on a notional principal amount.
Net periodic interest payments to be received or paid are accrued daily and are
recorded as realized gains or losses in the Statement of Operations. The Fund
may pay or receive cash to collateralize interest rate swap contracts. This cash
collateral is recorded as assets/liabilities on the Fund's books.
G. Federal Income Tax Policy -- It is the Fund's policy to comply with the
requirements of Subchapter M of the Internal Revenue Code applicable to
regulated investment companies and to distribute substantially all of its
taxable and nontaxable income to its shareholders. Therefore, no provision for
federal income taxes is required. The Fund files tax returns with the U.S.
Internal Revenue Service, New York State and New York City. The Fund adopted the
provisions of the Financial Accounting Standards Board ("FASB") Interpretation
No. 48 ("FIN 48") Accounting for Uncertainty in Income Taxes on June 27, 2008.
FIN 48 sets forth a minimum threshold for financial statement recognition of the
benefit of a tax position taken or expected to be taken in a tax return. The
implementation of FIN 48 did not result in any unrecognized tax benefits in the
accompanying financial statements. If applicable, the Fund recognizes interest
accrued related to unrecognized tax benefits in interest expense and penalties
in other expenses in the Statement of Operations. Each of the tax years in the
four year period ended June 30, 2008, remains subject to examination by taxing
authorities.
H. Dividends and Distributions to Shareholders -- Dividends and distributions to
shareholders are recorded on the ex-dividend date.
I. 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.
22
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (UNAUDITED) continued
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 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.
Under an agreement between the Administrator and State Street Bank and Trust
Company ("State Street"), State Street provides certain administrative services
to the Fund. For such services, the Administrator pays State Street a portion of
the fee the Administrator receives from the Fund.
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. Such
voluntary waivers may be terminated at any time without notice.
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 shares; (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 shares; and (iii) Class C -- up to 0.75% of
the average daily net assets of Class C shares.
23
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (UNAUDITED) continued
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, 2008.
At June 30, 2008, included in the Statement of Assets and Liabilities, is a
receivable from the Fund's Distributor which represents payments due to be
reimbursed to the Fund under the Plan. Because the Plan is what is referred to
as a "reimbursement plan", the Distributor reimburses to the Fund any 12b-1 fees
collected in excess of the actual distribution expenses incurred. This
receivable represents this excess amount as of June 30, 2008.
The Distributor has agreed to waive the 12b-1 fee on Class B shares to the
extent it exceeds 0.24% of the average daily net assets of such shares on an
annualized basis. The Distributor may discontinue this waiver in the future. For
the six months ended June 30, 2008, the Distribution fee was accrued for Class B
shares at the annual rate of 0.22%.
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 and other authorized
financial representatives at the time of sale may be reimbursed in the
subsequent calendar year. For the six months ended June 30, 2008, the
distribution fee was accrued for Class A shares and Class C shares at the annual
rate of 0.25% and 0.75%, respectively.
The Distributor has informed the Fund that for the six months ended June 30,
2008, it received contingent deferred sales charges from certain redemptions of
the Fund's Class A shares, Class B shares and Class C shares of $4, $50,077 and
$1,130, respectively and received $37,074 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.
24
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (UNAUDITED) continued
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, 2008 aggregated
$35,233,534 and $55,662,453, respectively.
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. 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. Aggregate
pension costs for the six months ended June 30, 2008, included in Trustees' fees
and expenses in the Statement of Operations amounted to $2,961. At June 30,
2008, the Fund had an accrued pension liability of $59,212 which is included in
accrued expenses in the Statement of Assets and Liabilities.
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 or she 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 fees and expenses for interest
earned on cash balances maintained by the Fund with the transfer agent and
custodian.
6. Purposes of and Risks Relating to Certain Financial Instruments
The Fund may invest a portion of its assets in inverse floating rate
instruments, either through outright purchases of inverse floating rate
securities or through the transfer of bonds to a Dealer Trust in exchange for
cash and residual interests in the Dealer Trust. These investments are typically
used by the Fund in seeking to enhance the yield of the portfolio. These
instruments typically involve greater risks than a fixed rate municipal bond. In
particular, these instruments are acquired through leverage or may have leverage
embedded in them and therefore involve many of the risks associated with
25
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (UNAUDITED) continued
leverage. Leverage is a speculative technique that may expose the Fund to
greater risk and increased costs. Leverage may cause the Fund's net asset value
to be more volatile than if it had not been leveraged because leverage tends to
magnify the effect of any increases or decreases in the value of the Fund's
portfolio securities. The use of leverage may also cause the Fund to liquidate
portfolio positions when it may not be advantageous to do so in order to satisfy
its obligations with respect to inverse floating rate instruments.
To hedge against adverse interest rate changes, the Fund may invest in financial
futures, municipal bond index futures and interest rate swap 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.
The Fund may enter into interest rate swaps and may purchase or sell interest
rate caps, floors and collars. The Fund expects to enter into these transactions
primarily to manage interest rate risk, hedge portfolio positions and preserve a
return or spread on a particular investment or portion of its portfolio. The
Fund may also enter into these transactions to protect against any increase in
the price of securities the Fund anticipates purchasing at a later date.
Interest rate swap transactions are subject to market risk, risk of default by
the other party to the transaction, risk of imperfect correlation and manager
risk. Such risks may exceed the related amounts shown in the Statement of Assets
and Liabilities.
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, 2007, the Fund had temporary book/tax differences primarily
attributable to book amortization of discounts on debt securities and mark-to-
market of open futures contracts.
26
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (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, 2008 DECEMBER 31, 2007
------------------------- ---------------------------
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ----------- -------------
(unaudited)
Class A Shares
Sold................................... 261,543 $ 3,058,383 361,602 $ 4,341,159
Conversion to Class B.................. -- -- (21,312,264) (257,677,039)
Reinvestment of dividends and
distributions ....................... 41,878 484,942 212,821 2,567,682
Redeemed............................... (152,961) (1,784,074) (1,796,927) (21,656,577)
---------- ------------ ----------- -------------
Net increase (decrease) -- Class A..... 150,460 1,759,251 (22,534,768) (272,424,775)
---------- ------------ ----------- -------------
Class B Shares
Sold................................... 202,974 2,401,534 334,223 4,022,842
Conversion from Class A................ -- -- 21,172,173 257,677,039
Reinvestment of dividends and
distributions ....................... 548,974 6,401,004 538,675 6,447,234
Redeemed............................... (2,097,366) (24,608,640) (3,907,522) (46,833,087)
---------- ------------ ----------- -------------
Net increase (decrease) -- Class B..... (1,345,418) (15,806,102) 18,137,549 221,314,028
---------- ------------ ----------- -------------
Class C Shares
Sold................................... 92,645 1,100,532 193,583 2,326,500
Reinvestment of dividends and
distributions ....................... 32,785 381,944 41,889 502,976
Redeemed............................... (246,621) (2,890,340) (225,524) (2,712,498)
---------- ------------ ----------- -------------
Net increase (decrease) -- Class C..... (121,191) (1,407,864) 9,948 116,978
---------- ------------ ----------- -------------
Class I Shares@
Sold................................... 109,343 1,298,717 278,435 3,333,721
Reinvestment of dividends and
distributions ....................... 82,742 961,390 115,275 1,380,112
Redeemed............................... (346,125) (4,072,790) (684,615) (8,220,649)
---------- ------------ ----------- -------------
Net decrease -- Class I................ (154,040) (1,812,683) (290,905) (3,506,816)
---------- ------------ ----------- -------------
Net decrease in Fund................... (1,470,189) $(17,267,398) (4,678,176) $ (54,500,585)
========== ============ =========== =============
</Table>
- ----------
@ Formerly Class D shares. Renamed Class I shares effective March 31, 2008.
9. Fair Valuation Measurements
The Fund adopted Financial Accounting Standards Board Statement of Financial
Accounting Standards No. 157, "Fair Value Measurements" ("FAS 157"), effective
December 1, 2007. In accordance with FAS 157, fair value is defined as the price
that the Fund would receive to sell an investment or pay to
27
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (UNAUDITED) continued
transfer a liability in a timely transaction with an independent buyer in the
principal market, or in the absence of a principal market the most advantageous
market for the investment or liability. FAS 157 establishes a three-tier
hierarchy to distinguish between (1) inputs that reflect the assumptions market
participants would use in pricing an asset or liability developed based on
market data obtained from sources independent of the reporting entity
(observable inputs) and (2) inputs that reflect the reporting entity's own
assumptions about the assumptions market participants would use in pricing an
asset or liability developed based on the best information available in the
circumstances (unobservable inputs) and to establish classification of fair
value measurements for disclosure purposes. Various inputs are used in
determining the value of the Fund's investments. The inputs are summarized in
the three broad levels listed below.
- Level 1 -- quoted prices in active markets for identical investments
- Level 2 -- other significant observable inputs (including quoted prices
for similar investments, interest rates, prepayment speeds, credit risk,
etc.)
- Level 3 -- significant unobservable inputs (including the Fund's own
assumptions in determining the fair value of investments)
The inputs or methodology used for valuing securities are not necessarily an
indication of the risk associated with investing in those securities.
The following is a summary of the inputs used as of June 30, 2008 in valuing the
Fund's investments carried at value:
<Table>
<Caption>
FAIR VALUE MEASUREMENTS AT JUNE 30, 2008 USING
------------------------------------------------------------
SIGNIFICANT SIGNIFICANT
QUOTED PRICES IN OTHER OBSERVABLE UNOBSERVABLE
ACTIVE MARKET FOR INPUTS INPUTS
TOTAL IDENTICAL ASSETS (LEVEL 1) (LEVEL 2) (LEVEL 3)
----- -------------------------- ---------------- ------------
Investments in Securities $407,296,646 -- $407,296,646 --
Other financial
instruments* (896,410) $(382,522) (513,888) --
------------ --------- ------------
Total $406,400,236 $(382,522) $406,782,758 --
============ ========= ============
</Table>
- ----------
<Table>
* Other financial instruments include futures, forwards, and swap
contracts.
</Table>
10. Accounting Pronouncement
On March 19, 2008, FASB released Statement of Financial Accounting Standards No.
161, Disclosures about Derivative Instruments and Hedging Activities ("SFAS
161"). SFAS 161 requires qualitative disclosures about objectives and strategies
for using derivatives, quantitative disclosures
28
Morgan Stanley California Tax-Free Income Fund
NOTES TO FINANCIAL STATEMENTS - JUNE 30, 2008 (UNAUDITED) continued
about fair value amounts of and gains and losses on derivative instruments, and
disclosures about credit- risk-related contingent features in derivative
agreements. The application of SFAS 161 is required for fiscal years beginning
after November 15, 2008 and interim periods within those fiscal years. At this
time, management is evaluating the implications of SFAS 161 and its impact on
the financial statements has not yet been determined.
29
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, 2008 2007 2006 2005 2004 2003
--------------------- ----------- ------------ ------------ ----------- -------
(unaudited)
Class A Shares
Selected Per Share Data:
Net asset value, beginning of
period............................ $11.83 $12.16 $12.16 $12.46 $12.58 $12.68
------- ------- ------- ------- ------- -------
Income (loss) from investment
operations:
Net investment income........... 0.24 0.50 0.49 0.52 0.54 0.55
Net realized and unrealized gain
(loss)........................... (0.34) (0.31) 0.06 (0.10) (0.02) (0.01)
------ ------ ----- ------ ------ ------
Total income (loss) from investment
operations........................ (0.10) 0.19 0.55 0.42 0.52 0.54
------ ----- ----- ----- ----- -----
Less dividends and distributions
from:
Net investment income........... (0.24) (0.49) (0.49) (0.51) (0.53) (0.55)
Net realized gain............... (0.01) (0.03) (0.06) (0.21) (0.11) (0.09)
------ ------ ------ ------ ------ ------
Total dividends and distributions.. (0.25) (0.52) (0.55) (0.72) (0.64) (0.64)
------ ------ ------ ------ ------ ------
Net asset value, end of period..... $11.48 $11.83 $12.16 $12.16 $12.46 $12.58
====== ====== ====== ====== ====== ======
Total Return(1).................... (0.88)%(5) 1.62% 4.64% 3.44% 4.26% 4.31%
Ratios To Average Net Assets(2) :
Total expenses (before expense
offset)........................... 0.86 %(3)(4)(6) 1.00%(3) 0.86%(3) 0.86%(3) 0.81% 0.78%
Total expenses (before expense
offset, exclusive of interest and
residual trust expenses).......... 0.86 %(4)(6) 0.84% 0.85% 0.86% 0.81% 0.78%
Net investment income.............. 4.17 %(3)(4)(6) 4.12%(3) 4.06%(3) 4.11%(3) 4.29% 4.34%
Supplemental Data:
Net assets, end of period, in
thousands......................... $25,639 $24,645 $299,414 $329,938 $19,203 $17,422
Portfolio turnover rate............ 9 %(5) 5% 5% 23% 10% 11%
</Table>
- ----------
<Table>
(1) Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(2) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(3) If the Fund had borne all of its expenses that were reimbursed or waived
by the Investment Adviser and Administrator, the annualized expense and
net investment income ratios, before expense offset, would have been as
follows:
</Table>
<Table>
<Caption>
EXPENSE NET INVESTMENT
PERIOD ENDED: RATIO INCOME RATIO
- ------------- ------- --------------
June 30, 2008 0.90% 4.13%
December 31, 2007 1.04 4.08
December 31, 2006 0.89 4.02
December 31, 2005 0.87 4.10
</Table>
<Table>
(4) Does not reflect the effect of expense offset of $0.01%.
(5) Not annualized.
(6) Annualized.
</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, 2008 2007 2006 2005 2004 2003
---------------------- ----------- ----------- ----------- ----------- -----------
(unaudited)
Class B Shares
Selected Per Share Data:
Net asset value, beginning of
period......................... $11.91 $12.24 $12.24 $12.52 $12.65 $12.75
--------- ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income........ 0.25 0.50 0.52 0.54 0.54 0.55
Net realized and unrealized
gain (loss)................... (0.35) (0.30) 0.05 (0.08) (0.02) (0.02)
------ ------ ----- ------ ------ ------
Total income (loss) from
investment operations.......... (0.10) 0.20 0.57 0.46 0.52 0.53
------ ----- ----- ----- ----- ------
Less dividends and distributions
from:
Net investment income........ (0.25) (0.50) (0.51) (0.53) (0.54) (0.54)
Net realized gain............ (0.01) (0.03) (0.06) (0.21) (0.11) (0.09)
------ ------ ------ ------ ------ ------
Total dividends and
distributions.................. (0.26) (0.53) (0.57) (0.74) (0.65) (0.63)
------ ------ ------ ------ ------ ------
Net asset value, end of period.. $11.55 $11.91 $12.24 $12.24 $12.52 $12.65
====== ====== ====== ====== ====== ======
Total Return(1)................. (0.89)%(6) 1.65% 4.81% 3.74% 4.22% 4.27%
Ratios To Average Net Assets(2):
Total expenses (before expense
offset)........................ 0.83 %(4)(5)(7) 0.97%(4) 0.69%(4) 0.68%(4) 0.78%(3) 0.83%(3)
Total expenses (before expense
offset, exclusive of interest
and residual trust expenses)... 0.83 %(5)(7) 0.81% 0.68% 0.68% 0.78%(3) 0.83%(3)
Net investment income........... 4.20 %(4)(5)(7) 4.15%(4) 4.23%(4) 4.29%(4) 4.32%(3) 4.29%(3)
Supplemental Data:
Net assets, end of period, in
thousands...................... $318,709 $344,606 $132,162 $159,221 $526,026 $599,737
Portfolio turnover rate......... 9 %(6) 5% 5% 23% 10% 11%
</Table>
- ----------
<Table>
(1) Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(2) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(3) If the Fund had borne all of its expenses that were reimbursed by the
Distributor, the annualized expense and net investment income ratios,
before expense offset, would have been as follows:
</Table>
<Table>
<Caption>
EXPENSE NET INVESTMENT
PERIOD ENDED RATIO INCOME RATIO
- ------------ ------- --------------
December 31, 2004 1.03% 4.07%
December 31, 2003 1.35 3.77
</Table>
<Table>
(4) If the Fund had borne all of its expenses that were reimbursed or waived
by the Investment Adviser and Administrator, the annualized expense and
net investment income ratios, before expense offset, would have been as
follows:
</Table>
<Table>
<Caption>
EXPENSE NET INVESTMENT
PERIOD ENDED: RATIO INCOME RATIO
- ------------- ------- --------------
June 30, 2008 0.87% 4.16%
December 31, 2007 1.01 4.11
December 31, 2006 0.72 4.19
December 31, 2005 0.69 4.28
</Table>
<Table>
(5) Does not reflect the effect of expense offset of $0.01%.
(6) Not annualized.
(7) Annualized.
</Table>
See Notes to Financial Statements
31
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, 2008 2007 2006 2005 2004 2003
---------------------- ----------- ----------- ----------- ------- -------
(unaudited)
Class C Shares
Selected Per Share Data:
Net asset value, beginning of
period.............................. $11.90 $12.23 $12.23 $12.52 $12.65 $12.74
------ ------ ------ ------ ------ ------
Income (loss) from investment
operations:
Net investment income............. 0.21 0.44 0.43 0.45 0.47 0.48
Net realized and unrealized gain
(loss)............................. (0.34) (0.30) 0.06 (0.08) (0.02) 0.00
------ ------ ----- ------ ------ -----
Total income (loss) from investment
operations.......................... (0.13) 0.14 0.49 0.37 0.45 0.48
------ ----- ----- ----- ----- -----
Less dividends and distributions
from:
Net investment income............. (0.21) (0.44) (0.43) (0.45) (0.47) (0.48)
Net realized gain................. (0.01) (0.03) (0.06) (0.21) (0.11) (0.09)
------ ------ ------ ------ ------ ------
Total dividends and distributions.... (0.22) (0.47) (0.49) (0.66) (0.58) (0.57)
------ ------ ------ ------ ------ ------
Net asset value, end of period....... $11.55 $11.90 $12.23 $12.23 $12.52 $12.65
====== ====== ====== ====== ====== ======
Total Return(1)...................... (1.10)%(5) 1.14% 4.12% 2.97% 3.61% 3.80%
Ratios To Average Net Assets(2):
Total expenses (before expense
offset)............................. 1.36 %(3)(4)(6) 1.50%(3) 1.36%(3) 1.36%(3) 1.36% 1.35%
Total expenses (before expense
offset, exclusive of interest and
residual trust expenses)............ 1.36 %(4)(6) 1.34% 1.35% 1.36% 1.36% 1.35%
Net investment income................ 3.67 %(3)(4)(6) 3.62%(3) 3.56%(3) 3.61%(3) 3.74% 3.77%
Supplemental Data:
Net assets, end of period, in
thousands........................... $20,727 $22,800 $23,320 $26,385 $27,519 $26,435
Portfolio turnover rate.............. 9 %(5) 5% 5% 23% 10% 11%
</Table>
- ----------
<Table>
(1) Does not reflect the deduction of sales charge. Calculated based on the
net asset value as of the last business day of the period.
(2) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(3) If the Fund had borne all of its expenses that were reimbursed or waived
by the Investment Adviser and Administrator, the annualized expense and
net investment income ratios, before expense offset, would have been as
follows:
</Table>
<Table>
<Caption>
EXPENSE NET INVESTMENT
PERIOD ENDED: RATIO INCOME RATIO
- ------------- ------- --------------
June 30, 2008 1.40% 3.63%
December 31, 2007 1.54 3.58
December 31, 2006 1.39 3.52
December 31, 2005 1.37 3.60
</Table>
<Table>
(4) Does not reflect the effect of expense offset of $0.01%.
(5) Not annualized.
(6) Annualized.
</Table>
See Notes to Financial Statements
32
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, 2008 2007 2006 2005 2004 2003
--------------------- ----------- ----------- ----------- ------- -------
(unaudited)
Class I Shares @@
Selected Per Share Data:
Net asset value, beginning of period......... $11.86 $12.20 $12.20 $12.49 $12.61 $12.71
------ ------ ------ ------ ------ ------
Income (loss) from investment operations:
Net investment income..................... 0.26 0.53 0.53 0.54 0.56 0.57
Net realized and unrealized gain (loss)... (0.34) (0.32) 0.05 (0.08) (0.01) (0.01)
------ ------ ----- ------ ------ ------
Total income (loss) from investment
operations.................................. (0.08) 0.21 0.58 0.46 0.55 0.56
------ ----- ----- ----- ----- -----
Less dividends and distributions from:
Net investment income..................... (0.26) (0.52) (0.52) (0.54) (0.56) (0.57)
Net realized gain......................... (0.01) (0.03) (0.06) (0.21) (0.11) (0.09)
------ ------ ------ ------ ------ ------
Total dividends and distributions............ (0.27) (0.55) (0.58) (0.75) (0.67) (0.66)
------ ------ ------ ------ ------ ------
Net asset value, end of period............... $11.51 $11.86 $12.20 $12.20 $12.49 $12.61
====== ====== ====== ====== ====== ======
Total Return(1).............................. (0.75)%(5) 1.80% 4.90% 3.74% 4.48% 4.50%
Ratios To Average Net Assets(2):
Total expenses (before expense offset)....... 0.61 %(3)(4)(6) 0.76%(3) 0.61%(3) 0.61%(3) 0.61% 0.60%
Total expenses (before expense offset,
exclusive of interest and residual trust
expenses)................................... 0.61 %(4)(6) 0.60% 0.60% 0.61% 0.61% 0.60%
Net investment income........................ 4.42 %(3)(4)(6) 4.36%(3) 4.31%(3) 4.36%(3) 4.49% 4.52%
Supplemental Data:
Net assets, end of period, in thousands...... $45,794 $49,024 $53,954 $53,857 $58,399 $66,143
Portfolio turnover rate...................... 9 %(5) 5% 5% 23% 10% 11%
</Table>
- ----------
<Table>
@@ Formerly Class D shares. Renamed Class I shares effective March 31, 2008.
(1) Calculated based on the net asset value as of the last business day of
the period.
(2) Reflects overall Fund ratios for investment income and non-class specific
expenses.
(3) If the Fund had borne all of its expenses that were reimbursed or waived
by the Investment Adviser and Administrator, the annualized expense and
net investment income ratios, before expense offset, would have been as
follows:
</Table>
<Table>
<Caption>
EXPENSE NET INVESTMENT
PERIOD ENDED: RATIO INCOME RATIO
- ------------- ------- --------------
June 30, 2008 0.65% 4.38%
December 31, 2007 0.80 4.32
December 31, 2006 0.64 4.27
December 31, 2005 0.62 4.35
</Table>
<Table>
(4) Does not reflect the effect of expense offset of $0.01%.
(5) Not annualized.
(6) Annualized.
</Table>
See Notes to Financial Statements
33
(This Page Intentionally Left Blank)
(This Page Intentionally Left Blank)
TRUSTEES
Frank L. Bowman
Michael Bozic
Kathleen A. Dennis
James F. Higgins
Dr. Manuel H. Johnson
Joseph J. Kearns
Michael F. Klein
Michael E. Nugent
W. Allen Reed
Fergus Reid
OFFICERS
Michael E. Nugent
Chairperson of the Board
Ronald E. Robison
President and Principal Executive Officer
Kevin Klingert
Vice President
Dennis F. Shea
Vice President
Amy R. Doberman
Vice President
Carsten Otto
Chief Compliance Officer
Stefanie V. Chang Yu
Vice President
Francis J. Smith
Treasurer and Chief Financial Officer
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
LEGAL COUNSEL
Clifford Chance US LLP
31 West 52nd Street
New York, NY 10019
COUNSEL TO THE INDEPENDENT TRUSTEES
Kramer Levin Naftalis & Frankel LLP
1177 Avenue of the Americas
New York, NY 10036
INVESTMENT ADVISER
Morgan Stanley Investment Advisors Inc.
522 Fifth Avenue
New York, New York 10036
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.
Morgan Stanley Distributors Inc., member FINRA.
(c) 2008 Morgan Stanley
[MORGAN STANLEY LOGO]
[MORGAN STANLEY LOGO]
INVESTMENT MANAGEMENT
Morgan Stanley
California Tax-Free
Income Fund
CLFSAN
IU08-04315P-Y06/08
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.
(a) Refer to Item 1.
(b) Not applicable.
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 second fiscal quarter of the period covered
by this report that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial reporting.
Item 12. Exhibits
(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 15, 2008
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 15, 2008
/s/ Francis Smith
Francis Smith
Principal Financial Officer
August 15, 2008
3