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FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

Yes      X       No            

Yes      X       No            

The aggregate market value of the Common Stock held by non-affiliates of the registrant as of March 5, 2004 was approximately $45,605,295. For purposes of this calculation only, (i) shares of Common Stock are deemed to have a market value of $2.62 per share, the closing price of the Common Stock as reported on the New York Stock Exchange on June 30, 2003, and (ii) each of the executive officers, directors and persons holding more than 10% of the outstanding Common Stock as of March 5, 2004 is deemed to be an affiliate.

As of March 5, 2004, there were 17,406,601 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for registrant’s Annual Meeting of Shareholders to be held on April 22, 2004 are incorporated by reference in Part III Items 10, 11, 12, 13 and 14.

MIDWEST AIR GROUP, INC.
FORM 10-K
For the fiscal year ended December 31, 2003

TABLE OF CONTENTS

PART I

Forward-Looking Statements

This Annual Report on Form 10-K, particularly the “Pending Developments” section, contains forward-looking statements that may state Midwest Air Group, Inc.‘s (the “Company”) or management’s intentions, hopes, beliefs, expectations or predictions for the future. In the following discussion and elsewhere in the report, statements containing words such as “expect,” “anticipate,” “believe,” “estimate,” “goal,” “objective” or similar words are intended to identify forward-looking statements. It is important to note that the Company’s actual results could differ materially from projected results due to the risk factors described in the Risk Factors section of Item 1 of this Annual Report on Form 10-K and the following:

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained from time to time in the Company’s Securities and Exchange Commission filings. The Company assumes no obligation, and disclaims any obligation, to update information contained in this Annual Report on Form 10-K, including forward-looking statements, as a result of facts, events or circumstances after the date of this report.

ITEM 1. BUSINESS

Background

The Company, formerly known as Midwest Express Holdings, Inc., was reincorporated under the laws of the State of Wisconsin in 1996. It is a holding company and its principal subsidiary is Midwest Airlines, Inc., (“Midwest Airlines”), formerly known as Midwest Express Airlines, Inc. Midwest Airlines currently operates a passenger jet airline that serves major destinations throughout the United States from Milwaukee, Wisconsin, and Kansas City, Missouri.

Midwest Airlines evolved out of Kimberly-Clark Corporation’s desire to provide a convenient and cost-effective way to meet its internal transportation needs. Kimberly-Clark began daily, nonstop aircraft shuttle service in October 1982 for employees traveling between offices in two cities. Key management personnel from Kimberly-Clark who successfully operated the shuttle service became the senior management of Midwest Airlines.

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Midwest Airlines began commercial operations in June 1984 with two DC-9-10 aircraft, serving three destinations from Milwaukee’s General Mitchell International Airport. Milwaukee, as Midwest Airlines’ original base of operations, has been the main focus of its route structure. Midwest Airlines established Kansas City as an additional base of operations in September 2000.

Skyway Airlines, Inc., doing business as Midwest Connect (“Midwest Connect”), formerly known as Astral Aviation, Inc., is a wholly owned subsidiary of Midwest Airlines, and serves as the regional airline for the Company. Midwest Connect began operations in early 1994 by taking over routes that Mesa Airlines, Inc. (“Mesa”) had operated as a commuter feed system under a marketing agreement between Mesa and Midwest Airlines. Under the agreement, Mesa operated the system from 1989 to 1994 as Skyway Airlines, using Midwest Airlines’ airline code.

On September 27, 1995, the stock of Midwest Airlines was transferred to the Company in connection with the initial public offering (“Offering”) by Kimberly-Clark of shares of common stock of the Company. Following the Offering, Kimberly-Clark retained 20% of the shares of outstanding common stock of the Company, which it subsequently sold in a secondary public offering consummated on May 23, 1996.

Midwest Airlines and Midwest Connect constitute the Company’s reportable segments. These reportable segments are strategic units that are managed independently because they provide different services, with different cost structures and marketing strategies. Additional detail on segment reporting is included in Note 12 of the Notes to Consolidated Financial Statements as of December 31, 2003 contained in this Annual Report on Form 10-K.

The Company currently has three principal product offerings. Midwest Airlines Signature Service, which is Midwest Airlines’ traditional product, is a single-class, premium service passenger jet airline that caters to business travelers, and as of December 31, 2003, served 15 major destinations in the United States from bases of operations in Milwaukee and Kansas City. In August 2003, the Company introduced low-fare Midwest Airlines Saver Service in high-volume, leisure-oriented markets from Milwaukee. As of December 31, 2003, Saver Service operated to eight destinations. Midwest Connect builds feeder traffic and provides regional scheduled passenger service to cities primarily in the Midwest. The Company’s operating subsidiaries also provide aircraft charter services, transport air freight and mail, and provide other airline services.

Name Change

As noted above, the Company changed its name during 2003; Midwest Express Holdings, Inc. became Midwest Air Group, Inc. as of January 1, 2004. Effective March 1, 2003, Midwest Airlines, Inc. became the corporate name for Midwest Airlines, replacing Midwest Express Airlines, Inc. In addition, Skyway Airlines, Inc. became the corporate name for the regional carrier, replacing Astral Aviation, Inc. The Company’s market research showed substantial lost income outside core markets due to the word “Express” in the corporate name, which potential customers may associate with a small airline. Additionally, research showed that many travelers did not understand the connection between Midwest Airlines and Midwest Connect. The Company’s ongoing acquisition of 25 Boeing 717 aircraft and planned acquisition of 20 Embraer regional jets provided an opportune time to make these name changes in a cost-efficient manner, as the new aircraft arrive from the manufacturers bearing the updated liveries with the new name. The Company plans to implement the name and corporate symbol changes over the next several years.

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Corporate Structure

The Company and Midwest Airlines have their principal executive offices in Oak Creek, Wisconsin. Both entities are Wisconsin corporations. As described above, Midwest Airlines has one operating airline subsidiary, Midwest Connect, a Delaware corporation. In addition to Midwest Connect, Midwest Airlines has the following subsidiaries:

Route Structure and Scheduling

Midwest Airlines Operations
Midwest Airlines currently has two bases of operations – Milwaukee and Kansas City. As of December 31, 2003, Midwest Airlines served 23 cities and was the largest carrier in Milwaukee, as measured by passenger enplanement data provided by the airport authority. Midwest Airlines provides nonstop service to most of its destinations from Milwaukee. Eleven other jet airlines serve Milwaukee’s airport. As of December 31, 2003, Midwest Airlines provided nonstop service from Kansas City to seven cities, and passengers in Kansas City can travel to most other cities throughout the route systems of Midwest Airlines and Midwest Connect via Milwaukee. Ten other jet airlines serve Kansas City’s airport.

Midwest Connect Operations
Although Midwest Connect’s operation is independent from Midwest Airlines – including separate pilot, flight attendant, aircraft maintenance and customer service personnel – Midwest Airlines coordinates Midwest Connect’s routes and schedules to complement Midwest Airlines service by providing passengers on short-haul, low-density routes the ability to connect to Midwest Airlines flights in Milwaukee without switching carrier systems. To enhance aircraft utilization and profitability, Midwest Connect also seeks to identify short-haul, low-density, point-to-point routes where there is likely to be consistent demand for air service even though there is no Milwaukee connection. As of December 31, 2003, Midwest Connect offered flights in 30 markets.

Codesharing Agreements
In 2003, Midwest Airlines continued a one-year renewable codeshare agreement with American Eagle that was originally established in 1998. Under the agreement, Midwest Airlines provided passengers with jet service to Boston, Dallas/Ft. Worth and Los Angeles, and American Eagle provided passengers with connecting service from those cities to select destinations throughout its system. Effective in February 2004, the codeshare agreement with American Eagle was terminated. The Company believes that the termination of this agreement will not have a material impact on the Company’s results of operations going forward.

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In 2003, Midwest Airlines continued a five-year codeshare agreement established in March 2001 with Air Midwest, Inc., a wholly owned subsidiary of Mesa Air Group, to provide passengers connecting service between Kansas City and select Midwestern cities. As of December 31, 2003, Midwest Airlines provided passengers with jet service to Kansas City, and Air Midwest provided passengers with connecting service from Kansas City to eight Midwestern cities. Both the Midwest Airlines and Air Midwest segments are designated in computer reservation systems with Midwest Airlines’ code.

Business Environment

The airline industry has undergone significant change in the last three years. The stagnant economy and the events of September 11, 2001 began a decline in travel demand, primarily by business travelers who traditionally have paid higher airline fares, that severely impacted the industry. Since then, the continued slowdown in the economy, the war with Iraq in early 2003, and high fuel prices in the latter half of 2003 and the first quarter of 2004 have continued to depress demand, increase costs and significantly decrease fares. Combined with excess capacity in the industry and significantly increased competition from legacy and low-fare carriers, these factors have resulted in substantial declines in passenger revenue, higher costs and substantial losses at many airlines, including the Company.

Although the Company was profitable for 14 consecutive years through 2000, the fundamental changes in the industry caused significant financial losses in 2001, 2002 and 2003 and have required the Company to implement broad changes to its operations, aimed at returning the Company to profitability by improving revenue and aggressively reducing costs. These changes are discussed more fully in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this Annual Report on Form 10-K.

Customer Service

Overall
Midwest Airlines has consistently been recognized as the best U.S. airline by travel publications and frequent flyer surveys, including Condé Nast Traveler, Travel+Leisure, OAG and the Zagat Airline Survey. Midwest Airlines caters primarily to business travelers and discerning leisure travelers by providing a travel experience that includes tangible amenities and a higher level of customer service at competitive fares. Tangible amenities include a passenger-friendly cabin and baked-onboard chocolate chip cookies on many flights, while passenger-pleasing service is provided by Midwest Airlines employees at each phase of the travel experience.

Saver Service and Signature Service
Midwest Airlines offers two products to meet the varying needs of its customers:

Both Saver and Signature flights provide passengers with extra legroom for added comfort. Pitch (the distance between seats) averages 33-34", depending on aircraft type – more than the 30” many airlines offer in coach class. The interior width of seat cushions on Midwest Airlines aircraft is generally 18” on Saver flights and 21” on Signature flights, compared with coach seating that is 17-18" wide on many airlines.

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Saver Service is expected to enhance the Company’s competitive position by enabling it to serve a segment of the market that is growing more rapidly than the business travel market, expand to destinations that have not been economically viable to serve with the premium product, and serve some existing destinations more cost efficiently. In the fourth quarter 2003, Saver Service exceeded the Company’s forecasts regarding passenger volume, but fares were lower than forecast. It is too soon following the launch of the service for the Company to determine the full impact of Saver Service until the service has been in place for additional seasonal periods. As a result of the introduction of Saver Service, the Company expects that it will compete with other low-fare carriers in ways that are different from its Signature Service. Among other things, the Company will compete more clearly on the basis of fare levels. There is no assurance that it will be able to compete successfully on these bases.

Fare Pricing and Revenue Management

Airlines generally offer a range of fares that are distinguished by restrictions on use, such as time of day and day of the week, length of stay, and minimum advance booking period. Midwest Airlines and Midwest Connect generally offer the same range of fares their competitors offer, although there are exceptions in particular markets, where Midwest Airlines will discount certain categories of fares or charge a premium compared with its competitors.

The number of seats an airline offers in each fare category is also an important factor in pricing. Midwest Airlines monitors the inventory and pricing of available seats with a computer-assisted revenue management system. The system enables Midwest Airlines’ revenue management analysts to examine Midwest Airlines’ and Midwest Connect’s historical demand and increases the analysts’ opportunity to establish the optimal allocation of the number of seats made available for sale at various fares. The analysts then monitor each flight to adjust seat allocations and actual booking levels, with the objective of maximizing revenues by optimizing the number of passengers and the fares paid on future flights.

Effective December 2002, the Company revised its service fee structure to lower costs and boost revenues. The Company began charging a service fee for paper tickets when electronic tickets are available, increased lost ticket fees, began charging for unaccompanied minors, and standardized excess and overweight baggage fees. This structure provides choices and options for customers, and charges an appropriate amount for specialized services. These fees are either consistent with or less than those charged by most U.S. carriers.

Marketing

Travel Agency Relationships and Ticket Sales
In 2003, Midwest Airlines sold approximately 50% of its tickets through travel agents (including online agencies), compared with 54% in 2002. This decrease in mix represents more ticket sales in 2003 than in 2002 from direct sales via the Company’s reservations center, Web site and ticket counters. Beginning in February 2003, the Company eliminated standard commissions on tickets sold through traditional travel agencies.

The Company maintains its own reservations call center at its headquarters in Milwaukee. Like many travel agencies, the Company’s reservations center provides airline information, makes reservations, and sells tickets for Midwest Airlines and Midwest Connect flights using a computer reservation system. The Company currently has an agreement to use SABRE’s computer reservation system; this agreement is effective through 2009.

Frequent Flyer Program
The Company operates a frequent flyer program, called Midwest Miles (the “frequent flyer program”), under which mileage credits are earned by flying on Midwest Airlines, Midwest Connect or other participating airlines (Air Jamaica, American Airlines and Frontier Airlines) and by using the services of participating hotels (Baymont, Hilton, Hyatt, Loews, Radisson, Raffles, Swissôtel, Wyndham and others), car rental firms (Avis, Hertz and National), Sprint telecommunications, Midwest Airlines MasterCard, Midwest Airlines Vacations and other program partners. Members can redeem frequent flyer program miles for travel on Midwest Airlines or Midwest Connect, or other participating airlines. In addition to free travel, miles can be redeemed at participating hotels, car rental firms and other program partners. The program is designed to enhance customer loyalty, and thereby retain and increase the business of frequent travelers, by offering incentives for their continued patronage. The frequent flyer program also includes a premier level, Midwest Miles Executive, for members who fly 25 one-way trips or 20,000 miles annually. Midwest Miles Executive offers additional benefits to its members, including mileage bonuses and partner benefits.

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The Company provides two levels of award tickets for domestic travel on Midwest Airlines or Midwest Connect. The standard travel award for a roundtrip ticket is 25,000 frequent flyer miles, while a companion travel award requires 20,000 miles. Choice awards eliminate capacity controls for award tickets, allowing customers to redeem an additional 25,000 miles for any available seat on Midwest Airlines or Midwest Connect flights on which the standard frequent flyer award seats have already been filled, up to the maximum seating capacity of the aircraft. Standard awards remain subject to capacity controls, which limit seat availability during peak travel times.

A marketing agreement between Midwest Airlines and Northwest Airlines, which allowed members of the airlines’ respective frequent flyer programs to redeem miles for award travel on the other airline, was terminated on May 28, 2003. This program was replaced with a new marketing agreement with American Airlines, which allows the company’s frequent flyer program members to earn Midwest Miles on American, American Eagle and AmericanConnection flights, as well as redeem Midwest Miles for award travel on these flights. The new program became effective on June 1, 2003. The agreement provides for economic compensation to American for all awards issued on American, American Eagle and AmericanConnection flights, and to Midwest Airlines for all Midwest Miles earned on American, American Eagle and AmericanConnection flights.

The Company also offers the Midwest Airlines MasterCard program. The program allows Midwest Airlines to offer a co-branded credit card to enhance loyalty to the airline and to increase frequent flyer membership. The Company generates income by selling frequent flyer program miles to Juniper Bank, which in turn awards the miles to cardholders for purchases made with their credit cards.

As of December 31, 2003, the Company had 1,654,000 members enrolled in its frequent flyer program (compared with 1,553,000 at year-end 2002). The Company estimates that as of December 31, 2003, the total number of awards available under the frequent flyer program was 178,000 (compared with 140,000 at year-end 2002), after eliminating those accounts below the minimum award level. Air travel awards redeemed were approximately 64,000 during 2003 and 87,000 during 2002, respectively. Free travel awards accounted for approximately 5% of the Company’s total revenue passenger miles during 2003. Since the Company controls the number of seats available for free travel on each flight (other than with respect to its choice awards), it does not believe that the use of frequent flyer program awards results in a significant displacement of revenue passengers. In addition, the Company does not believe that the use of the choice awards significantly displaces revenue passengers.

Miles accrued in a member’s account expire unless there is qualifying activity in the frequent flyer program account in a 36-month period. Qualifying activity includes flights on Midwest Airlines and/or Midwest Connect, or accrued mileage from any program partner activity during the previous 36-month period. If the account does not remain active, the mileage expires and the account is considered inactive. Mileage in approximately 111,000 accounts expired in 2003.

The Company accounts for its frequent flyer program obligations for travel miles on the accrual basis using the incremental cost method. This method requires accrual of the average incremental cost to provide roundtrip transportation to one additional passenger. The incremental cost includes the cost of fuel, commissary, reservations and insurance. The incremental cost does not include a contribution to overhead, aircraft cost or profit. The accrual is based on estimated redemption percentages applied to actual mileage recorded in members’ accounts. For purposes of calculating the frequent flyer program accrual, the Company anticipates that approximately 76% of outstanding awards will be redeemed.

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A portion of the revenue from the sale of frequent flyer miles to program partners is deferred and recognized straight-line over 32 months.

Related Business

The Company also offers ancillary airline services directly to customers, including cargo services and aircraft charters. The cargo business consists of transporting freight, United States mail and counter-to-counter packages on regular passenger flights.

As of December 31, 2003, Midwest Airlines operated one DC-9-30 and two MD-80 series jet aircraft configured specifically for the purpose of providing charter services. The primary customers of aircraft charter services are athletic teams, business groups and tour operators.

The Company also generates revenue from inflight liquor sales, providing aircraft ground handling and aircraft maintenance services for other airlines, and miscellaneous other services.

Competition

The Company competes with other air carriers on most routes it serves. Many of the Company’s competitors have elaborate route structures that transport passengers to their hub airports for transfer to many destinations, including those served by Midwest Airlines and Midwest Connect. Some competitors offer flights from cities served by Midwest Airlines to more than one of their hub airports, permitting them to compete in the Company’s markets by offering multiple routings. In some markets, Midwest Airlines and Midwest Connect also compete against ground transportation.

In July 2003, Northwest Airlines added one nonstop roundtrip flight in each of the following six markets from Milwaukee: Boston, Las Vegas, Los Angeles, New York City, Orlando and Washington, D.C. Northwest Airlines also added seasonal service to Phoenix in February 2004. In addition, Frontier Airlines and AirTran Airlines added new nonstop service in the Milwaukee market during 2003. This new competition has decreased fares in many of the Company’s markets. As noted above, the Company competes with other carriers in most markets it serves. However, this new competition is unique because it constitutes the addition of other carriers with nonstop service in Midwest Airlines’ Milwaukee base of operations.

The Company competes in its core businesses by offering what it believes are superior airline services at competitive fares. To more closely align its offerings with the needs of the markets it serves, the Company offers three types of service: Midwest Airlines Signature Service, Midwest Airlines Saver Service and Midwest Connect regional service. Midwest Airlines Signature Service is designed to compete by 1) careful selection of markets, 2) generation of premium yields through service-oriented philosophy and rigorous yield management, and 3) providing superior customer service while operating in a cost-efficient manner. Midwest Airlines Saver Service, the Company’s low-fare product offering, which was launched in August 2003, better serves markets where value-conscious leisure travelers are predominant. Midwest Connect regional service provides feed traffic for Midwest Airlines jet routes and serves select point-to-point markets. Overall, the Company believes its efforts to identify favorable markets and provide nonstop service enable it to generate a high degree of loyalty among passengers and attract a larger percentage of business travelers on its flights than higher volume carriers.

The Company has the largest market share of passengers in Milwaukee. During December 2003, Midwest Airlines and Midwest Connect collectively carried 38.7% of the passengers boarded in Milwaukee, while Northwest Airlines, which has the second-largest share, carried 20.4%. During December 2003, Midwest Airlines carried 4.8% of the passengers boarded in Kansas City, compared with 31.2% carried by Southwest Airlines and 13.2% by American – the carriers with the two largest market shares in Kansas City.

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This increased competition has not impacted the Company in market share; however, it has impacted the Company most noticeably in the significant decrease in fares in the Milwaukee market. The Company has successfully competed with legacy and low-cost carriers in the past and has maintained market share in these markets. However, there can be no assurance it will be able to successfully compete with competitors in the future.

Employees

As of December 31, 2003, Midwest Airlines had 2,143 employees (442 of whom were part-time and 35 of whom were intermittents) and Midwest Connect had 724 employees (243 of whom were part-time). The categories of employees were as indicated in the following table:

The Company makes extensive use of part-time employees to increase operational flexibility. Given the size of Midwest Airlines’ and Midwest Connect’s fleet and flight schedules, the Company does not have continuous operations at many locations. The use of part-time employees enables the Company to schedule employees when they are needed. Part-time employees are eligible for most benefit programs, subject to certain restrictions and co-pay requirements, because doing so enables the Company to attract quality employees and reinforces the value the Company places on part-time employees.

Labor Relations

Midwest Airlines and Midwest Connect pilots are represented by the Air Line Pilots Association, a labor union, for representation in collective bargaining. Midwest Airlines flight attendants are represented by the Association of Flight Attendants, AFL-CIO, a labor union, for representation in collective bargaining. In August 2003, all represented employee groups ratified amendments to their collective bargaining agreements; the duration of these agreements is five years.

Regulation

General
The Department of Transportation (“DOT”) has the authority to regulate economic issues affecting air service including, among other things, air carrier certification and fitness, insurance, deceptive and unfair competitive practices, advertising, computer reservation systems (“CRS”), and other consumer protection matters such as on-time performance, denied boarding and baggage liability. It is also authorized to require reports from air carriers and to inspect a carrier’s books, records and property. The DOT has authority to investigate and institute proceedings to enforce its economic regulations, and may, in certain circumstances, assess civil penalties, revoke operating authority and seek criminal sanctions.

In response to the terrorist attacks of September 11, 2001, Congress enacted the Aviation and Transportation Security Act (“ATSA”) of November 2001. ATSA created the Transportation Security Administration (“TSA”), an agency within the DOT, to oversee, among other things, aviation and airport security. In 2003, TSA was transferred from the DOT to the Department of Homeland Security, however the basic mission and authority of TSA remain unchanged. ATSA provided for the federalization of airport passenger, baggage, cargo, mail, and employee and vendor screening processes. ATSA also enhanced background checks, provided federal air marshals aboard flights, improved flight deck security, enhanced airline crew security training, improved training of security screening personnel and enhanced airport perimeter access, among other security measures. ATSA also required that all checked baggage be screened by explosive detection systems beginning December 31, 2002. The Company is actively involved in the industry’s efforts to work with TSA to ensure compliance with ATSA. Compliance with ATSA has resulted in increased costs and can result in operational delays and service disruptions. ATSA also imposed a $2.50 per enplanement security fee (subject to a $5.00 one-way trip cap). This fee is collected by air carriers and remitted to the government for payment for enhanced security.

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The Federal Aviation Administration (“FAA”) regulates the Company’s aircraft maintenance and operations, including flight operations, flight equipment, aircraft noise, ground facilities, dispatch, communications, training, security, weather observation, flight and duty time, crew qualifications, aircraft registration, and other matters affecting air safety. The FAA has the authority to temporarily suspend or permanently revoke the authority of the Company or its licensed personnel for failure to comply with regulations promulgated by the FAA, and to assess civil penalties for such failures.

The Company also is subject to regulation and/or oversight by federal agencies other than the DOT, TSA and FAA. Antitrust laws are enforced by the U.S. Department of Justice; labor relations are generally regulated by the Railway Labor Act, which vests certain regulatory powers in the National Mediation Board with respect to airlines and labor unions arising under collective bargaining agreements; the use of radio facilities is regulated by the Federal Communications Commission. Also, the Company is generally regulated by federal, state and local laws relating to the protection of the environment and to the discharge of materials into the environment. In addition, the Immigration and Naturalization Service, the U.S. Customs Service, and the Animal and Plant Health Inspection Service of the Department of Agriculture have jurisdiction over inspection of the Company’s aircraft, passengers and cargo to ensure compliance with U.S. immigration, customs and import laws.

Maintenance
In compliance with FAA regulations, the Company’s aircraft are subject to many levels of maintenance or checks, and periodically go through complete overhauls. The FAA typically monitors maintenance efforts with FAA representatives on site.

Slots
FAA regulations currently permit the buying, selling, trading and leasing of certain airline slots at New York’s La Guardia and Kennedy International, and Washington National airports. A slot is an authorization to schedule a takeoff or landing at the designated airport within a specified time window. The FAA must be advised of all slot transfers and can disallow any such transfer.

The FAA’s slot regulations require the use of each slot at least 80% of the time, measured on a bimonthly basis. Failure to comply with these regulations without a waiver from the FAA (which is granted only in exceptional cases) subjects the slot to recall by the FAA. In addition, slot regulations provide that the FAA may withdraw slots at any time and without compensation to meet the DOT’s operational needs (such as providing slots for international or essential air transportation). The Company’s ability to increase its level of operations at these airports is affected by the number of slots available for takeoffs and landings. These slots have been pledged as security to holders of the Company’s convertible senior secured notes (as described more fully below).

Essential Air Service Program

The Essential Air Service program (“EAS”) was created following airline deregulation action in 1978. The EAS program, which is administered by the DOT, subsidizes and guarantees a minimum level of air service to small communities that might not otherwise have service. In January 2003, Midwest Connect commenced service to three such cities: Iron Mountain, Ironwood and Manistee, Michigan. There is no guarantee the Company will continue to receive subsidies for serving these cities. If funding were terminated for any reason, the Company would not continue to operate in these markets and would find alternate routes for the aircraft currently deployed in these markets.

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Aircraft Fuel

Because fuel costs constitute a significant portion of the Company’s operating costs (approximately 20% as of December 31, 2003 and 16% as of December 31, 2002), significant changes in fuel costs can materially affect the Company’s operating results. Fuel prices continue to be susceptible to political events and other factors that affect the supply of fuel, and the Company cannot predict the effect of changes in near- or long-term fuel prices. In the event of a fuel supply shortage resulting from a disruption of oil imports or otherwise, higher fuel prices or curtailment of scheduled service could result. The Company has periodically entered into short-term option cap agreements in an attempt to reduce its exposure to jet fuel price fluctuations. As of December 31, 2003, the Company had not placed any such agreements for the first quarter of 2004 or later periods.

Insurance

The Company carries types and amounts of insurance customary in the airline industry, including coverage for general liability, passenger liability, property damage, product liability, aircraft loss or damage, baggage and cargo liability, and workers’ compensation.

As a result of the terrorist attacks on September 11, 2001, aviation insurers have significantly reduced the amount of insurance coverage available to commercial air carriers for war risk coverages (which include terrorism and hijacking). In addition, insurance companies have significantly increased the cost of this coverage, as well as aviation insurance in general. Under the Air Transportation Safety and System Stabilization Act, U.S. air carriers may purchase certain war risk liability insurance from the United States government on an interim basis at rates that are more favorable than those available from private aviation insurance carriers. As a result of the Emergency Wartime Supplemental Appropriations Act of 2003, the Company received an extension of this coverage through August 31, 2004.

Commercial air carriers are required by the DOT to obtain appropriate aviation insurance coverage. The effects of September 11 insurance losses, additional terrorist attacks or other unanticipated events could result in aviation insurers further increasing their premiums or a future shortage of available aviation insurance. Significant increases in insurance premiums or a shortage of available insurance could result in the curtailment or discontinuation of scheduled service.

Seasonality

The Company’s results of operations are impacted by the seasonality associated with the airline industry. Any interim period is not necessarily representative of results for the entire fiscal year. Generally, quarterly operating income and, to a lesser extent, revenues tend to be lower in the first and fourth quarters.

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Risks Related to the Company and to the Commercial Airline Industry

Investors should carefully consider the following risk factors, as well as other information included or incorporated by reference in this Annual Report on Form 10-K in connection with any investment in the Company’s common stock. The risks and uncertainties described below are not only the only ones that the Company faces. Additional risks and uncertainties not presently known or that the Company currently believes to be immaterial may also adversely affect the Company.

Business may be harmed if the Company cannot benefit from premium pricing.
The reduction in the demand for air travel, particularly business travel, and the growing use of travel substitutes such as audio, video and Web conferencing have affected fares throughout the airline industry. Greater cost sensitivity on the part of travelers, especially business travelers, and increasing competition from low-cost carriers have reduced pricing power among airlines. At the same time, the increase in pricing transparency resulting from the use of the Internet has enabled cost-conscious customers to more easily obtain the lowest fare on any given route. In addition, the Company must now compete with carriers that are reorganizing or have reorganized under the protection of Chapter 11 of the United States Bankruptcy Code. Historically, air carriers involved in Chapter 11 reorganizations have undertaken substantial fare discounting to maintain cash flows and enhance customer loyalty. There can be no assurance that attempts to increase fares will be successful. The Company’s business strategy involves premium pricing on Signature Service routes, and it is possible that premium pricing in the airline industry will not recover. If premium pricing does not recover, then the Company’s business and financial results would suffer.

Customer loyalty may be affected due to diminishing product differentiation.
The Company’s business strategy includes a premium travel experience at fares that cater to business and leisure travelers. The Company seeks to differentiate itself through better customer service throughout the customer’s travel experience. Due to the current state of the airline industry in general, and the Company’s current state, it has been forced to reduce or suspend some of the amenities that helped it achieve differentiation. For example, complimentary inflight meal service has been reduced to beverages, snacks and cookies, with buy-onboard dining service. Given these changes, there can be no assurance that customers will perceive any differentiation from other airlines and remain loyal to the Company. Any loss of customers due to diminishing product differentiation could harm business.

The September 11, 2001 terrorist attacks seriously harmed business and may further harm it in the future.
The terrorist attacks of September 11, 2001 materially impacted and continue to impact the airline industry. Concerns about further terrorist attacks have had a negative impact on air travel demand. In addition, security procedures introduced at airports since the attacks have increased – both in reality and in customer perception – the inconvenience of air travel, leading to further reduction in demand.

Increased competition could harm business.
Midwest Airlines competes with other air carriers on all routes that it serves. Many of Midwest Airlines’ competitors have elaborate route structures that transport passengers to their hub airports, permitting them to compete in Midwest Airlines’ markets by offering multiple routings. In some markets, Midwest Airlines and Midwest Connect also compete against ground transportation.

As a result of the introduction of Saver Service, Midwest Airlines expects it will compete with other low-fare carriers in ways that are different from its Signature Service. Among other things, it will compete more clearly on the basis of fare levels. There is no assurance it will be able to compete successfully on these bases.

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There are risks associated with Midwest Airlines’ ongoing purchases of Boeing 717 aircraft.
Midwest Airlines currently has a firm purchase order for 25 Boeing 717 aircraft and options to purchase up to 25 additional Boeing 717s at pre-negotiated prices. Midwest Airlines took delivery of the first Boeing 717 on February 28, 2003, and 10 more through December 2003. It plans to continue taking delivery of the Boeing 717s at the current rate of one per month through March 2004, when deliveries will change to approximately one per quarter until concluding in October 2006. The new Boeing 717s will replace Midwest Airlines fleet of DC-9s. Among other risks, the acquisition of these aircraft involves the following:

Increases in fuel costs would harm business.
Fuel costs constitute a significant portion of the Company’s total operating costs (approximately 20% for the quarter ended December 31, 2003). Accordingly, significant increases in fuel costs would harm its financial condition and results of operations. For the year ended December 31, 2003, a one-cent increase in the price per gallon of fuel expense would have increased fuel expenses by $800,000. Historically, fuel costs have been subject to wide price fluctuations based on geopolitical issues and changes in supply and demand. Fuel availability is also subject to periods of market surplus and shortage, and is affected by demand for both home heating oil and gasoline. Because of the effect of these events on the price and availability of fuel, the cost and future availability of fuel cannot be predicted with any degree of certainty. In the event of a fuel supply shortage, higher fuel prices or the curtailment of scheduled service could result. There can be no assurance that increases in the price of fuel can be offset with higher fares or surcharges.

In addition, although the Company periodically manages the price risk of fuel by purchasing commodity options that establish ceiling prices and partially protect against significant increases in fuel prices, these options do not protect against ordinary course price increases and are limited in fuel volume and duration. The Company has periodically hedged fuel prices by entering into short-term option cap agreements in an attempt to reduce exposure to substantial jet fuel price fluctuations. There can be no assurance that attempts to manage this risk are sufficient to protect against increases in the price of fuel due to inadequate fuel supplies or otherwise. Currently, the Company has no hedges in place for current or future periods.

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Changes in government regulation imposing additional requirements and restrictions on operations could increase operating costs and result in service delays and disruptions.
Airlines are subject to extensive regulatory and legal requirements, both domestically and internationally, that involve significant compliance costs. For example, on November 19, 2001, the President signed into law the Aviation and Transportation Security Act, which federalizes substantially all aspects of civil aviation security and requires, among other things, the implementation of security measures, such as the requirement that all passenger bags be screened for explosives. Funding for airline and airport security under the law is primarily provided by a new $2.50 per enplanement ticket tax, with authority granted to the Transportation Security Administration to impose additional fees on air carriers if necessary to cover additional federal aviation security costs. Implementation of the requirements of the act resulted in increased costs for passengers and the Company.

In addition to increased costs, the security measures required to be implemented under the Aviation Security Act, as well as additional security measures that the Federal Aviation Administration has implemented, have resulted in a longer check-in process for passengers and caused delays and disruptions in airline service, resulting in customer frustration and reducing demand for airline travel.

Additional laws, regulations, taxes, and airport rates and charges have been proposed periodically that could significantly increase the cost of airline operations or reduce demand for air travel. If adopted, these measures could have the effect of raising ticket prices, reducing revenue and increasing costs. There can be no assurance that these and other laws or regulations enacted in the future will not harm business.

An unfavorable resolution of the Company’s exemption from Wisconsin ad valorem property taxes could harm the business.
On November 7, 2003, a Dane County, Wisconsin, circuit court, in an action brought by Northwest Airlines, Inc., declared invalid the Wisconsin statute that provides the hub airline exemption from Wisconsin ad valorem property taxes. Savings to the Company from the exemption have been approximately $2.0 million annually. However, the Company estimates savings could be as high as $7.0 million annually by 2010. The Company is working with the State of Wisconsin on an appeal or other action to reduce or eliminate the potential effect of the decision. The Company believes there will be no retroactive impact of the decision.

The Company may be unable to compete effectively against airlines with greater financial resources or lower operating costs.
The airline industry is characterized generally by low profit margins and high fixed costs, primarily for personnel, debt service and rent. The expenses of an aircraft flight do not vary significantly with the number of passengers carried, and as a result, a relatively small change in the number of passengers or in pricing could have a disproportionate effect on an airline’s operating and financial results.

In addition, the airline industry is highly competitive and particularly susceptible to price discounting because airlines incur only nominal costs to provide service to passengers occupying otherwise unsold seats. The Company currently competes with other airlines on most of its routes. Many of these airlines are larger and have significantly greater financial resources and name recognition or lower operating costs.

The airline industry tends to experience adverse financial results during general economic downturns.
Since a substantial portion of air travel is discretionary, the industry tends to experience adverse financial results during general economic downturns. The airline industry has been experiencing a decline in passenger traffic, particularly traffic by business travelers, due to slower general economic conditions. Soft economic conditions continue to put pressure on the profitability of the industry. Any general decline in passenger traffic may harm the Company’s business. Any decline in traffic by business travelers may have a greater impact on the Company than on many of its competitors because it believes a greater percentage of its passengers are business travelers.

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The Company’s business is heavily dependent on the Milwaukee market, and a reduction in demand for air travel in this market could harm business.
A substantial percentage of the Company’s flights have Milwaukee as their origin or destination. As a result, the Company remains largely dependent on the Milwaukee market, and a reduction in its share of the Milwaukee market or reduced passenger traffic to or from Milwaukee could have a material adverse effect on business.

The Company’s indebtedness could adversely affect its financial health.
The Company’s indebtedness could have important consequences, including:

Available Information

The Company maintains a Web site at www.midwestairlines.com. On its Web site, the Company makes available, free of charge, the Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, as soon as reasonably practical after the reports have been electronically filed or furnished to the Securities and Exchange Commission. In addition, on or after April 22, 2004, the Company will have available on its Web site, free of charge, its (a) code of business conduct; (b) code of ethics for its Chief Executive Officer and financial officers; (c) corporate governance guidelines; and (d) the charters for the following Committees of the Board of Directors: Audit, Compensation, and Board Affairs and Governance; all of which are also available in print upon written request to the Director of Investor Relations of the Company at 6744 South Howell Avenue, Oak Creek, WI 53154. The Company is not including the information contained on or available through its Web site as a part of, or incorporating such information by reference into, this Annual Report on Form 10-K.

ITEM 2. PROPERTIES

Aircraft Equipment

As of December 31, 2003, Midwest Airlines had 11 Boeing 717 and 17 McDonnell Douglas jet aircraft in service, including four DC-9-30, two MD-88, eight MD-81 and three MD-82 aircraft.

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As part of the Company’s restructuring, the Company renegotiated its agreements with aircraft lessors and lenders. The information in this section reflects the amended agreements.

One MD-88 lease expires in 2007, two MD-81/82 aircraft leases and one MD-88 aircraft lease expire in 2011, and the remaining MD-81 lease expires in 2013. The four DC-9 aircraft will be periodically removed from service through April 2004 and sold or returned to lessors. The Boeing 717 aircraft leases all have 20-year terms.

As of December 31, 2003, Midwest Connect’s fleet consisted of 24 aircraft: 14 Beech 1900D turboprop aircraft and 10 Fairchild 328JET aircraft.

Midwest Connect acquired 15 new Beech 1900D turboprop aircraft between January 11, 1994 and May 18, 1995. During fourth quarter 2003, the Beech 1900D fleet was reduced to 14 as one aircraft was removed from the fleet and sold by the lessor. Each of these aircraft has 19 passenger seats. As of December 31, 2003, Midwest Connect’s 14 turboprop aircraft were financed under operating leases with lease terms of 12 years and expiration dates of 2008, except for two turboprop leases that expire in 2009. These leases permit renewal for various periods at rates approximating fair market value and purchase options at or near the end of the lease term at fair market value.

In 1999, Midwest Connect acquired five 32-passenger Fairchild 328JET aircraft. The five aircraft were financed by operating leases from one financial institution, with expiration dates all occurring in 2016. Four aircraft were placed in service in late 1999; the fifth was placed in service in 2000. Five additional 328JET aircraft were acquired and placed in service during January, April and June 2001, and January and February 2002. These aircraft are currently owned, three of which are financed with debt.

All owned, otherwise unencumbered aircraft have been pledged as security to holders of the Company’s convertible senior secured notes (described in Note 5 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K).

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Facilities

The Company has secured long-term use of gates and maintenance facilities at General Mitchell International Airport in Milwaukee. The Company is a signatory to the airport master lease, which expires in 2010, for 19 gates at the Milwaukee airport, including ticket counters, baggage handling and operations space. In 1988, the Company completed construction of its maintenance facility at the Milwaukee airport with a lease of land from the airport for an initial term of five years ending March 31, 1993, with an option for the Company to extend the lease for 11 successive renewal terms of five years each. To date, the Company has chosen to renew the lease for three successive renewal terms, and the lease will expire in 2008 if the Company chooses not to extend such lease for another five years.

In October 1998, Midwest Airlines completed construction of a 97,000-square-foot maintenance facility that is owned by Milwaukee County and located at General Mitchell International Airport adjacent to its other maintenance facility. See Note 5 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K for further detail regarding the financing of this facility.

In August 1997, the Company purchased its Oak Creek, Wisconsin headquarters building, which it had previously leased. In July 2000, the Company opened a new 55,000-square-foot training facility as an addition to its headquarters. In November 2003, the Company completed a sale/leaseback transaction on the Company’s headquarters facility. The initial term of the lease is 15 years.

Midwest Airlines leases airport facilities (gates, operations space, ticket counter) at each location it operates. In 10 of the 23 cities Midwest Airlines served as of December 31, 2003, gates at the airport were leased directly from the airport authority. In 13 cities, Midwest Airlines subleased gates from other carriers.

Midwest Connect has secured long-term leases of facilities at General Mitchell International Airport. Midwest Connect currently operates five gates at General Mitchell International Airport in Milwaukee; all gates are leased directly from Milwaukee County. Midwest Connect owns its 10,000 square-foot headquarters building, which is located off airport grounds. This building is pledged as collateral under the convertible senior secured notes.

Midwest Connect leases airport facilities at each location it operates unless the airport also has Midwest Airlines service. Midwest Connect also leases space from Midwest Airlines at three locations that were originally served by Midwest Airlines. Additionally, Midwest Connect serves markets where third parties deliver aircraft and passenger handling services. These leases are for various terms and contain other provisions that are customary in the industry.

In February 2002, the Company completed construction of a new maintenance facility for Midwest Connect, located at General Mitchell International Airport. The facility is owned by Milwaukee County. See Note 5 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K for further detail regarding the financing of this facility.

ITEM 3. LEGAL PROCEEDINGS

The Company is a party to routine litigation incidental to its business. Management believes that none of this litigation is likely to have a material adverse effect on the Company’s consolidated financial position and results of operations.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the Company’s Special Meeting of Shareholders held on November 21, 2003, shareholders approved each of the following matters:

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PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Price of Common Stock

The following table sets forth, for the periods indicated, the high and low price per share of the Company’s common stock for the two most recent fiscal years. The Company’s common stock is traded on the New York Stock Exchange (Symbol: MEH).

As of December 31, 2003, the Company had 18,108,959 shares issued and 17,401,839 shares outstanding and 919 registered shareholders. The Company has not paid a dividend on its common stock since its initial public offering in 1995 and has no intention to pay any dividends on such common stock in the foreseeable future. The Company is also subject to a dividend restriction under outstanding indebtedness, which is further discussed in Note 5 of the Notes to the Consolidated Financial Statements contained in this Annual Report on Form 10-K.

Recent Sales of Unregistered Securities

Lease Restructuring
On August 19, 2003, the Company reached final agreements on renegotiating its finance agreements with 11 aircraft lessors and lenders to reflect current market conditions. The lessors and lenders, in return for making the agreed-to amendments to these finance agreements, received warrants, with certain protection from dilutive issuances of common stock. Currently, the warrants give the warrant holders the right to purchase, in the aggregate, 1,571,467 shares of the Company’s common stock at an exercise price per share of $4.72. All of the lessors and lenders to whom warrants were issued were accredited investors (other than one lessor who qualified as a sophisticated investor due to its knowledge and experience in financial, business and investment matters, including the airline industry and businesses and operations of companies that operate in lines of business similar to the Company’s) in accordance with and in reliance upon the exemption from securities registration afforded by Section 4(2) of the Securities Act of 1933, as amended.

2003 Private Placement
In 2003, the Company raised financing of approximately $33 million. The financing included two components: the sale of $25 million in convertible senior secured notes and the sale of shares of the Company’s common stock for approximately $8 million. The Company sold the convertible senior secured notes and the common stock in a private placement to certain qualified institutional investors and accredited investors in accordance with and in reliance upon the exemption from securities registration afforded by Section 4(2) of the Securities Act of 1933 and Rule 506 under Regulation D as promulgated by the United States Securities and Exchange Commission under the Securities Act of 1933.

Debt Transaction
On September 29, 2003, pursuant to a Securities Purchase Agreement, the Company sold convertible senior secured notes (the “Notes”), with certain subsidiaries of the Company as co-borrowers (the “Co-Borrowers”), to certain qualified institutional investors and accredited investors (each a “Debt Investor” and, collectively, the “Debt Investors”) in an aggregate principal amount of $15.0 million (the “First Closing”). In addition, subject to shareholder approval and satisfaction of certain other conditions, the Company agreed to sell additional Notes to the Debt Investors at a later date in an aggregate principal amount of $10.0 million (the “Second Closing,” together with the First Closing, the “Debt Transaction”).

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On November 25, 2003, subsequent to receiving the requisite shareholder approval on November 21, 2003 and satisfying certain other conditions, the Company consummated the Second Closing, which was the second and final step in the Debt Transaction.

The Notes bear interest at 6.75% and mature on October 1, 2008. Each share of common stock will be accompanied by four-ninths of a Preferred Share Purchase Right in accordance with the Rights Agreement, dated February 14, 1996, as amended, between the Company and American Stock Transfer & Trust Company (each a “Right”). The Notes are secured by certain assets of the Company and the Co-Borrowers in accordance with a Security Agreement and by a Mortgage granted by one of the Co-Borrowers in favor of the Debt Investors. At any time from and after October 1, 2006, subject to the Company and the Co-Borrowers satisfying certain conditions specified in the Notes, the Company and the Co-Borrowers will have the right to redeem all or part of the Notes.

The Notes are generally convertible at any time at the option of the note holders into shares of common stock of the Company at an initial conversion price of $5.00 per share, which is subject to adjustment pursuant to certain anti-dilution provisions. The note holders may not convert any portion of the outstanding and unpaid principal of the Notes to the extent that, after giving effect to such conversion, the note holder (together with such note holder’s affiliates) would beneficially own in excess of 4.99% or 9.99%, as the case may be for the respective note holder, of the number of shares of common stock outstanding immediately after giving effect to such conversion. A note holder may waive the 4.99% limitation with such waiver being effective on the 61st calendar day after the Company receives notice of the waiver.

Equity Transaction
Contemporaneously with the Debt Transaction, on November 25, 2003, the Company sold 1,882,353 shares of Common Stock to certain qualified institutional investors and accredited investors (collectively, the “Equity Investors”) at a price of $4.25 per share in a private placement for an aggregate purchase price of approximately $8.0 million (the “Equity Transaction”). Each share of Common Stock was accompanied by a Right.

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ITEM 6. SELECTED FINANCIAL DATA

Five-Year Financial and Operating Data
Midwest Air Group, Inc.
(Dollars in thousands, except per share amounts)

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Five-Year Financial and Operating Data
Midwest Air Group, Inc.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Executive Overview

Beginning with the economic slowdown that commenced in 2000 and was exacerbated by the events of September 11, 2001, the past three years have brought unprecedented challenges to the airline industry and to the Company. The sluggish economy, coupled with the effects of the war in Iraq and increased security measures, have depressed passenger demand and increased operating costs. These pressures, along with increased competition from legacy and low-cost carriers that has depressed fares, resulted in the Company reporting operating losses in 2001, 2002 and 2003.

In 2003, the Company took comprehensive action to improve its financial performance by increasing revenue, reducing costs and providing for improved liquidity. The efforts included:

Detailed discussion of each of these measures is included in Recent Developments.

Looking forward, the Company believes it will realize the full benefits of its profit improvement initiatives (discussed more fully below in Recent Developments) in 2004. The Company also expects to realize additional benefits from Midwest Airlines Saver Service, which the Company will be offering during some key leisure travel periods for the first time in 2004. If current trends toward an economic recovery continue, the Company would also expect to see increased business travel. Key risks to the Company achieving a return to profitability include the depressed fare environment, increased competition, the economy, world events and high fuel costs. The Company discusses these and other risks more fully in the Risk Factors section of Item I, Business contained in this Annual Report on Form 10-K.

Recent Developments

Restructuring Efforts
In February 2003, the Company announced measures aimed at improving cash flow in addition to previous cost control initiatives and other actions to improve its profitability and liquidity position, which began in September 2001. Since then, the Company has realigned capacity, switched to a buy-onboard dining program, discontinued standard travel agency commissions to match the industry, and implemented service fee increases for nonrefundable tickets. In addition, the Company implemented an additional workforce reduction, and remaining non-union employees received temporary across-the-board compensation reductions. In addition, in August 2003, the Company finalized agreements with labor unions, lessors and lenders on permanent cost reductions.

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The Company is targeting its financial restructuring initiatives to improve profitability and reduce costs, relative to what it would have experienced if it had not effected these changes, by approximately $70 million annually going forward. The cost reductions relate to the following areas:

In connection with the restructuring efforts, the Company issued warrants to the lessors and lenders. Also, in connection with the restructuring efforts, the Company agreed to grant options to its employees (represented and non-represented) to purchase shares of the Company’s common stock pursuant to the Midwest Air Group, Inc. 2003 All-Employee Stock Option Plan. The warrants and options are further discussed in Note 7 of the Notes to the Consolidated Financial Statements contained in this Annual Report on Form 10-K.

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A summary of revenue improvement/cost reduction measures implemented during 2003 is as follows:

The Company completed a majority of the items listed above during various times in 2003 and most were reflected in fourth quarter 2003 financial results. As of December 31, 2003, the Company has not implemented the advertising cost reduction plan because additional costs were incurred to support the introduction of Saver Service, respond to increased competition in Milwaukee, and support expanded service in the Kansas City market. The Company believes approximately 90% of the cost reduction measures planned for represented employees and 50% of the cost reduction measures planned for non-represented employees were implemented by year-end, although the Company did not receive full benefit in 2003. The remaining cost reductions are expected to be achieved in 2004.

Completion of County Transaction
On October 21, 2003, the Company completed a transaction that resulted in Milwaukee County becoming the guarantor of principal and interest payments on approximately $14.2 million of industrial development revenue bonds issued in 1998 and 2001 by the City of Milwaukee to finance the construction of two airport-based maintenance facilities. Credit support for the bonds was previously provided by letters of credit issued under the Company’s bank credit facility. The guarantee provided by Milwaukee County enabled the Company to reduce its bank credit facility exposure from $15.5 million to approximately $1.1 million. The remaining $1.1 million represented letters of credit for which the Company was required to provide cash as collateral. This enabled the credit facility banks to release all other collateral previously provided as security. In addition, certain of the Company’s facilities and cash totaling $0.9 million were pledged as security under the agreement with Milwaukee County. This transaction resulted in the termination of the senior secured bank credit facility after approximately $1.1 million of letters of credit were cancelled or transferred to another financial institution, which was completed in the first quarter of 2004.

Private Placement of Debt and EquityOn September 29, 2003, the Company entered into agreements under which it raised financing of approximately $33.0 million (net proceeds of approximately $31.1 million, after commissions and expenses). The financing included two components: the sale of $25.0 million in convertible senior secured notes and the sale of approximately 1.9 million shares of the Company’s common stock for an aggregate purchase price of approximately $8.0 million. See further discussion of the financings in Note 5 of the Notes to Consolidated Financial Statements as of December 31, 2003 contained in this Annual Report on Form 10-K.

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Sale/Leaseback On November 12, 2003, the Company closed on an agreement to complete a sale/leaseback of its Oak Creek, Wisconsin headquarters facility. This transaction provided the Company with net proceeds of approximately $10.0 million after payment of the existing mortgage and transaction expenses.

CRS Regulations
During 2003, the DOT ruled that most regulations governing the CRS industry were to be lifted on January 31, 2004. Two remaining restrictions are to be phased out in July 2004. One prohibits CRS firms from favoring one airline’s flight listings over another, and the second restricts the CRS companies from making an airline provide all of its fares. The Company is currently evaluating the effect of these regulatory changes on its operations.

2003 Financial Overview

The Company’s 2003 operating loss was $(30.5) million, which reflects a decrease in operating loss of $23.8 million from the 2002 operating loss of $(54.3) million. Net loss for the year was $(13.3) million, which reflects an increase in net loss of $2.7 million from the 2002 net loss of $(10.6) million. Net loss per diluted share in 2003 was $(0.85), a $0.13 decline from the 2002 net loss per diluted share of $(0.72). 2003 results include income of $11.4 million (pre-tax) received from the April 2003 Emergency Wartime Supplemental Appropriations Act for reimbursement of security costs, as well as a charge of $5.0 million (pre-tax) related to the early recognition of lease expense on seven leased DC-9 aircraft removed from service during the year. 2002 results include a $29.9 million (pre-tax) impairment charge related to the early retirement of the Company’s DC-9 fleet and other income of $39.5 million (pre-tax) associated with the Fairchild arbitration settlement over the cancellation of the 428JET program.

Capacity, as measured by scheduled service available seat miles (“ASMs”), decreased 6.6% in 2003. Capacity decreased 7.0% at Midwest Airlines and decreased 3.4% at Midwest Connect. Midwest Airlines’ capacity decreased due to a net of four fewer aircraft in the fleet year over year, as well as a 17.3% decrease in the number of scheduled operations as the Company attempted to align capacity with lower demand, partially offset by the additional seats on the Saver Service product during the latter part of the year. Midwest Connect’s capacity decrease was due primarily to the implementation of schedule changes to reduce average flight lengths on regional jet routes and to better align capacity with demand, particularly on turboprop routes. Traffic, as measured by revenue passenger miles, increased 0.6%. Load factor increased from 60.2% in 2002 to 64.9% in 2003.

The Company’s total revenue in 2003 decreased $43.0 million, or 10.1%, from 2002 to $383.9 million. The decrease in revenue was due primarily to a decline in revenue yield of 15.0% at Midwest Airlines and 11.3% at Midwest Connect. The decreases in revenue yield were due in large part to a continued decline in high-yield business travel, heavy industrywide fare discounting implemented to stimulate travel demand, and increased competition in many markets, including Midwest Airlines’ main base of operations in Milwaukee. The introduction of Saver Service, which began operations in August 2003, also contributed to the decline in revenue yield as fares are generally lower, by design, for that service.

The Company’s operating expenses decreased by $66.8 million, or 13.9%, in 2003 to $414.4 million. The Company realized savings from companywide cost reduction efforts, with reduced costs in most expense categories. 2003 operating costs include a charge of $5.0 million (pre-tax) related to the early recognition of lease expense on seven leased DC-9 aircraft removed from service during the year. 2002 operating costs include a $29.9 million (pre-tax) impairment charge related to the early retirement of the Company’s DC-9 fleet. Cost changes are further explained in the sections that follow.

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The following table provides operating revenues and expenses for the Company expressed as cents per total ASM, including charter operations, and as a percentage of total operating revenues for 2003, 2002 and 2001.

Note: Numbers in this table may not be recalculated due to rounding.

Year Ended December 31, 2003 Compared With
Year Ended December 31, 2002

Operating Revenues

Company operating revenues totaled $383.9 million in 2003, a $43.0 million, or 10.1%, decrease from 2002. Passenger revenues accounted for 85.4% of total revenues and decreased $50.1 million, or 13.3%, from 2002 to $327.9 million in 2003.

Midwest Airlines passenger revenue decreased $45.4 million, or 14.9%, from 2002 to $260.1 million in 2003. This decrease was primarily caused by a 15.0% decrease in revenue yield. Revenue yield decreased due to a substantial decline in high-yield business travel, the sluggish economy and increased competition in many markets, including Midwest Airlines’ main base of operations in Milwaukee. The introduction of Saver Service during the third and fourth quarters also contributed to the decrease in revenue yield. Load factor increased from 61.6% in 2002 to 66.3% in 2003.

Midwest Connect passenger revenue decreased $4.7 million, or 6.5%, from 2002 to $67.8 million in 2003. This decrease was primarily caused by an 11.3% decrease in revenue yield. Revenue yield decreased due to decreased business travel and lower fares that were used to stimulate travel demand. The decrease in revenue yield was partially offset by a 5.4% increase in passenger volume, as measured by revenue passenger miles. Load factor increased from 48.9% in 2002 to 53.3% in 2003.

Revenue from cargo, charter and other services increased $7.1 million in 2003. Midwest Airlines benefited from increased revenue from charter sales as more aircraft time was available for charter service and the Company had exclusive charter rights for nine professional sports teams as of December 31, 2003. The increased charter revenue was partially offset by a $1.2 million decrease in cargo revenue. Most of this decrease was due to lower U.S. Postal Service mail volumes, in large part the result of security directives and restrictions, as well as a new contract with the U.S. Postal Service that has resulted in lower initial volumes.

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Operating Expenses

2003 operating expenses decreased $66.8 million, or 13.9%, from 2002 to $414.4 million in 2003. The Company realized savings from companywide cost reduction efforts, with reduced costs in many categories, as detailed below. 2002 operating costs include a $29.9 million (pre-tax) impairment charge related to the early retirement of the Company’s DC-9 fleet. The Company’s cost per total ASM decreased 8.0%, from 13.2¢ in 2002 to 12.1¢ in 2003.

Salaries, Wages and Benefits
Salaries, wages and benefits decreased $16.5 million, or 10.6%, from 2002 to $140.1 million in 2003. The labor cost decrease reflects the reduction of 496 full-time equivalent employees year over year. The headcount decrease was primarily the result of furloughing employees to align with reduced capacity and increase employee productivity, as well as attrition. A $1.6 million reduction in labor rates also contributed to decreased labor costs. These decreases were partially offset by increased benefit costs, primarily higher medical insurance costs. On a cost per total ASM basis, labor costs decreased from 4.3¢ in 2002 to 4.1¢ in 2003.

Aircraft Fuel and Oil
Aircraft fuel and oil and associated taxes increased $2.4 million, or 3.1%, from 2002 to $81.1 million in 2003. Costs increased 10.1% on a cost per ASM basis. Into-plane fuel prices increased 21.5% in 2003, averaging $1.01 per gallon in 2003 versus $0.83 per gallon in 2002, resulting in a $14.2 million unfavorable pre-tax price impact. Fuel consumption decreased 15.1% in 2003 because of a decrease in flight operations, as well as lower fuel consumption rates of the Boeing 717 aircraft compared with the DC-9 fleet. As of December 31, 2003, the Company had no fuel hedges in place for current or later periods.

Commissions
Commissions decreased $7.0 million, or 38.1%, from 2002 to $11.4 million in 2003. This category includes travel agent commissions and credit card transaction commissions. The decrease was primarily due to the elimination of standard travel agency commissions beginning March 1, 2003, as well as a 13.3% decrease in passenger revenue. In addition, savings were realized because of increased travel booked directly through the Company’s reservations center and Web site, and other travel-related Web sites. Commissions, as a percentage of passenger revenue, decreased from 4.9% in 2002 to 3.5% in 2003.

Dining Services
Dining service costs decreased $11.6 million, or 59.0%, from 2002 to $8.0 million in 2003. The decrease was due to the elimination of complimentary onboard meal service in April 2003 as well as a 2.0% decrease in origin and destination passengers at Midwest Airlines. Total dining service costs per Midwest passenger decreased from $9.47 in 2002 to $3.92 in 2003.

Station Rental, Landing and Other Fees
Station rental, landing and other fees decreased $1.2 million, or 3.2%, from 2002 to $36.5 million in 2003. On a cost per total ASM basis, these costs increased 3.4%. Costs per seat mile increased primarily because of fixed costs that were not absorbed as efficiently following the Company’s capacity reductions, as well as a decrease in flight lengths at Midwest Connect.

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Aircraft Maintenance Materials and Repairs
Aircraft maintenance costs decreased $8.9 million, or 21.8%, from 2002 to $32.0 million in 2003. Aircraft maintenance costs decreased 16.5% on a cost per total ASM basis. The decrease was caused by lower costs at Midwest Airlines due to the phase-out of the DC-9 aircraft and was partially offset by increased maintenance costs at Midwest Connect due to higher costs of maintaining the 328JET aircraft.

Depreciation and Amortization
Depreciation and amortization decreased $0.3 million, or 1.2%, from 2002 to $20.9 million in 2003. Costs in this category were essentially unchanged as the addition of one MD-80 aircraft to the fleet in March 2003 and the acquisition of spare parts to support the Boeing 717 program were offset by the decrease in depreciation related to the DC-9 aircraft retired from the fleet year over year. On a cost per total ASM basis, these costs increased 5.5% due to the Company’s reduced capacity year over year.

Aircraft Rentals
Aircraft rental costs increased $7.3 million, or 29.1%, from 2002 to $32.6 million in 2003. The increase was due primarily to the early recognition of $5.0 million (pre-tax) of lease expense on seven leased DC-9 aircraft removed from service during 2003, as well as the addition of 11 leased Boeing 717 aircraft to the Midwest Airlines fleet year over year. The increase was partially offset by the lower lease rates negotiated on all other leased aircraft remaining in service. Lease expense was recorded at the new restructured rates beginning in the third quarter 2003. On a cost per total ASM basis, these costs increased 37.9% from 2002.

Impairment Loss
During the first quarter 2002, the Company decided to accelerate the retirement of the Midwest Airlines DC-9 fleet in anticipation of accelerated deliveries of Boeing 717 aircraft. In connection with this decision, the Company performed evaluations to determine, in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal on Long-Lived Assets,” whether probability-weighted future cash flows from an asset (undiscounted and without interest charges) expected to result from the use and eventual disposition of these aircraft would be less than the aggregate carrying amounts. As a result of the evaluation, the Company determined that the estimated probability-weighted future cash flows would be less than the aggregate carrying amounts, resulting in impairment as defined by SFAS No. 144. Consequently, in first quarter 2002, the cost bases of these assets were reduced to reflect the fair market value at the date of the decision, resulting in a $29.9 million (pre-tax) impairment loss, and the remaining depreciable lives were adjusted for the new retirement schedule. In determining the fair market value of these assets, the Company considered market trends in aircraft dispositions, data from third parties and management estimates.

Other Operating Expenses
Other operating expenses decreased $1.2 million, or 2.2%, from 2002 to $51.7 million in 2003. Other operating expenses consist primarily of advertising and promotion, insurance, property taxes, flight training, legal fees, crew hotel rooms, reservation fees, administration and other items. The decrease was primarily due to cost decreases in insurance, advertising, flight training and crew hotel room expenses. These decreases were partially offset by increased legal and professional services costs of $2.5 million associated with the Company’s restructuring efforts, increased costs for the frequent flyer program and a $4.0 million loss recorded on the sale/leaseback of one MD-80 aircraft. The MD-80 aircraft sale/leaseback transaction was part of the overall aircraft restructuring transactions. The transaction resulted in the retirement of approximately $7.0 million of debt related to the aircraft, which had a book value of approximately $11.0 million on the date of the sale/leaseback. On a cost per total ASM basis, other operating costs increased 4.4% from 2002.

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Interest Income and Interest Expense

Interest income reflects interest earned on the Company’s cash and cash equivalents. Interest expense consists of mortgage interest associated with the Company’s headquarters building, as well as interest on a short-term note payable, interest associated with the borrowings against the secured bank credit facility, and interest on the Company’s long-term debt related to aircraft and convertible debt.

Other Income (Expense)

In May 2003, the Company recorded other income of $11.4 million (pre-tax) received from the April 2003 Emergency Wartime Supplemental Appropriations Act for reimbursement of security costs.

In 2002, the Company recorded other income of $39.5 million (pre-tax) associated with the Company’s settlement of arbitration with Fairchild Dornier GmbH (“Fairchild”) over the cancellation of its 428JET program.

Credit for Income Taxes

Income tax credit for 2003 was $(7.1) million, a $1.4 million increase from the 2002 income tax credit of $(5.7) million. The effective tax rates for 2003 and 2002 were (35.0)% and (35.0)%, respectively. For purposes of calculating the Company’s income tax expense and effective tax rate, the Company treats amounts payable to an affiliate of Kimberly-Clark Corporation under a tax allocation and separation agreement entered into in connection with the Company’s initial public offering as if they were payable to taxing authorities.

Net Loss

Net loss for 2003 was $(13.3) million, which reflects a decline of $2.7 million from the 2002 net loss of $(10.6) million. The net loss margin declined from (2.5)% in 2002 to (3.5)% in 2003.

Year Ended December 31, 2002 Compared With
Year Ended December 31, 2001

Operating Revenues

Year-over-year comparisons of financial results and performance data may not be meaningful because the comparisons are distorted by the impact of the events of September 11, 2001.

Company operating revenues totaled $427.0 million in 2002, a $30.5 million, or 6.7%, decrease from 2001. Passenger revenues accounted for 88.6% of total revenues and decreased $36.1 million, or 8.7%, from 2001 to $378.0 million in 2002.

Midwest Airlines passenger revenue decreased $41.6 million, or 12.0%, from 2001 to $305.5 million in 2002. Revenue yield decreased 11.7% due to lower business fares and decreased business travel demand, increased competition from low-fare airlines, and new pricing structures that enable business passengers to purchase lower fares. Load factor increased from 61.1% in 2001 to 61.6% in 2002.

Midwest Connect passenger revenue increased $5.5 million, or 8.2%, from 2001 to $72.5 million in 2002. Traffic, as measured by revenue passenger miles, increased 28.2%. Load factor increased from 48.3% in 2001 to 48.9% in 2002. Revenue yield decreased 15.6%, from $0.44 in 2001 to $0.38 in 2002, due to decreased business travel as a result of the slowing economy, a revised mix of longer flights with lower yields, and lower fares used to stimulate travel demand.

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Revenue from cargo, charter and other services increased $5.6 million in 2002. Revenue from charter sales increased $4.7 million from 2001 as more aircraft time was available for charter service and the Company acquired exclusive charter rights for two professional baseball teams and other sports teams. Cargo revenue decreased $3.2 million, or 36%, with most of the decrease due to lower U.S. Postal Service mail volumes, in large part the result of new federal security directives and restrictions.

Operating Expenses

2002 operating expenses decreased $14.3 million, or 2.9%, from 2001. The decrease was primarily the result of lower costs in the following categories: labor, fuel, commissions, dining services and maintenance. These decreases were partially offset by higher costs in the “other” category (insurance costs, advertising and a nonrecurring property tax credit in 2001). Cost per ASM decreased 4.5% at Midwest Airlines and decreased 13.2% at Midwest Connect in 2002. The Company’s cost per total ASM decreased 4.7%, from 13.8¢ in 2001 to 13.2¢ in 2002.

Salaries, Wages and Benefits
Salaries, wages and benefits decreased $10.6 million, or 6.4%, from 2001 to $156.7 million in 2002. The Company decreased headcount throughout 2001 and 2002 to better align with slower capacity growth and reduced passenger levels, and to reduce costs given the revenue environment. The overall headcount decrease was primarily the result of furloughing employees, which reduced labor costs by $10.5 million. In October 2001, the Company implemented a salary freeze for all employees except pilots, whose wages are covered by a collective bargaining agreement. The pay freeze was removed effective October 1, 2002 and employees became eligible for a pay increase after they had had their compensation frozen for 12 months. A salary freeze for officers and other members of senior management has been in effect for a longer period of time and continued as of year-end. A $1.5 million reduction in overtime also contributed to decreased labor costs. These decreases were partially offset by higher pilot labor costs, higher medical insurance costs and less labor capitalized for maintenance projects. On a cost per total ASM basis, labor costs decreased 8.1% from 4.7¢ in 2001 to 4.3¢ in 2002.

Aircraft Fuel and Oil
Aircraft fuel and oil and associated taxes decreased $8.3 million, or 9.5%, in 2002. Costs decreased 11.2% on a cost per ASM basis. Into-plane fuel prices decreased 8.9% per gallon, averaging 83.4¢ per gallon in 2002 versus 91.5¢ per gallon in 2001, resulting in a $7.8 million favorable pre-tax price variance. Fuel consumption decreased 0.7% in 2002. As of December 31, 2002, the Company had options in place for approximately 20% and 15% of its projected aircraft fuel purchases in the first and second quarters of 2003.

Commissions
Commissions decreased $5.1 million, or 21.7%, from 2001 to $18.5 million in 2002. This category includes travel agent commissions and credit card commissions. The decrease was due primarily to an 8.7% decrease in passenger revenue and to savings resulting from an increase in travel booked directly through the Company’s reservations centers and Web site, and other travel-related Web sites. Commissions, as a percentage of passenger revenue, decreased from 5.7% in 2001 to 4.9% in 2002. In December 2002, Midwest Airlines changed its travel agent commission cap to a maximum of $10 per roundtrip or one-way ticket from $20 per roundtrip.

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Dining Services
Dining service costs decreased $6.3 million, or 24.3%, from 2001 to $19.6 million in 2002. The decrease was due to the implementation of roundtrip catering on most flights, a 1.7% decrease in origin and destination passengers at Midwest Airlines, and lower food prices. Roundtrip catering provides for meals to be loaded at the origin city of a roundtrip route, rather than loading the aircraft with meals at both cities on the route. Also, effective November 1, 2002, the Company began limiting its meal service to traditional meal times and offering passengers one of three levels of meal service based on flight duration and market segment. Total dining service costs per Midwest Airlines passenger (including food, beverage, linen, catering equipment and supplies) decreased from $12.47 in 2001 to $9.47 in 2002.

Regional jet flights longer than 30 minutes generally offer onboard inflight services ranging from snacks to light meals, full beverage service and complimentary champagne. Baked-onboard chocolate chip cookies and hot towel service are featured on select flights. Total dining service cost per regional jet passenger (including food, beverage, catering equipment and supplies) was $3.47 in 2002, compared with $3.89 in 2001.

Station Rental, Landing and Other Fees
Station rental, landing and other fees increased $1.2 million, or 3.4%, from 2001 to $37.7 million in 2002. The increase was caused by 22.1% higher costs at Midwest Connect, partially offset by 2.4% lower costs at Midwest Airlines, due to fewer flight segments being operated. Passenger screening-related security costs increased $0.6 million year-over-year. Airport costs were favorably impacted in 2001 by nonrecurring credits received from Milwaukee County. On a cost per total ASM basis, these costs increased 1.4%.

Aircraft Maintenance Materials and Repairs
Aircraft maintenance costs decreased by $9.1 million, or 18.2%, from 2001 to $41.0 million in 2002. Aircraft maintenance costs decreased 19.7% on a cost per total ASM basis. Costs at Midwest Airlines decreased $10.8 million, or 27.1%, in 2002 while costs at Midwest Connect increased $1.8 million, or 17.4%. The decrease at Midwest Airlines was caused by lower costs in almost all maintenance categories, including lower DC-9 engine overhaul costs, lower long-term maintenance costs on the DC-9 fleet due to the near-term phase-out of the DC-9-10 series, lower purchased maintenance costs, and lower maintenance materials and cost savings realized through the MSG-3 aircraft maintenance program that was fully implemented in June 2001. The MSG-3 program is designed such that major airframe maintenance events are divided into smaller, more frequent events that result in fewer duplicate tasks, and airframe maintenance costs are expensed as they are incurred. Costs at Midwest Connect increased as a result of two additional regional jets entering scheduled service during 2002, the expiration of the warranty period on 328JETs, and several heavy maintenance checks on the Beech 1900Ds. On a cost per total ASM basis, Midwest Airlines costs decreased 26.8% and Midwest Airlines Connect’s costs decreased 7.4%.

Depreciation and Amortization
Depreciation and amortization increased $0.2 million, or 1.1%, from 2001 to $21.2 million in 2002. On a cost per total ASM basis, these costs decreased 0.9%.

Aircraft Rentals
Aircraft rental costs increased $0.5 million, or 2.0%, from 2001 to $25.3 million in 2002. On a cost per total ASM basis, these costs increased 0.1%.

Impairment Loss
A $29.9 million (pre-tax) impairment charge was recorded in 2002. The Company accelerated the retirement of the Midwest Airlines DC-9 fleet in anticipation of accelerated deliveries of Boeing 717 aircraft. In connection with this decision, the Company performed evaluations to determine, in accordance with Statement on Financial Accounting Standards (“SFAS”) No. 144, whether probability-weighted future cash flows (undiscounted and without interest charges) expected to result from the use and eventual disposition of these aircraft would be less than the aggregate carrying amounts. As a result of the evaluation, the Company determined that the estimated probability-weighted future cash flow would be less than the carrying amount of the aircraft, resulting in impairment as defined by SFAS No. 144. Consequently, the cost bases of these assets were reduced to reflect the fair market value at the date of the decision, resulting in a $29.9 million (pre-tax) impairment loss, and the remaining depreciable lives were adjusted for the new retirement schedule. In determining the fair market value of these assets, the Company considered market trends in aircraft dispositions, data from third parties and management estimates.

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An $8.8 million (pre-tax) impairment charge was recorded in 2001 for eight company-owned DC-9-10 aircraft. During 2001, the Company accelerated the retirement of these aircraft beginning in 2003. In connection with this decision, the Company performed an evaluation, in accordance with SFAS No. 121, to determine whether future cash flows (undiscounted and without interest charges) expected to result from the use and eventual disposition of these aircraft would be less than the aggregate carrying amount of these aircraft. As a result of the evaluation, the Company determined that the estimated future cash flows expected to be generated by these aircraft would be less than their carrying amounts, resulting in impairment, as defined SFAS No. 121. Consequently, the original cost bases of these aircraft were reduced to reflect the fair market value at the date of the decision, resulting in an $8.8 million (pre-tax) impairment charge.

Other Operating Expenses
Other operating expenses increased $2.2 million, or 4.3%, from 2001 to $52.8 million in 2002. Other operating expenses consist of advertising and promotion, insurance, legal fees, property taxes, consulting services, crew hotel rooms, reservation booking fees, administration and other items. The increase was primarily due to a $4.8 million increase in hull and liability insurance, $1.0 million in increased flight training costs and $0.8 million in increased advertising, offset by a decrease in frequent flyer costs, crew hotel rooms, communications, mail handling costs, air cargo, software costs, reservation fees and other items. 2001 expenses were favorably impacted by a $1.0 million property tax refund resulting from legislation in Wisconsin that exempted hub airlines from property tax. On a cost per total ASM basis, other operating costs increased 2.3%.

Interest Income and Interest Expense

Interest income reflects interest earned on the Company’s cash and cash equivalents. Interest expense consists of mortgage interest associated with the Company’s headquarters building, as well as interest on the short-term note payable, interest associated with the borrowings against the secured bank credit facility, and interest on the Company’s long-term debt.

Other Income (Expense)

In 2002, the Company recorded other income of $39.5 million (pre-tax) associated with the Company’s settlement of arbitration with Fairchild over the cancellation of its 428JET program. Following Fairchild’s filing of insolvency in 2002, the previously disclosed gain of $46 million was reduced primarily due to a decrease in the estimated fair market value of two Fairchild 328JET regional jets that the Company received in January and February 2002. The Company does not expect to receive any additional benefits from the settlement. Midwest Connect currently operates 10 32-passenger 328JET regional jets.

In 2001, to support the airline industry, the federal government implemented the Air Transportation Safety and System Stabilization Act. This legislation included support to passenger airlines in the form of a $4.5 billion grant, $10 billion in loan guarantees and assistance with increased insurance costs. The Company recorded non-operating income of $16.3 million in 2001 associated with federal government grant support. Of the amount claimed, the Company received $13.9 million as of December 31, 2001 with the balance of $2.4 million received in 2002. In addition, a remaining amount of $0.3 million was recorded and received in 2002. Total incurred losses were in excess of amounts claimed and recorded.

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Credit for Income Taxes

Income tax credit for 2002 was $(5.7) million, a $3.1 million decrease from the 2001 income tax credit of $(8.8) million. The effective tax rates for 2002 and 2001 were (35.0)% and (37.0)%, respectively. The 2002 rate decreased due to the uncertainty of realization of state net operating losses.

Net Loss

Net loss for 2002 was $(10.6) million, which reflects an improvement of $4.4 million from the 2001 net loss of $(14.9) million. The net loss margin improved from (3.3)% in 2001 to (2.5)% in 2002.

Critical Accounting Policies and Estimates

The preparation of the Company’s financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates, assumptions and judgments that affect amounts of assets and liabilities reported in the consolidated financial statements, the disclosure of contingent assets and liabilities as of the date of the financial statements, and reported amounts or revenues and expenses during the year. The Company believes its estimates and assumptions are reasonable, however future results could differ from those estimates under different assumptions or conditions.

Critical accounting policies are policies that reflect material judgment and uncertainty and may result in materially different results using different assumptions or conditions. The Company considers the following as its critical accounting policies and estimates: frequent flyer revenue, impairment of long-lived assets and warrant valuation. For a detailed discussion of accounting policies, refer to the Notes to the Consolidated Financial Statements as of December 31, 2003 contained in this Annual Report on Form 10-K.

Frequent Flyer Revenue
A portion of the revenue from the sale of frequent flyer mileage credits is deferred and recognized as passenger revenue when transportation is likely to be provided, based on estimates of the fair value of tickets to be redeemed, straight-line over 32 months, which is the Company’s estimate of when travel will occur. The estimated incremental cost of providing future transportation in conjunction with travel miles under the Company’s frequent flyer program is accrued based on an estimated redemption percentage of 76% applied to actual mileage recorded in members’ accounts over the standard award level. As part of estimating incremental costs, the Company includes the additional costs related to transportation of passengers, over and above costs to transport vacant seats, such as fuel, meals, insurance and ticketing. A change to these cost estimates and the estimated redemption percentage could have a significant impact on the Company’s liability in the period the change is made, as well as in future periods. The ultimate cost will depend on the actual redemption of frequent flyer miles, and may be greater or less than amounts accrued at December 31, 2003.

Impairment of Long-Lived Assets
The Company records impairment charges on long-lived assets used in operations when events and circumstances indicate the assets may be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amount. The Company uses judgment when applying the impairment rules to determine when an impairment test is necessary. Factors the Company considers that could trigger an impairment review include significant underperformance relative to historical or forecasted operating results, a significant decrease in the market value of an asset, and significant negative industry or economic trends.

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Impairment losses are measured as the amount by which the carrying value of an asset exceeds its estimated fair value. The Company is required to make estimates of its future cash flows related to the asset subject to review. These estimates require assumptions about demand for the Company’s service, future market conditions and industry competition. Other assumptions include determining the discount rule and future growth rates.

During 2003, the Company performed an analysis to determine if there was potential impairment of the MD-80 fleet. Based on the estimated useful lives of these assets of approximately 15 years, no impairment was determined. This determination would not change with a 10% change in the assumptions and estimates used in the calculation of the impairment.

Warrant Valuation
In connection with the final restructuring agreements with the aircraft lessors and lenders, the Company issued warrants to certain lessors and lenders that currently give the holders the right to purchase, in the aggregate, 1,571,467 shares of the Company’s stock at an exercise price per share of $4.72. The Company used the Black-Scholes model to value the liability to the Company as of the date of issuance. The Black-Scholes model uses a number of estimates, such as expected volatility, risk-free interest rate, forfeiture rate and expected life in years. The estimation techniques used are consistent with those used in Note 7 of the Notes to the Consolidated Financial Statements contained in this Annual Report on Form 10-K.

Off-Balance Sheet Arrangements

An off-balance sheet arrangement is any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a company has (1) made guarantees, (2) a retained or a contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity, or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the company, or that engages in leasing, hedging, or research and development arrangements with the company.

The Company has no arrangements of the types described in any of the categories that may have a material current or future effect on the Company’s financial condition, liquidity or results of operations. See Note 4 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K.

Liquidity and Capital Resources

The Company’s unrestricted cash and cash equivalents totaled $88.3 million at December 31, 2003, compared with $41.5 million at December 31, 2002. At December 31, 2003, the restricted cash balance was $26.1 million, compared with $15.1 million on December 31, 2002. The change in restricted cash is primarily attributable to an increase in the cash holdback amount related to credit card processing agreements that are discussed in more detail in Note 5 to the Consolidated Financial Statements. Cash collateral used to support outstanding letters of credit also contributed to the increase in restricted cash.

The unrestricted cash balance at December 31, 2003 reflects the effects of the significant restructuring of lease and debt payments and other cost reduction measures completed in third and fourth quarters 2003, as well as the debt financing, equity financing and sale/leaseback of the Company’s headquarters. These transactions are discussed in more detail in Note 5 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K. As part of the restructuring efforts, the Company suspended lease and debt payments on most of its aircraft from March 2003 to August 2003. The aggregate amount of the payments that the Company had not made as a result of the lease and debt payment moratorium was approximately $11.7 million. In July 2003, the Company made payments totaling $4.8 million to the lessors and lenders in conjunction with the signing of tentative agreements to restructure the aircraft financings. In August 2003, the agreements were finalized and the Company paid an additional $2.3 million to the lessors and lenders. For the remainder of the year, the Company made lease payments at revised, lower lease rates. The Company’s subsidiaries also delivered subordinated promissory notes to the lessors and lenders, the aggregate principal amount of which is $7.5 million.

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As of December 31, 2003, the Company had a working capital surplus of $39.3 million compared with a $45.2 million deficit on December 31, 2002. The improvement in working capital as of December 31, 2003 is primarily related to an increase in cash associated with the proceeds from the private placement of convertible debt and equity and the sale/leaseback of the Company’s headquarters. A reduction in notes payable related to the bank credit facility and a reduction in current maturities of long-term debt related to the aircraft debt restructuring finalized in August 2003 also contributed to the improvement in working capital.

Operating Activities
Net cash provided by operations for the year ended December 31, 2003 totaled $15.7 million. Cash provided by operations at December 31, 2003 primarily reflects the effects of credits used related to the acquisition of Boeing 717 aircraft. Midwest Airlines has used credit memos from certain suppliers associated with the delivery of each Boeing 717 aircraft for the acquisition of aircraft spare parts and maintenance tooling, employee training, flight simulator rental, aircraft lease payments and engine maintenance agreements, and accordingly there was no cash outlay for these expenses. As of December 31, 2003, the amount of unused credit memos totaled $10.1 million and is recorded as Other Assets. Midwest Airlines will receive additional credit memos on the delivery of each subsequent Boeing 717 aircraft, and will continue to use the credits as needed to pay for applicable services. The benefit of these credit memos is being recognized over the term of the leases. Credits available for aircraft lease payments will, for the most part, be used up during the first quarter of 2004.

Investing Activities
Net cash provided by investing activities totaled $3.0 million compared to $55.3 million used by investing activities for the year ended December 31, 2002. The change from 2002 primarily relates to increases in aircraft purchase deposits and pre-delivery progress payments related to future deliveries of Boeing 717 aircraft that were more than offset by purchase deposits that had been returned for the 11 Boeing 717 deliveries in 2003. Capital spending totaled $13.6 million for the year ended December 31, 2003. Capital expenditures consisted primarily of costs associated with the start-up of the Boeing 717 program, with the majority of that spending related to the acquisition of spare parts for the program. In addition, spending was incurred to convert some of the MD-80 fleet to the Saver Service configuration.

Financing Activities
Net cash provided by financing activities during 2003 totaled $28.1 million. During the third and fourth quarter of 2003, the Company netted approximately $31.1 million from the issuance of private placement convertible debt and equity. In addition, the sale/leaseback of the Company headquarters facility generated approximately $10.0 million in new capital.

In the second quarter 2002, Midwest Airlines entered into a loan agreement to fund pre-delivery progress payments to The Boeing Company for new Boeing 717 aircraft. Midwest Airlines also entered into a loan agreement with Kreditanstalt fur Wiederaufbau Bank (“KfW”) with the assistance of Rolls-Royce Deutschland Ltd. & Co. KG (“Rolls-Royce”). Rolls-Royce agreed to guarantee this loan agreement on behalf of Midwest Airlines. This agreement is discussed in more detail in Note 5 to the Consolidated Financial Statements. As of December 31, 2003, the Company owed $26.5 million under the loan agreement. The Company expects that the debt associated with this financing transaction will continue to trend downward, as the firm aircraft delivery schedule is more than half completed.

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With the loan agreement with KfW and the BCC commitment, the Company believes it has requisite financing for the Boeing 717 program. Although BCC is able to terminate its financing commitment if it deems the Company has experienced a material adverse change and the commitment is subject to other conditions, the Company does not anticipate that the financing commitment will be terminated or that the Company will be unable to meet the conditions.

The Company maintains a qualified defined benefit plan, the Pilots’ Supplemental Pension Plan (the “Qualified Plan”), which provides supplemental retirement benefits to Midwest Airlines pilots, and an unfunded nonqualified defined benefit plan to provide Midwest Airlines pilots with annuity benefits for salary in excess of amounts permitted to be paid under the provisions of the tax law to participants in the Qualified Plan. The method used to determine the market-related value of plan assets is the prior year’s market-related value of assets, adjusted by contributions, disbursements, expected return on investments and 20% of investment gains (losses) during the five prior years. As of December 31, 2003, the Qualified Plan assets are invested primarily in equities and fixed income instruments. Additional discussion of Plan investment strategy is at Note 11 of the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K. 2003 funding requirements for the Qualified Plan were $1.7 million. As of December 31, 2003, funding requirements for 2003 had been fulfilled. Estimated 2004 funding requirements for the Qualified Plan are $1.6 million.

As discussed in Note 5 to the Consolidated Financial Statements contained in this Annual Report on Form 10-K, the Company issued promissory notes to the lessors and lenders as part of the restructuring agreements. The aggregate principal amount of these notes is $7.5 million. Principal and interest on the Basic Moratorium Notes are payable, in arrears, in 36 monthly installments commencing in July 2004.

As a result of the restructuring of lease and debt agreements described in Recent Developments, the Company has significantly lowered its obligations compared with the obligations under the previous lease and debt agreements. Included in the restructured agreements are clauses that would make the Company’s obligations, under certain default situations, increase to the amounts under the previous agreements. Such defaults include the Company filing for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The amount of such contingent obligation of the Company is approximately $23.2 million as of December 31, 2003.

Other Factors Affecting Liquidity
In second quarter 2003, the Company received a grant of $11.4 million (pre-tax) for reimbursement of security costs as a result of the April 2003 Emergency Wartime Supplemental Appropriations Act. In addition, the Company received $0.5 million in third quarter 2003 related to the reimbursement of cockpit door reinforcement costs. The Company does not expect to receive any additional reimbursement under the Act.

The Company has not paid federal income taxes in the last three years. As of December 31, 2003, the Company had a non-current deferred tax liability of $13.4 million and deferred tax assets aggregating $8.7 million. These amounts included $9.6 million related to net operating losses (“NOLs”) and a valuation allowance of $5.4 million.

At December 31, 2003, the Company had estimated tax NOLs of $11.0 million for federal income tax purposes that will expire through 2023. The Company had also previously recorded estimated state NOLs of $125 million, as well as alternative minimum tax carryforward of $2.4 million. Due to the uncertainty of realizing the state NOLs, the Company recorded an additional valuation allowance of $2.7 million in the year ended December 31, 2003.

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Contractual Obligations
The following table of material debt and lease commitments at December 31, 2003, summarizes the effect these obligations are expected to have on the Company’s cash flow in the future periods set forth below (in thousands):

2004 and Beyond
The current weak revenue environment and volatile nature of fuel prices make it difficult to accurately project cash flow from operations for 2004 and beyond. Absent adverse factors outside the control of the Company such as events similar to September 11, 2001, further substantial deterioration in the current industry revenue environment or significant increases in fuel prices from fourth quarter 2003 prices, the Company believes current liquidity and cash flow from operations will be sufficient to fund current operations through 2004. Some key cash flow items for 2004 and beyond include:

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company’s primary market risk exposures include commodity price risk (i.e. aircraft fuel prices) and interest rate risk. The Company’s operating results are significantly impacted by changes in the price and availability of aircraft fuel. The Company periodically manages the price risk of fuel primarily by purchasing commodity options that establish ceiling prices. Those options are recorded at their fair market value, and the changes in fair market value are recorded in the consolidated statement of operations in accordance with Statement of Financial Accounting Standards (“SFAS”), No. 133, “Accounting for Derivative Instruments and Hedging Activities” and the corresponding amendments under SFAS No. 138 “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” For 2003, aircraft fuel and oil and associated taxes (including the effect of any of the Company’s options) represented 20% of the Company’s total operating expenses. Based on the Company’s fiscal 2004 fuel consumption estimate of 86 million gallons, a one-cent change in the average annual price per gallon of aircraft fuel would increase the Company’s fuel expense by approximately $0.9 million. As of December 31, 2003, the Company had no options in place for any current or later periods.

As of December 31, 2003, the Company had no short- or long-term debt obligations that were subject to variable interest rates. The Company’s fixed rate debt was adjusted to market rates during the restructuring that was completed in August 2003; the convertible notes were priced at fixed rates during third quarter 2003 and therefore all debt reflects the current fair value at December 31, 2003.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Consolidated Financial Statements

All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because they are not applicable, not required or the information has been furnished elsewhere.

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INDEPENDENT AUDITORS’ REPORT

To the Shareholders and Board of Directors of Midwest Air Group, Inc.:

We have audited the accompanying consolidated balance sheets of Midwest Air Group, Inc. (formerly known as Midwest Express Holdings, Inc.,) and subsidiary (the “Company”) as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such financial statements present fairly, in all material respects, the financial position of Midwest Air Group, Inc. and subsidiary as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche LLP

Milwaukee, Wisconsin
February 17, 2004

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CONSOLIDATED STATEMENTS OF OPERATIONS

MIDWEST AIR GROUP, INC.
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

See notes to consolidated financial statements.

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CONSOLIDATED BALANCE SHEETS

MIDWEST AIR GROUP, INC.
AS OF DECEMBER 31, 2003 AND 2002
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

See notes to consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

MIDWEST AIR GROUP, INC.
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(DOLLARS IN THOUSANDS)