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FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

Commission File Number       1-13934     

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes       X               No            

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes       X               No            

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

As of April 30, 2004, there were 17,420,445 shares of Common Stock, $.01 par value, of the registrant outstanding.

MIDWEST AIR GROUP, INC.
FORM 10-Q
For the period ended March 31, 2004

INDEX

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PART I – FINANCIAL INFORMATION

Item 1.   Financial Statements (Unaudited)

MIDWEST AIR GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
(Unaudited)

See notes to unaudited condensed consolidated financial statements.

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MIDWEST AIR GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
(Unaudited)

See notes to unaudited condensed consolidated financial statements.

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MIDWEST AIR GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

See notes to unaudited condensed consolidated financial statements.

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Midwest Air Group, Inc.
Notes to Condensed Consolidated Financial Statements (Unaudited)

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Three Months Ended March 31, 2004

Three Months Ended March 31, 2003

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Results of Operations

The Company’s first quarter 2004 operating loss was ($10.2) million, an improvement of $7.7 million from the first quarter 2003 operating loss of ($17.9) million. Net loss for the quarter was ($6.9) million, an improvement of $4.9 million from the first quarter 2003 net loss of ($11.8) million. First quarter 2004 net loss per share on a diluted basis was ($0.39), an improvement of $0.37 from first quarter 2003 net loss per share on a diluted basis of ($0.76), which includes the effects of the November 2003 issuance of approximately 1.9 million shares in conjunction with the Company’s private placement of shares to accredited investors. First quarter 2004 results include $1.2 million (pre-tax) in lease expense on two leased DC-9 aircraft removed from service during first quarter 2004.

The Company’s total revenue in the first quarter 2004 increased $7.3 million, or 7.7%, compared to first quarter 2003. Revenue for the first quarter 2004 was impacted favorably by increased charter service revenue, and was influenced by the Company’s new Saver Service, as well as continued downward pressure on fares resulting from a difficult industry environment and a challenging competitive situation in Milwaukee.

First quarter 2004 was the Company’s initial first-quarter period with the new Saver Service product. As expected, Saver Service enabled Midwest Airlines to carry significantly increased numbers of passengers to leisure-oriented destinations, particularly Florida and Phoenix. Saver Service represented approximately half of the total scheduled service capacity of Midwest Airlines during the first quarter, in part due to the Company’s seasonal service, which ended in April 2004, and had a significant impact on both unit revenues and unit costs of the Company. As anticipated, unit revenues declined as the Company offered lower fares to stimulate travel. The result was higher load factors and lower revenue yields in these markets, but more revenue per flight segment than if these routes would have been operated with Signature Service. Company unit costs declined as well, since Saver Service added more seats on each corresponding flight segment. In total, Saver Service met the Company’s expectations in revenue generation, cost reduction and customer satisfaction in the first quarter 2004.

Unit costs were also impacted by the restructuring completed in 2003 and the transition to new Boeing 717 aircraft. The Company’s restructuring efforts resulted in unit cost reductions in most categories, with the major impact on the labor, commissions, dining services and aircraft rental line items. The Company removed from service all but two DC-9 aircraft by the end of the first quarter 2004, and completed the retirement of the DC-9 fleet by the end of April 2004, just 14 months after the transition was initiated. The impact of this transition on unit costs was most evident in the fuel, maintenance materials and aircraft rentals line items.

Fuel prices were higher than anticipated in first quarter 2004 and were the highest for any quarter in the Company’s history. Company fuel consumption totaled approximately 21 million gallons in the quarter; at this rate, each penny change in fuel price resulted in approximately $200,000 of additional cost in the quarter. The Company’s business plan for 2004 was based on an average fuel price of $0.90 per gallon; the average actual fuel price per gallon for the first quarter 2004 was $1.18.

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The Company continues to adjust to changes in competition and industry pricing initiatives, particularly in the Milwaukee market. Northwest Airlines recently announced plans to increase operations in Milwaukee, but at the same time transition from large jet aircraft to regional jets on several business routes. The Company has also experienced multiple pricing initiatives from other airlines attempting to gain market share or stimulate traffic. The Company intends to vigorously compete in the changing environment by offering clearly differentiated service at competitive fares.

The first quarter of the Company’s fiscal year is historically the most challenging financially, as travel in the Company’s core business markets is seasonally low. The Company expects the second quarter 2004 to be more encouraging and, barring any major unforeseen circumstances, expects to report a modest profit for the second quarter.

There is further detailed discussion of revenue and cost comparisons for the quarter in subsequent sections.

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Operating Statistics

The following table provides selected operating statistics for Midwest Airlines and Midwest Connect.

Note:  All statistics exclude charter operations except the following: total available seat miles (“ASMs”), cost per total ASM, into-plane fuel cost, number of employees and aircraft in service. Aircraft acquired but not yet placed into service are excluded from the aircraft in service statistic. Numbers in this table may not be recalculated due to rounding.

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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 revenues:

Note: Numbers, percents and totals in this table may not be recalculated due to rounding.

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Three Months Ended March 31, 2004 Compared With
Three Months Ended March 31, 2003

Operating Revenues

Company operating revenues totaled $101.3 million in first quarter 2004, a $7.3 million, or 7.7%, increase from first quarter 2003. Passenger revenues accounted for 82.8% of total revenues and increased $4.0 million, or 5.0%, from first quarter 2003 to $83.9 million. The increase is attributable to a 21.6% increase in passenger volume, as measured by scheduled service revenue passenger miles, as well as a 3.2-point increase in load factor. The increase was partially offset by a 13.7% decrease in revenue yield. The decrease in revenue yield was due primarily to reduced business fares, the introduction of Saver Service, heavy industrywide fare discounting implemented to stimulate travel demand, and increased competition in many markets, including Midwest Airlines’ main base of operations in Milwaukee.

Midwest Airlines passenger revenue increased $3.2 million, or 5.0%, from 2003 to $67.8 million. The increase was primarily the result of a 24.6% increase in passenger volume, as measured by scheduled service revenue passenger miles. The increase in traffic was partially offset by a decrease in revenue yield of 15.7% due to the factors described above. Load factor increased from 61.1% in 2003 to 63.6% in 2004. Total capacity, as measured by scheduled service ASMs, increased 19.5%, with 12% due to the introduction of Saver Service and 7.5% due to other schedule changes.

Midwest Connect passenger revenue increased $0.8 million, or 5.1%, from first quarter 2003 to $16.1 million. A 14.9% increase in revenue yield, caused primarily by schedule changes that resulted in a transition to shorter flights with higher yields, was the key factor in the increased revenue. The yield increase was partially offset by an 8.6% decline in passenger volume, which was caused primarily by a 15.3% reduction in capacity. Fewer passengers were carried despite a 3-point increase in load factor.

Revenue from cargo, charter and other services increased $3.3 million in first quarter 2004. Revenue from charter sales accounted for the majority of the change, and increased 75% over first quarter 2003 as more aircraft time was dedicated to charter service, two additional sports teams contracted with the Company for charter services, and the Company’s agreement with The Mark Travel Corporation provided additional charter service for the Company.

Operating Expenses

First quarter 2004 operating expenses decreased $0.5 million, or 0.4%, from first quarter 2003. Lower costs in almost all categories due to the Company’s restructuring initiatives were offset by higher costs in the “other” category — primarily due to higher advertising ($0.7 million), the accrual of Wisconsin property taxes, as discussed further in Pending Developments ($0.6 million), charter service costs ($0.6 million), frequent flyer-related costs ($0.4 million), and facilities rent ($0.4 million) due to the sale/leaseback of the Company’s headquarters facility in November 2003 — and increased aircraft lease expense, due to the recognition of $1.2 million (pre-tax) of lease expense on two leased DC-9 aircraft removed from service during first quarter 2004, as well as the addition of 13 leased Boeing 717 aircraft to the Midwest Airlines fleet year over year. Cost per total ASM (unit costs) at Midwest Airlines decreased 18.0% to 9.6¢ in first quarter 2004; Midwest Connect’s cost per total ASM increased 8.3% to 23.2¢.

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Salaries, wages and benefits decreased $3.9 million, or 10.1%, from first quarter 2003 to $35.1 million. The labor cost decrease is primarily due to a decrease in headcount of 203 full-time equivalents quarter over quarter ($4.1 million), as well as lower labor rates ($0.7 million), partially offset by increased costs for fringe benefits ($0.8 million). On a cost per total ASM basis, labor costs decreased 24.4% to 3.3¢ in 2004.

Aircraft fuel and oil and associated taxes were essentially unchanged from first quarter 2003 at $24.5 million. Into-plane fuel prices increased 5.6% in first quarter 2004, averaging $1.18 per gallon versus $1.11 per gallon in first quarter 2003, and resulted in a $1.3 million (pre-tax) unfavorable price impact (calculated by applying 2003 prices to actual gallons consumed in 2004 and comparing the result to actual 2004 expense). Fuel consumption decreases resulted in a $1.5 million (pre-tax) favorable impact in the quarter (calculated by applying 2004 prices to the actual reduction in gallons consumed in 2004 relative to 2003), primarily as a result of the transition of the Midwest Airlines fleet to Boeing 717s, which are more fuel-efficient than the DC-9s.

Commissions for travel agents and commissions related to credit card transactions decreased $0.9 million, or 27.8%, from first quarter 2003 to $2.4 million. The decrease was due primarily to the effects of the Company’s decision, in March 2003, to discontinue payment of standard travel agent commissions. Commissions as a percentage of passenger revenue decreased from 4.2% in first quarter 2003 to 2.9% in first quarter 2004.

Dining services costs decreased $1.3 million, or 39.8%, from first quarter 2003 to $2.0 million. The decrease was due to the elimination of complimentary onboard meal service in March 2003. Total dining services costs per Midwest Airlines passenger decreased from $6.78 in first quarter 2003 to $3.42 in first quarter 2004.

Depreciation and amortization decreased $0.8 million, or 15.6%, from first quarter 2003 to $4.5 million. On a cost per total ASM basis, these costs decreased 29.1%. Depreciation was lower as the DC-9 fleet was essentially replaced quarter over quarter with leased Boeing 717 aircraft.

Aircraft rental costs increased $3.5 million, or 53.9%, from first quarter 2003 to $9.9 million. These costs increased due to the recognition of $1.2 million (pre-tax) of lease expense on two leased DC-9 aircraft removed from service during first quarter 2004, as well as the addition of 13 leased Boeing 717 aircraft to the Midwest Airlines fleet quarter over quarter ($6.4 million), partially offset by lower lease rates on remaining aircraft in the Company fleet as a result of the restructuring ($4.0 million). On a cost per total ASM basis, these costs increased 29.3%.

Other operating expenses increased $2.7 million, or 25.5%, from first quarter 2003 to $13.5 million. Other operating expenses consist primarily of advertising and promotion, insurance, property taxes, crew hotel rooms, reservation fees, administration and other items. Cost increases were primarily due to higher advertising ($0.7 million), the accrual of Wisconsin property taxes, as discussed in Pending Developments ($0.6 million), charter service costs ($0.6 million), frequent flyer-related costs ($0.4 million), and facilities rent ($0.4 million) due to the sale/leaseback of the Company’s headquarters facility in November 2003. On a cost per total ASM basis, other operating expenses increased 5.5%.

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Credit for Income Taxes

Income tax credit for first quarter 2004 was ($3.9) million, a $2.4 million decrease from the 2003 credit of ($6.3) million. The effective tax rates for the first quarters of 2004 and 2003 were 36.5% and 35.0%, respectively.

Net Loss

Net loss for first quarter 2004 was ($6.9) million, an improvement of $4.9 million from the first quarter 2003 net loss of ($11.8) million.

Liquidity and Capital Resources

The Company’s unrestricted cash and cash equivalents totaled $101.3 million at March 31, 2004, compared with $88.3 million at December 31, 2003. At March 31, 2004, the restricted cash balance was $27.5 million, compared with $26.1 million on December 31, 2003. The change in restricted cash is primarily attributable to increased bookings, partially offset by a decrease in the credit card holdback amount that is discussed in more detail in Note 8 to the condensed consolidated financial statements.

The unrestricted cash balance at March 31, 2004 reflects the favorable impact of credits related to the acquisition of Boeing 717 aircraft and a reduction in the percent of cash held back (from 100% to 80% as discussed in Note 8 to the condensed consolidated financial statements) by the processor of Visa/MasterCard transactions.

As of March 31, 2004, the Company had a working capital surplus of $47.5 million compared with a $39.3 million surplus in December 31, 2003. The change in working capital as of March 31, 2004 is primarily related to an increase in unrestricted cash as discussed above, which offset increases in the liability for airline tickets purchased but not yet used and various other accrued liabilities.

Operating Activities
Net cash provided by operations for the three months ended March 31, 2004 totaled $8.8 million. Cash provided by operations for the three months ended March 31, 2004 primarily reflects the effects of credits 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; therefore, the majority of these expenses for the quarter involved no cash outlay. As of March 31, 2004, the amount of unused credit memos totaled $5.8 million and is recorded as other assets in the condensed consolidated balance sheet. The credits available for aircraft lease payments were used up during the first quarter of 2004; going forward, the Company expects it will make lease payments primarily from cash flows from operations. 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 related leases. In addition to the credits, net cash provided from operations increased due to the reduction in the cash holdback on advance sales by the Mastercard/Visa processor, resulting in reduced restricted cash.

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Investing Activities
Net cash provided by investing activities for the three months ended March 31, 2004 totaled $11.4 million compared with $3.0 million provided by investing activities for the year ended December 31, 2003. The change in net cash provided from investing activities during the quarter primarily relates to purchase deposits that were returned for the three Boeing 717 deliveries in the first quarter 2004. Capital spending totaled $1.6 million for the quarter; however, credits were used for a portion of such spending, with cash outlay of $0.5 million for the quarter ended March 31, 2004. Capital expenditures consisted primarily of costs associated with the acquisition of additional spare parts for the Boeing 717 fleet.

Financing Activities
Net cash used in financing activities during the first quarter 2004 was $7.1 million, compared with $28.1 million net cash provided by financing activities for the year ended 2003. The change in net cash used in financing activities during the quarter primarily relates to the return of progress payments associated with three Boeing 717 aircraft delivered during the first quarter 2004. The progress payments were originally provided to The Boeing Company (“Boeing”) by Kreditanstalt fur Wiederaufbau Bank (“KfW”) on behalf of Rolls-Royce Deutschland Ltd. & Co. KG (“Rolls-Royce”).

In second quarter 2002, Midwest Airlines entered into a loan agreement to fund pre-delivery progress payments to Boeing for the Boeing 717 aircraft. Midwest Airlines also entered into a loan agreement with KfW with the assistance of 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 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. As of March 31, 2004, the Company owed $18.1 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.

With the loan agreement with KfW and the Boeing Capital Corporation (“BCC”) commitment to finance the Boeing 717 aircraft, 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 March 31, 2004, the Qualified Plan assets are invested primarily in equities and fixed income instruments. Additional discussion of Qualified Plan investment strategy is included in Note 11 of the Notes to Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

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As discussed in Note 5 to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, 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 these 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 the Recent Developments section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, 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 $15.5 million as of March 31, 2004; the term of this contingent obligation of the Company is until July 2006.

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 the remainder of 2004 and beyond. Absent adverse factors outside the control of the Company such as terrorist attacks or fear of terrorist attacks, further substantial deterioration in the industry revenue environment, or significant increases in fuel prices from first quarter 2004 prices, the Company believes current liquidity and cash flow from operations will be sufficient to fund current operations through 2004. Key cash flow items for 2004 and beyond include:

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Pending Developments

This Form 10-Q filing, particularly this “Pending Developments” section and the “Overview” and “2004 and Beyond” sections above, contain forward-looking statements that may state the Company’s 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 the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and the following:

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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.

Labor Relations – In March and April 2004, the International Brotherhood of Teamsters filed petitions with the National Mediation Board to represent Midwest Airlines’ mechanics and related employees and Midwest Airlines’ stock clerks, respectively. The Company expects to hear the results of the respective elections in May and June 2004.

Regional Services Alliance – In April 2004, Skyway Airlines, Inc. announced it was in discussions with Delta Air Lines to operate Delta Connection’s Fairchild 328JET fleet. Skyway has been evaluating opportunities to operate aircraft for other airlines, which would constitute a shift in its business model. To date, Skyway has provided connections for Midwest Airlines while operating as Midwest Connect, as well as providing point-to-point service in select Midwestern markets.

Property Tax Exemption – 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.

CRS Regulations – Pursuant to a DOT ruling in 2003, most regulations governing the computer reservation systems (“CRS”) industry were 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.

Competition – On April 15, 2004, Northwest Airlines announced additional nonstop service from Milwaukee. The announcement related to new service to three destinations currently served by the Company and additional frequencies on existing routes. The announcement also included a change in equipment on several business routes from mainline jet service to regional jet service. This change in service represents an approximate 8% net increase in Northwest Airlines scheduled service capacity from Milwaukee.

Litigation – Dornier Aviation (North America) Inc. (“DANA”) Liquidating Trust filed litigation against Skyway Airlines, disputing the validity of $3.5 million of credit memorandums used by the Company to purchase aircraft parts and services. The credit memorandums obtained by the Company were associated with the acquisition of the Dornier 328JET aircraft and through subsequent resolution of Dornier’s cancellation of the 428JET program. The Company contends the credit memorandums were properly applied.

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Item 3.   Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in the Company’s market risk since December 31, 2003.

Item 4.   Controls and Procedures

(a)     Evaluation of disclosure controls and procedures. In accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s management evaluated, with the participation of the Company’s principal executive officer and principal financial officer, the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon their evaluation of these disclosure controls and procedures, the Company’s Chairman of the Board, President and Chief Executive Officer and the Company’s Senior Vice President and Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of the date of such evaluation to ensure that material information relating to the Company, including its consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this Quarterly Report on Form 10-Q was being prepared.

(b)     Changes in internal controls. There was no change in the Company’s internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 6.   Exhibits and Reports on Form 8-K

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX
MIDWEST AIR GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2004

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