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

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x]

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

Yes     X         No          

The aggregate market value of the Common Stock held by non-affiliates of the registrant as of January 31, 2005 was approximately $72,853,328. For purposes of this calculation only, (i) shares of Common Stock are deemed to have a market value of $4.17 per share, the closing price of the Common Stock as reported on the New York Stock Exchange on June 30, 2004, and (ii) each of the executive officers, directors and persons holding more than 10% of the outstanding Common Stock as of January 31, 2005 is deemed to be an affiliate.

As of January 31, 2005, there were 17,470,822 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 20, 2005 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, 2004

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.

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ITEM 1. BUSINESS

Background

The Company 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”). 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.

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, is 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”), 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 13 of the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K.

The Company currently has three principal product offerings: Midwest Airlines Signature Service, Midwest Airlines Saver Service and Midwest Connect regional service. 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, 2004, served 14 major cities 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, 2004, Saver Service operated to seven cities. 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.

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:

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Route Structure and Scheduling

Midwest Airlines Operations
Midwest Airlines currently has two bases of operations – Milwaukee and Kansas City. As of December 31, 2004, Midwest Airlines served 23 cities and was the largest carrier in Milwaukee, as measured by passenger enplanement data provided by the airport authority for 2004. Midwest Airlines provides nonstop service to most of its destinations from Milwaukee. Twelve other jet airlines serve Milwaukee’s airport. As of December 31, 2004, Midwest Airlines provided nonstop service from Kansas City to eight 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, 2004, Midwest Connect offered flights to 29 cities.

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. In February 2004, the codeshare agreement with American Eagle was terminated. The Company believes that the termination of this agreement has not had a material impact on the Company’s results of operations.

In 2004, 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, 2004, 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.

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Business Environment

The airline industry has undergone significant change in recent 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, higher fuel prices, the continuing turmoil in the Middle East, and increased security measures have continued to increase costs. 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 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.

Aircraft Fuel

Because fuel costs constitute a significant portion of the Company’s operating costs (approximately 24% and 20% for 2004 and 2003, respectively), 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 and currently has collars in place for a portion of the fuel usage for all of 2005. During 2004, $0.3 million was expensed because jet fuel prices have fallen outside the collar and $0.8 million recorded as a potential liability for future fuel prices that may fall outside of the collar. The collars for first quarter 2005 cover approximately 25% of the total estimated fuel consumption with an average floor price of $1.37 per gallon and average ceiling price of $1.60 per gallon, which includes into-plane costs. There are collars in place that cover 18.0%, 13.6% and 9.2% of the estimated fuel consumption for second, third and fourth quarters of 2005, respectively as of January 31, 2004.

Customer Service

Overall
Midwest Airlines has consistently been recognized as the best U.S. airline by travel publications and frequent flyer surveys, including Travel+Leisure, Condé Nast Traveler, Global Traveler 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 extra legroom for added comfort 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.

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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.

Saver Service has enhanced 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. With Saver Service, the Company has been able to compete with other low-fare carriers in ways that are different from its Signature Service. Among other things, the Company competes more clearly on the basis of fare levels. There is no assurance that it will continue to 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 2004, Midwest Airlines sold approximately 52% of its tickets through travel agents (including online agencies), compared with 51% in 2003. In September 2004, Midwest Airlines relaunched its Web site – www.midwestairlines.com – featuring an updated look and offering an enhanced fare-shopping tool. In 2004, ticket sales through the Midwest Airlines Web site contributed 25.1% of the Company’s revenue compared with 23.7% in 2003, and continued to reflect the shift toward this distribution channel.

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The Company maintains its own reservations call center at its headquarters in Oak Creek, Wisconsin. 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 (American Airlines and Frontier Airlines) and by using the services of participating hotels (Hilton, Hyatt, Loews, Radisson, Raffles, Swissôtel, Wyndham and others), car rental firms (Avis, Hertz and National), Juniper Bank (issuer of the 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 air 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.

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 with American Airlines 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 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, 2004, the Company had 1.8 million members enrolled in its frequent flyer program (compared with 1.7 million at year-end 2003). The Company estimates that as of December 31, 2004, the total number of awards available under the frequent flyer program was 136,000 (compared with 178,000 at year-end 2003), after eliminating those accounts below the minimum award level. Air travel awards redeemed were approximately 69,000 during 2004 and 64,000 during 2003, respectively. Free travel awards accounted for approximately 5% of the Company’s total revenue passenger miles during 2004. 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.

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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 112,000 accounts expired in 2004.

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, 2004, Midwest Airlines operated 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 the summer of 2004, Northwest Airlines converted its once-daily Airbus service between Milwaukee and each of Boston, New York La Guardia and Washington Reagan National to twice-daily regional jets resulting in the reduction of seats offered on each route. In the second half of 2004, Northwest Airlines also initiated limited regional jet service between Milwaukee and each of Baltimore, St. Louis and Kansas City. AirTran Airways ceased service between Milwaukee and Baltimore in July 2004. In the fall of 2004, US Airways eliminated service between Pittsburgh and each of Milwaukee and Kansas City. The Company responded to the change in the Milwaukee-Pittsburgh route with added capacity.

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. The Company competes by 1) carefully selecting markets, 2) attempting to generate maximum RASM (Revenue per Available Seat Mile) through a service-oriented philosophy and rigorous yield management, and 3) providing superior customer service while operating in a cost-efficient manner. Overall, the Company believes its efforts to identify favorable markets and provide quality 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.

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During the second half of 2004, the Company focused its route planning strategy on increased frequency to existing destinations, additional connection opportunities and more competitive pricing tactics designed to create increased total system revenue. This “network” focus is continuing as a priority in 2005.

The Company has the largest market share of passengers in Milwaukee. During 2004, Midwest Airlines and Midwest Connect collectively carried 39.6% of the passengers boarded in Milwaukee, while Northwest Airlines, which has the second-largest share, carried 21.4%. In Kansas City, Midwest Airlines carried 4.6% of the passengers during 2004, compared with 33.7% carried by Southwest Airlines and 13.2% by American – the carriers with the two largest market shares in Kansas City.

Employees

As of December 31, 2004, Midwest Airlines had 2,290 employees (421 of whom were part-time and 38 of whom were intermittent) and Midwest Connect had 910 employees (273 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.

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-CWA, 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 from that date.

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 National Mediation Board notified the Company that the mechanics and related employees and the stock clerks voted against representation by the International Brotherhood of Teamsters.

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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.

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, 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 and Border Protection (under the Department of Homeland Security), Department of Defense, OSHA, 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 Ronald Reagan 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.

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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 in Note 4 of the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K).

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, and in August 2003, Escanaba, Michigan was added. 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. The markets that were entered into in January 2003 were up for bid in January 2005. The Company is currently in the process of bidding for the subsidy for these locations.

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, 2005.

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.

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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.

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.
Financially distressed airlines, excess capacity throughout the industry 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 competes 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 could 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 affected the industry.
The terrorist attacks of September 11, 2001 materially affected the airline industry. Since then, security procedures have been increased at airports including more security personnel and more sophisticated screening equipment, which has had a significant impact on the profitability of airlines.

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.

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

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 16 more through December 2004. The Company plans to take delivery of the remaining seven Boeing 717s for which it has a firm order, but is currently in discussions regarding the delivery schedule for these aircraft. The Company is also in discussions with Boeing regarding the options to purchase 25 additional Boeing 717s. Among other risks, the acquisition of these aircraft involves the following:

Increases in fuel costs, or the failure of fuel costs to decrease, could harm business.
Fuel costs constitute a significant portion of the Company’s total operating costs (approximately 24% for the year ended December 31, 2004). Accordingly, significant increases in fuel costs or the failure of current fuel prices to decrease would harm its financial condition and results of operations. For the year ended December 31, 2004, a one-cent increase in the price per gallon of fuel expense would have increased fuel expenses by approximately $0.8 million. 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, fuel prices will rise, which could result in the curtailment of scheduled service. There can be no assurance that increases in the price of fuel can be offset with higher fares or surcharges.

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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 collars in place for a portion of fuel usage for all of 2005. During 2004, $0.3 million was expensed because jet fuel prices fell outside the collar; $0.8 million was recorded as a potential liability for future fuel prices that may fall outside of the collars. The collars for first quarter 2005 cover approximately 25% of the total estimated fuel consumption with an average floor price of $1.37 per gallon and average ceiling price of $1.60 per gallon, which includes into-plane costs. There are collars in place that cover 18.0%, 13.6% and 9.2% of the estimated fuel consumption for second, third and fourth quarters of 2005, respectively as of January 31, 2004. Ceiling prices are set at $1.39, $1.40 and $1.40 per gallon and floor prices are set at $1.19, $1.20 and $1.20 per gallon for the second, third and fourth quarter of 2005, respectively. The Company anticipates continuing to hedge future fuel purchases for 2005 as circumstances and market conditions allow.

Changes in regulations 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 $2.50 per enplanement security fee (subject to a $5.00 one-way trip cap), with authority granted to the Transportation Security Administration (under the Department of Homeland Security) 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 Transportation Security 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.

The Company’s common stock could be delisted by the New York Stock Exchange, which could materially reduce the liquidity of the common stock.
The Company’s common stock is listed on the New York Stock Exchange. A prolonged reduction in the trading price of the Company’s common stock could cause the Company to be delisted. This risk is greater if the New York Stock Exchange adopts a proposal to modify its listing standards to increase the dollar thresholds for the average total market capitalization and the average shareholders equity that a listed company is required to maintain. Delisting could materially reduce the liquidity of the Company’s common stock and result in a corresponding material reduction in the price of the Company’s common stock. The lack of liquidity could make it more difficult for the Company to raise capital in the future.

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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 exceeded $2.5 million annually. The Company estimates savings as high as $7 million annually by 2010. The State of Wisconsin and the Company have appealed the trial court decision. Northwest Airlines, Inc., and several other airlines have brought related identical cases for subsequent tax years, and these cases have been stayed or consolidated. The appeal of the underlying case is pending in the Wisconsin Court of Appeals, and a decision is expected in the first half of 2005. The Company believes it is probable that it will be ultimately successful in the litigation, resulting in a decision upholding the ad valorem exemption. The Company also believes it would not be subject to retroactive collection of the tax for 2004 or prior years even if the exception is found to be invalid by the Court of Appeals.

An unfavorable resolution to the Company’s litigation filed by Dornier Aviation (North America) Inc. Liquidating Trust.
In December 2003, Dornier Aviation (North America) Inc. Liquidating Trust filed litigation against Skyway, 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 Fairchild 328JET aircraft and through subsequent resolution of Dornier’s cancellation of the 428JET program. The Company contends the credit memorandums were properly applied and has not recorded any reserve in respect to this matter.

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. However, recent improvements in the economy have not resulted in improved financial conditions for the airline industry as a whole due to, among other things, excess industry capacity. 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.

Continuing financial uncertainty in the airline industry may make it increasingly difficult to attract and retain personnel.
The airline industry has endured four years of financial losses. Like most other carriers, the Company has had to make numerous changes to pay and benefit practices that have resulted in significant economic sacrifices by employees. Organizational streamlining, while an essential part of enhancing productivity, has likewise increased demands on staff and limited growth opportunities. Uncertainty as to the industry’s or the Company’s long-term prospects is an additional impediment to the career confidence of current staff and future candidates for recruitment. As general improvements in the economy and labor markets surpass those in the airline industry, there is an increasing risk that airlines will have difficulty competing for talent, especially in key roles.

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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, the Company has 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, 2004, Midwest Airlines had 17 Boeing 717 and 13 McDonnell Douglas jet aircraft in service, including two MD-88, eight MD-81 and three MD-82 aircraft.

Midwest Airlines Aircraft in Service

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As part of the Company’s restructuring in 2003, the Company renegotiated its agreements with aircraft lessors and lenders. The information in this section reflects the amended agreements.

One MD-88 aircraft 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 Boeing 717 aircraft leases all have 20-year terms, the first of which expires in 2023.

As of December 31, 2004, Midwest Connect’s fleet consisted of 22 aircraft: 12 Beech 1900D turboprop aircraft and 10 Fairchild 328JET aircraft.

Midwest Connect Aircraft in Service

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. The fleet was further reduced to 12 in the first and second quarters of 2004, as two Beech 1900D aircraft were removed from the fleet and sold by the lessor in the first quarter 2004. Each of these aircraft had 19 passenger seats. As of December 31, 2004, Midwest Connect’s 12 turboprop aircraft were financed under operating leases with lease terms of 12 years; five of the aircraft leases have expiration dates of 2008 and the other leases 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. A lessor of five of the aircraft sold its interest to another party in December 2004. The terms associated with the new leases were substantially the same as the original lease, except that the new agreement required a deposit of $2.3 million, which is classified as a security deposit in other assets on the balance sheet. This deposit is fully refundable if the Company meets its obligations.

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 4 of the Notes to the Consolidated Financial Statements contained in this Annual Report on Form 10-K).

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 4 of the Notes to the Consolidated Financial Statements contained in this Annual Report on Form 10-K for further detail regarding the financing of this facility.

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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 facility as an addition to its headquarters. In November 2003, the Company completed a sale/leaseback transaction on the 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, 2004, gates at the airport were leased directly from the airport authority. In 13 cities, Midwest Airlines has agreements with various airlines to lease available space.

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 4 of the Notes 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. The more significant legal proceedings are discussed below.

On November 7, 2003, a Dane County, Wisconsin, circuit court, in an action brought by Northwest Airlines, Inc., against the State of Wisconsin, declared invalid the Wisconsin statute that provides the hub airline exemption from Wisconsin ad valorem property taxes. Savings to the Company from the exemption had been approximately $2.0 million annually. However, the Company estimates savings could be as high as $7.0 million annually by 2010. The State of Wisconsin has appealed the ruling. The Company has intervened in the case and joined in the appeal. The Company believes the appeal will be successful and has not recorded any reserve with respect to this matter.

In December 2003, Dornier Aviation (North America) Inc. Liquidating Trust filed litigation against Skyway, 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 Fairchild 328JET aircraft and through subsequent resolution of Dornier’s cancellation of the 428JET program. The Company contends the credit memorandums were properly applied and has not recorded any reserve in respect to this matter.

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

No matters were submitted to a vote of security holders during the fourth quarter of 2004.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

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, 2004, the Company had 18,178,398 shares issued and 17,470,822 shares outstanding and 894 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 4 of the Notes to the Consolidated Financial Statements contained in this Annual Report on Form 10-K.

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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

Overview

The past three years have brought unprecedented challenges to the airline industry. As an industry, airlines recorded a combined $14.9 billion loss for 2002 and 2003, and once again posted a multi-billion dollar net loss in 2004. High fuel prices, coupled with the effects of the conflict in the Middle East and increased security measures, have increased operating costs. These pressures, along with excess industry capacity and increased competition from legacy carriers, their regional affiliates and low-cost carriers that has depressed fares, resulted in the Company reporting operating losses in 2002, 2003 and 2004.

In 2003, the Company took action to improve its financial performance through the launch of Midwest Airlines Saver Service, changes to schedules at Midwest Connect, significant cost restructuring measures and a recapitalization of the Company.

In 2004, the Company took a more comprehensive look at its operations, processes and significant cost drivers. Changes have been made based on this analysis, including entering into fuel hedges to reduce the risk associated with the rising fuel prices and outsourcing of heavy maintenance to better align maintenance operations with the current fleet. Cost reduction and efficiency improvement initiatives will continue through 2005. Detailed discussion of each of these measures is included in Recent Developments.

Key risks to the Company achieving a return to profitability include the depressed business travel 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 1, Business contained in this Annual Report on Form 10-K.

Recent Developments

Fuel Hedges
In October 2004, the Company began hedging a portion of the price risk related to anticipated future jet fuel requirements through a collar option strategy. The collars, which have been designated as cash flow hedges, involve the purchase of fuel call options with the simultaneous sale of fuel put options with identical expiration dates. As of the end of December 2004, $0.3 million has been expensed because jet fuel prices have fallen below the collars. The collars for first quarter 2005 cover approximately 25% of the total estimated fuel consumption at a swap rate of approximately $1.45 per gallon and with an average floor price of $1.37 per gallon and average ceiling price of $1.60 per gallon, which includes into-plane costs. There are collars in place that cover 18.0%, 13.6% and 9.2% of the estimated fuel consumption for second, third and fourth quarters of 2005, respectively, as of January 31, 2005. The Company anticipates continuing to hedge future fuel purchases for 2005 as circumstances and market conditions allow.

Heavy Maintenance
In the fourth quarter of 2004, the Company announced that heavy maintenance operations for the MD-80 aircraft would be outsourced to a third party maintenance provider beginning in early 2005. Due to changes in the composition of the Company’s airline fleet, the Company determined it is no longer economical to maintain a heavy maintenance operation in-house. Outsourcing this activity will reduce costs and turn time for the aircraft.

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2004 Financial Overview

Capacity, as measured by scheduled service available seat miles (“ASMs”), increased 16.9% in 2004. Capacity increased 19.8% at Midwest Airlines and decreased 5.2% at Midwest Connect. Midwest Airlines capacity increased primarily due to the full year effect of the introduction of the Saver Service in late 2003, which increased the number of seats on the aircraft compared to Signature Service, plus the net addition of two more aircraft in the fleet year over year, which resulted in a 3.0% increase in the number of operations (an operation is one take-off and landing). Midwest Connect’s capacity decrease was due primarily to removal of two aircraft during the year. Traffic, as measured by revenue passenger miles, increased 15.1%. Load factor decreased from 64.9% in 2003 to 63.8% in 2004.

The Company’s total revenue in 2004 increased 8.2% from 2003. The increase in revenue was due primarily to an increase in passenger volume at Midwest Airlines of 16.6%, as measured by revenue passenger miles. Passenger volume at Midwest Connect remained constant. Charter revenue increased $2.5 million primarily due to the Company’s agreement with The Mark Travel Corporation, which was entered into in late 2003. However, the increase in revenue was partially offset by a 6.1% decrease in revenue yield due 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 Company’s operating expenses increased 11.1% in 2004. Operating costs for 2004 include a $10.5 million, or 32.9%, increase in maintenance expense due to $3.4 million (pre-tax) in engine maintenance contract-related expenses as well as a charge of $1.2 million (pre-tax) related to aircraft disposal and lease restructuring. Operating expenses also include a $27.3 million, or 33.6%, increase in fuel costs; per-gallon fuel prices averaged $1.35 for the year up from $1.01 in 2003. These costs were partially offset by savings realized from companywide cost reduction efforts and reduced costs in commissions, dining services and depreciation. 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. 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 2004, 2003 and 2002.

Year Ended December 31, 2004 Compared WithYear
Ended December 31, 2003

Operating Revenues

Company operating revenues totaled $415.2 million in 2004, a $31.3 million, or 8.2%, increase from 2003. Passenger revenues accounted for 85.3% of total revenues and increased $26.3 million, or 8.0%, from 2003 to $354.2 million in 2004.

Midwest Airlines passenger revenue increased $19.1 million, or 7.3%, from 2003 to $279.2 million in 2004. The increase in revenue was primarily due to an increase in passenger volume of 16.6% at Midwest Airlines. However, this was partially offset by a decrease in load factor from 66.3% in 2003 to 64.6% in 2004 and an 8.0% decrease in revenue yield due 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.

Midwest Connect passenger revenue increased $7.2 million, or 10.6%, from 2003 to $75.0 million in 2004. Revenue yield increased due to the transition to shorter flights with higher yields, as seen by a decrease of 12.2% in average trip length. Load factor increased from 53.3% in 2003 to 56.2% in 2004.

Revenue from cargo and other services increased $5.0 million in 2004. Cargo increased $0.5 million primarily due to an increased volume of mail. Other services revenue increased due to a $2.5 million increase in charter revenue primarily from the Company’s agreement with The Mark Travel Corporation. This was partially offset by a decrease in private charters from the National Hockey League players’ lockout. An increase in passenger volume caused revenue from fees (excess baggage, administration, service charges) to increase 15%, which was the primary reason for the $2.0 million increase in other services revenue.

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Operating Expenses

2004 operating expenses increased $46.1 million, or 11.1%, from 2003 to $460.5 million in 2004. 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. The Company’s cost per total ASM decreased 6.2%, from 12.1¢ in 2003 to 11.4¢ in 2004.

Salaries, Wages and Benefits
Salaries, wages and benefits increased $2.6 million, or 1.9%, from 2003 to $142.7 million in 2004, primarily due to a 12.9% increase in headcount. The headcount increase was primarily the result of a 3.1% increase in the number of operations and a 15.1% increase in passenger volume. Costs for 2003 include a $1.6 million reduction in labor rates, which also contributed to decreased unit labor costs year-over-year. On a cost per total ASM basis, labor costs decreased from 4.1¢ in 2003 to 3.5¢ in 2004.

Aircraft Fuel and Oil
Aircraft fuel and oil and associated taxes increased $27.3 million, or 33.6%, from 2003 to $108.4 million in 2004. Costs increased 12.8% on a cost per ASM basis. Into-plane fuel prices increased 33.1% in 2004, averaging $1.35 per gallon in 2004 versus $1.01 per gallon in 2003, resulting in a $27.0 million unfavorable pre-tax price impact (calculated by applying 2003 prices to actual gallons consumed in 2004 and comparing the result to actual 2004 expense). Fuel consumption increased 0.5% in 2004 due to a 3.1% increase in the number of operations.

Commissions
Commissions decreased $1.0 million, or 9.2%, from 2003 to $10.4 million in 2004. The decrease was primarily due to the elimination of standard travel agency commissions beginning March 1, 2003. In addition, savings were realized because of increased travel booked directly through the Company’s reservations center and Web site. Commissions, as a percentage of passenger revenue, decreased from 3.5% in 2003 to 2.9% in 2004.

Dining Services
Dining service costs decreased $0.6 million, or 7.2%, from 2003 to $7.5 million in 2004. The decrease in dining services was primarily due to the elimination of complimentary onboard meal service in April 2003, which is reflected in a decrease in dining service costs per Midwest passenger from $3.92 in 2003 to $3.24 in 2004.

Station Rental, Landing and Other Fees
Station rental, landing and other fees increased $2.9 million, or 8.0%, from 2003 to $39.4 million in 2004. On a cost per total ASM basis, these costs decreased 8.8%. The increase was due to a $1.4 million increase in ground handling fees caused by the 3.1% increase in the number of operations. Security fees increased $0.6 million due to the fact that 2004 includes 12 months of security fees compared with only 10 months in 2003. This increase was partially offset by the effects of additional capacity created by the introduction of Saver Service.

Aircraft Maintenance Materials and Repairs
Aircraft maintenance costs increased $10.5 million, or 32.9%, from 2003 to $42.6 million in 2004. Aircraft maintenance costs increased 12.2% on a cost per total ASM basis. The increase was partially caused by a $3.4 million expense relating to an engine maintenance agreement. Additionally, a 4.4% increase in flight hours for the Boeing 717 and MD-80 aircraft increased engine overhaul costs $6.8 million.

Depreciation and Amortization
Depreciation and amortization decreased $3.6 million, or 17.2%, from 2003 to $17.3 million in 2004. Depreciation costs decreased primarily due to one owned DC-9 aircraft that was retired from the fleet in 2004. On a cost per total ASM basis, these costs decreased 30.1%.

Aircraft Rentals
Aircraft rental costs increased $7.7 million, or 23.6%, from 2003 to $40.3 million in 2004. The increase was due primarily to the addition of six leased Boeing 717 aircraft to the Midwest Airlines fleet year over year. On a cost per total ASM basis, these costs increased 4.4% from 2003.

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Other (Expense) Income

Interest income reflects interest earned on the Company’s cash and cash equivalents. Interest expense consists of interest on a short-term note payable and interest on the Company’s long-term debt related to aircraft and convertible debt.

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.

Credit for Income Taxes

Income tax credit for 2004 was $(4.1) million, a $3.0 million decrease from the 2003 income tax credit of $(7.1) million. The effective tax rates for 2004 and 2003 were (8.6)% and (35.0)%, respectively. The decrease in the effective tax rate is the result of the Company no longer recording income tax benefits on losses beginning in the second quarter due to accumulated losses and the inability to offset net operating losses against deferred tax liabilities.

Net Loss

Net loss for 2004 was $(43.1) million, which reflects a decline of $29.8 million from the 2003 net loss of $(13.3) million. The net loss margin declined from (3.5)% in 2003 to (10.4)% in 2004.

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 resulted in lower initial volumes.

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.

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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 (calculated by applying 2002 prices to actual gallons consumed in 2003 and comparing the result to actual 2003 expense). 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.

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.

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Aircraft Rentals
Aircraft rental costs increased $7.3 million, or 29.1%, from 2002 to $32.6 million in 2003. The increase was primarily due 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 of 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.

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.

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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.

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 and impairment of long-lived assets. For a detailed discussion of accounting policies, refer to the Notes to Consolidated Financial Statements 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, 2004.

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.

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 rate and future growth rates.

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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 Notes 3 and 4 of Notes 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 $81.5 million at December 31, 2004, compared with $88.3 million at December 31, 2003. At December 31, 2004, the restricted cash balance was $29.1 million, compared with $26.1 million on December 31, 2003. The change in restricted cash is primarily attributable to an increase in the cash holdback amount related to credit card processing agreement for MasterCard/Visa transactions, which is discussed in more detail in Note 4 of the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K. In the third quarter of 2004, the Company did not achieve the monthly covenants stated in the MasterCard/Visa agreement, and the credit card processor increased the holdback amount from 80% to 90% in December 2004, or approximately $23.0 million. Due to a subsequent violation, the credit card processor may opt to increase the holdback amount up to 100%, and the Company and the credit card processor are currently in discussions to determine what, if any, adjustments will be made to the holdback amount. The aggregate amount of the risk exposure of all the processors (other than amounts under holdback) as of January 31, 2005 was approximately $10.7 million. In addition to the holdback amount, the restricted cash balance also includes amounts for insurance and collateral for letters of credit and the fuel collar agreement.

As of December 31, 2004, the Company had a working capital surplus of $30.5 million compared with $39.3 million on December 31, 2003. The reduction in working capital as of December 31, 2004 is primarily related to a decrease in unrestricted cash and an increase in air traffic liability, partially offset by an increase in inventories and restricted cash.

Operating Activities
Net cash used in operations for the year ended December 31, 2004 totaled $5.1 million. Cash used by operations at December 31, 2004 primarily reflects the $43.1 million net loss incurred during the year. This was partially offset by 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 and engine lease payments, and engine maintenance agreements. As of December 31, 2004, the amount of unused credit memos totaled $3.3 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 income statement benefit of these credit memos is being recognized over the term of the leases. Credits available for aircraft lease payments were, for the most part, used up during the first quarter of 2004.

Investing Activities
Net cash provided by investing activities totaled $12.9 million compared with $3.6 million for the year ended December 31, 2003. The change primarily relates to the increase in capital expenditures in 2003 relating to the build-up of spare parts and other equipment in anticipation of the introduction of the Boeing 717 program. The change was also caused by decreases in aircraft purchase deposits and pre-delivery progress payments related to future deliveries of Boeing 717 aircraft that were offset by a decrease in purchase deposits that had been returned for the six Boeing 717 deliveries in 2004. Capital spending (net of credits) decreased year-over-year, totaling $5.2 million for the year ended December 31, 2004.

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Financing Activities
Net cash used in financing activities during 2004 totaled $14.6 million compared with net cash provided by financing activities in 2003 of $21.4 million. During 2003, the Company netted approximately $31.1 million from the issuance of private placement convertible debt and equity and generated approximately $10.0 million in new capital from the sale/leaseback of the Company headquarters facility. There was no activity for these two items in 2004. This change was partially offset by a $2.7 million increase in the net payments of debt in regard to the progress payments due to the change in timing of the Boeing 717 deliveries.

In 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 4 of the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K. As of December 31, 2004, the Company owed $13.5 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.

With the KfW loan agreement and a commitment from Boeing Capital Corporation (“BCC”) to finance the Boeing 717 aircraft, the Company believes it has requisite financing for the remaining firm aircraft deliveries under 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, 2004, the Qualified Plan assets are invested primarily in equities and fixed income instruments. Additional discussion of Plan investment strategy is in Note 10 of the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K. Funding requirements for the Qualified Plan in 2003 were $0.4 million, which was fully paid in 2004. Estimated 2004 plan year funding requirements for the Qualified Plan are $1.5 million, which will be paid in September 2005.

As discussed in Note 4 of the Notes to Consolidated Financial Statements contained in this Annual Report on Form 10-K, the Company issued promissory notes (the “Basic Moratorium Notes”) to its lessors and lenders as part of its restructuring agreements in 2003. The aggregate principal amount of these notes is $7.5 million. Principal and interest on these Basic Moratorium Notes are payable, in arrears, in 36 monthly installments. Payments on the Basic Moratorium Notes began in July 2004 for a total of $1.3 million in principal payments as of December 31, 2004.

As a result of the 2003 restructuring of lease and debt agreements, 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 $24.7 million as of December 31, 2004.

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Other Factors Affecting Liquidity
The Company has not paid federal income taxes in the last three years. As of December 31, 2004, the Company had a non-current deferred tax liability of $8.0 million and deferred tax assets aggregating $7.3 million. These amounts included $35.2 million related to net operating losses (“NOLs”) and a valuation allowance of $21.6 million. Due to accumulated losses and the inability to offset net operating losses against deferred tax liabilities, the Company no longer records income tax benefits effective with the second quarter of 2004.

At December 31, 2004, the Company had estimated tax NOLs of $74.4 million for federal income tax purposes that will expire through 2023. The Company had also previously recorded estimated state NOLs of $187 million, as well as alternative minimum tax carryforward of $2.4 million. Due to the uncertainty of realizing the NOLs, the Company recorded an additional state valuation allowance of $23.1 million and a federal valuation allowance of $13.1 million in the year ended December 31, 2004.

Contractual Obligations
The following table of material debt and lease commitments at December 31, 2004, summarizes the effect these obligations are expected to have on the Company’s cash flow in the future periods set forth below (in thousands):

2005 and Beyond
The current weak revenue environment and volatile nature of fuel prices make it difficult to accurately project cash flow from operations for 2005 and beyond. Absent adverse factors outside the control of the Company – such as terrorist attacks or heightened fear of terrorist attacks, further substantial deterioration in the current industry revenue environment, significant increases in fuel prices or failure of prices to decrease from fourth quarter 2004 prices – the Company believes current liquidity and cash flow from operations will be sufficient to fund current operations through 2005. Key cash flow items for 2005 and beyond include:

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New Accounting Pronouncement
In December 2004, FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123R”). This standard requires expensing of stock options and other share-based payments and supersedes SFAS No. 123, which had allowed companies to choose between expensing stock options or showing proforma disclosure only. This standard is effective for the Company as of July 1, 2005 and will apply to all awards granted, modified, cancelled or repurchased after that date as well as the unvested portion of prior awards. The Company will adopt the standard as of the effective date and believes it will not have a material effect on the financial statements.

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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 fuel hedge collars that establish floor and 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 2004, aircraft fuel and oil and associated taxes (including the effect of any of the Company’s options) represented 24% of the Company’s total operating expenses. Based on the Company’s fiscal 2004 fuel consumption of approximately 80 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 $0.8 million. As of December 31, 2004, the Company had fuel hedge collars in place covering a percentage of the total fuel consumption for 2005. The collars for first quarter 2005 cover approximately 25% of the total estimated fuel consumption with an average floor price of $1.37 per gallon and average ceiling price of $1.60 per gallon, which includes into-plane costs. There are collars in place that cover 18.0%, 13.6% and 9.2% of the estimated fuel consumption for the second, third and fourth quarters of 2005, respectively. Ceiling prices are currently at $1.39, $1.40 and $1.40 per gallon, and floor prices are set at $1.19, $1.20 and $1.20 per gallon for the second, third and fourth quarter of 2005, respectively.

As of December 31, 2004, 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 the Company believes that all debt appropriately reflects the current fair value at December 31, 2004.

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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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying consolidated balance sheets of Midwest Air Group, Inc. and subsidiaries (the “Company”) as of December 31, 2004 and 2003, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 consolidated financial statements present fairly, in all material respects, the financial position of Midwest Air Group, Inc. and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 16, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/  Deloitte & Touche LLP

Deloitte & Touche LLP

Milwaukee, WI
February 16, 2005

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CONSOLIDATED STATEMENTS OF OPERATIONS

MIDWEST AIR GROUP, INC.
YEARS ENDED DECEMBER 31, 2004, 2003, AND 2002
(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, 2004 AND 2003
(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, 2004, 2003 AND 2002
(DOLLARS IN THOUSANDS)