| MIDWEST AIR GROUP INC Item 1A Risk Factors 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 Each of these risk factors could adversely affect the company’s business, operating results and/or financial condition, as well as adversely affect the value of investment in the company’s Common Stock |
| The risks and uncertainties described below are not 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 yield (revenue per revenue passenger mile) on Signature Service routes, and it is possible that premium pricing in the airline industry will not recover to levels acceptable to the Company |
| If premium pricing does not recover, then the Company’s business and financial results could suffer |
| 10 _________________________________________________________________ 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 replaced 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 |
| Future terrorist attacks could seriously affect 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 |
| Additional terrorist attacks, even if not made directly on the airline industry, or the fear of such attacks (including elevated national threat warnings or selective cancellation or redirection of flights due to terror threats) could negatively affect the Company and the airline industry |
| Increased competition could harm business |
| Midwest Airlines competes with other air carriers on most 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 |
| 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’ fleet of Boeing 717 aircraft |
| Midwest Airlines currently has a firm order for 25 Boeing 717 aircraft at pre-negotiated prices |
| Midwest Airlines took delivery of the first Boeing 717 on February 28, 2003, and 21 more through December 2005 |
| The Company plans to take delivery of the remaining three Boeing 717s in the first and second quarters of 2006 |
| Among other risks, the acquisition of these aircraft involves the following: · The acquisition significantly affects the Company’s cost structure by adding higher fixed costs because the Boeing 717 aircraft have higher ownership costs (ie, purchase costs and lease payment expenses) than the DC-9 aircraft they replaced |
| Midwest Airlines believes that benefits of Boeing 717 aircraft include greater fuel efficiency, lower maintenance costs, improved dispatch reliability, increased aircraft utilization and reduced regulatory compliance costs |
| Midwest Airlines also believes it will realize higher revenues through increased utilization and because demand for air travel will increase due to it using these aircraft |
| While Midwest Airlines believes the combined effect of these higher revenues and reduced costs will offset the higher ownership costs, there can be no guarantee that will be the case |
| Further, it relies on benefits that are variable in nature to offset fixe d costs |
| To date, the Boeing 717 program has realized certain benefits, such as higher fuel efficiency |
| However, this has been offset by an increase in aircraft rental costs |
| · Due to the number of Boeing 717 aircraft Midwest Airlines intends to have in its fleet, it would be vulnerable if any design defect or mechanical problem becomes associated with the Boeing 717 aircraft or if there is adverse public perception of these aircraft |
| · If there are not markets in which the Company can employ its Boeing 717s, it may have excess aircraft in its fleet |
| · Boeing has announced that it will discontinue manufacturing Boeing 717 jet aircraft in 2006 |
| The Company currently operates 23 Boeing 717s (including an aircraft that was received in February 2006) and has a firm order for two more aircraft |
| Boeing may not offer the same level of support once the Boeing 717 production is discontinued |
| This could lead to increased prices on parts or services for the Company |
| 11 _________________________________________________________________ Increases in fuel costs, or the failure of fuel costs to decrease, could harm business |
| Fuel costs constitute a significant portion (approximately 30prca for the year ended December 31, 2005) of the Company’s total operating costs |
| Accordingly, significant increases in fuel costs or the failure of current fuel prices to decrease would harm the Company’s financial condition and results of operations |
| For the year ended December 31, 2005, a one-cent increase in the price per gallon of fuel increased fuel expenses by approximately dlra1dtta0 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 home heating oil, diesel fuel 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 shor tage, 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 |
| 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 |
| 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 dlra2dtta50 per enplanement security fee (subject to a dlra5dtta00 one-way trip cap), in addition to a fixed fee of dlra1dtta9 million per year for the Company, 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 r equirements 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 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 |
| 12 _________________________________________________________________ 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 greater financial resources and name recognition, and some have lower operating costs, which may affect the Company’s ability to compete |
| 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 over the past several years 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 the Company 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 and Company have endured financial losses for the last five years |
| Like most other carriers, the Company has made 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 |
| 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 adverse consequences, including: · increasing its vulnerability to general adverse economic and industry conditions; · requiring that a portion of cash flow from operations be used for the payment of interest on debt, thereby reducing the ability to use cash flow to fund working capital, capital expenditures and general corporate requirements; · limiting the ability to obtain additional financing to fund future working capital, capital expenditures and general corporate requirements; · limiting flexibility to plan for or react to changes in business and the airline industry; and · placing the Company at a competitive disadvantage to its competitors that have less indebtedness |