Tom Horton was bonefishing in the Bahamas recently when he got the call from Gerard Arpey, the chief executive of AMR ( AMR), about returning to the company he left four years ago.

"I said, 'Gerard, I think I just want to go back to fishing,'" Horton recalled.

But after a few more conversations, Horton rejoined AMR last month, in an expanded role as chief financial officer and executive vice president of finance and planning.

On Wednesday, he told reporters on a conference call that his decision wasn't based on the fact that he was returning to the airline industry, even though he kept a roomful of airplane models in his office at AT&T ( T), where he was vice chairman and CFO. Instead, he said, it was about returning to AMR and working with Arpey, whom he called "probably the most principled guy I've ever known."

AMR is a proud company in an industry of intense corporate loyalties, and it's currently on a roll, the only one of the six legacy airlines that has never sought bankruptcy court protection. AMR, the parent of American Airlines, has cut annual expenses by $5 billion since 2002, while figuring out how to gain revenue premiums over its competitors.

International flying, with its higher yields, now accounts for about 40% of its operations. AMR's shares, which fell as low as $1.25 in March 2003, closed Wednesday at $28.10.

Still, American faces serious challenges. The carrier has $20 billion in debt, and its fleet of 699 aircraft includes 327 inefficient MD-80s. Avoiding bankruptcy means that its labor costs exceed those of its competitors. And its fuel costs rose by $1.7 billion in 2005, eating up a sizable portion of the cost improvements.

"The biggest challenge is to avoid complacency and not to confuse a rising tide with a solution to a problem," Horton said. "We've done a great job here in managing the cost structure of the company. Unfortunately, we've gotten our cost structure about to (the level of) the network carriers, and what's happened since is that the network carriers went through bankruptcy and cut their costs below ours. So we keep going."

Horton acknowledged that many of the achievable nonlabor-cost reductions have been made, but despite repeated questions he wouldn't comment on whether the company will seek further cuts in labor expenses.

"We are three years into the turnaround plan, and each year we've found ways to drive costs down further," he said. "We have to keep working at it. I don't have all the answers. It does get harder."

He said management must make the strategy of engaging labor be fruitful and that reducing costs through Chapter 11 isn't the answer. "If you put your company through bankruptcy, at the end of the day, I don't think you are going to create an environment where your people are going to feel really motivated to do a good job," he said.

There are similarities between the airline industry and the telecommunications industry, Horton said. Both have "a checkered history of regulation and re-regulation." Both had overcapacity and, a few years ago, both faced financial distress. Horton said the solution at AT&T included focusing on the business market, paying down debt to reduce interest costs, improving technology and eventually, merging with SBC, which retained the AT&T name.

That's not to say Horton is considering another merger for American, which became the largest airline in the world because of the 2000 acquisition of TWA.

"In retrospect, we can all say we shouldn't have done the TWA merger," he said. At the time, UAL ( UAUA) unit United Airlines had announced plans to merge with US Airways. Horton didn't think the deal would be approved by the Justice Department, "but had they succeeded, they would have taken a lot of revenue out of our hide, (so) we were in the scramble mode."

American considered merging with Northwest Airlines ( NWACQ), and also approached United about splitting up US Airways, but neither plan went very far.

Now, airline consolidation is again widely discussed.

"Never say never," Horton said. "Airline mergers are inherently complex, inherently rife with labor issues. But it is an industry that probably has too much capacity. If you look at it as a man from Mars, you could conclude that the industry ought to consolidate more."

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