Virgin America (NASDAQ: VA) made its public trading debut last Friday. Its first few days as a public company have been incredibly successful -- at least from the perspective of early investors. The Virgin America IPO priced at $23 (above the midpoint of the projected $21-$24 range). In its first three days of trading, the stock soared more than 60% to close at $37.05 on Tuesday.

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Virgin America Stock Chart, data by YCharts

On the day of Virgin America's IPO, I spoke with CEO David Cush and CFO Peter Hunt about the company's strategy for growth and margin expansion. Here's how Virgin America plans to take the U.S. airline industry by storm. (A full transcript of our conversation follows.)

High unit revenue and low costs

To hear Cush talk about it, Virgin America's formula for long-term success is extremely simple: keep unit revenues high and unit costs low.

Well, I think the key thing is understanding our model. Our model is we do have a premium product, we do generate a revenue premium to most of the industry, but we do it with a low-cost model.

So we have a very pure low-cost model. We are single fleet type; we are point-to-point. That was really the original playbook for the low-cost model. So: high revenue, low cost, and I think we're seeing it on the bottom line now that the network has matured.

--Virgin America CEO David Cush

Of course, having high revenues and low costs is what every CEO wants. Virgin America is making progress toward this goal. In the 2 years leading up to Virgin America's IPO, the company dramatically boosted its profitability.

Through the first 9 months of 2014, the company reported operating income of $86.3 million, representing an operating margin of 7.7%. By contrast, in the first 9 months of 2012, Virgin America posted an operating loss of $36.8 million for a -3.7% operating margin.

The Virgin America IPO came in the midst of strong earnings momentum. Photo: Virgin America

That said, among the top 10 U.S. airlines, Virgin America had the second lowest operating margin (excluding special items) for the 12-month period ending in September. Virgin America has solid margin growth momentum, but it still has plenty of work to do.

Plans to earn a revenue premium

Let's take a look at the revenue side first. Virgin America plans to boost its unit revenue by continuing to offer a superior on-board product, including leather seats, a first-class section on every flight, Wi-Fi on every plane, mood lighting, etc.

In addition, Virgin America will focus its growth on high traffic routes in its top markets. "We're not a big connect-the-dot carrier," says Cush. "We like to focus on where we're strong." This really means San Francisco and Los Angeles: more than 95% of its capacity touches one of these two cities.

In other words, the seasonal routes from New York to Fort Lauderdale and from Boston to Las Vegas that Virgin America announced last month will be the exception, not the rule.

Virgin America has strong roots in San Francisco and Los Angeles. Moreover, these are two of the top business markets in the U.S. Both factors make it easier to attract corporate travel accounts there. On average, corporate travelers pay 50% more than other customers for Virgin America tickets. Thus, the carrier has a strong incentive to expand in those two cities.

Virgin America has a strong presence in San Francisco and Los Angeles. Photo: Virgin America

The one promising market that Virgin America sees aside from San Francisco and Los Angeles is Dallas. Earlier this year, Virgin America snagged two gates at Love Field, a small airport that is much closer to downtown Dallas than the significantly larger Dallas-Fort Worth International Airport.

Love Field is a unique expansion opportunity. Nearly all of its gates are controlled by Southwest Airlines, a carrier that doesn't offer many of Virgin America's amenities (like first-class seats and personal TVs). As a result, Virgin America thinks it can attract corporate travelers who want those amenities but also value Love Field's convenience.

Virgin America began flying from Love Field a month before the IPO. According to Cush, financial results for its flights to San Francisco and Los Angeles (which had previously used DFW) have been better at Love Field from day one.

Virgin America's has also seen plenty of demand in its new markets from Dallas: New York City and Washington, D.C. This should lead to excellent financial results once these routes have a few years to mature, due to the capacity-constrained nature of all 3 airports.

Cost containment plans

Virgin America also has to keep its costs in line to produce outsize profits. Like most young carriers, Virgin America currently benefits from comparatively low labor costs. Its young fleet is also easy to maintain. However, as the company's workforce and fleet age, both will be sources of cost pressure. (Unionization of its workers is another potential cost driver.)

Another challenge Virgin America faces is its refusal to mimic competitors by cramming rows closer together to fit more passengers on each plane. How can Virgin America mitigate or offset these cost headwinds?

One thing that both CEO David Cush and CFO Peter Hunt emphasized in our conversation was Virgin America's "simple production model." By maintaining a single fleet type and outsourcing more tasks than other airlines, Virgin America avoids complexity and keeps costs down.

Virgin America's IPO will improve the company's access to capital, according to CFO Peter Hunt. This will allow it to reduce its aircraft financing costs. For example, rather than leasing planes, it could take advantage of the low interest rate environment to issue cheap debt and buy the planes outright.

Virgin America also keeps costs down by not using flat-bed seats in first class on the lucrative transcontinental routes from JFK Airport in New York City to San Francisco and Los Angeles, where it deploys a lot of its capacity. This puts it at odds with the other 4 carriers serving those routes.

Flat-bed seats are an "overrated feature unless you're on a red-eye," David Cush recently told Bloomberg. Most transcontinental flights are not red-eyes. Virgin America doesn't operate any red-eye flights going westbound, and it operates one daily red-eye on each of the San Francisco-JFK and Los Angeles-JFK routes.

American Airlines has fewer seats on transcontinental flights than Virgin. Photo: American Airlines

Flat-bed seats take up lots of space, increasing unit costs. Most of Virgin America's planes are A320s configured with 146 or 149 seats. By contrast, American Airlines recently began flying the A321 on its transcontinental routes. The A321 is a bigger airplane, yet American Airlines has configured these planes with just 102 seats (of which 30 are flat-bed seats).

Thus, for transcontinental flights, Virgin America operates with a denser configuration than its competitors (which is the reverse of the situation on most of its routes). If Cush is right and very few people care about having a flat-bed seat for their transcontinental flights, Virgin America will be able to generate plenty of revenue on those flights while having the lowest unit costs.

Time to get to work

Virgin America has plenty of work to do if it is to earn a revenue premium to the U.S. airline industry while maintaining low unit costs. In some areas, it has clear plans. Its recent buildup at Dallas Love Field should boost unit revenue. Virgin America's IPO should reduce aircraft financing costs.

However, there are some big open questions. Is Virgin America right that flat-bed first-class seats aren't necessary on transcontinental flights? Can Virgin America avoid the cost creep that has hurt various other low-cost carriers as they have aged? Only time will tell.

Edited Transcript
Adam Levine-Weinberg, The Motley Fool: Give me the elevator speech: If you're pitching to a long-term investor -- somebody who is thinking about holding a stock for five to 10 years, what's the investment thesis for Virgin America? Is it growth, is it margin expansion, is it free cash flow, is it something else?

David Cush, Virgin America CEO: Well, I think the key thing is understanding our model. Our model is we do have a premium product, we do generate a revenue premium to most of the industry, but we do it with a low-cost model.

So we have a very pure low-cost model. We are single-fleet type; we are point-to-point. That was really the original playbook for the low-cost model. So: high revenue, low cost, and I think we're seeing it on the bottom line now that the network has matured. The thesis to investors really is that we are in the mode of expanding at a reasonable pace, but a modest pace. So we're not where Spirit is, or maybe those other guys.

Adam: Right.

David: And we think we can do it with either stable or expanding margins. So we won't sacrifice margins for growth.

Adam: OK, sure. That makes sense. So, just to talk about your growth plans: I know that you just about two years ago exactly now, changed your fleet plan, decided to basically go cold-turkey on growth for a couple of years. Then you have 10 new planes coming between next year and 2016. So, after that, you then have another break. What are your thoughts about growth in the sort of 2017-2019 period, before you have the [Airbus A320] neos coming in 2020?

David: Well, internally we believe this. If the market stays strong, the economy stays strong, that we can fill in those years. We don't have the obligation to do so, so we can get closer to the period before we make a commitment. It would be again, modest growth, and we're at 1.3% of the domestic industry. So the good news is we can grow at that rate without really impacting things.

Adam: That makes sense. So what would be your plan in terms of leasing or buying used because I assume there's not a lot of new planes left just because the backlog for narrowbodies is pretty long at this point?

David: Well, I'll let Peter talk about that.

Peter Hunt, Virgin America CFO: There actually are a fair number of aircraft out there because lessors placed big order books in this period, so there's both ceo and neo aircraft available with lessors, and Airbus, too, has -- while their order book's pretty full, when you're talking about five to seven aircraft a year, which is all we're talking about, they have flexibility within their production cycle within some of those years as well. So we think there's a lot of opportunity for new aircraft.

Adam: OK.

Peter: And we'll look at the entire market. I think we have an affinity for new aircraft because of all of the low operating costs and high reliability that it brings, but you know, we'll look at the overall market to make sure we're making the best economic decisions.

Adam: Sure, that makes sense. And what do you think would be the timeframe when you would have to decide? How much lead time would you need to make a decision on growing the fleet before you start getting extra planes?

Peter: Lessors are really focused one year to 18 months out at a time when they're filling in the aircraft they have on order. So right now, lessors would be talking about 2015 and 2016 for example. We already have planes in those years. So I think really, we can focus on absorbing the growth right now, and late next year, 2016, we can start thinking about '17 and '18.

Adam: So then, to transition a little bit into your network strategy: when you're thinking about growing in the future -- and obviously, you have to be thinking already about what you're doing with the planes coming starting next year -- what's your preference between either adding new dots to your route map or connecting the dots in what you already have?

David: Yeah, we're not a big connect the dot carrier. We like to focus on where we're strong. Our focus will remain on creating new dots out of San Francisco and Los Angeles.

Adam: OK. And so how would you describe your network strategy at a high level? Because obviously you're mostly in business markets, but then you do have a good number of more leisure-oriented destinations: Mexico, etc. So how do those two things kind of play off one another?

David: Well, what we look at when we expand to markets is what's going to be profitable. So we do best in business markets. At the same time, some of these Mexico markets are quite lucrative. If you look at what we do out of Mexico, it's really not a lot. We fly from Cancun to L.A. and San Francisco -- a huge market -- we fly out of PVR [Puerto Vallarta], and we fly to Cabo. So we don't do a lot in terms of pure leisure.

Our focus is really going in and finding markets that have a lot of business traffic, that we can go into and create a revenue premium, and that's what you'll see going forward. We're looking hard at Hawaii which is a good premium market -- premium leisure market -- out of California, but our focus will continue to be business markets.

Adam: OK. And what do you see as the advantages and disadvantages of moving into more business markets as opposed to more leisure markets -- just from a strategy point of view?

David: Well, the key thing with business markets is the ticket prices are higher. If you look at our traffic mix right now, we're at about 40% business in terms of revenue: 30% in terms of passengers. And if you look at the managed corporate business within that -- which is about half of that business revenue -- it travels at a ticket price that's about 50% higher than the cabin. So if you can penetrate business, that's certainly what you want to do. And our product, we think -- and our network, we think -- is really built for business.

Adam: Do you find that business markets take longer to ramp up to profitability than leisure markets?

David: Absolutely. You have to go in -- you know, as opposed to just Spirit or someone who can just go in and simply stimulate the market -- we have to not only stimulate the market, we have to go in and penetrate the business market, and that takes a little bit of time in terms of going into corporate accounts, getting people to transition over. So it certainly takes us longer. Once we get there, it's more lucrative, though.

Adam: So of your corporate travel, how much of it is based in San Francisco and Los Angeles? Have you had any success getting accounts from people coming the other way?

David: Well, I think the key thing with corporate travel is when you sign up a corporation, it's your entire network. So most of our corporations aren't based in San Francisco and L.A. -- they just have a lot of travel to San Francisco and L.A. So we've been quite successful signing up accounts all over the country.

Adam: So maybe you can talk about the first month at Love Field and how that's been going so far.

David: Well, we're very happy with it. There's a lot of noise in the Love Field market because first of all we went in, and then of course Southwest went in and basically redesigned their entire network out of Love Field because of the Wright Amendment. What we've seen thus far is in our mature markets -- L.A. and San Francisco -- is that they are performing better than they did at DFW, which is what we expected.

Adam: OK, so from day one. And what are your thoughts about returning to Philadelphia? I know you mentioned when you left that it was really just an aircraft availability issue, rather than a problem with the market.

David: Well, the market was slow to mature, so it did take longer to ramp up. We were there for two years; it was not a profitable market for us, but it was improving quite a bit. The people there were very good to us and we want to get back there.

Adam: So maybe we can just talk a little bit about cost. So I think one of the big things investors worry about with young airlines is that as they get older, there's just inevitable cost creep. What do you think are the biggest potential challenges you might face in the next few years with cost inflation, and what are the kind of levers that you can pull to offset that?

David: I'm going to make a general comment, and then I'll let Peter comment on that. I think the key thing in terms of our cost structure is our simple production model. As long as we don't deviate from that, we can control our costs long term, and I think where other carriers have gotten in trouble is they deviate from it. So that's our philosophy. Peter can probably address it more specifically.

Peter: Right, and I would totally agree with that, and I think -- just by way of example -- we outsource a lot more than the typical airline, and that will help us manage our costs in the long term. While we will have some areas where we have cost pressure -- as every airline does -- I'm excited because of the opportunities that going public brings in terms of lowering our overall cost of capital, our cost of financing new aircraft. I think we'll be able to make some tremendous inroads in that over time that will actually really help improve our cost structure.

Adam: One more question: in terms of your fleet planning, do you have any interest in upgauging to A321s in the future? Do you think the A319s that you have in the fleet now are there longer term, or do you expect to go toward larger aircraft?

Peter: Well, the 319s are on lease, and so we're going to have them until the maturity of their leases, which is several years out. There are markets that they're fine in -- I mean, we have smaller markets that we can put them in. We are interested in the 321; we've looked at it. I think it's a question of price with Airbus: making the economics work.

Adam: Thank you very much for your time.