Virgin America Inc. burst upon the U.S. airline industry two years ago with the panache that invariably follows its founder, Richard Branson.

A launch celebration at San Francisco's airport featured water cannons, wriggling dancers, prancing models, and an ebullient Branson proclaiming: “Virgin (America) will make a real difference.”

Branson, the flashy billionaire Brit, was right.

As the low-cost domestic carrier works through its third year of operations, rivals see there is substance behind Virgin America’s sparkle.

The airline this year is selling on average nearly 82 percent of the seats in its planes, slightly better than larger low-cost carriers like Southwest Airlines Co., JetBlue Airways Corp., and AirTran Airways. Aiming for growth, Virgin America plans to expand the number of cities it serves by as much as 50 percent starting next year. Meanwhile it is moving toward the break-even point, narrowing its losses for each of the last three quarters.

But even as it gains traction in the cutthroat U.S. market, some nettlesome issues linger for the Burlingame, California-based company.

The U.S. Department of Transportation is looking into accusations, filed by rival airlines, that Virgin America runs afoul of U.S. “citizenship” laws because of Branson's investment in the company. If federal regulators rule that Virgin America is in violation, it could suspend the company’s license to fly.

Other challenges loom.

Virgin America must be sure it has sufficient cash and passengers to fuel growth as it competes in an industry smarting from the Great Recession. It also needs to expand its network—and perhaps its alliances with other airlines—to remain competitive, particularly among business travelers who tend to pay higher ticket prices.

From its first days of operation, Virgin America has followed a two-pronged strategy.

First: Fly routes already well-traveled by big incumbent rivals like United Airlines, American Airlines Inc., and Delta Air Lines Inc. That allows Virgin America to avoid one-on-one confrontations with big, established carriers and makes it more difficult for every big carrier in a city to match Virgin America’s prices at the same time.

Second: Make flying fun. Flying Virgin America, according to some passengers, is like riding an airborne iPod. The company’s planes offer multiple diversions: hundreds of videogames, movies, and music are available on demand. All of this is available on small computer screens at every seat. Passengers also use those computers to order food that is delivered within minutes after swiping a credit card.

Each seat has power outlets and passengers can surf the Web at 35,000 feet. The company even plays a humorous safety video before each flight that features a bull and a matador that continues to make the rounds on YouTube.