3. Summary of Significant Accounting Policies

Revenue Recognition and Promotional Allowances

Gaming revenue is the aggregate net difference between gaming wins and losses, with liabilities recognized for funds deposited by customers before gaming play occurs, for chips and “ticket-in, ticket-out” coupons in the customers’ possession, and for accruals related to the anticipated payout of progressive jackpots. Progressive slot machines, which contain base jackpots that increase at a progressive rate based on the number of coins played, are charged to revenue as the amount of the jackpots increase.

Food, beverage and other revenue, including racing revenue, is recognized as services are performed. Racing revenue includes the Company’s share of pari-mutuel wagering on live races after payment of amounts returned as winning wagers, its share of wagering from import and export simulcasting, and its share of wagering from its off-track wagering facilities.

Revenue from the management service contract for Casino Rama is based upon contracted terms and is recognized when services are performed.

Revenues are recognized net of certain sales incentives in accordance with Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 605-50, “Revenue Recognition—Customer Payments and Incentives.” The Company records certain sales incentives and points earned in point-loyalty programs as a reduction of revenue.

The retail value of accommodations, food and beverage, and other services furnished to guests without charge is included in gross revenues and then deducted as promotional allowances. The estimated cost of providing such promotional allowances is primarily included in food, beverage and other expense.

The amounts included in promotional allowances for the three and nine months ended September 30, 2013 and 2012 are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
	(in thousands)
Rooms	$	9,639	$	6,535	$	27,951	$	19,094
Food and beverage	31,327		26,089		95,049		80,804
Other	2,748		2,250		8,469		7,209
Total promotional allowances	$	43,714	$	34,874	$	131,469	$	107,107

The estimated cost of providing such complimentary services for the three and nine months ended September 30, 2013 and 2012 are as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
	(in thousands)
Rooms	$	3,223	$	2,337	$	9,583	$	7,000
Food and beverage	21,883		18,095		64,981		54,750
Other	1,909		1,393		4,936		4,344
Total cost of complimentary services	$	27,015	$	21,825	$	79,500	$	66,094

Gaming and Racing Taxes

The Company is subject to gaming and pari-mutuel taxes based on gross gaming revenue and pari-mutuel revenue in the jurisdictions in which it operates. The Company primarily recognizes gaming and pari-mutuel tax expense based on the statutorily required percentage of revenue that is required to be paid to state and local jurisdictions in the states where or in which wagering occurs. In certain states in which the Company operates, gaming taxes are based on graduated rates. The Company records gaming tax expense at the Company’s estimated effective gaming tax rate for the year, considering estimated taxable gaming revenue and the applicable rates. Such estimates are adjusted each interim period. If gaming tax rates change during the year, such changes are applied prospectively in the determination of gaming tax expense in future interim periods. Finally, the Company recognizes purse expense based on the statutorily required percentage of revenue that is required to be paid out in the form of purses to the winning owners of horse races run at the Company’s racetracks in the period in which wagering occurs. For the three and nine months ended September 30, 2013, these expenses, which are recorded primarily within gaming expense in the condensed consolidated statements of income, were $251.2 million and $800.2 million, respectively, as compared to $258.1 million and $801.6 million for the three and nine months ended September 30, 2012, respectively.

Earnings Per Share

The Company calculates earnings per share (“EPS”) in accordance with ASC 260, “Earnings Per Share” (“ASC 260”). Basic EPS is computed by dividing net income applicable to common stock by the weighted-average number of common shares outstanding during the period. Diluted EPS reflects the additional dilution for all potentially-dilutive securities such as stock options and unvested restricted shares.

At September 30, 2013, the Company had outstanding 12,050 shares of Series B Redeemable Preferred Stock (the “Series B Preferred Stock”), which the Company determined qualified as a participating security as defined in ASC 260. Under ASC 260, a security is considered a participating security if the security may participate in undistributed earnings with common stock, whether that participation is conditioned upon the occurrence of a specified event or not. In accordance with ASC 260, a company is required to use the two-class method when computing EPS when a company has a security that qualifies as a “participating security.” The two-class method is an earnings allocation formula that determines EPS for each class of common stock and participating security according to dividends declared (or accumulated) and participation rights in undistributed earnings. A participating security is included in the computation of basic EPS using the two-class method. Under the two-class method, basic EPS for the Company’s common stock is computed by dividing net income applicable to common stock by the weighted-average common shares outstanding during the period. Diluted EPS for the Company’s common stock is computed using the more dilutive of the two-class method or the if-converted method.

The following table sets forth the allocation of net income for the three and nine months ended September 30, 2013 and 2012 under the two-class method:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
	(in thousands)

Net income	$	41,317	$	46,446	$	94,408	$	191,732
Net income applicable to preferred stock	7,691		8,990		17,692		37,165
Net income applicable to common stock	$	33,626	$	37,456	$	76,716	$	154,567

The following table reconciles the weighted-average common shares outstanding used in the calculation of basic EPS to the weighted-average common shares outstanding used in the calculation of diluted EPS for the three and nine months ended September 30, 2013 and 2012:

	Three Months Ended September 30,		Nine Months Ended September 30,
	2013	2012	2013	2012
	(in thousands)
Determination of shares:
Weighted-average common shares outstanding	78,635	76,336	78,169	76,196
Assumed conversion of dilutive employee stock-based awards	2,929	2,059	3,020	2,243
Assumed conversion of restricted stock	111	168	101	157
Assumed conversion of preferred stock	21,767	27,278	21,817	27,278
Diluted weighted-average common shares outstanding	103,442	105,841	103,107	105,874

The Company is required to adjust its diluted weighted-average common shares outstanding for the purpose of calculating diluted EPS as follows: 1) when the price of the Company’s common stock at the end of the reporting period is less than $45, the diluted weighted-average common shares outstanding is increased by 26,777,778 shares (regardless of how much the stock price is below $45); 2) when the price of the Company’s common stock at the end of the reporting period is between $45 and $67, the diluted weighted-average common shares outstanding is increased by an amount which can be calculated by dividing $1.205 billion (face value) by the current price per share of the Company’s common stock, which will result in an increase in the diluted weighted-average common shares outstanding of between 17,985,075 shares and 26,777,778 shares; and 3) when the price of the Company’s common stock at the end of the reporting period is above $67, the diluted weighted-average common shares outstanding is increased by 17,985,075 shares (regardless of how much the stock price exceeds $67). See Note 15 for discussion of the Spin-Off’s future impact on the calculation of diluted weighted-average common shares outstanding.

Options to purchase 20,625 shares and 30,625 shares were outstanding during the three and nine months ended September 30, 2013, respectively, but were not included in the computation of diluted EPS because they were antidilutive. Options to purchase 4,353,529 shares and 3,132,000 shares were outstanding during the three and nine months ended September 30, 2012, respectively, but were not included in the computation of diluted EPS because they were antidilutive.

The following table presents the calculation of basic and diluted EPS for the Company’s common stock:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
	(in thousands, except per share data)

Calculation of basic EPS:
Net income applicable to common stock	$	33,626	$	37,456	$	76,716	$	154,567
Weighted-average common shares outstanding	78,635		76,336		78,169		76,196
Basic EPS	$	0.43	$	0.49	$	0.98	$	2.03

Calculation of diluted EPS:
Net income	$	41,317	$	46,446	$	94,408	$	191,732
Diluted weighted-average common shares outstanding	103,442		105,841		103,107		105,874
Diluted EPS	$	0.40	$	0.44	$	0.92	$	1.81

Stock-Based Compensation

The Company accounts for stock compensation under ASC 718, “Compensation-Stock Compensation,” which requires the Company to expense the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. Stock based compensation expense for the three and nine months ended September 30, 2013 was $6.4 million and $18.1 million, respectively, as compared to $6.9 million and $22.2 million for the three and nine months ended September 30, 2012, respectively. This expense is recognized ratably over the requisite service period following the date of grant.

The fair value for stock options was estimated at the date of grant using the Black-Scholes option-pricing model, which requires management to make certain assumptions. The risk-free interest rate was based on the U.S. Treasury spot rate with a term equal to the expected life assumed at the date of grant. Expected volatility was estimated based on the historical volatility of the Company’s stock price over a period of 6.57 years, in order to match the expected life of the options at the grant date. Historically, at the grant date, there has been no expected dividend yield assumption since the Company has not paid any cash dividends on its common stock since its initial public offering in May 1994 and since the Company intends to retain all of its earnings to finance the development of its business for the foreseeable future. The weighted-average expected life was based on the contractual term of the stock option and expected employee exercise dates, which was based on the historical and expected exercise behavior of the Company’s employees. No stock options were granted by the Company during the nine months ended September 30, 2013, however, the Company granted 257,500 shares of restricted stock during this same time period.

The Company has also issued cash-settled phantom stock unit awards, which vest over a period of four to five years. Cash-settled phantom stock unit awards entitle employees and directors to receive cash based on the fair value of the Company’s common stock on the vesting date. These phantom stock unit awards are accounted for as liability awards and are re-measured at fair value each reporting period until they become vested with compensation expense being recognized over the requisite service period in accordance with ASC 718-30, “Compensation—Stock Compensation, Awards Classified as Liabilities.” As of September 30, 2013, there was $25.7 million of total unrecognized compensation cost that will be recognized over the grants remaining weighted average vesting period of 2.86 years. For the three and nine months ended September 30, 2013, the Company recognized $3.3 million and $8.3 million of compensation expense associated with these awards, respectively, as compared to $1.0 million and $3.5 million for the three and nine months ended September 30, 2012, respectively.

Additionally, the Company has issued stock appreciation rights to certain employees, which vest over a period of four years. The Company’s stock appreciation rights are accounted for as liability awards since they will be settled in cash. The fair value of these awards is calculated during each reporting period and estimated using the Black-Scholes option pricing model based on the various inputs discussed below. As of September 30, 2013, there was $8.9 million of total unrecognized compensation cost that will be recognized over the awards remaining weighted average vesting period of 2.07 years. For the three and nine months ended September 30, 2013, the Company recognized $0.4 million and $4.1 million of compensation expense associated with these awards, respectively, as compared to $0.5 million and $3.0 million for the three and nine months ended September 30, 2012, respectively.

The following are the weighted-average assumptions used in the Black-Scholes option-pricing model at September 30, 2013 and 2012:

	2013		2012

Risk-free interest rate	1.08	%	0.84	%
Expected volatility	46.27	%	45.78	%
Dividend yield	—		—
Weighted-average expected life (years)	6.57		6.64