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Summary of Significant Accounting Policies (Policies)
 3 Months Ended
Mar. 31, 2012
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 months ended March 31, 2012 and 2011 are as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

Rooms

 

$

6,294

 

$

5,211

 

Food and beverage

 

27,479

 

23,228

 

Other

 

2,596

 

2,255

 

Total promotional allowances

 

$

36,369

 

$

30,694

 

 

The estimated cost of providing such complimentary services for the three months ended March 31, 2012 and 2011 are as follows:

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

Rooms

 

$

2,356

 

$

2,014

 

Food and beverage

 

18,480

 

17,619

 

Other

 

1,522

 

1,354

 

Total cost of complimentary services

 

$

22,358

 

$

20,987

 
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 horseraces run at the Company’s racetracks in the period in which wagering occurs. For the three months ended March 31, 2012 and 2011, these expenses, which are recorded primarily within gaming expense in the consolidated statements of income, were $276.9 million and $264.1 million, 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, excluding net income attributable to noncontrolling interests, 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 March 31, 2012, the Company had outstanding 12,275 shares of Series B Redeemable Preferred Stock (the “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 months ended March 31, 2012 and 2011 under the two-class method:

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

 

 

 

 

 

 

Net income

 

$

78,619

 

$

51,528

 

Net income applicable to preferred stock

 

15,272

 

9,785

 

Net income applicable to common stock

 

$

63,347

 

$

41,743

 

 

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 months ended March 31, 2012 and 2011:

 

 

 

Three Months Ended March 31,

 

 

 

2012

 

2011

 

 

 

(in thousands)

 

Determination of shares:

 

 

 

 

 

Weighted-average common shares outstanding

 

75,994

 

78,162

 

Assumed conversion of dilutive employee stock-based awards

 

2,360

 

1,479

 

Assumed conversion of preferred stock

 

27,278

 

27,278

 

Diluted weighted-average common shares outstanding

 

105,632

 

106,919

 

 

Reflecting the issuance of the Preferred Stock and the repurchase of 225 shares of Preferred Stock during the year ended December 31, 2010, 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 is less than $45, the diluted weighted-average common shares outstanding is increased by 27,277,778 shares (regardless of how much the stock price is below $45); 2) when the price of the Company’s Common Stock is between $45 and $67, the diluted weighted-average common shares outstanding is increased by an amount which can be calculated by dividing $1.23 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 18,320,896 shares and 27,277,778 shares; and 3) when the price of the Company’s Common Stock is above $67, the diluted weighted-average common shares outstanding is increased by 18,320,896 shares (regardless of how much the stock price exceeds $67).

 

Options to purchase 3,122,903 shares and 3,734,446 shares were outstanding during the three months ended March 31, 2012 and 2011, 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 March 31,

 

 

 

2012

 

2011

 

 

 

(in thousands, except per share data)

 

 

 

 

 

 

 

Calculation of basic EPS:

 

 

 

 

 

Net income applicable to common stock

 

$

63,347

 

$

41,743

 

Weighted-average common shares outstanding

 

75,994

 

78,162

 

Basic EPS

 

$

0.83

 

$

0.53

 

 

 

 

 

 

 

Calculation of diluted EPS:

 

 

 

 

 

Net income

 

$

78,619

 

$

51,528

 

Diluted weighted-average common shares outstanding

 

105,632

 

106,919

 

Diluted EPS

 

$

0.74

 

$

0.48

 
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 months ended March 31, 2012 and 2011, was $7.9 million and $6.2 million, 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 5.82 years, in order to match the expected life of the options at the grant date. There is no expected dividend yield 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. Forfeitures are estimated at the date of grant based on historical experience.

 

The following are the weighted-average assumptions used in the Black-Scholes option-pricing model at March 31, 2012 and 2011:

 

Three Months Ended March 31,

 

2012

 

2011

 

 

 

 

 

 

 

Risk-free interest rate

 

1.04

%

2.27

%

Expected volatility

 

47.60

%

48.02

%

Dividend yield

 

—

 

—

 

Weighted-average expected life (years)

 

5.82

 

5.73

 

Forfeiture rate

 

5.00

%

5.00

%

 

Beginning in the fourth quarter of 2010, the Company issued cash-settled phantom stock unit awards, which vest over a period of 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 March 31, 2012, there was $14.6 million of total unrecognized compensation cost that will be recognized over the grants remaining weighted average vesting period of 3.6 years. For the three months ended March 31, 2012 and 2011, the Company recognized $1.2 million and $0.4 million, respectively, of compensation expense associated with these awards.

 

Additionally, starting in 2011, the Company 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 previously. As of March 31, 2012, there was $13.0 million of total unrecognized compensation cost that will be recognized over the awards remaining weighted average vesting period of 3.4 years. For the three months ended March 31, 2012 and 2011, the Company recognized $1.4 million and $0.3 million, respectively, of compensation expense associated with these awards.

 
Accounting for Derivatives and Hedging Activities

The Company uses fixed and variable-rate debt to finance its operations. Both funding sources have associated risks and opportunities, such as interest rate exposure, and the Company’s risk management policy permits the use of derivatives to manage this exposure. The Company does not hold or issue derivative financial instruments for trading or speculative purposes. Thus, uses of derivatives are strictly limited to hedging and risk management purposes in connection with managing interest rate exposure. Acceptable derivatives for this purpose include interest rate swap contracts, futures, options, caps, and similar instruments.

 

When using derivatives, the Company has historically desired to obtain hedge accounting, which is conditional upon satisfying specific documentation and performance criteria. In particular, the underlying hedged item must expose the Company to risks associated with market fluctuations and the instrument used as the hedging derivative must generate offsetting effects in

prescribed magnitudes. If these criteria are not met, a change in the market value of the financial instrument and all associated settlements would be recognized as gains or losses in the period of change.

 

Under cash flow hedge accounting, effective derivative results are initially recorded in other comprehensive income (“OCI”) and later reclassified to earnings, coinciding with the income recognition relating to the variable interest payments being hedged (i.e., when the interest expense on the variable-rate liability is recorded in earnings). Any hedge ineffectiveness (which represents the amount by which hedge results exceed the variability in the cash flows of the forecasted transaction due to the risk being hedged) is recorded in current period earnings. Under cash flow hedge accounting, derivatives are included in the consolidated balance sheets as assets or liabilities at fair value.

 

Previously, the Company had a number of interest rate swap contracts in place. These contracts served to mitigate income volatility for a portion of the Company’s variable-rate funding. In effect, these interest rate swap contracts synthetically converted the portion of variable-rate debt being hedged to the equivalent of fixed-rate funding. Under the terms of the swap contracts, the Company received cash flows from the swap contract counterparties to offset the benchmark interest rate component of variable interest payments on the hedged financings, in exchange for paying cash flows based on the swap contracts’ fixed rates. These two respective obligations were net-settled periodically. The fair value of the Company’s interest rate swap contracts was measured at the present value of all expected future cash flows based on the LIBOR-based swap yield curve as of the date of the valuation, subject to a credit adjustment to the LIBOR-based yield curve’s implied discount rates. The credit adjustment reflected the Company’s best estimate as to the Company’s credit quality. There were no outstanding interest rate swap contracts as of March 31, 2012 and December 31, 2011.