Is Coach a Rule Breaker?

At a time when Sony's(NYSE: SNE) low-budget horror flick The Grudge screamed to the top of the box office, raking in $40 million on its opening weekend, the scariest thing in the industry might be the self-induced cash hemorrhaging at Regal Entertainment(NYSE: RGC). This morning, the nation's largest movie theater operator posted third-quarter net income that plummeted 37% to $27.8 million, or $0.19 cents, on revenue that fell 3% to $611.3 million. Both measures fell far short of estimates.

Admissions revenue decreased by 3.6% to $410.4 million, as a 4,000 drop in the number of moviegoers to 62,300 offset an $0.18 rise in average ticket prices to $6.59. Smaller crowds left fewer people to splurge on overpriced snacks, and concession revenues declined 4% to $154.6 million. Unfortunately, the bottom line took an even bigger hit, as operating margins dropped by over 300 basis points to 12.14%. Through the first nine months, despite a slight increase in sales, net income has plunged by more than half to $58 million ($0.39), versus $126.6 million ($0.89) earned at this time last year.

For a company that is experiencing a falloff in business, some cash management prudence might be expected, but Regal is spending more than ever. In June, management authorized a one-time $5 dividend payment. As I mentioned earlier, the $710 million debt-financed payment was four times the size of Regal's entire $185 million net income last year. At the time, the company only had around $300 million in cash to play with.

This was actually the second such special dividend -- a similar payment had been authorized the summer before. The decision -- which was contested in court by some shareholders -- left the company heavily leveraged, forcing both Moody's(NYSE: MCO) and McGraw-Hill's(NYSE: MHP) Standard & Poor's to lower their credit outlook for Regal from stable to negative.

Now, Regal is continuing to shower shareholders with money, by announcing a 50% boost in the company's quarterly dividend payment. There is nothing wrong with enhancing shareholder value through dividends, provided it can meet other obligations. But why raise the company's yield to 6.3% now? The move seems questionable considering that total debt has swelled to more than $2 billion (with a debt/equity ratio in excess of 25), cash flows are down from last year, and the current ratio of 0.75 indicates that short-term assets are not sufficient to cover short-term liabilities.

Management's generosity doesn't stop there, however, as a planned $50 million stock buyback is also in the works. Stock repurchases can be another great way to enhance shareholder value, but like dividends, only under the right circumstances. There is very little benefit if the price paid is too steep. Essentially, Regal's management is saying they believe the stock is currently undervalued, and while it may not be overvalued, it would be hard to call any stock trading at 35 times book value with a PEG ratio above two a bargain.

Regal is the country's dominant movie exhibitor, operating over 6,000 screens (one in five nationwide). That's 2,500 more than AMC(AMEX: AEN), the next closest rival, and twice as many as privately owned Cinemark. The company owns 540 theatres in nearly all of the top 50 markets, and will soon be adding more after acquiring the Signature theater chain in California and Hawaii. Regal also generates advertising revenue through its CineMedia subsidiary, which was a bright spot during the quarter, increasing revenue by 15%.

But with a deteriorating balance sheet, sliding revenues, contracting margins, and slumping earnings lurking behind the curtains, shareholders might be better off running straight for the exits.

Fool contributor Nathan Slaughter is preparing for a horror-movie marathon leading up to Halloween. He owns none of the companies mentioned.

BorgWarner Revs Up

By