UNEDITED!

The government's tally of personal spending for June confirmed that spending contracted. In fact, the report published by the Commerce Department showed that spending had the largest drop since September 2001. The question now becomes whether June was the beginning of the end of the consumer spending binge or just a hiccup. Early indications show that it was merely a hiccup, but the rest of this week will offer a very good indication. Retailers report same store sales on Thursday and the Labor Department releases the July employment situation report on Friday.

Vehicle sales were one of the first indications of the strength of the economy and consumer spending. Auto sales were higher than analysts expected and provided a significant bounce over the lackluster results in June. The 17.4 million unit rate was also higher than the average rate so far this year. Unfortunately for the automakers it took higher incentives to boost sales. Additionally, Ford said that incentives were starting to have less impact. The domestic automakers lost market share again and for the second month Toyota overtook Chrysler as the number three nameplate.

Retailers report same store sales on Thursday which will yield more evidence on whether the consumer rebounded in July. A few retailers reported same store sales on Wednesday.

• Men's Warehouse reported July same store sales rose 5.5% compared to analysts estimates of 4.3%. The company also said it will beat the upper end of analysts' forecasts.

• American Eagle Outfitter reported July comparable sales increased 21.7%, trouncing 11.5% that analysts predicted. The retailer also increased its guidance from a range of $0.37 - $0.38 per share to $0.42 to $0.47 per share. This compares to $0.11 per share earned last year.

• Aeropostale also reported same store sales that were better than expected, 13.8% v. 9.7% and bumped its EPS guidance to 17 cents from eleven cents.

• The one retailer that reported lower same store sales on Wednesday still managed to do better than analysts predicted. Hot Topic reported its same-store sales fell 5.0%, but it was less than the 6.2% drop analysts estimated.

Coach, the high-end retailer of accessories and leather goods, reported its fiscal fourth quarter earnings on Tuesday. The market was duly unimpressed with the firm's results, sending the stock lower by 7% Tuesday and another 5% Wednesday. Investors jumped on the fact that same store sales in Japan rose in the mid-single-digits versus an expectation of double digit comps. Here is another recent example of a market that is expecting the world out of companies and punishing them for not delivering.

There definitely were some bright spots in Coach's "negative" earnings release. Sales increased 46% compared to 4Q 2003 and earnings per share rose 113% to $0.34 (vs. expectations of $0.31). Coach reported market share expansion, gross margins increased by 350bp and SG&A expenses declined by 750bp. Same store sales in the US increased 17.7% (retail 20.1% and factory 14.5%) while same store sales in Japan rose in the "mid-single digits". The company also issued fiscal 2005 guidance of $1.68, stronger than analysts' expectations of $1.64.

In recent months, we have witnessed several example of what could be classified as an increasingly dichotomous consumer spending environment. At the high end, there seems to be room to grow and increase margins. According to Tuesday's conference call, the average Coach customer purchases 3.5 handbags per year and "customers are embracing $300 handbag price points." Ann Taylor Stores, a specialty retailer of better quality women's apparel, has also spoken recently of higher full-price selling and very strong results in high end accessories such as handbags. Recently, Ann Taylor has had the confidence to test the price-elasticity of its handbags, increasing average ticket by 18%. Previously, Ann Taylor's highest priced handbag cost $115, now that price is reported to be $158.

It also appears that other companies have been noticing this trend as well, viewing that there is more margin and sales opportunities at the high end of the retailing spectrum. Wednesday clothing designer Tommy Hilfiger Corp. announced their first quarter results, reporting a net loss of $7.6M after sales fell 11%. According to Bloomberg, Tommy is refocusing its efforts from the baggy jeans and popular shirts that first inspired the company's dramatic growth to "dressier and more expensive" lines of clothing such as H Hilfiger, to be sold at Federated Department Stores (the owner of Bloomingdales and Macys stores). Additionally, Tommy Hilfiger is reducing product distribution to Dillard's, its largest customer, in an effort to limit discounting.

In other high-end retail news, Polo Ralph Lauren reported first quarter earnings that doubled while sales increased 24 per cent. The company cited rising demand for full priced merchandise in their Ralph Lauren and Club Monaco stores. COO Roger Farah put the results in perspective by commenting, "The luxury customer continues to look for the best and is willing to pay for it." Polo also announced that it has pulled some of its men's sportswear from poorly performing department stores and is also reducing distribution to TJ Maxx.

Meanwhile, lower to middle class consumers appear to have slowed down their spending. Discount retailers such as Wal-Mart and Target have been citing higher gas and energy costs as reasons that their customers are spending less. While, this view is held among other retailers and economists, it is more likely that it is more of a function of the overall inflation that consumer are experiencing is much greater than the government figures indicate. We have previously discussed increases in various other item, including staple foods such as milk, cheese, chicken, and beef. Tuesday, Performance Food Group, a grocery distribution firm that distributes over 64,000 products to 48,000 restaurants, hotels, schools and cafeterias, reported their second quarter results. The most interesting part of the earnings release was that the firm reported food inflation of 6% for the quarter, reducing real sales growth for the quarter from 14% to 8%.

Here is an excerpt from the Performance Food Group analyst conference call addressing food inflation and the pass through of higher costs to customers:

Analyst: Quick question on the inflation front. This looked like more a hyper inflation quarter. Is it your meat costs and what do you expect that to do going forward?

Company: It's meat and dairy. Dairy expectations are that dairy is probably going to moderate some in the last half of the year. I mean, meat, it doesn't really affect us whether meat goes up or not. It affects our margin, but all of the meat is basically sold on a cents per pound basis, so that, whether it goes up or down, actually has little impact on us. It does affect the margin percentages and meat, we are not sure what meat is going to do at this point and time.

Analyst: Going back to inflation, it looks as though you are doing a good job passing costs on to your customers, are there any segments that are more or less willing to take the price increases?

Company:I think that it is pretty evenly divided. We're passing the price increases to all our customers - we have to pass through the increases along, they understand that. There is some, you know, some lag time as we indicated with some customers that don't allow us to raise prices immediately, but we do raise prices within 30 days.

Similarly, grocery retailer Safeway reported significant non-packaged or commodity-based inflation during its second quarter conference call on July 27. Management saw major increases in the cost of milk, cheese, eggs, and meat. Meat costs were up 20% for the quarter and raw milk costs increased 29%. Safeway said that it chose to pass these costs on to their consumers; however in each case it has had a dampening effect on sales growth.

Consumer spending slowed in June and so far it appears to have rebounded in July. As we have chronicled, there are several tailwinds that aided consumer spending last year that have diminished. Now consumers have to deal with inflation in consumer goods as well. Even if consumer spending remains buoyant, retailers may not be able to take advantage since retailers have aggressively expanded their store base over the past several years.