By  on June 5, 2007

WASHINGTON — Facing the first increase in the federal minimum wage rate in a decade, retailers are scrambling to manage the impact on payroll costs and profits. And it could be substantial.

The teen retail segment could feel the sharpest blow because many companies hire teens at minimum wage, according to equity analysts. Independent specialty chains with stores in multiple states are expected to be hit, as are mass merchants operating on thin margins. The federal minimum wage will increase in stages to $7.25 an hour from $5.15 over the next two years.

Retailers have been grappling with recent increases in minimum wages in dozens of states, which have taken hourly pay well above the current federal minimum, and the issue has been a key topic in earnings conference calls as company executives try to explain to analysts and Wall Street why their payroll costs are rising.

"It's definitely a hit to teen retailers," said Crystal Kallik, an equity analyst with D.A. Davidson & Co., who covers Abercrombie & Fitch, American Eagle Outfitters, AnnTaylor Stores and Hot Topic. "They tend to hire their customer base: teens."

Michael Kramer, A&F's executive vice president and chief financial officer, recently said on a first-quarter conference call that the company expected an increase in expenses of $3 million a quarter directly as a result of the minimum wage increases.

Kallik called A&F's $3 million quarterly increase in payroll costs "significant," noting it amounts to $12 million on an annual basis, but she said the company had shown it could manage the increases by aggressively looking for inefficiencies.

"The ones who will get caught off guard are the [retailers] who are funding infrastructure as they go and are now getting hit with additional costs and haven't been working to find…offsets," Kallik said.

Gerald M. Chaney, senior vice president and cfo of Pacific Sunwear, said on a call that certain expenses rose nearly 1 percent in the first quarter as a result of the addition of 61 net new stores and the minimum wage increase that has occurred in some states.

"That's significant for them," said Kallik. "One assumes it will mean a few pennies' impact on this year's earnings. You don't typically hear a payroll called out in a conference call."Hot Topic cfo Jim McGinty also told analysts on the company's earnings call, "We are challenged…when it comes to store payroll. We've had over 20 states have minimum wage increases."

President Bush signed a bill on May 25 that raises the federal minimum wage in three steps: to $5.85 an hour 60 days after enactment (at the end of July), to $6.55 a year later and to $7.25 by July 2009. Many economists have come out in support of a wage increase for those toiling on the lowest rung of the economic ladder. They feel the economy will absorb the increase without suffering a major shock or massive layoffs and that added wages could increase disposable income, particularly for low-income workers that shop at mass merchants.

H. Lee Scott, president and chief executive officer of Wal-Mart Stores Inc., the world's biggest retailer, said the discount giant supported a minimum wage increase because it would give customers more spending power.

Historically, minimum wage increases have not led to massive layoffs or a spike in unemployment, according to Brian Bethune, U.S. economist at Global Insight, an economic and business consulting company. After all, the initial increase would still take a worker's annual salary to only $12,168 for a 40-hour work week, and the eventual minimum will amount to a yearly salary of just above $15,000.

"There are numerous factors that affect things, but primarily the dominant factor is the business cycle, which overwhelms other influences" in relation to a wage increase, said Bethune. "In this case, you also have states that already have wage rates above the federal level, so the impact would be substantially muted in those states."

Bethune said discounters would be the most "vulnerable" to a wage increase because "their customers have a higher percentage of disposable income that goes toward energy costs."

A spokeswoman for the Retail Industry Leaders Association, with membership that includes Wal-Mart and other mass merchants, said the minimum wage increase would not have an effect on that base because many retailers already pay well above the federal minimum wage.

Thirty-two states plus the District of Columbia have higher minimum wages than the $5.15 hourly federal rate, including many densely populated retail areas. The state of Washington has the highest, $7.93, followed by Oregon, $7.80, and California, $7.50. However, 18 states have rates equaling the current federal minimum, and retailers with stores in those areas could feel a bigger squeeze on payroll costs and profits. Those states include Alabama, Georgia, South Carolina, Mississippi, Louisiana, Idaho, Indiana, Kansas, North Dakota, South Dakota and Texas.Margaret Mager, an equity analyst with Goldman Sachs, who covers Limited Brands, Gap, Polo Ralph Lauren, J. Crew, A&F and Aéropostale, said the wage increase would affect retailers on a geographic basis.

"In places like New York City and Southern California, companies have to pay competitive wages to attract labor and that means they are already paying, in large part, above the minimum wage," said Mager. "In places where there are higher levels of unemployment or more availability of workers, there is going to be more upward pressure on costs. Rising labor costs will be felt more by lower-end retailers because they are selling at lower price points and they depend on a higher velocity of inventory turnover."

Most analysts said retailers would not lay off employees but would likely reduce hours to offset the increase in payroll costs.

"That's a big jump, and even those retailers who are already paying more than the $5.15 federal rate will have to bump up employees who are not making $7.25, in addition to the current employees [who are paid higher rates], to maintain the differential between experienced employees and new employees," said Mark Montagna, an analyst with C.L. King & Associates. "A retailer like Abercrombie, which has a lot of pricing power, has a greater ability to do it than Gap, which is losing pricing power. The increase [in the wage] is certainly going to be a negative for Gap."

Apparel manufacturers also are looking for ways to absorb the increase in labor costs, but textile firms won't be affected as much because they already pay wages higher than the federal level, according to industry experts. However, it was rising wage costs that drove the apparel and textile industry offshore in the last quarter-century, so what jobs are left could be at stake.

Stephen Lamar, executive vice president at the American Apparel & Footwear Association, said, "There is a lot of indexing in the government contract business, and if the minimum wage goes up, those manufacturers will have to pay more."

Bruce Raynor, general president of UNITE HERE, said, "I think the minimum wage increase will affect apparel workers and some distribution center employees in the apparel industry, where the wages are very low. The minimum wage increase will push up wages in general, which we hope to see. When you lift up the bottom, it has an impact throughout the system."Lamar and Raynor said they don't expect firms to shift more production offshore because most of the minimum-wage jobs that would be affected, such as distribution center workers, need to be here.

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