An earnings warning from teen retailer

Hot Topic

(HOTT)

wrinkled the teen apparel sector Wednesday.

The hip retailer, which sells rock music-themed clothing to teenagers, saw its shares crumble around 30% after it said earnings in the second and third quarters would be lower than anticipated.

The shortfall set off a sharp selloff among the company's competitors as investors worried that a slowing economy would further punish retail stocks. The news came on the same day that the government said the economy shrank during the first three quarters last year -- not just one -- and that second-quarter growth was less than half as strong as expected. Big stock indices fell modestly.

Cooling Down

City of Industry, Calif.-based Hot Topic said July same-store sales would fall 3% to 4%, reversing an expected single-digit gain, and that August sales would also be disappointing. The company said it expects second-quarter earnings of 13 cents a share on sales of $92 million. Analysts had been projecting 15 cents a share and revenue over $93 million, according to Thomson Financial/First Call.

"While sales in women's, rock-tees, music and many accessory categories continue to comp positively, the men's business, both tops and bottoms, has been very disappointing," said Betsy McLaughlin, president and CEO, in a statement. "In the absence of a clear men's trend, coupled with the historically significant contribution of men's during the back-to-school period, we are also revising our original expectations for the third quarter."

In the third quarter, Hot Topic now projects earnings of 27 cents to 29 cents a share, compared with consensus expectations of 32 cents, according to Thomson Financial/First Call.

Slowing Down

Hot Topic shares dropped $6.45 to $16. The stock has been a highflyer in recent years, as investors were attracted by the company's strong growth. For example, in 2000, monthly same-store sales gains above 20% were common. But more recently, the company has begun to show cracks. Same-store sales growth has slowed markedly, and the company has come under the microscope for alleged

trademark problems.

While the company has enjoyed near-unanimous support among sell-side analysts, short sellers have glommed onto the stock this year. At times in recent months nearly a third of the company's outstanding shares were sold short, according to figures provided by Nasdaq. The shorts say the company's merchandise is faddish and that the company's growth outlook is dismal.

Predictably, some analysts downgraded the stock Wednesday. In a note titled "Not as Hot as We Thought," Wells Fargo Securities analyst Jennifer Black lowered her rating from buy to hold. But she thinks the company's problems won't last long. "We do believe that Hot Topic's relatively short lead times and the expertise of Betsy McLaughlin -- in our opinion one of the strongest CEOs in the industry -- would enable the company to get back on track quickly," she writes.

Hot Topic's woes took down a slew of other apparel companies, especially those that cater to teenagers.

American Eagle Outfitters

(AEOS)

was off $1.80, or 10%, at $16.16;

Abercrombie & Fitch

(ANF) - Get Report

lost $2.64, or 10.6%, to trade at $22.39;

Gap

(GPS) - Get Report

lost 51 cents to trade at $12.29; and

Urban Outfitters

(URBN) - Get Report

fell $4.65, or $16.8%, to $23.11.