* Q2 EPS $0.10 vs est $0.11
* Q2 sales $675.7 mln vs $648.5 mln
* Sees Q3 EPS $0.22- $0.27 vs est $0.26
* Plans promotions for back-to-school
* Shares fall as much as 14 percent (Adds conference call, analyst comments; updates share movement)
BANGALORE, Aug 24 (Reuters) - American Eagle Outfitters Inc forecast disappointing third-quarter earnings as higher product costs and discounts eat into margins, joining a slew of apparel retailers that have raised concerns over consumer spending during the key back-to-school selling season.
American Eagle's shares fell 14 percent to their lowest in over two years, as the company's smaller-than-expected quarterly profit and soft margin outlook worried investors.
"While back-to-school has gotten off to a terrific start, we're facing lower customer confidence in spending, especially during non-peak selling periods," Chief Executive Jim O'Donnell, who is slated to retire soon, said in a conference call with analysts.
But there appear to be few positives in the key selling season for the company as it promises more promotions, amid increased pressure on margins.
"Markdowns (are) a bit higher than I would like it to be. It's ... because of the competitive environment out there," Roger Markfield, the company's executive creative director, said.
American Eagle projected third-quarter earnings of 22-27 cents a share, while analysts had expected 26 cents a share, according to Thomson Reuters I/B/E/S.
"Currently, back-to-school promotional levels are higher than last year ...higher product costs and a low single digit increase in SG&A are expected to hold back earnings in the third quarter," Stifel Nicolaus analyst Richard Jaffe said.
Most apparel retailers are being cautious about the second half of the year. Companies like Aeropostale Inc , Ross Stores , Children's Place and Abercrombie & Fitch , are also battling high raw material costs and have warned of a brittle economic environment that could weigh on sales if shoppers go into hiding.
American Eagle has been losing market share to peers like Abercrombie & Fitch and Lazard Capital analyst Jennifer Davis expects this trend to continue.
Meanwhile, Abercrombie, which has outperformed the teen apparel segment in the recent past, has upped the ante in a highly competitive teen apparel market by advertising attractive discounts for back-to-school shoppers.
Pittsburgh-based American Eagle, already struggling with high costs of raw materials, is likely to find it much more difficult to guard margins if it takes to heavy promotions.
"American Eagle is competing in an over-stored, over-inventoried teen space," Lazard analyst Davis said.
"It is stuck in the middle of Abercrombie and Aeropostale for basics, and can't compete with Forever 21 on fashion."
Inventory rose by $121 million in the second quarter, while margins slipped to 34.3 percent from 36.8 percent last year.
"We expect markdown pressure in the second-half," analyst Davis, who has a "sell" rating on the company's stocks, said.
For the second quarter, American Eagle earned $19.7 million from continuing operations, or 10 cents a share, while analysts were expecting earnings of 11 cents.
Sales rose 4 percent to $675.7 million, beating estimates.
American Eagle shares were down 12 percent at $10.21, making it the second biggest loser on the New York Stock Exchange on Wednesday. They had earlier touched a low of $10.01. (Reporting by Nivedita Bhattacharjee in Bangalore; Editing by Viraj Nair)