UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED OCTOBER 27, 2012

OR

COMMISSION FILE NO. 001-11679

Orchard Supply Hardware Stores Corporation

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code: (408) 361-2536281-3500

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨x    No  x¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of December 21, 2011,November 30, 2012, the registrant had 6,000,0004,830,147 shares of Class A Common Stock, 8,644par value $0.01 per share, 8,644.06788 shares of Class B Common Stock, par value $0.01 per share, and no1,194,000 shares of Class C Common Stock, par value $0.01 per share, outstanding.

We are an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012. We are indicating our status as an “emerging growth company” at this time as a result of the recent views confirmed by the Securities and Exchange Commission in its Frequently Asked Questions Nos. 53 and 54 released on September 28, 2012. For implications of our status as an “emerging growth company,” please see “Part II — Item 1A — Risk Factors” elsewhere in this Quarterly Report on Form 10-Q.

ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

QUARTERLY PERIOD ENDED OCTOBER 29, 201127, 2012

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATIONINDEX

PART I. FINANCIAL INFORMATION

ITEM 1. UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

AS OF OCTOBER 29, 2011,27, 2012, JANUARY 29, 201128, 2012, AND OCTOBER 30, 201029, 2011

(In thousands, unaudited)Unaudited, in thousands)

See notes to condensedinterim consolidated financial statements.

ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE 13 AND 39 WEEK PERIODS ENDED OCTOBER 27, 2012 AND OCTOBER 29, 2011

(Unaudited, in thousands, except per share amounts)

Transition Service Arrangements—The Effective with the Spin-Off, the Company does not maintain all of its own legal, tax, and certain other corporate support functions. In connection withentered into a series of recapitalization transactions in November 2005,transition service agreement (the “Transition Services Agreement”) whereby Sears Holdings continues to provide to the Company certain services provided prior to the Spin-Off and which enables the Company to retain access to various other third-party services until the Company is able to set up its stand-alone corporate functions and/or contract with third-party service providers. The services provided under the Transition Services Agreement are individually terminable upon 60 days notification by the Company. All services to be provided under the Transition Services Agreement will terminate upon the first anniversary of the effective date of the Transition Services Agreement. In December 2011, the Company completed its transition of payroll and legal functions from Sears Holdings. The remaining miscellaneous accounting and tax support services are expected to be transitioned by the end of fiscal 2012.

Prior to the Spin-Off, the Company entered into a series of annual shared services agreements (the “Transaction Service“Services Agreement”) to provide the Company with certain corporate support services while the Company buildsbuilt its own stand-alone corporate support functions for legal, tax, and certain other corporate support functions. The costs and allocations charged to the Company by Sears Holdings domay not necessarily reflecthave reflected the costs of obtaining the services from unaffiliated third parties, or ofif the Company providinghad performed the applicable services itself. The methods by which Sears Holdings allocatesallocated its costs arewere based on a

prorated estimate of costs expected to be incurred by Sears Holdings. The interim condensed consolidated financial statements contained herein may not be indicative of the Company’s interim condensed consolidated financial position, operating results and cash flows in the future, or what they would have been if it had been a stand-alone company during all periods presented. The Company has not included an estimate of what these costs would have been on a stand-alone basis because it is not practicable to do so. The Company does not expect the allocated expenses for these functions on a stand-alone basis to be materially different than what is reflected in its historical consolidated financial statements.

Effective2. LIQUIDITY

As of October 27, 2012, the Company had cash and cash equivalents of $10.5 million and total debt and capital lease obligations of $228.4 million. The Company’s liquidity is dependent upon its cash and cash equivalents, cash flows provided by operating activities and the continued availability of borrowings under its financing arrangements. The financing arrangements require the Company to maintain compliance with certain financial covenants including a leverage ratio covenant in its Senior Secured Term Loan. On October 26, 2012, the Company received a waiver of this leverage ratio covenant for the October 27, 2012 measurement date (see Note 7 to the interim consolidated financial statements). As anticipated, as of October 27, 2012, the Company was not in compliance with the Distribution,leverage ratio covenant

The Company expects that it will not be in compliance with its leverage ratio covenant in its Senior Secured Term Loan as of the next measurement date, which is February 2, 2013, in part due to the decline in the Company’s operating results during fiscal 2012.

Non-compliance with the leverage ratio covenant as of the next measurement date would cause a default under the financing arrangements if the Company entered intois unable to otherwise restructure or repay the term loan by that time or otherwise obtain a transition service agreement (the “Transition Service Agreement”)waiver from the term loan debt holders. A default could result in the Company’s lenders under the Senior Secured Term Loan declaring the outstanding indebtedness ($127.7 million as of October 27, 2012) to be due and payable, by accelerating the current maturity dates of December 21, 2013 ($55.2 million) and December 21, 2015 ($72.5 million). As a result of the cross-default provisions in the Company’s debt agreements, a default under the Senior Secured Term Loan could result in a default under, and the acceleration of, payments in our Senior Secured Credit Facility. A default could result in the Company’s lenders under the Senior Secured Credit Facility declaring the outstanding indebtedness ($46.0 million as of October 27, 2012) to be due and payable. In addition, the Company’s lenders would be entitled to proceed against the collateral securing the indebtedness.

The Company is currently in discussions to replace its Senior Secured Term Loan by means of issuing new long-term debt and/or equity. The Company may also request that the lenders under the Senior Secured Term Loan refinance or modify the terms of its debt. It is uncertain whether these endeavors by the Company to refinance or modify its debt will be successful. In addition, any refinancing could be at higher interest rates and may require the Company to comply with financial and other covenants which supercededcould restrict business operations. If the Transaction Service Agreement with Sears Holdings whereby Sears Holdings will continueCompany issues equity securities, the Company’s stockholders may experience significant dilution. If the Company is unable to providerefinance its debt, or do so on terms acceptable to the Company, the same services provided priorlenders could demand repayment of the amounts outstanding under the Company’s financing agreements as described above. If the indebtedness described above were to the Distribution and still needed bybe accelerated, the Company would not have sufficient liquidity to make full repayments of the outstanding debt.

These interim consolidated financial statements have been prepared assuming the Company’s existing cash and to enablecash equivalents, cash flows provided by operating activities and the continued availability of funds under its financing arrangements will provide the needed liquidity for the Company to retain accesscontinue as a going concern. The uncertainties surrounding our ability to various other third-party services untilreplace or modify the Company is ableSenior Secured Term Loan with our lenders, and the consequences of our inability to set up its stand-alone corporate functions and/replace or contractamend the Senior Secured Term Loan or obtain an additional waiver of the anticipated leverage covenant violation raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans concerning these matters are discussed above. The interim consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of Estimates — The preparation of consolidated financial statements in conformity with third-party service providers. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Merchandise Inventories —The services providedCompany’s housewares, hardware and garden inventory are valued under the Transition Service Agreement will be individually terminable upon 60 days notification byretail inventory method using a last-in, first-out (“LIFO”) cost flow assumption. To estimate the Company. All services to be provided under the Transition Service Agreement will terminate upon the first anniversaryeffects of the effective date of the Transition Services Agreement.changing prices in inventory The Company does not expectutilizes external price indices determined by an outside source, the costs incurred under the Transition Service Agreement to differ materially from the costs incurred under the Transaction Service Agreement.

Stock split — On December 8,Bureau of Labor Statistics. At October 27, 2012, January 28, 2012 and October 29, 2011, the Company completed a 6-for-1 stock split of its common stock. The stock split increased the number of sharesapproximately $55.9 million, $47.3 million and $41.7 million, respectively, of the Company’s common stock issuedmerchandise inventories were valued under LIFO. If the first-in, first-out method of inventory valuation had used instead of the LIFO method, merchandise inventories would have been $5.8 million, $4.0 million and outstanding from approximately 1.0$1.8 million to approximately 6.0 million. All sharelower at October 27, 2012, January 28, 2012 and per share amounts herein are presented on a post-stock split basis.October 29, 2011, respectively.

Segment ReportingAccounting for the Impairment of Long-lived Assets — —Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset or asset group may not be recoverable. If the carrying value of the asset or asset group exceeds the expected future cash flows expected to result from the use of the asset, on an undiscounted basis, an impairment loss is recognized. The impairment loss recognized is the excess of the carrying value of the asset or asset group over its fair value. The fair market value of these assets or asset group is determined using the income approach and Level 3 inputs , which require management to make estimates about future cash flows. The Company has one reportable segment. The Company’s operations include activities related to its stores that are all locatedestimates the amount and timing of future cash flows based on historical experience and knowledge of the retail market in California.

Vendor Rebates and Allowances —which each store operates. The Company receives various vendor-funded rebatesrecorded approximately $4.8 million and allowances through a variety$12.4 million of programsproperty and arrangements intended to offset the Company’s costs of promoting and selling certain vendor products. These vendor payments are recorded as a reduction to the cost of merchandise inventories when earned and, thereafter, as a reduction of cost of sales, as the merchandise is sold. Up-front consideration received from vendors linked to purchases or other commitments is deferred until performance of the specified activity is deemed to be complete. Forequipment impairment charges in connection with store assets for the 13 and 39 weeks periods ended October 29, 2011, the Company earned vendor rebates and allowances of $7.5 million and $22.6 million,27, 2012, respectively. ForNo impairment charges were recorded for the 13 and 39 weeksweek periods ended October 30, 2010,29, 2011.

Income Taxes and Deferred Taxes— The Company monitors its operating performance and evaluates the likelihood of the future realization of its deferred federal and state tax assets. In assessing the realization of these deferred tax assets and the need for a valuation allowance, the Company earned vendor rebatesconsiders both positive and allowancesnegative evidence related to the likelihood of $7.9 millionrealization of the deferred tax assets taking into account achieving a certain level of future taxable income or being able to carry back any taxable losses and $22.0 million, respectively. Vendor rebatesclaim refunds against previously paid income taxes. If, based on the weight of available evidence, it is more likely than not the deferred tax assets will not be realized, the Company records a valuation allowance. The weight given to the positive and allowancesnegative evidence is commensurate with the extent to which the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses. A pattern of objectively measured recent and cumulative financial reporting losses are a source of significant negative evidence that is difficult to overcome in determining that a valuation allowance is not needed against deferred at October 29, 2011, January 29, 2011tax assets. As of July 28, 2012, the Company concluded that the negative evidence outweighed the positive evidence, and October 30, 2010 were $11.2 million, $11.8 millionaccordingly, it was more likely than not that the Company would not be able to realize all of its federal and $11.9 million, respectively, and are included as a reduction to merchandise inventoriesstate deferred tax assets. Therefore, in the interim condensed consolidated balance sheets.second quarter of fiscal 2012, the Company recorded a charge of $18.4 million to income tax expense to establish a valuation allowance against its deferred tax assets. At October 27, 2012 the Company’s valuation allowance was $27.8 million.

Assets available for saleDerivatives —— Assets that have met the criteria to be classified as held for sale under ASC 360-10-45Derivative financial instruments embedded in leases are recorded at fair value within prepaid expenses andin the consolidated balance sheets as capital lease asset if the lease is a capital lease or as other currentlong-term assets withinif the balance sheetlease is an operating lease. The assets are amortized over the life of the interim condensedlease to depreciation and amortization expense. In addition, they are recorded in other long-term liabilities at fair value and any gain or loss on the derivative financial instruments is recorded in interest expense in the consolidated statements of operations. At October 27, 2012 and January 28, 2012, the fair value of the derivative financial statements.instruments embedded in the Company’s lease was $3.5 million and $2.3 million, respectively. At October 29, 2011 the Company had $2.6 million of assets held for sale. There were no assets classified as held for sale at January 29, 2011 and October 30, 2010.did not have any derivative financial instruments embedded in its leases.

Leases— The Company leases certain stores, office facilities, computers,Gift Cards and transportation equipment. The determination of operating and capital lease obligations is based upon the expected terms of the lease, and the contractual minimum lease payments as defined within the lease agreements. The Company may enter into sale-leaseback agreements to sell certain facilities and lease them back consistent with their current operational use. If the lease under a new agreement is determined to be a capital lease, any gain or loss on the sale would be amortized in proportion to the amortization of the leased asset over the life of the lease. If the new lease is an operating lease, any gain would be amortized in proportion to the gross rent charged to expense over the lease term and any loss onGift Card Breakage — Proceeds from the sale of gift cards are recorded as a liability and are recognized as revenue from merchandise sales when the asset would be recognized immediately.

cards are redeemed. The Company’s gift cards do not have an expiration date. Prior to the third quarter of 2012, all unredeemed gift card proceeds were reflected as a current liability, and the Company did not recognize any income from unredeemed gift cards. On October 24, 2011, a subsidiary of26, 2012, the Company entered into a Purchase and Sale Agreement pursuant to which a subsidiaryan agreement with an unrelated third party who became the issuer of the Company’s gift cards going forward and also assumed the existing liability for unredeemed gift cards for which there were no currently existing claims under unclaimed property statutes. The Company soldis no longer the primary obligor for $21.2 million, netthe third party issued gift cards and is therefore not subject to claims under unclaimed property statutes, as the agreement effectively transfers the ownership of fees, all of its interest in its distribution center located in Tracy, California, which is comprised of a building containing approximately 458,000 square feetsuch unredeemed gift cards and the underlying land. In connection with the sale of the distribution center, a subsidiary of the Company entered into a lease agreement with respectrelated future escheatment liability, if any, to the distribution center. The commencement datethird party. Accordingly, gift card breakage income of the lease$1.4 million was October 28, 2011. The lease is for a 20-year period and provides for three five-year extension options. The initial base rent under the lease is $1.7 million per year with 10% increases every five years. The Company recorded a non-cash loss of $14.3 million on the sale of the distribution center forrecognized in the 13 weeks ended October 29, 2011. 27, 2012 for such unredeemed gift cards.

Stock-Based Compensation —The Company will continuerecognizes as expense the fair value of all stock-based compensation awards, including stock options. The Company recognizes compensation expense as awards vest on a straight-line basis over the requisite service period of the award. The Company accounts for stock-based compensation using the fair value method. The total compensation expense is reduced by estimated forfeitures expected to operateoccur over the facility consistentvesting period of the award.

Comprehensive Income (Loss) — Comprehensive income (loss) encompasses all changes in equity other than those arising from transactions with its existing use throughout the lease term.stockholders. Comprehensive income (loss) was equal to net loss for all periods presented. The Company had no items of other comprehensive income (loss) in any period presented.

Earnings Per Share (“EPS”)— The Company computes and reports both basic EPS and diluted EPS. Basic EPS is computed by dividing net earnings by the weighted average number of common shares outstanding for the period. Diluted EPS is computed by dividing net earnings by the sum of the weighted average number of common shares and dilutive common stock equivalents outstanding during the period. Diluted EPS reflects the total potential dilution that could occur from outstanding equity plan awards, including unexercised stock options.

There are no dilutive common stock equivalents, and therefore basic and dilutive EPS are the same for all periods presented.

Fair Value of Financial InstrumentsMeasurements — Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures, (“ASC 820”) defines fair value, establishes a framework for

measuring fair value in GAAP and requires certain disclosures about fair value measurements. Under ASC 820, fair value is considereddefined as the price that would be received to besell an asset or paid to transfer a liability in the exchange priceprincipal or most advantageous market in an orderly transaction between market participants to sell an asset or transfer a liability aton the measurement date. ASC 820 also establishesEntities are required to use a fair valuethree-level hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describesvaluation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date. The three levels of inputs that may be used to measure fair value:are defined as follows:

Level 1 — QuotedUnadjusted quoted prices in active markets for identical assets or liabilities;

Level 2 — Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable; and

Level 3 — Unobservable inputs that are supported by little or no market activity, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing.

Due to their short-term nature, the carrying value of the Company’s cash and cash equivalents, restricted cash, other current assets, merchandise payables, accrued expenses and other current liabilities approximate their fair value. Based

Financial instruments are measured at fair value on a recurring basis. Included in cash and cash equivalents are money market funds for which fair value was determined using Level 1 inputs. The fair value of the Senior Secured Term Loan is based on its trading value as determined by using Level 1 inputs. The fair value of the Company’s debt obligations with respect to the Senior Secured Credit Facility is determined using borrowing rates available to the Company, which are considered Level 2 inputs, and have approximated their carrying value at October 27, 2012, January 28, 2012 and October 29, 2011.

Assets that are measured at fair value on a nonrecurring basis relate primarily to the Company’s operating store fixed assets and other intangible assets, which are remeasured when the derived fair value is below carrying value on the Company’s consolidated balance sheets. For these assets, the Company does not periodically adjust carrying value to fair value except in the event of impairment. When the Company determines that impairment has occurred, the carrying value of the Company’s debt obligations approximated theirasset is reduced to fair value at October 29, 2011, January 29, 2011, and October 30, 2010.the difference is recorded within operating income in the Company’s consolidated statements of operations.

The Company measures certain non-financial assets and liabilities, includingIn connection with the Company’s evaluation of long-lived assets for impairment, certain long-lived assets were remeasured at fair value on a non-recurring basis. Thebasis using Company did not record anyspecific assumptions which would fall within Level 3 inputs of the fair value hierarchy. In the determination of impairment for operating stores, the 13Company determined the fair values of individual operating stores fixed assets using an income approach, which required discounting projected future cash flows. When determining the projected future cash flows associated with an individual operating store’s fixed assets, management made assumptions, incorporating local market conditions, about key store variables, including sales growth rates, gross margin and 39 weeks ended October 29, 2011controllable expenses such as store payroll and October 30, 2010.occupancy expense. In order to calculate the present value of those future cash flows, the Company discounted cash flow estimates at a rate commensurate with the risk used as the cost of its capital.

The Company was not required to measure any other significant non-financial assets and liabilities atmeasures the fair value of store lease derivative liabilities on a recurring basis using Company specific assumptions which would fall within Level 3 inputs of the fair value hierarchy. Ten of the Company’s store leases have future rent increases tied to an index of annual changes in the Consumer Price Index (“CPI”). The fair value of the derivative liabilities is computed using historical increases in CPI and the value calculated using the maximum rent escalation cap as of October 29, 2011 and October 30, 2010.defined by the leases.

New Accounting Pronouncements — — In June 2011,Under the Financial Accounting Standards BoardJumpstart Our Business Startups Act (“FASB”JOBS Act”) issued, the Company meets the definition of an “emerging growth company”. The Company has irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards updatepursuant to reviseSection 107(b) of the mannerJOBS Act.

4. FAIR VALUE OF FINANCIAL INSTRUMENTS

The following tables summarize the valuation of the Company’s financial instruments as measured at fair value on a recurring basis as of October 27, 2012 and January 28, 2012:

The estimated fair value of the Company’s financial instrument was as follows:

5. TRADE NAME ASSET IMPAIRMENT

The Company’s trade name assets,OSH andOrchard Supply Hardware, are not subject to amortization. Trade names are tested for impairment annually (as of the last day of the Company’s November accounting period) or more frequently if events or changes in which entities present comprehensive income incircumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of the trade names with their financial statements. This guidance requires entities to present each component of net income along with total net income, each component of other comprehensive income (“OCI”) along with a total for OCI, and a total amount for comprehensive income, either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This accounting standards update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.carrying amount. The Company will adoptuses the provisionsrelief from royalty method (which utilizes a discounted cash flow model) to determine the fair value of the trade names. Potential impairment exists if the fair value of trade names is less than their carrying amount. The use of different assumptions, estimates or judgments in the trade name asset impairment testing process, such as the estimated future revenues, royalty rates, and the discount rate used to discount such cash flows, could significantly increase or decrease the estimated fair value of the assets, and therefore, impact the related impairment charge.

Due to the recent decline in our market capitalization, the decline in revenues during the 13 weeks ended October 27, 2012, and lowered forecasted future revenues (compared to a forecast prepared in the fourth quarter of fiscal 2011), the Company tested its trade names for possible impairment as of October 27, 2012. As a result of this analysis, which included reduced royalty rates, trade names were measured at a fair value $47.3 million, and the Company recognized non-cash trade name impairment of $60.3 million in the 13 weeks ended October 27, 2012.

6. SALE-LEASEBACK TRANSACTIONS

The Company evaluates sales of properties which occur in sale-leaseback transactions to determine the proper accounting standards updatefor the proceeds of such sales transactions either as a sale or a deposit. This evaluation requires certain judgments in determining whether all considerations have been exchanged and whether there is continuing involvement with respect to the property. For transactions that have not yet met the sale criteria, the Company accounts for the proceeds as deposits from the sale of real properties and offsets rent payments against the deposits. Once all conditions of the sale have been met, the property will be evaluated for sale-leaseback accounting.

In the first quarter of fiscal 2012. This amendment will change2012, the Company sold all of its interest in a store property located in San Lorenzo, California and entered into a sale-leaseback agreement with respect to the store. The term of the lease is from April 2012 to November 2013 and may be terminated after November 2012 with 30 days notice. The aggregate gross purchase price received from this property was approximately $6.6 million. For accounting purposes, the sale of the store was consummated and the Company recorded a $0.7 million gain on the transaction during the quarter ended April 28, 2012.

In the second quarter of fiscal 2012, the Company sold all of its interest in six store properties located in San Jose, Van Nuys, Pinole, Chico, and Clovis, California and entered into a master sale-leaseback agreement with respect to those stores. In conjunction with the sale-leaseback, the Company entered into a lease agreement allowing the Company to continue to operate the stores in a manner consistent with their existing use throughout the lease term. The initial lease term of the lease is from July 27, 2012 to July 27, 2030 with three 5-year renewal options. The aggregate gross purchase price received from these properties was approximately $42.8 million. For accounting purposes, the sale of these stores was not consummated due to continued involvement and risk. Thus, no gain or loss was recorded on the transaction.

As of October 27, 2012, the Company had $26.2 million of short-term deposits from the sale-leaseback of real property on three stores in the fourth quarter of fiscal 2011 and $40.5 million of long-term deposits from the sale-leaseback of real property on six stores in the second quarter of fiscal 2012 recorded as liabilities in the consolidated balance sheet. The sale-leaseback agreement with respect to the six stores sold in the second quarter of fiscal 2012 includes provisions for the remodeling of the stores for which the landlord will reimburse the Company presents comprehensive income in its consolidated financial statements.

for the costs of Tenant Improvements (“Improvements”) up to an agreed upon amount. In May 2011,addition, if the FASB issued guidanceCompany fails to amendcomplete construction during the accounting and disclosure requirements on fair value measurements. The new guidance limitsspecified period, the highest-and-best-use measurelandlord will have one year to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risksexercise an option to be measured at a net basis, and provides guidance onrequire the applicability of premiums and discounts. Additionally,Company to repurchase the new guidance expandsproperties. Due to the disclosures on Level 3 inputs by requiring quantitative disclosure ofCompany’s continuing involvement during the unobservable inputs and assumptions,remodeling period, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. The new guidance will be effectiveleases provide for the Company beginning January 29, 2012.to assume substantially all of the construction period risk, the sale-leaseback will not be consummated until the Improvements are completed within the specified timeframe, and amounts spent are fully reimbursed to the Company by the landlord. The remodeling of three of these stores is expected to be completed during fiscal 2013 and the remaining stores are expected to be completed in fiscal 2014. The Company does not anticipate a material impactexpects to recognize the sale on its financial statements upon adoption.

3.	DEBT AND CAPITAL LEASE OBLIGATIONS

7. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

The components of the Company’s debt and capital lease obligations as ofat October 27, 2012, January 28, 2012 and October 29, 2011 January 29, 2011 and October 30, 2010, are as follows (in millions):

Senior Secured Credit FacilityTerm Loan — On December 21, 2006, OSH LLC entered into an Amended and Restated Senior Secured Credit Agreement (the “Replaced Facility”) with a syndicate of lenders. The Replaced Facility provided revolving availability of up to $130 million (subject to borrowing base limits and fixed charge coverage ratio) for a period of five years, maturing on December 21, 2011. On January 29, 2010, OSH LLC22, 2011, the Company amended, and restated and extended the Replaced Facility (the “Seniorits Senior Secured Credit Facility”) and reduced the revolving availability down to $120.0 million (subject to borrowing base

limits).Term Loan. The amendment bifurcatedand restatement split the facility into a $20.0 milliontwo tranches. The first tranche maturing December 21, 2011was with lenders who elected not to extend and a $100.0 million tranche maturing on the earlier to occur of 90 days prior to the maturity beyond December 21, 2013 (“non-extended lenders”), of which $55.2 million was outstanding as of October 27, 2012. The second tranche was with lenders who elected to extend the maturity date to December 21, 2015 (“extended lenders”), of which $72.5 million was outstanding as of October 27, 2012.

Eurodollar loans owing to non-extended lenders bear interest at LIBOR, plus the “Eurodollar applicable rate” which ranges between 4.50% and 4.75%. As of October 27, 2012, the Company’s interest rate under the Senior Secured Term Loan for non-extended loans was 5.0%.

Eurodollar loans owing to extended lenders have both cash and December 21, 2013 with lenders who electedPIK interest components. Such loans bear interest at LIBOR (which shall be deemed to extend. As of January 29, 2011, $48.0 million was borrowed under the facility, with approximately $8.0 million due in December 2011 and approximately $40.0 million due in December 2013.be equal to at least 1.25%), plus 5.75%. As of October 29, 2011, $32.0 million was borrowed27, 2012, the Company’s interest rate under the facility, with approximately $5.3 million due in December 2011 and approximately $26.7 million due in December 2013. The Company anticipates repaying $20.0 million on the Senior Secured Credit Facility within the next 12 months. The Company intends to draw funds from extending lenders to repay amounts due to non-extending lenders.

The Senior Secured Credit Facility also permits the ability to obtain letters of credit. As of October 29, 2011, January 29, 2011 and October 30, 2010, there were $8.1 million, $7.3 million and $7.8 million of outstanding letters of credit, respectively.

Borrowings under the Senior Secured Credit Facility are subject to a borrowing base consisting of the sum of (i) 90% of eligible credit card accounts receivable plus (ii) 80% of other eligible accounts receivable plus (iii) the lesser of (x) 70% of eligible inventory (valued at the lower of cost, on a first in first out basis, or market value) or (y) 85% of the appraised net ordinary liquidation value of eligible inventory. The Company must deliver borrowing base certificates and reports at least monthly. The borrowing base also may be subject to certain other adjustments and reserves to be determined by the agent. As of October 29, 2011, there was $70.9 million available to borrow under the Senior Secured Credit Facility.

The Senior Secured Credit Facility places various restrictions on OSH LLC and Guarantors, including, but not limited to, limitations on their ability to incur additional debt, pay dividends, or make distributions, sell assets, or make investments.

The Senior Secured Credit Facility required OSH LLC and the Guarantors to meet specific covenants, including a fixed charge coverage ratio that is triggered when availability reaches a minimum threshold for three consecutive days. Borrowings under the Senior Secured Credit Facility are also subject to a Fixed Charge Coverage Ratio of 1.1 to 1. At any time the fixed charge coverage ratio falls below 1.1, the Company can only borrow up to 90% of the available borrowing base. The Company was in compliance with these covenants as of October 29, 2011, January 29, 2011 and October 30, 2010.

Senior Secured Term Loan— On December 21, 2006, OSH LLC entered into a $200 million senior secured term loan agreement (the “Senior Secured Term Loan”), which requires quarterly principal paydowns (the “Mandatory Payments”) of $0.5 million and has a seven-year term, maturing on December 21, 2013. On January 28, 2011, OSH LLC entered into the first amendment to the Senior Secured Term Loan (the “Senior Secured Term Loan First Amendment”), which resulted in changesfor extended loans was 7.0%. In addition, the Company’s extended loans bear a PIK interest due at the end of the term at a rate equal to 3.00% or 4.00% per annum, with such interest automatically increasing the principal amount of the extended term loans on an annual basis. When the Company’s credit rating falls below B3 by Moody’s or B- by S&P, the PIK interest rate increases to 4.00%. On October 24, 2012, Moody’s cut the Company’s credit rating to Caa1 from B3. As of October 27, 2012, the Company’s PIK interest rate was 4.00% based on its credit rating. Additional interest rate increases may also apply as a result of entering into the Waiver and Amendment No. 1 due to the Company’s noncompliance with its maximum adjusted leverage ratio covenant (the “Leverage Covenant”), applicable interest rates, definitionas of EBITDA and excess cash flow prepayment percentage rate.October 27, 2012, as discussed below.

In addition to the Mandatory Payments,required quarterly principal payments of $0.4 million, the Company is requiredhas the option to make annualperiodic repayments on the Senior Secured Term Loan equal to a defined percentage rate (determined based on the Company’s leverage ratio) of excess cash flows. In accordance with the Senior Secured Term Loan First Amendment, the defined percentage rateratio and ratings) of excess cash flows, was increased to 75% from 50%which ranges between 25% and 100%. The Company did not make any prepayments pursuant to this requirement in fiscal 2010 or fiscal 2011 and does not anticipate paying any prepayments under this requirement in fiscal 2012.

The Senior Secured Term Loan places various restrictions on OSH LLC and the Guarantors, including, but not limited to, limitations on their ability to incur additional debt, pay dividends, make distributions, sell assets or make investments. The Senior Secured Term Loan requires OSH LLC and the Guarantors to meet specific covenants, including the Leverage Covenant. The Company was in compliance with the Senior Secured Term Loan Leverage Covenantsoption during the first, second and third quarters of fiscal 2011 and all of fiscal 2010.

Real Estate Secured Term Loan— In October 2010, OSH Properties entered into a $50 million real estate secured loan (the “Real Estate Secured Term Loan”) with a group of lenders that required quarterly payments of $0.1 million and that matures in December 2013. On February 17, 2011, OSH Properties entered into the first amendment to the Real Estate Secured Term Loan, which raised the maximum thresholds, as defined by the Real Estate Secured Term Loan, on the Leverage Covenant for certain periods and amended the definition of EBITDA. On December 19, 2011, the Company entered into the first amendment to the Real Estate Secured Term Loan, which, among other things, lowered the minimum principal amount required under the Real Estate Secured Term Loan, which allowed the Company to conduct certain sale and leaseback transactions described in Note 7 below.

The Real Estate Secured Term Loan requires the Company to meet the Leverage Covenant, subject to maximum thresholds established by the Real Estate Secured Term Loan. The Company was in compliance with these covenants during the first, second, and third quarters of fiscal 2011 and all of fiscal 2010.

Change in Control— The Senior Secured Credit Facility, Senior Secured Term Loan and Real Estate Secured Term Loan each contain an event of default resulting from a change of control, which includes the following: (i) certain mergers, consolidations, sales or transfers of all or substantially all of the assets of OSH LLC and OSH LLC’s subsidiaries to persons other than ACOF, ESL Investments, Inc. (“ESL”) and Sears Holdings; (ii) adoption of a plan of liquidation of OSH LLC; (iii) prior to an initial underwritten public offering of common stock of the Company, Sears Holdings, ESL and ACOF ceasing to collectively hold directly or indirectly at least 50% of the total voting power of all shares of the Company and OSH LLC’s voting capital stock; (iv) following an initial underwritten public offering of common stock of the Company, a person or group, other than Sears Holdings, ESL and ACOF, collectively holding directly or indirectly at least 40% of the total voting power of all shares of the Company and OSH LLC’s voting capital stock and Sears Holdings, ESL and ACOF collectively holding less than such person or group; and (v) the Company’s board of directors not consisting of continuing directors (“Change in Control”).

If, following the Distribution, one or both of ESL and ACOF dispose of all or part of their shareholding in the Company such that their combined total voting power drops below 50%, this may trigger a Change in Control event of default under the Senior Secured Credit Facility, Senior Secured Term Loan and Real Estate Secured Term Loan. An event of default could trigger certain acceleration clauses and cause those and the Company’s other obligations to become immediately due and payable and the Company may not have sufficient cash funds available to repay its debt obligations upon such a Change in Control.

Immediately following the Distribution:

Neither ESL nor ACOF have agreed to maintain their shareholding in the Company following the Distribution.

The Company’s liquidity is dependent upon the continued availability of borrowings under its current financing arrangements. As discussed in Note 3, the Senior Secured Term Loan and Real Estate Secured Term Loan are subject to certain financial and other covenants. As of October 29, 2011, the Company was in compliance with its financial covenants under its financing arrangements, and the Company currently believes that it will continue to be in compliance with these covenants through at least the end of the third quarter of fiscal 2012. However, the decline in the Company’s operating results for the 39 weeks ended October 29, 2011, coupled with continued economic weakness in the markets in which the Company operates, has adversely impacted the Company’s prospective compliance with the financial covenants under the Senior Secured Term Loan and the Real Estate Term Loan. On October 24, 2011, in order to reduce the Company’s leverage, a subsidiary of the Company sold its distribution center located in Tracy, California for cash proceeds of $21.2 million, net of fees and on October 26, 2011, the Company entered into the Appliances Agreement with a subsidiary of Sears Holdings that the Company had planned to enter into at the Distribution, pursuant to which it transferred certain inventory purchased from Sears Holdings to a subsidiary of Sears Holdings, for $1.9 million in cash. Additional actions taken by the Company to further reduce the Company’s leverage include, on December 12, 2011, a subsidiary of the Company completed the sale of all of its interest in the property occupied by its store located in Hollywood, California and on December 20, 2011, a subsidiary of the Company completed the sale of all of its interests in three properties occupied by its stores located in Pismo Beach, California, Cottle Road in San Jose, California, and Capitol Expressway in San Jose, California.

The Company utilized $21.6 million of the proceeds received in the sale and leaseback transactions to pay-down its Real Estate Secured Term Loan and expects to utilize the remainder of the proceeds to pay-down its Senior Secured Term Loan. In connection with that pay-down, the Company expects to enter into an agreement with lenders holding a majority of the principal under the Company’s Senior Secured Term Loan to, among other things, extend the maturity date to December 21, 2015 and to secure improved financial covenants and to make certain other technical amendments.

If the agreement with lenders holding a majority of the principal under the Company’s Senior Secured Term Loan does not occur, the Company seeks to remain in compliance with its financing arrangements and generate sufficient liquidity by executing its sales growth strategy by, among other things, making improvements to its stores and store operations and upgrading and differentiating its product assortment. Notwithstanding the foregoing, the Company continues to examine a number of alternatives with respect to future compliance and liquidity, including asset sales and/or sale-leaseback transactions. In addition, if necessary or advisable, the Company may seek to further renegotiate its financing arrangements in order to remain in compliance while continuing to follow its current business plan, which includes plans for store expansion. In such case, if such renegotiations were necessary but unsuccessful, the Company would expect to take certain actions that would allow it to remain in compliance. Such actions could include, among others, a reduction of capital expenditures by delaying or reducing new store openings and store remodels, a reduction in payroll and benefit costs, deferring certain maintenance and other expenditures, as well as generating additional cash through sale or sale leaseback of certain real estate assets in order to reduce leverage. However, the implementation of these actions could result in slower growth and could potentially reduce future sales.

Notwithstanding the Company’s expectations, if operating results were to continue to decline or if market conditions were to worsen, the Company may be unable to meet its financial covenants, and lenders could demand repayment of the amounts outstanding under its financing agreements. Under such circumstances, no assurances can be given that the Company’s financing arrangements could be renegotiated, or that alternative financing would be available on terms acceptable to the Company, if at all. In addition, any refinancing could be at higher interest rates and may require the Company to comply with more onerous covenants which could further restrict its business operations.

The Company purchases Sears Holdings exclusive brands such as Craftsman, Kenmore, Easy Living, and Weatherbeater directly from Sears Holdings and outside vendors. Purchases of these exclusive brands for the 13 and 39 weeks ended October 29, 2011 and October 30, 2010 are as follows (in millions):

For the 13 and 39 weeks ended October 29, 2011, the Company purchased approximately $3.2 million and $11.0 million, respectively, of merchandise directly from Sears Holdings, which represented 56% of total purchases of the exclusive brands for each period. For the 13 and 39 weeks ended October 30, 2010, the Company purchased approximately $3.3 million and $8.6 million, respectively, of merchandise directly from Sears Holdings, which represented 49% and 44%, respectively, of total purchases of the exclusive brands.

Concurrent with the Recapitalization, the Company and Sears Holdings entered into various agreements, including an appliance sales agreement (the “Appliance Sales Agreement”) and a brand sales agreement (the “Brand Sales Agreement”) (collectively, the “Agreements”). The salient terms of the Agreements between the Company and Sears Holdings, all of which have an effective date of November 23, 2005, are as follows:

Appliance Sales Agreement— In 2005, the Company entered into an Appliances Sales Agreement with Sears Holdings that granted the Company the right to purchase from Sears Holdings and to sell certain major branded appliances, including major Kenmore-branded appliances (the “Products”). The Company is permitted to sell the Products at currently identified retail locations and if approved by Sears Holdings, at additional retail locations (the “Appliance Stores”). The price paid by the Company for Products purchased from Sears Holdings equals Sears Holdings’ cost for such Products. If the Appliance Sales Agreement is terminated by Sears Holdings, Sears Holdings has the right, but not an obligation, to purchase all Products held in the Company’s inventory at the last price such Products were sold to the Company. In addition, the Company is required to pay a monthly monitoring fee per Appliance Store to Sears Holdings, which currently approximates $0.1 million per year.

In accordance with Sears Holdings’ policy, the Company is entitled to receive from Sears Holdings an allocation of vendor subsidies earned from the purchase of appliances made on behalf of the Company. These vendor subsidies are based on contractual relationships established between Sears Holdings and the vendor and are applicable only to purchases made by Sears Holdings. For the 13 and 39 weeks ended October 29, 2011, the Company recognized approximately $0.2 million and $0.5 million, respectively, in vendor subsidies. For the 13 and 39 weeks ended October 30, 2010, the Company recognized approximately $0.1 million and $0.3 million, respectively, in vendor subsidies.

The agreement from 2005 was terminated on October 26, 2011, when the Company entered into a new appliances agreement (the “Appliances Agreement”) with a subsidiary of Sears Holdings pursuant to which Sears Holdings has authorized the Company to sell the Products and related protection agreements on a consignment basis as a distributor through its designated retail locations. The Appliances Agreement requires that Sears Holdings pay the Company commissions on the Company’s sales of the Products and the protection agreements for the Products. Commissions for Products varies by Product category and Sears Holdings may in its sole discretion modify from time to time the commission rate for each category of Product but the annual weighted-average aggregate commission rate for all categories of Products for each Sears Holdings fiscal year for the Sears Holdings Authorized Hometown Stores as a group, including the Company, will not be less than a specified rate. The products include specified categories of Kenmore, Bosch, Electrolux, GE, LG, Samsung and Whirlpool branded appliances. The agreement generally incorporates arm’s length terms and conditions, including market-based pricing and term of duration.

Under the Appliances Agreement, the Company transferred to Sears Holdings its entire inventory of major appliances purchased from Sears Holdings for $1.9 million in cash on October 27, 2011, which represented the Company’s cost of the purchased appliances, subject to adjustments based on, among other things, the results of a physical inventory of the purchased appliances and the cost of certain clearance markdowns realized by Sears Holdings during the 60-day period following the effective date of the Appliances Agreement.

The Appliances Agreement has a term of five years. The Company may terminate the Appliances Agreement early for convenience after the first 18 months of the Appliances Agreement or if Sears Holdings fails to comply with any of its material obligations in the Appliances Agreement and the failure remains uncured for 30 days or more following notice. Sears Holdings may terminate the Appliances Agreement early for its convenience by delivering six months’ prior written notice to the Company after the first anniversary of the effective date of the Appliances Agreement or if (a) with respect to a Sears Holdings’ fiscal quarter, the Company sales of Products during the fiscal quarter are not at least 70% of the Company sales of Products during the same fiscal quarter in the prior year or (b) the Company fails to comply with any of its material obligations in the Agreement and the failure remains uncured for 30 days or more following notice. The Appliances Agreement provides that during its term of the Appliances Agreement, the Company will not be able to operate in California other businesses that sell merchandise similar to the Products. The Appliances Agreement also provides that for two years following the end of the term, the Company will not be able to operate a business that competes with Sears Holdings Businesses at, or within ten miles of, its retail locations that sold Products at any time during the term.

Brand Sales Agreement— In 2005, Sears Holdings granted the Company the right to purchase from Sears Holdings and its approved vendors, as well as to sell certain additional products, which include products marketed under Sears Holdings’ exclusive brands, such as Craftsman, Easy Living and Weatherbeater (the “Additional Products”). The price paid by the Company for the Additional Products purchased from Sears Holdings equals Sears Holdings’ cost for such Products.

The agreement from 2005 will be terminated on the Distribution Date, when the Company enters into new brands license agreements (the “Brands Agreements”) with a subsidiary of Sears Holdings to be effective at the Distribution pursuant to which Sears Holdings will allow the Company to purchase a limited assortment of Craftsman products, Easy Living and Weatherbeater paints, Kenmore-branded water heaters and consumer household products directly from vendors. Under the Brands Agreements, the Company will pay specified license fees to Sears Holdings. The Brands Agreements generally will incorporate arm’s length terms and conditions, including market-based pricing and term of duration. Each of the Brands Agreements is expected to have a three-year term and may be extended subject to the mutual agreement of the parties. If the aggregate of the Company’s Craftsman product sales over any 12-month period falls by more than 25% below the preceding 12-month period following the second anniversary of the Distribution, Sears Holdings will be permitted to terminate that Brands Agreement in its sole discretion with 60 days’ notice.

For the 13 and 39 weeks ended October 29, 2011, the Company recognized approximately $0.3 million and $1.0 million, respectively, in royalty expenses. For the 13 and 39 weeks ended October 30, 2010, the Company recognized approximately $0.3 million and $1.0 million, respectively, in royalty expenses.

Stockholders’ Agreement — In November 2005, the Company entered into a stockholders’ agreement with Sears Roebuck and ACOF that was amended and restated as of January 8, 2008 (the “Existing Stockholders’ Agreement”). Pursuant to the terms of the Existing Stockholders’ Agreement, certain of the Company’s preferred stock is issuable to Sears Roebuck. The Company, Sears Holdings and ACOF have agreed that this preferred stock will be issued to Sears Roebuck in the form of the preferred stock described herein, and that Sears Holdings will thereafter distribute such preferred stock to its shareholders in the Distribution. The Existing Stockholders’ Agreement also provides for certain transfer restrictions, governance provisions, registration rights and other matters.

In connection with the Distribution, the Company, ESL, Edward S. Lampert, William C. Crowley and ACOF will amend and restate the Existing Stockholders’ Agreement (as amended and restated, the “Stockholders’ Agreement”), and Sears Roebuck will cease to be a party to the Stockholders’ Agreement. The Existing Stockholders’ Agreement will be terminated and superseded by the provisions of the Stockholders’ Agreement. The Stockholders’ Agreement will be effective immediately following the Distribution and will provide certain rights and obligations to the parties thereto.

On April 1, 2011, a judgment for $5.1 million by the California Superior Court was entered against the Company in favor of Save Mart Supermarkets (“Save Mart”). The Company recorded a $5.1 million liability and expense in selling and administrative expenses in the condensed consolidated statement of operations for the year ended January 29, 2011. On August 24, 2011, the Company entered into a settlement agreement with Save Mart (the “Settlement Agreement”) to satisfy the $5.1 million judgment, release the Company of all liabilities, and waive all rights of appeals by both parties. The Settlement includes three parts: 1) a $0.5 million cash consideration payable to Save Mart, 2) the amendment and extension of an existing lease between Save Mart and the Company, and 3) the lease of a new property to the Company. Pursuant to the Settlement Agreement, the Company paid the $0.5 million cash consideration and recorded a $1.6 million reduction to this liability, which is classified as a reduction to selling and administrative expense in the condensed consolidated statements of operations.

The Company is party to various legal proceedings arising in the ordinary course of its business. Based on the information currently available, the Company is not currently a party to any legal proceeding that management believes would have a material adverse effect on the consolidated financial position or results of operations of the Company.

On December 12, 2011, a subsidiary of the Company completed the sale of all of its interest in the property occupied by its store located in Hollywood, California, which is comprised of a building containing approximately 31,000 square feet of enclosed space, plus approximately 8,000 square feet of nursery and garden area and the

underlying land. In connection with the closing of the sale, a subsidiary of the Company entered into a lease agreement with respect to the Hollywood store. The term of the lease began on December 12, 2011 and may be terminated on January 1, 2014, upon six months notice by the Company. The lease may also terminate upon two months notice from the landlord at any time except during February through June of each year. The Company will continue to operate the facility consistent with its existing use throughout the term. The Company has not yet completed its evaluation of the financial impact of these transactions on the Company’s consolidated financial statements.

On December 20, 2011, a subsidiary of the Company completed the sale of all of its interests in the properties occupied by (i) its store located in Pismo Beach, California, which is comprised of a building containing approximately 34,000 square feet of enclosed space, plus approximately 6,000 square feet of nursery and garden area and the underlying land, (ii) its store located on Cottle Road in San Jose, California, which is comprised of a building containing approximately 38,000 square feet of enclosed space, plus approximately 9,000 square feet of nursery and garden area and the underlying land and (iii) its store located on Capitol Expressway in San Jose, California, which is comprised of a building containing approximately 42,000 square feet of enclosed space, plus approximately 11,000 square feet of nursery and garden area and the underlying land. In connection with the closing of the sale, a subsidiary of the Company entered into lease agreements with respect to each of the stores. The term of the Pismo Beach store lease is 16 years, the others are 18 years, beginning on December 20, 2011. The Company will continue to operate the facilities consistent with its existing use throughout the term of each lease. The Company has not yet completed its evaluation of the financial impact of these transactions on the Company’s consolidated financial statements.

The aggregate purchase price received from these four properties was approximately $36 million. The Company expects to pay $3.2 million of additional rent annually with respect to the four leases.

On December 16, 2011, the Company’s Board and the Company’s stockholders approved the adoption of the 2011 Equity Incentive Plan (the “Plan”) and forms of Restricted Stock Agreement and Time-Based Option Agreement for use under the Plan. The Plan provides for the issuance of a maximum of 1.0 million shares of our Class A Common Stock in connection with the grant of stock options, stock appreciation rights, restricted stock awards, restricted stock units, stock bonus awards, dividend equivalents, performance compensation awards (including cash bonus awards) or any combination of the foregoing.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

You should read the following discussion and analysis in conjunction with our financial statements and related notes included elsewhere in this report. Except for historical information, the discussion in this report contains certain forward-looking statements that involve risks and uncertainties. Forward-looking statements are subject to risks and uncertainties that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these forward-looking statements. Forward-looking statements include information concerning our future financial performance, business strategy, plans, goals and objectives.

Statements preceded or followed by, or that otherwise include, the words “believes,” “expects,” “anticipates,” “intends,” “project,” “estimates,” “plans,” “forecast,” “is likely to” and similar expressions or future or conditional verbs such as “will,” “may,” “would,” “should” and “could” are generally forward-looking in nature and not historical facts. Such statements are based upon the current beliefs and expectations of management and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements.

EXECUTIVE OVERVIEW

We are a specialty retailer primarily focused on homeowners with repair, maintenance and improvement needs. Founded as a purchasing cooperative in San Jose in 1931, as of October 29, 2011, we operated 89 full-service hardware stores in California. Our stores average approximately 43,600 square feet of enclosed space plus approximately 8,300 square feet of nursery and garden area, carrying a broad assortment of merchandise across three primary categories: repair and maintenance, lawn and garden and in-home products. The stores are easy to navigate and convenient to shop, designed to appeal to do-it-yourself customers for home repair and maintenance. We also serve the small professional customer whose purchases are largely motivated by a need for incremental supplies and tools to complete construction projects. We offer customers a unique value proposition comprised of service, selection and convenience. We believe we are California’s “large hardware store.”

Fiscal 2011 represents the year ending January 28, 2012 and fiscal 2010 represents the year ended January 29, 2011.

2011 Third Quarter Financial Highlights

2011 Third Quarter Business Highlights

We are in the midst of positioning ourselves for future growth and long-term stockholder value. In fiscal 2011, we started to lay the foundation to set us in a new direction to develop and evolve the Orchard brand and implement new business strategies that we believe will lead to positive financial impacts. We are focused on five key initiatives:

During the first three quarters of fiscal 2011, we have made strong progress in all of these areas. During the third quarter of fiscal 2011, in particular, some specific achievements in these areas included:

Brand Identity. We opened our flagship store in Princeton Plaza in San Jose, California. This new store prototype offers an updated and innovative customer-friendly design to showcase our merchandise and service offerings. We expect to remodel select existing stores to further test the new prototype in 2012 and we will evaluate the results to determine longer-term remodeling plans. We also began a new and comprehensive product line review process to strengthen our product assortment and optimize margins as we enhance our customers’ shopping experience.

Sales and Operational Efficiencies. With a goal of putting our customers first and simplifying and enhancing the deployment of our associates in our stores for sales activities, we implemented a zone coverage in-store structure and “armed” our associates with radio communications devices to quickly contact other associates in the store. We believe these actions have helped to drive an increase in average ticket. Sales momentum was also helped by more effective promotional initiatives.

Talent Development. We streamlined our field organization into four geographic regions, led by four newly-hired Regional Vice Presidents, to drive faster decision making with greater accountability and alignment. We also continued to focus on attracting and retaining quality store managers. In anticipation of, and to prepare for, the spin-off, we also hired a new Chief Financial Officer and a new General Counsel.

Spin-off. The spin-off from Sears Holdings is scheduled to occur on December 30, 2011.

Financial Position. We entered into a sale-leaseback transaction involving our distribution center in Tracy, California. This transaction allowed us to repay a portion of our debt and reduce the leverage under our financial loan covenants. We also negotiated lease amendments for our corporate headquarters (store support center) and one other store and, as part of those lease amendments, received tenant improvement allowances to help upgrade and remodel those properties.

RESULTS OF OPERATIONS

Our results of operations are presented using key accounting policies that are further described in Note 1 of the Notes to the Unaudited Interim Condensed Consolidated Financial Statements derived from the Company’s audited consolidated financial statements for the fiscal year ended January 29, 2011. Key definitions include:

Revenue Recognition— We recognize revenues from merchandise sales at the later of point of sale or delivery of goods to customers. Merchandise sales are reported net of estimated returns and allowances and customer rebates, excluding sales taxes. The reserve for returns and allowances is calculated as a percentage of sales based on historical return percentages. Net sales are presented net of any taxes collected from customers and remitted to governmental authorities. We also record deferred revenue for the sale of gift cards and recognize this revenue upon the redemption of the gift cards. Comparable sales figures are defined as follows:

A store is included in the calculation of comparable metrics above if it has been opened for at least 12 months, including relocated and remodeled stores. The key metrics discussed above are intended only as supplemental information and are not a substitute for information presented in accordance with generally accepted accounting principles.

Cost of Sales— Cost of sales includes the cost of merchandise, distribution, warehousing and delivery costs and store occupancy costs, offset by vendor allowances and rebates received by us.

Gross Margin— Gross margin is defined as net sales, less cost of sales.

Selling and Administrative Expenses— Selling and administrative expenses primarily include selling and support payroll, advertising and other administrative expenses.

Depreciation and Amortization— Our buildings, furniture, fixtures and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the original term of the lease or the useful life of the improvement, whichever is shorter. Our property and equipment are depreciated using the following estimated useful lives:

Income Taxes— The tax balances and income tax expense recognized by us are based on management’s interpretation of the tax laws of multiple jurisdictions. Income tax expense also reflects our best estimates and assumptions regarding, among other things, the level of future taxable income, interpretation of the tax laws and tax planning. Future changes in tax laws, changes in projected levels of taxable income and tax planning could affect the effective tax rate and tax balances recorded by us. We provide deferred income tax assets and liabilities based on the estimated future tax effects of differences between the financial and tax bases of assets and liabilities based on currently enacted tax laws.

Adjusted EBITDA— In addition to our net income (loss) determined in accordance with GAAP, for purposes of evaluating operating performance, we use an Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization (“Adjusted EBITDA”), which is adjusted to exclude certain significant items as set forth below. Our management uses Adjusted EBITDA to evaluate the operating performance of our business, as well as executive compensation metrics, for comparable periods. Adjusted EBITDA should not be used by investors or other third parties as the sole basis for formulating investment decisions as it excludes a number of important cash and non-cash recurring items. The Adjusted EBITDA should not be considered as a substitute for GAAP measurements.

While Adjusted EBITDA is a non-GAAP measurement, management believes that it is an important indicator of operating performance because:

Adjusted EBITDA was determined as follows:

The Adjusted EBITDA is not the same as the EBITDA as defined Senior Secured Term Loan.

Other significant items include certain reserves and charges not in the normal course of our operations periodically affecting the comparability of our results. We recorded a $0.4 million severance charge in the 39 weeks ended October 29, 2011 due to changes in our management structure. In the fourth quarter of fiscal 2010, we recorded a $5.1 million legal judgment pursuant to the Save Mart case and $0.5 million in fees. In the first quarter of fiscal 2011, we reversed $0.5 million of the Save Mart accrual as we no longer expected to pay the fees. In the third quarter of fiscal 2011, we entered into a Settlement Agreement with Save Mart and reversed $1.6 million of this accrual.

Impact from the Spin-Off

Following the Distribution, we will operate as a publicly traded company independent from Sears Holdings, which will have a range of impacts on our operations. Historically, we have used the corporate functions of Sears Holdings for a variety of services. We expect to incur increased costs as a result of becoming a publicly traded company independent from Sears Holdings, primarily from higher charges than in the past from Sears Holdings for transition services and from establishing or expanding the corporate support for our business, including information technology, human resources, treasury, tax, risk management, accounting and financial reporting, investor relations, legal, procurement and other services. In addition, we have historically procured appliances and other merchandise from Sears Holdings pursuant to agreements between us and Sears Holdings. We will continue to procure merchandise from Sears Holdings, but will now sell certain appliances and related protection agreements supplied to us by Sears Holdings on a consignment basis, which we expect will result in a reduction in net sales and net income. We also expect an impact on prices for goods and services purchased from third parties as a result of the loss of pricing benefits as a result of Sears Holdings’ buying volume and processes.

13-week period ended October 29, 2011 compared to the 13-week period ended October 30, 2010

Net sales

Net sales increased $4.2 million, or 2.7%, to $158.7 million for the quarter ended October 29, 2011, as compared to $154.5 million for the quarter ended October 30, 2010. The increase in net sales was primarily due to a $1.8 million increase in our lawn and garden category, a $1.6 million increase in our repair and maintenance category, and a $0.7 million increase in our in-home category. The increase in net sales was driven primarily by increased demand for seasonal products. Additionally, net sales were positively impacted by the relocation and opening of our new store prototype in Princeton Plaza in San Jose, California.

Our comparable store sales increased by 1.5% for the quarter ended October 29, 2011. The increase in comparable store sales was driven by an increase of 4.8% in average ticket comparables offset by a decrease in comparable transaction volume of 3.3% for the quarter ended October 29, 2011, as compared to the quarter ended October 30, 2010. We believe the higher average ticket was driven by the sale of bigger ticket items such as appliances, barbeques, and furniture, and the decline in transaction volume was in part due to the continued weakness in consumer demand from volatility in the capital markets and uncertainty around the macro-economic and political environments.

Gross margin

Gross margin decreased $0.2 million to $51.5 million, or 32.5% of net sales, for the quarter ended October 29, 2011, as compared to $51.7 million, or 33.5% of net sales, for the quarter ended October 30, 2010. The decrease of 100 basis points in gross margin was primarily due to higher occupancy costs of 120 basis points. The increase in occupancy was due to rent associated with renegotiated leases, increased store maintenance, and increased insurance reserves as compared to the third quarter in fiscal 2010.

Selling and administrative

Selling and administrative expenses increased $0.5 million for the quarter ended October 29, 2011 to $40.8 million, or 25.7% of net sales, from $40.3 million, or 26.1% of net sales, for the quarter ended October 30, 2010. The increase in selling and administrative expenses was primarily due to a $1.6 million increase in contract services and temporary labor to execute key strategic initiatives and $0.5 million in transition costs related to the spin-off in the quarter ended October 29, 2011, as compared to the quarter ended October 30, 2010. These increases were offset by a non-cash $1.6 million legal benefit as a result of the Settlement Agreement with Save Mart.

Loss on sale of real property

On October 24, 2011, we sold our distribution center located in Tracy, California and recorded a non-cash loss of $14.3 million in connection with the sale.

Depreciation and amortization

Depreciation and amortization decreased $0.1 million to $7.7 million, or 4.9% of net sales, for the quarter ended October 29, 2011, as compared to $7.8 million, or 5.0% of net sales, for the quarter ended October 30, 2010. The slight decrease of $0.1 million of depreciation and amortization expense was primarily due to an increase in fully depreciated assets.

Interest expense, net

Interest expense, net increased $1.4 million to $5.7 million, or 3.6% of net sales, for the quarter ended October 29, 2011, as compared to $4.3 million, or 2.8% of net sales, for the quarter ended October 30, 2010. The increase in interest expense, net was primarily due to the increase in our applicable interest rate spreads as a result of the amendment of both our Senior Secured Term Loan and our Real Estate Secured Term Loan.

Income taxes

Income tax benefit increased $6.7 million to $7.0 million for an effective tax rate of 40.8%, for the quarter ended October 29, 2011, as compared to $0.3 million, for an effective tax rate of 39.0%, for the quarter ended October 30, 2010. The increase in our effective tax rate was primarily due to differences in tax credits applicable year over year.

Adjusted EBITDA

Adjusted EBITDA decreased $2.4 million to $9.3 million, or 5.9% of net sales, for the quarter ended October 29, 2011 as compared to $11.7 million, or 7.5% of net sales, for the quarter ended October 30, 2010. The decrease in Adjusted EBITDA of $2.4 million was primarily due to the increased spending on strategic initiatives and transition costs.

39-week period ended October 29, 2011 compared to the 39-week period ended October 30, 2010

Net sales

Net sales decreased $0.3 million, or 0.1%, to $518.9 million for the first nine months of fiscal 2011, as compared to $519.2 million for the first nine months of fiscal 2010. The decrease in net sales was primarily due to a $1.9 million decline in our repair and maintenance category and a $1.6 million decline in our lawn and garden category, both of which were impacted by unfavorable weather during the months of March and June 2011. Partially offsetting these declines was an increase of approximately $3.2 million of net sales in our in-home category, which was primarily driven by appliances. For the majority of the first nine months of fiscal 2011, we have approximately doubled the number of stores offering appliances as compared to the first nine months of fiscal 2010.

Our comparable store sales decreased by 1.4% for the first nine months of fiscal 2011. The decrease in comparable store sales was driven by a decline in comparable transaction volume of 5.1%, partially offset by an increase of 3.7% in average ticket comparables for the first nine months of fiscal 2011, as compared to the first nine months of fiscal 2010. We believe the decline in transaction volume was primarily due to unfavorable weather during the months of March and June 2011, as well as continued weakness in consumer demand resulting from volatility in the capital markets and uncertainty around the macro-economic and political environments. Our average ticket benefited from the sale of bigger ticket items, such as appliances, barbeques and furniture.

Gross margin

Gross margin decreased $8.7 million to $172.5 million, or 33.2% of net sales, for the first nine months of fiscal 2011, as compared to $181.2 million, or 34.9% of net sales, for the first nine months of fiscal 2010. The decrease of 170 basis points in gross margin was primarily due to increases of 60 basis points in markdowns, 70 basis points in occupancy costs, and 40 basis points in inventory shrink costs. The increase in markdowns was primarily due to increased clearance and promotional activities to clear slow moving inventory and increase sales. Occupancy costs for the first nine months of fiscal 2011 were higher as compared to the first nine months of fiscal 2010 due to a favorable deferred rent adjustment in the first nine months of fiscal 2010. Inventory shrink increased in the first nine months of fiscal 2011 as compared to the same period last year due to previous reductions in store staffing.

Selling and administrative

Selling and administrative expenses increased $5.7 million for the first nine months of fiscal 2011 to $131.1 million, or 25.3% of net sales, from $125.4 million, or 24.2% of net sales, for the first nine months of fiscal 2010. The increase in selling and administrative expenses was primarily due to a

$3.0 million increase in contract services and temporary labor to execute key strategic initiatives. Insurance costs also increased by approximately $1.3 million as a result of increases in casualty claim reserves. Other administrative costs increased approximately $3.0 million due to increased travel, display costs, and direct marketing, as well as transition costs related to the spin-off in the first nine months of fiscal 2011, as compared to the first nine months of fiscal 2010. The increase was partially offset by a non-cash legal benefit of $1.6 million as a result of the Settlement Agreement with Save Mart.

Loss on sale of real property

On October 24, 2011, we sold our distribution center located in Tracy, California and we recorded a non-cash loss of $14.3 million in connection with the sale.

Depreciation and amortization

Depreciation and amortization decreased $0.7 million to $22.4 million, or 4.3% of net sales, for the first nine months of fiscal 2011 as compared to $23.1 million, or 4.4% of net sales, for the first nine months of fiscal 2010. The decrease of $0.7 million was primarily due to a capital lease conversion in the first nine months of fiscal 2010 and an increase in fully depreciated assets in the first nine months of fiscal 2011.

Interest expense, net

Interest expense, net increased $4.0 million to $16.8 million, or 3.2% of net sales, for the first nine months of fiscal 2011, as compared to $12.8 million, or 2.5% of net sales, for the first nine months of fiscal 2010. The increase in interest expense, net was primarily due to a $3.3 million increase in interest expense as a result of higher interest rate spreads from the amendment of both the Senior Secured Term Loan and the Real Estate Secured Term Loan. In addition, amortization of deferred financing costs increased by $0.9 million due to increased financing costs from the amendments of our loan agreements.

Income taxes

Income tax benefit of $4.9 million and income tax expense of $7.8 million was recorded for the first nine months of fiscal 2011 and the first nine months of fiscal 2010, respectively. The effective tax rate was 40.5% in the first nine months of fiscal 2011 and 39.0% in the first nine months of fiscal 2010. The change in our effective tax rate was primarily due to differences in tax credits applicable year over year.

Adjusted EBITDA

Adjusted EBITDA decreased $16.2 million to $40.2 million, or 7.7% of net sales, for the first nine months of fiscal 2011 as compared to $56.4 million, or 10.9% of net sales, for the first nine months of fiscal 2010. The decrease in Adjusted EBITDA was primarily due to an $8.7 million decline in gross margin and increased spending on strategic initiatives and transition costs.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity and Capital Resources

The following table summarizes our cash flows for the 39 week periods ended October 29, 2011 and October 30, 2010 (in thousands):27, 2012.

We believe that our existing cash and cash equivalents, cash flows from our operating activities and available borrowings under our financing arrangements will be sufficientIn the event of a sale of a property owned by the Company, the Company is required to meet our anticipated liquidity needs for at least the next 12 months. Our liquidity is dependent upon the continued availability of borrowings under our current financing arrangements and certain transactions that we have entered into or may enter into in the future to increase liquidity. The adequacy of our available funds will dependmake repayments on many factors, including the macroeconomic environment, the operating performance of our Company stores and continued compliance with our financing arrangements.

As discussed below under “Financing Arrangements,” the Senior Secured Term Loan and Real Estate Secured Term Loan are subjectequal to a maximum adjusted leverage ratio covenant (the “Leverage Covenant”). The Leverage Covenant is calculated on

the last day of each fiscal quarter as (a) consolidated total funded debt on such date minus unrestricted cash over $3 million (as defined in the Senior Secured Term Loan) to (b) trailing four fiscal quarters adjusted EBITDA (as defined in the Senior Secured Term Loan), which includes debt under our financing arrangements and capital leases. As of October 29, 2011, we were in compliance with the Leverage Covenant under our financing arrangements, and we currently believe that we will continue to be in compliance with this covenant (and other covenants under our financing arrangements) through at least the end75% of the third quarter of fiscal 2012.

However, the decline in our operating results for the 39 weeks ended October 29, 2011, coupled with continued economic weakness in the markets in which we operate, has adversely impacted our prospective compliance with the financial covenants under the Senior Secured Term Loan and the Real Estate Term Loan. On October 24, 2011, in order to reduce our leverage, a subsidiary of the Company sold its distribution center located in Tracy, California for cash proceeds, of $21.2 million, net of fees, cash tax, and on October 26, 2011, we entered intoother mandatory debt repayments. Pursuant to the Appliances Agreement with a subsidiary of Sears Holdings that we had planned to enter into at the Distribution, pursuant to which it transferred certain inventory purchased from Sears Holdings to a subsidiary of Sears Holdings, for $1.9 million in cash. Additional actions taken by us to further reduce our leverage include, on December 12, 2011, a subsidiarysale-leaseback of the six collateralized stores properties, the Company completedmade a $7.6 million prepayment under this requirement on August 24, 2012. Pursuant to the salesale-leaseback of all of its interest in the property occupied by itscollateralized store located in Hollywood,San Lorenzo, California, and on December 20, 2011, a subsidiary of the Company completed the sale of all of its interestsmade $1.2 million in three properties occupied by its store located in Pismo Beach, California, Cottle Road in San Jose, California, and Capitol Expressway in San Jose, California.

We utilized $21.6 million of the proceeds received in the sale and leaseback transactions to pay-down its Real Estate Secured Term Loan and expect the remainder of the proceeds to pay-down our Senior Secured Term Loan. In connection with that pay-down, we expect to enter into an agreement with lenders holding a majority of the principalprepayments under our Senior Secured Term Loan to, among other things, extend the maturity date to December 21, 2015 and to secure improved financial covenants and to make certain other technical amendments.

If the agreement with lenders holding a majority of the principal under our Senior Secured Term Loan does not occur, we seek to remain in compliance with our financing arrangements and generate sufficient liquidity by executing our sales growth strategy by, among other things, making improvements to our stores and store operations and upgrading and differentiating our product assortment. Notwithstanding the foregoing, we continue to examine a number of alternatives with respect to future compliance and liquidity, including asset sales and/or sale-leaseback transactions. In addition, if necessary or advisable, we may seek to further renegotiate our financing arrangements in order to remain in compliance while continuing to follow our current business plan, which includes plans for store expansion. In such case, if such renegotiations were necessary but unsuccessful, the Company would expect to take certain actions that would allow it to remain in compliance. Such actions could include, among others, a reduction of capital expenditures by delaying or reducing new store openings and store remodels, a reduction in payroll and benefit costs, deferring certain maintenance and other expenditures, as well as generating additional cash through sale or sale leaseback of certain real estate assets in order to reduce leverage. However, the implementation of these actions could result in slower growth and could potentially reduce future sales.

Notwithstanding our expectations, if operating results were to continue to decline or if market conditions were to worsen, we may be unable to meet our financial covenants, and lenders could demand repayment of the amounts outstanding under our financing agreements. Under such circumstances, no assurances can be given that our financing arrangements could be renegotiated, or that alternative financing would be availablethis requirement on terms acceptable to us, if at all. In addition, any refinancing could be at higher interest rates and may require us to comply with more onerous covenants which could further restrict our business operations.

Our debt and capital lease obligations as of October 29, 2011, January 29, 2011 and October 30, 2010 are as follows (in millions):

Financing Arrangements

Our lending arrangements on and as of October 29, 2011and January 29, 2011 are as follows:

Senior Secured Credit Facility— In December 2006, we entered into an amended and restated five-year, $130.0 million senior secured revolving credit facility (the “Replaced Facility”) with a syndicate of lenders. On January 29, 2010, we amended, restated and extended the Replaced Facility, reducing the revolving commitment to $120.0 million (subject to borrowing base limits). The amendment and restatement bifurcated the facility into a $20.0 million tranche maturing December 2011 with lenders who elected not to extend and a $100.0 million tranche maturing on the earlier to occur of 90 days prior to the maturity of the Senior Secured Term Loan and December 21, 2013 with lenders who elected to extend. As of January 29, 2011, $48.0 million was borrowed under the facility, with approximately $8.0 million due in December 2011 and approximately $40.0 million due in December 2013. As of October 29, 2011, $32.0 million was borrowed under the facility, with approximately $5.3 million due in December 2011 and approximately $26.7 million due in December 2013. We intend to draw funds from extending lenders to repay amounts due to non-extending lenders. The Senior Secured Credit Facility permits us to obtain letters of credit, provided that our obligations with respect to letters of credit issued under our Senior Secured Credit Facility cannot exceed $25.0 million. As of October 29, 2011 and January 29, 2011, we had outstanding letters of credit of $8.1 million and 7.3 million, respectively.

The Senior Secured Credit Facility is available for general corporate purposes. The borrower under the Senior Secured Credit Facility is Orchard Supply Hardware LLC, a wholly owned subsidiary through which we conduct substantially all our operations (“OSH LLC”). The Senior Secured Credit Facility is guaranteed by Orchard Supply Hardware Stores Corporation, and our wholly owned subsidiary, OSH Finance Corporation (together, the “Guarantors”). Borrowings under the Senior Secured Credit Facility are collateralized by a first lien on substantially all of the assets of OSH LLC and the Guarantors, other than the Term Loan Collateral (as defined below), and a second lien on the Term Loan Collateral. Borrowings under the Senior Secured Credit Facility are either base rate (“BR”) loans or Eurodollar loans, at our discretion. BR loans owing to non-extending lenders bear interest at the greater of (a) the prime rate as publicly announced by Wells Fargo Bank, N.A., or (b) the federal funds rate plus 0.5%, plus the “BR applicable rate”, with the “BR applicable rate” ranging between 0% to 0.75%. BR loans owing to each extending lender bear interest at the greater of (a) the prime rate as publicly announced by Wells Fargo Bank, N.A., (b) the federal funds rate plus 0.5%, or (c) one month London Inter-Bank Offered Rate (“LIBOR”) plus 1.0%, plus the “BR extended term applicable rate”, with the “BR extended term applicable rate” ranging between 1.50%

and 2.25%. Eurodollar loans owing to each non-extending lender bear interest at LIBOR, plus the “Eurodollar applicable rate,” with the “Eurodollar applicable rate” ranging between 1.0% and 1.75%. Eurodollar loans owing to each extending lender bear interest at LIBOR plus the “Eurodollar extended term applicable rate,” with the “Eurodollar extended term applicable rate” ranging between 2.50% and 3.25%. The interest rate spreads applicable to our borrowings fluctuate based upon the performance of OSH LLC and the Guarantors as measured by their leverage ratio. In addition, we are required to pay unused commitment fees, based on OSH LLC’s and the Guarantors leverage ratio; such fees were 0.38% and 0.50% at October 29, 2011 and 0.25% and 0.75% at January 29, 2011, for non-extending lenders and for extending lenders, respectively.

Availability under the Senior Secured Credit Facility is determined pursuant to a borrowing base formula based on inventory and accounts and credit card receivables, subject to certain limitations. The Senior Secured Credit Facility subjects us to certain restrictive covenants, including a fixed charge coverage ratio that is triggered when availability under the Senior Secured Credit Facility reaches a minimum threshold of 10% of the total availability for three consecutive days. The fixed charge coverage ratio requires OSH LLC and the Guarantors to maintain a minimum ratio of 1.1 to 1.0 EBITDAR (EBITDA plus rent expense) to certain fixed charges.

Our Senior Secured Credit Facility, Senior Secured Term Loan and Real Estate Secured Term Loan impose operating and financial restrictions on us, including, among other things, limitations on our ability to:

Senior Secured Term Loan— In December 2006, we entered into a $200 million senior secured term loan agreement (the “Senior Secured Term Loan”), which requires quarterly principal payments of $0.5 million and matures in December 2013. On January 28, 2011, we amended the Senior Secured Term Loan to change the maximum adjusted leverage ratio covenant, applicable interest rates, definition of EBITDA and excess cash flow prepayment percentage rate. In addition to the quarterly principal payments discussed above, in the event we have excess cash flows at the end of a fiscal year, we are required to apply between 25% and 75% of such excess cash flows (reduced by previous voluntary prepayments) to repay outstanding loans. The annual excess cash flow prepayment percentage rate is a percentage of our excess cash flows determined by our leverage ratio. We did not pay any excess cash flow prepayments in fiscal 2010 or 2011 and we do not anticipate making any prepayments in fiscalMay 18, 2012.

The borrower under the Senior Secured Term Loan is OSH LLC and the loan is guaranteed by the Guarantors. Borrowings under the Senior Secured Credit Facility are collateralized by a first lien on OSH LLC’s and the Guarantors’ subsidiary stock, equipment, real property, intangibles relating to such stock, proceeds and products of the foregoing (the “Term Loan Collateral”) and a second lien on substantially all of OSH LLC’s and the Guarantors’ other assets.

Borrowings under the Senior Secured Term Loan are either alternate base rate (“ABR”) loans or Eurodollar loans, at our discretion. ABR loans bear interest at the greater of (a) the prime rate as publicly announced by JPMorgan Chase Bank, and (b) the federal funds rate, plus 0.5%, plus the “ABR applicable rate”, with the “ABR applicable rate” ranging between 3.50% and 3.75%. Eurodollar loans bear interest at LIBOR, ranging between 4.50% and 4.75% (5.0%, 5.1%, and 3.1% at October 29, 2011, January 29, 2011, and October 30, 2010, respectively). The interest rate spreads applicable to our borrowings fluctuate based upon the Company’s performance as measured by our leverage ratio.

The Senior Secured Term Loan subjects us to certain restrictions, including a maximum adjusted leverage ratio covenant. In addition, the Senior Secured Term Loan requires us to make certain mandatory repayments in connection with the transfer of or damage to property securing the loan or in the event we incur certain types of debt.

The maximum adjusted leverage ratio covenant (as defined in the Senior Secured Term Loan) is calculated on the last day of each fiscal quarter as (a) consolidated total funded debt on such date minus unrestricted cash over $3 million (as defined in the Senior Secured Term Loan) to (b) trailing four fiscal quarters adjustedAdjusted EBITDA (as defined in the Senior Secured Term Loan). The following table provides ourthe Company’s maximum leverage ratio during the remaining term of the Senior Secured Term Loan.Loan:

We believe that we wereAs of October 27, 2012, the Company’s maximum leverage ratio was 7.64:1, which was not in compliance with the Senior Secured Term Loan covenants includingenumerated above. In anticipation of this noncompliance, on October 26, 2012, the Company and the Senior Secured Term Loan lenders entered into a Waiver and Amendment No. 1 whereby (i) the Senior Secured Term Loan lenders waived any and all defaults or events of default which would otherwise occur under the Senior Secured Term Loan as a result of any failure by the Company to comply with the maximum leverage ratio which, atcovenant contained therein for the fiscal quarter ended October 29, 2011 and27, 2012, (ii) the applicable interest rate in respect to the extended tranche, would be increased by 50 basis points if the aggregate amount of such loans outstanding as of January 29, 2011, were 5.0231, 2013 is equal to 1.00 and 4.89 to 1.00, respectively. At October 29, 2011 and January 29, 2011, assuming our current level of consolidated total funded debt remains constant, we estimate that a 8.8% and 11.0% or greater declinethan $59.2 million or (iii) the applicable interest rate in our trailing four fiscal quarters adjusted EBITDA, respectively,respect to the non-extended tranche would cause us to exceed our maximum leverage ratio covenant for that period.be increased by 50 basis points if any portion of the non-extended tranche remains outstanding as of January 31, 2013.

Real Estate Secured Term LoanChange in Control —On October 27, 2010, we entered into a $50 million real estate secured term loan (the “Real Estate Secured Term Loan”) that requires quarterly payments of $0.1 million and matures in December 2013. The proceeds from the Real Estate Secured Term Loan, together with $33.0 million of available cash and a $37.0 million borrowing on our Senior Secured Credit Facility were used to repay our then existing $120.0 million commercial mortgage-backed securities loan in full on October 27, 2010. The Real Estate Secured Term Loan requires us to meetand the leverage covenant set forth in our Senior Secured Term Loan subject to certain maximum thresholds. On February 17, 2011, we amended the Real Estate Secured Term Loan to raise the maximum thresholds on the loan’s leverage covenant for certain periods and change the definition of EBITDA. On December 19, 2011, we entered into the first amendment to the Real Estate Secured Term Loan, which lowered the minimum principal amount required under the Real Estate Secured Term Loan and allowed us to conduct certain sale and leaseback transactions.

Interest on the Real Estate Secured Term Loan is based on LIBOR plus 4.25% per annum (4.5% and 4.511% at October 29, 2011 and January 29, 2011, respectively), and is payable in monthly installments. In connection with the Real Estate Secured Term Loan, we entered into an interest rate cap agreement, which establishes a maximum interest rate on the Real Estate Secured Term Loan for LIBOR at 4% with a $25 million notional amount.

The Real Estate Secured Term Loan is secured by a first lien mortgage on 19 properties, which includes 15 properties owned and 4 properties on ground leases, each owned or leased by our wholly owned subsidiary, OSH Properties LLC. The loan is subject to a lapsing prepayment premium and breakage costs in the event we elect to repay all or a portion of the loan early. After closing the transactions described below, the Real Estate Secured Term Loan would be secured by a first lien mortgage on 14 remaining properties, which includes 10 owned properties and 4 on ground leases.

On October 24, 2011, a subsidiary of the Company entered into a Purchase and Sale Agreement pursuant to which a subsidiary of the Company sold for $21.2 million, net of fees, all of its interest in its distribution center located in Tracy,

California, which is comprised of a building containing approximately 458,000 square feet and the underlying land. In connection with the closing of the sale of the distribution center, a subsidiary of the Company entered into a lease agreement with respect to the distribution center. The commencement date of the lease was October 28, 2011. The lease is a 20-year lease and provides for three five-year extension options. The initial base rent under the lease is $1.7 million per year with 10% increases every five years. We recorded a non-cash loss in the amount of $14.3 million on the sale of the distribution center for the 13 weeks ended October 29, 2011. In connection with the transaction, we repaid $7.6 million of the Real Estate Secured Term Loan and removed the distribution center from the loan collateral. We paid $0.1 million in fees, penalties, and interest.

On December 12, 2011, a subsidiary of the Company entered into a Purchase and Sale Agreement to which a subsidiary of the Company’s Hollywood store sold all of its interest in the property occupied by its store located in Hollywood, California. The property is comprised of a building containing approximately 31,000 square feet of enclosed space, plus approximately 8,000 square feet of nursery and garden area and the underlying land. In connection with the closing of the sale, a subsidiary of the Company entered into a lease agreement with respect to the Hollywood store. The term of the lease began on December 12, 2011 and may be terminated on January 1, 2014, upon six months notice by us. The lease may also terminate upon two months notice from the landlord at any time except during February through June of each year. We will continue to operate the facility consistent with its existing use throughout the term. We have not yet completed our evaluation of the financial impact of these transactions on our condensed consolidated financial statements. On December 20, 2011, a subsidiary of the Company entered into a Purchase and Sale Agreement to which a subsidiary of the Company sold all of its interests in the properties occupied by (i) its store located in Pismo Beach, California, which is comprised of a building containing approximately 34,000 square feet of enclosed space, plus approximately 6,000 square feet of nursery and garden area and the underlying land, (ii) its store located on Cottle Road in San Jose, California, which is comprised of a building containing approximately 38,000 square feet of enclosed space, plus approximately 9,000 square feet of nursery and garden area and the underlying land, and (iii) its store located on Capitol Expressway in San Jose, California, which is comprised of a building containing approximately 42,000 square feet of enclosed space, plus approximately 11,000 square feet of nursery and garden area and the underlying land. In connection with the closing of the sale, a subsidiary of the Company entered into lease agreements with respect to each of the stores. The term of the Pismo Beach store lease is 16 years, the others are 18 years, beginning on December 19, 2011. We will continue to operate the facilities consistent with its existing use throughout the term of each lease. We have not yet completed our evaluation of the financial impact of these transactions on our condensed consolidated financial statements. The aggregate purchase price received from these four properties was approximately $36 million. We expect to pay $3.2 million of additional rent annually with respect to these four leases.

On December 19, 2011, OSH Properties entered into the first amendment to the Real Estate Secured Term Loan, which lowered the minimum principal amount required under the Real Estate Secured Term Loan, among other things, and allowed OSH Properties to conduct certain sale and leaseback transactions described above.

Each of the Senior Secured Credit Facility, Senior Secured Term Loan and Real Estate Secured Term Loan required the payment of upfront and arrangement fees of between 1.0% and 2.25%.

Our Senior Secured Credit Facility, Senior Secured Term Loan and Real Estate Secured Term Loan eachboth contain an event of default resulting from a change of control, default, which includes the following: (i) certain mergers, consolidations, sales or transfers of all or substantially all of the assets of OSH LLCthe Company and OSH LLC’s subsidiaries to persons other than ACOF, ESL Investments, Inc. (“ESL”) and Sears Holdings; (ii) adoption of a plan of liquidation of OSHOrchard Supply Hardware LLC; (iii) prior to an initial underwritten public offering of common stock of the Company, Sears Holdings, ESL and ACOF ceasing to collectively hold directly or indirectly at least 50% of the total voting power of all shares of our and OSH LLC’s voting capital stock; (iv) following an initial underwritten public offering of common stock of the Company, a person or group, other than Sears Holdings, ESL and ACOF, collectively holding directly or indirectly at least 40% of the total voting power of all shares of our and OSH LLC’s voting capital stock of the Company or Orchard Supply Hardware LLC and Sears Holdings, ESL and ACOF collectively holding less than such person or group; and (v) our board(iv) the Company’s Board of directorsDirectors not consisting of continuing directors (“Change in Control”).

Immediately following the Distribution:

Neither ESL nor ACOF have agreed to maintain their shareholding in the Company following the Distribution. If, following the Distribution, one or both of ESL and ACOF dispose of all or part of their shareholding in the Company such that their combined total voting power drops below 50%, this may trigger a Change in Control event of default under the Senior Secured Credit Facility, Senior Secured Term Loan and Real Estate Secured Term Loan.directors. An event of default could trigger certain acceleration clauses and cause those and ourthe Company’s other obligations to become immediately due and payable and wethe Company may not have sufficient cash funds available to repay ourits debt obligations upon such a Change in Control.

Cash FlowsSenior Secured Credit Facility — On October 17, 2012, the Company amended and restated its Senior Secured Credit Facility to, increase the credit facility’s revolving loan facility from Operating Activities$100.0 million to $120.0 million, decrease the interest rate margins on which interest rates are calculated on the revolving loan facility and add a FILO term facility of $7.5 million. The Senior Secured Credit Facility matures on the earlier to occur of 90 days prior to the maturity of any portion of the Senior Secured Term Loan and October 17, 2017. As of October 27, 2012, $46.0 million was outstanding under the credit facility. As of October 27, 2012, the Company had $59.8 million available to borrow on the credit facility. The amended credit facility contains provisions that allow the Company to request an expansion of the facility by up to $50.0 million and the addition of a last-in-last-out term loan tranche, in each case subject to certain conditions such as no default having occurred, and in each case subject to lenders’ election to participate.

Interest rates on borrowings under the revolving credit facility are either base rate (“BR”) loans or Eurodollar loans, at the Company’s discretion. BR loans bear interest at the greatest of (a) the prime rate as publicly announced by Wells Fargo Bank, N.A., or (b) the federal funds rate plus 0.5%, plus the BR applicable margin, which ranges between 0.50% and 1.00%. Eurodollar loans bear interest at LIBOR plus the LIBOR applicable margin, which ranges between 1.50% and 2.00%. At October 27, 2012, the Company’s interest rate was 2.13%. The interest rate spreads applicable to the Company’s borrowings fluctuate based upon the average excess availability as defined by the agreement.

Interest rate on the FILO term facility is at the Company’s option, either (a) the BR interest plus 1.75% or (b) LIBOR plus 2.75%.

The Senior Secured Credit Facility subjects the Company to certain restrictive covenants. The Company was in compliance with its covenants as of October 27, 2012.

Real Estate Secured Term Loan — In October 2010, the Company entered into a $50.0 million real estate secured term loan. On July 27, 2012 the Company completed a sale-leaseback transaction for six properties. Proceeds of $25.2 million from the sale-leaseback transaction were used to pay-off the Real Estate Secured Term Loan in its entirety as of July 28, 2012.

Current Liability Presentation — As discussed in Note 2 to the interim consolidated financial statements, the Company expects that it will not be in compliance with the maximum leverage ratio covenant under the Senior Secured Term Loan as of the next measurement date, which is February 2, 2013. Non-compliance with the leverage ratio covenant as of the next measurement date would cause a default under the financing arrangements if the Company is unable to otherwise restructure or repay the term loan by that time or otherwise obtain a waiver from the term loan debt holders at that time. A default could result in the Company’s lenders under the Senior Secured Term Loan declaring the outstanding indebtedness ($127.7 million as of October 27, 2012) to be due and payable. Because of the cross-default provisions in the Company’s debt agreements, a default under the Senior Secured Term Loan could result in a default under, and the acceleration of, payments in our Senior Secured Credit Facility. A default could result in the Company’s lenders under the Senior Secured Credit Facility declaring the outstanding indebtedness ($46.0 million as of October 27, 2012) to be due and payable. In addition, the Company’s lenders would be entitled to proceed against the collateral securing the indebtedness. As a result, the amounts owing under the Senior Secured Term Loan and Senior Secured Credit Facility are presented as Current Liabilities in the consolidated balance sheet as of October 27, 2012.

8. RELATED-PARTY AGREEMENTS

The Company purchases Sears Holdings’ brands such as Craftsman, Kenmore, Easy Living, and Weatherbeater directly from Sears Holdings and outside vendors. During the 13 weeks October 29, 2011, the Company purchased $5.7 million of merchandise directly from Sears Holdings. During the 39 weeks ended October 27, 2012 and October 29, 2011, the Company purchased approximately $0.1 million and $19.8 million, respectively, of merchandise directly from Sears Holdings.

In October 2011, the Company entered into a new appliances agreement (the “Appliances Agreement”) with a subsidiary of Sears Holdings pursuant to which Sears Holdings has authorized the Company to sell certain major branded appliances, (the “Products”) and related protection agreements on a consignment basis as a distributor through its designated retail locations on a commission basis. Commissions for Products varies by Product category and Sears Holdings may in its sole discretion modify from time to time the commission rate for each category of Product as defined in the agreement. The Products include specified categories of Kenmore, Bosch, Electrolux, GE, LG, Samsung and Whirlpool branded appliances. The agreement generally incorporates arm’s length terms and conditions, including market-based pricing and term of duration.

The Appliances Agreement was amended on March 22, 2012 (the “Amended Appliances Agreement”). Under the Amended Appliances Agreement, the Company may close up to 14 currently identified retail locations that carry appliances (the “Appliance Centers”) at specified times through August 2013 and close the remaining 13 Appliance Centers on January 31, 2015. The Amended Appliances Agreement has a term of five years. The Company exercised its right to close six Appliance Centers in specified stores and the closing of these appliance centers has been completed as of the third quarter of fiscal 2012.

The Company has net payables of $0.1 million, $2.9 million, and $3.1 million with Sears Holdings, as of October 27, 2012, January 28, 2012, and October 29, 2011, respectively.

9. COMMITMENTS AND CONTINGENCIES

Two putative class action lawsuits, brought on behalf of current and former employees, are pending against the Company. One of these lawsuits was brought in 2010 and one was brought in 2011. These lawsuits allege the Company failed to comply with various California labor laws, including misclassification of non-exempt employees as exempt employees, failure to pay regular, overtime, and final wages, failure to provide meal and/or rest breaks, and failure to provide accurate wage statements. The Company reached settlement of these two lawsuits, one in October 2012 on a California statewide basis and one in November 2012 with the individual plaintiff on a non-class basis. The settlements are currently being memorialized and will then be presented to the respective courts for approval. However, the Company has established an accrual based on the expected amount the Company will pay under the settlements.

The Company is a defendant in various other legal proceedings arising in the ordinary course of business. Based on the information currently available, the Company is not currently a party to any legal proceeding that management believes would have a material adverse effect on the Company’s consolidated financial position or results of operations.

10. INCOME TAXES

The Company regularly assesses the need for a valuation allowance against its deferred tax assets. In making that assessment, the Company considers both positive and negative evidence related to the likelihood of realization of the deferred tax assets to determine, based on the weight of available evidence, if it is more likely than not that some or all of the deferred tax assets will not be realized. In evaluating whether to record a valuation allowance, the applicable accounting standards deem that the existence of cumulative losses in recent years is a significant piece of objectively verifiable evidence that must be overcome by objectively verifiable positive evidence to avoid the need to record a valuation allowance.

Prior to the start of the second quarter of 2012, the Company concluded that positive evidence outweighed negative evidence, and no valuation allowance was necessary. The Company assessed the relevant positive and negative evidence at the conclusion of the second quarter ended July 28, 2012. As a result of this assessment, the Company concluded that, from an accounting perspective, the negative evidence now outweighed the positive evidence. In accordance with that conclusion, the Company recorded a non-cash charge to income tax expense in the second quarter of 2012 in the amount of $18.4 million by establishing a valuation allowance against its deferred tax assets. In determining the appropriate amount of the valuation allowance, the Company considered the timing of future reversal of its taxable temporary differences and available tax strategies that, if implemented, would result in realization of deferred tax assets. Due to the accumulated negative evidence at the end of the second quarter of fiscal 2012, the Company is no longer allowed under those accounting standards to consider future income projections exclusive of the reversing temporary differences. This accounting treatment has no effect on the ability of the Company to use loss carryforwards and tax credits in the future to reduce cash tax payments. As of October 27, 2012, there was a valuation allowance of $27.8 million against its deferred tax assets. The income tax benefit of $24.6 million in the 13 week period ended October 27, 2012 is primarily comprised of the reversal of deferred tax liabilities resulting from the trade name impairment of $60.3 million.

11. STOCK-BASED COMPENSATION

For the 13 and 39 weeks periods ended October 27, 2012 stock-based compensation expense was $0.5 million and $1.0 million, respectively, which is included in selling and administrative expenses in the consolidated statements of operations. Stock-based compensation expense for the comparable periods ended October 29, 2011 was $0.1 million and $0.3 million, respectively. The Company recognizes stock-based compensation costs, net of a forfeiture rate, for only those shares expected to vest on a straight-line basis over the requisite service period of the award.

Company uses the Black-Scholes option-pricing model to value its stock options. The weighted average assumptions relating to the valuation of the Company’s stock options were as follows:

Stock-Based Awards Activity

As of October 27, 2012, approximately 216,000 shares remain available for future grants of either stock options, restricted stock or restricted stock units.

The following table presents a summary of the Company’s stock option activity for the 39 weeks period ended October 27, 2012:

The following table presents a summary of the Company’s nonvested restricted stock activity for the 39 weeks ended October 27, 2012:

Performance-based Unit Awards

In the 39 week period ended October 27, 2012, 290,551 of performance-based restricted stock unit awards were granted to certain employees. Under the terms of the performance-based restricted stock unit awards granted, certain employees are eligible to receive restricted stock unit awards, contingent upon the achievement of certain Company-specific performance goals. Any stock unit awards earned as a result of the achievement of such goals vests at a rate of 8.33% in each subsequent fiscal quarter when the Company achieves the certain Company-specific performance goals during any of the trailing four fiscal quarters during the “Performance Period”. The Performance Period commences on the first nineday of the second fiscal quarter of 2012 and ends on the last day of the third fiscal quarter of 2018. Any stock units earned as a result of the achievement of such goals will vest in full over 6.75 years from the date of grant. No compensation expense with respect to performance-based stock unit awards has been recognized because the achievement of the performance goals was not probable.

ITEM 2. — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

You should read the following discussion and analysis in conjunction with the Company’s consolidated financial statements and related notes elsewhere in this report. Except for historical information, the discussion in this report contains certain forward-looking statements that involve risk and uncertainty. The Company has based these forward-looking statements on our current expectations and assumptions about future events. You can identify these statements by forward-looking words such as “outlook”, “believes”, “expects”, “appears”, “may”, “will”, “should”, “intend”, “target”, “projects”, “estimates”, “plans”, “forecast”, “is likely to”, “anticipates”, or the negative thereof or comparable terminology. Examples of such statements include references to revenue growth, new store openings and remodels, comparable store sales, demand for the Company’s products and services, the state of the California economy, inventory and in-stock positions, cash flow, and the like. Forward-looking statements are based on the Company’s beliefs as well as the Company’s current assumptions, expectations, and projections about future events based on information currently available to the Company. As a result, these statements are subject to various risks and uncertainties. For a discussion of material risks and uncertainties that the Company faces, see the discussion entitled “Risk Factors” in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012 and in Part II, Item 1A hereof, as supplemented by the Company’s subsequent SEC filings.

EXECUTIVE OVERVIEW

Orchard Supply Hardware Stores Corporation, (together with its wholly-owned subsidiaries, Orchard Supply Hardware LLC and OSH Properties LLC the “Company” or “we” or “our”), operates neighborhood hardware and garden stores focused on paint, repair and the backyard. We were founded as a purchasing cooperative in San Jose in 1931. Today our stores average 44,000 square feet of enclosed retail space and 8,000 square feet of exterior nursery and garden space. As of October 27, 2012, we had 89 stores in California. Our stores are easy to navigate and convenient to shop and are designed to appeal to do-it-yourself customers. We also serve the small professional customer whose purchases are largely motivated by a need for incremental supplies and tools to complete construction projects. We offer customers a unique value proposition comprised of service, selection and convenience.

On December 30, 2011, we became an independent, publicly-traded company as a result of Sears Holdings Corporation’s (“Sears Holdings”) distribution of its shares of the Company to Sears Holdings’ stockholders whereby Sears Holdings’ stockholders of record as of the close of business on December 16, 2011 received one share of our Class A Common Stock and one share of our Series A Preferred Stock for every 22.141777 shares of Sears Holdings’ common stock held (the “Spin-Off”).

At the time of the Spin-Off, Class A Common Stock owned by Ares Corporate Opportunities Fund (“ACOF”) immediately prior to the Spin-Off was exchanged for Class C Common Stock. Class A and Class C Common Stock represent approximately 80% and 20% of the general voting power of our outstanding capital stock, respectively. The outstanding shares of Preferred Stock represent 100% of our outstanding nonvoting capital stock.

Following the Spin-Off, since January 3, 2012, our Class A Common Stock has been listed and traded on NASDAQ under the symbol “OSH” and our Series A Preferred Stock has been quoted on the OTCQB under the symbol “OSHSP.”

2012 Third Quarter Financial Highlights

2012 Third Quarter Business Highlights

The Company is focused against five key strategic priorities:

Key accomplishments during the third quarter of fiscal 2012 included:

Financial Position. During the third quarter, we successfully refinanced our Senior Secured Credit Facility, which enabled us to increase our borrowing capacity at a lower cost and, as a result, we have strengthened our liquidity position. During the third quarter, we also engaged Moelis & Co. to lead us in the refinancing efforts of our Senior Secured Term Loan and, as a first step in this process, the Company obtained a short-term waiver from our current term loan lenders related to compliance with the leverage ratio covenant for the October 27, 2012 measurement period. See discussion under Liquidity below.

Brand Identity. During the third quarter, we opened our new South Bay store in Torrance and celebrated the grand reopening of three remodeled stores, two in San Jose and one in Los Angeles, as we continued the rollout of our innovative, neighborhood store format. These stores continue our progress in our multi-year brand and repositioning plan which, we believe, will lead to the achievement of an increase in comparable store sales and an increase in gross margin. At the end of the third quarter, we had eight stores in our new neighborhood store format. During the third quarter we also hired a new Vice President of Marketing to help us continue to build our brand as we grow our concept through traditional marketing initiatives as well as nontraditional methods such as social media and mobile technologies.

Drive Sales. The third quarter was the first time our remodeled stores became drivers of our performance. We made the decision to keep the three remodeled stores open during construction both to continue to serve our customers and to not have to furlough our employees. However, the construction was disruptive and relative to the prior year periods comparable store sales during the end of the second quarter and beginning of third quarter were adversely affected. As we opened the three remodeled stores during the third quarter, comparable stores sales for these stores met our expectations both in terms of traffic and average ticket and positively affected the Company’s comparable store sales. We believe our investments in remodels and new stores with our new format will continue to positively impact sales momentum into the future and be a key component of our repositioning.

Improve Operating Efficiencies. We continue to seek continuous improvement to our operations and ways to reduce expenses. During the third quarter, we realigned our field operations from four to three regions and discontinued certain functions at our support center in order to focus on the primary areas that will drive our business and differentiate us from our competitors. We also continue to execute on several programs to reduce our inventory levels while at the same time ensuring in-stocks to satisfy customer demand.

Align Resources and Talent. During the third quarter, we revised our associate incentive programs to better focus our associates on achieving success through strong performance and results.

RESULTS OF OPERATIONS

The discussion that follows should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements that are included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012, as well as the unaudited interim consolidated financial statements and accompanying notes contained in this report. Our unaudited consolidated results of operations for the 13 and 39 weeks periods ended October 27, 2012 and October 29, 2011 are summarized below (dollars and shares in millions, except per share amounts and store count).