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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended February 2, 2013

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) 281-3500

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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  ¨

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

The holders of Class A Common Stock are entitled to voting rights. The aggregate market value of voting stock held by non-affiliates of the registrant, computed by reference to the closing sales price of the Company’s Class A Common Stock as quoted on the NASDAQ Capital Market on July 27, 2012, the last business day of the registrant’s second fiscal quarter ended July 28, 2012, was $22,200,000. The holders of the Class B Common Stock are entitled to one-tenth of a vote for each share of Class B Common Stock held. No shares of the registrant’s Class C Common Stock, which are entitled to voting rights, are held by non-affiliates. (For purposes of this calculation, all of the registrant’s executive officers, directors and 10% owners known to the registrant may be deemed affiliates of the registrant and the aggregate value does not include the value of the Class B Common Stock, which is not publicly traded.)

As of April 18, 2013, the registrant had 4,830,147 shares of Class A Common Stock, par value $0.01 per share, 8,644.06788 shares of Class B Common Stock, par value $0.01 per share, and 1,194,000 shares of Class C Common Stock, par value $0.01 per share, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Pursuant to General Instruction G to Form 10-K, information required by Part III of this Form 10-K, either is incorporated herein by reference to a definitive proxy statement filed with the SEC no later than 120 days after the end of the fiscal year covered by this Form 10-K or will be included in an amendment to this Form 10-K filed with the SEC no later than 120 days after the end of the fiscal year covered by this Form 10-K.

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ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARIES

INDEX

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Special Note Regarding Forward-Looking Statements

We believe that some of the information in this document constitutes forward-looking statements. 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 our products and services, the state of the California economy, inventory and in-stock positions, cash flow, and the like. You should read statements that contain these words carefully because they:

We believe it is important to communicate our expectations to our stockholders. However, there may be events in the future that we are not able to accurately predict or over which we have no control. The risk factors and cautionary language discussed in this document outline examples of risks, uncertainties and events that may cause actual results to differ materially from the expectations described in the forward-looking statements, including among other things:

You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document.

All forward-looking statements included herein are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. Except to the extent required by applicable laws and regulations, we undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this document or to reflect the occurrence of unanticipated events.

You should be aware that the occurrence of the events described in the “Risk Factors” portion of this Annual Report on Form 10-K, the documents incorporated herein and our other Securities and Exchange Commission (the “SEC”) filings could have a material adverse effect on our business, prospects, financial condition or operating results.

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Part I

Item 1.—Business

Company Background

Orchard Supply Hardware Stores Corporation operates neighborhood hardware and garden stores focused on paint, repair and the backyard. The Company is a Delaware corporation incorporated on March 31, 1989 and was originally founded as a purchasing cooperative in San Jose, California in 1931. The Company’s stores average approximately 36,000 square feet of interior selling space and 8,000 square feet of exterior nursery and garden space. As of February 2, 2013, the Company operated 89 stores in California and had entered into leases to open four new stores in fiscal 2013, two in Oregon and two in California.

Unless the context otherwise requires, Orchard Supply Hardware Stores Corporation, the registrant, together with Orchard Supply Hardware LLC, its wholly-owned operating company subsidiary, and its other indirectly owned subsidiary, are collectively referred to in this Annual Report on Form 10-K (“Form 10-K”) as the “Company”, “Orchard”, “we”, “us” and “our.” Information regarding the Company’s fiscal periods is included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

In 1996, the Company was purchased by Sears, Roebuck and Co., (“Sears, Roebuck”), a subsidiary of Sears Holding Corporation (“Sears Holdings”). In 2005, Ares Corporate Opportunities Fund (“ACOF”) purchased approximately a 20% ownership interest in Orchard, leaving Sears, Roebuck owning approximately an 80% ownership interest.

On December 30, 2011, Orchard became an independent, publicly traded company as a result of Sears Holdings distribution of its shares of Orchard to Sears Holdings’ stockholders (the “Spin-Off” or “Distribution”). Upon the Spin-Off, Sears Holdings’ stockholders of record as of the close of business on December 16, 2011 (the “Record Date”) received one share of Orchard’s Class A Common Stock and one share of Orchard’s Series A Preferred Stock for every 22.141777 shares of Sears Holdings’ common stock held as of the Record Date. 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 (our “Preferred Stock”) has been quoted on the OTCQB under the symbol “OSHSP.”

At the time of the Spin-Off, Class A Common Stock owned by ACOF immediately prior to the Spin-Off was exchanged for Orchard’s Class C Common Stock. Orchard also has issued Class B Common Stock held by certain former employees of Orchard who acquired such shares of Class B Common Stock in connection with past equity compensation programs of Orchard.

Liquidity and Capital Restructuring

As of February 2, 2013, the Company had cash and cash equivalents of $6.5 million and total debt and capital lease obligations of $261.4 million. As of April 22, 2013, the Company had $17.4 million available to borrow on its credit facility. 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 agreement (“Senior Secured Term Loan”).

In fiscal 2012, the Company’s ability to comply with the leverage ratio covenant under its financial arrangements has been adversely impacted by, among other things:

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At the end of the second fiscal quarter on July 28, 2012, we would not have been in compliance with the leverage ratio covenant under our Senior Secured Term Loan had we not completed a six-store sale leaseback transaction.

At the end of the third fiscal quarter on October 27, 2012, we were not in compliance with the leverage ratio covenant under our Senior Secured Term Loan, but received a waiver of this covenant for that measurement date.

At the end of the fiscal year on February 2, 2013, we were not in compliance with the leverage ratio covenant under our Senior Secured Term Loan. On February 14, 2013, we received a waiver from the lenders under the Senior Secured Term Loan for the leverage ratio covenant with respect to our quarter ended February 2, 2013, as well as for the first fiscal quarter of 2013 ending May 4, 2013. Under the provisions of the waiver, and subject to our continued compliance with the terms and conditions of the waiver, our next applicable measurement date for the leverage ratio covenant compliance is August 3, 2013.

In connection with this waiver, the Senior Secured Term Loan lenders imposed several requirements upon us, including achieving a mutually acceptable agreement with them by May 1, 2013 with regard to refinancing or modifications to our capital structure. On April 26, 2013, the lenders extended such date to June 30, 2013. We continue to explore all financial and strategic alternatives including, but not limited to, one or more transactions that may include a comprehensive financial reorganization of our company or a transaction such as a sale or merger of the Company. We may also acquire funding through the issuance of debt, preferred stock, equity, additional real estate sale or sale leaseback transactions, or a combination of these items. Implementation of any of these strategies is likely to result in very significant dilution to our stockholders or a complete loss of their investment.

Failure to comply with the terms and conditions of the waiver would cause a default and, as a result, the lenders under our Senior Secured Term Loan could declare the outstanding indebtedness to be due and payable, in acceleration of the current maturity dates of December 21, 2013 and December 21, 2015. As a result of the cross-default provisions in our 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 revolving credit facility (“Senior Secured Credit Facility”). In addition, our lenders would be entitled to proceed against the collateral securing the indebtedness. If any of our indebtedness were to be accelerated, it would adversely affect our ability to operate our business, which could prevent us from continuing our ongoing operations.

Going Concern Uncertainty

The fiscal 2012 consolidated financial statements included herein have been prepared assuming the Company will continue as a going concern. The uncertainties surrounding (i) our inability to maintain compliance with the leverage ratio covenant under the Senior Secured Term Loan, (ii) our ability to comply with the terms and conditions of the waiver described above, noncompliance with which would cause a default and, as a result, the lenders under the Senior Secured Term Loan and the Senior Secured Credit Facility could declare the aggregate outstanding indebtedness of $208.2 million as of February 2, 2013 to be due and payable, and (iii) the requirement to agree upon a mutually acceptable refinancing or modifications to our capital structure with the Senior Secured Term Loan lenders, raises substantial doubt as to the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this going concern uncertainty.

The Company’s plans concerning these matters are discussed above in “Liquidity and Capital Restructuring.” For more information regarding our financial condition, liquidity and risks and uncertainties regarding our future liquidity, see “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition.”

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The report of our independent registered public accounting firm includes an explanatory paragraph which states there is substantial doubt about the Company’s ability to continue as a going concern.

Narrative Description of Our Business

We operate neighborhood hardware and garden stores focused on paint, repair, and the backyard. Our stores are designed to appeal to convenience-oriented customers, whose purchase occasions are largely driven by their home repair, maintenance and improvement needs throughout the home, garden and outdoor living areas. We also serve the small professional customer whose purchases are largely motivated by a need for incremental supplies and tools to complete construction projects.

The Company operates in a single reportable segment. We provide a merchandise mix which consists of various product categories, including repair and maintenance, backyard, and paint and home products. Our repair and maintenance category consists of plumbing, electrical, tools, hardware, and industrial products. Our backyard category consists of nursery, garden, outdoor power and seasonal products. Our paint and home category consists mainly of our paint, housewares and appliances products.

Reporting Status

We are a “smaller reporting company,” as defined in Rule 12b-2 of the Exchange Act, and also an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”), and are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not smaller reporting companies or emerging growth companies. These include, but are not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a non-binding advisory vote on executive compensation and the requirement to obtain stockholder approval of any golden parachute payments not previously approved.

Industry

The U.S. home improvement industry is an estimated $277 billion market consisting of the consumer and professional segments. We compete primarily in the $203 billion consumer segment where, according to the Home Improvement Research Institute, sales during 2012 grew at an estimated 3.8% average growth rate. The consumer segment of the U.S. home improvement industry is also expected to grow at a 5.0%, five-year average growth rate from 2012 through 2016.

Our Operating and Growth Strategy

We are dedicated to providing a superior customer experience through convenient store locations and formats with in-stock availability of a broad and differentiated selection of high-quality products at competitive prices, all delivered by friendly, motivated, and knowledgeable employees. We believe a great customer experience will help drive customer loyalty and satisfaction, thus increasing frequency of visits and market share. Success in these areas will also support our growth objectives. The key elements of this strategy are Merchandising and Marketing, Store Design, and Store Operations as described more fully below:

Merchandising and Marketing

A typical Orchard store offers a wide selection of repair and maintenance products comparable to larger warehouse competitors and carries more products than the typical smaller independent hardware store. We focus on offering the complete solution for customers to satisfy their home repair and maintenance, paint, seasonal, outdoor living, and lawn and garden needs. Our merchandising initiatives are focused on enhancing our product assortments, in-store merchandising and store layouts to drive incremental revenue and improve gross margin performance.

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We offer our customers a broad selection of national brand products from well-known manufacturers such as 3M, American Standard, Benjamin Moore, Black and Decker, Bosch, Corona, Craftsman, Delta, DeWalt, Duracell, General Electric, Kohler, Leviton, Moen, Quikrete, RainBird, Rubbermaid, Rustoleum, Scotts, Stanley, Toro and Weber. Our private label brands typically generate higher gross profit margins than third-party brands and include Aqua Vista, Orchard, Pacific Bay and Western Hawk; these private label brands also add to the distinctive nature of our product selection. For fiscal 2012, private label sales accounted for approximately 11.3% of our total net sales.

We believe that we have a good working relationship with over 800 merchandising suppliers. In fiscal 2012, our largest supplier accounted for 4.1% of our merchandise and our top ten suppliers accounted for approximately 22.9% of our total purchases. We believe that alternative and competitive suppliers are available for most of our products.

To complement and improve our product assortment, we continue to conduct product line reviews and form strategic alliances with selected suppliers. Examples of these activities include our distribution agreement for paint with Benjamin Moore & Co. and our license agreement with Sunset Publishing for outdoor furniture.

In 2012, we introduced Club Orchard, our customer loyalty and e-mail program in order to create and encourage repeat visits from our customers. We currently have over one million Club Orchard members.

Store Design

Our new-store format is bright, easy to navigate and features a unique navigational sign program which helps customers find items quickly. Related departments are generally located adjacent to each other and most merchandise is displayed according to centrally developed floor plans that are designed to optimize space utilization. In addition, we strive to select store sites that are easily accessible, conveniently located and have ample parking capacity. These features are intended to provide customers with a comfortable and convenient shopping experience. The new store format features the updated Orchard logo and branding elements, enhanced curb appeal, a prominent and conveniently located nursery and garden center, and a new “Workbench” area.

A key component of our growth strategy is to implement this new store format, or aspects of it, throughout our existing stores. By fiscal year end 2013, we expect to have transitioned nearly 20% of our stores into this new-store format.

Store Operations

We strive to promote a strong company culture featuring a team approach to store operations. Our store associates work in a zone coverage in-store structure “armed” with radio communications devices to quickly contact each other in order to serve our customer. This approach has also allowed us to simplify and enhance the deployment of our associates to help them focus on store sales activities.

Our stores are generally open seven days per week. Our stores are operated by store managers, who report to one of two regional teams each lead by a regional vice president. Our store managers are responsible for day-to-day store operations and subject to operating procedures established at our store support center. We believe our store-level management is one of the more stable and experienced groups in the industry with the average tenure of an Orchard store manager being approximately 13 years. We believe that our employees are the key to our success and support the development of a culture that fosters personal interaction, mutual respect, empowerment, enthusiasm, and commitment.

We have increasingly focused on recruiting, training, motivating, and retaining employees and we believe the quality, performance, and morale of our employees have increased as a result.

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Competition

The home improvement industry is highly competitive. We are positioned between larger warehouse home center competitors and smaller independent hardware stores and consider The Home Depot, Lowe’s, Ace Hardware and True Value as our primary competitors. Based on publically-available information, we believe that in California each of The Home Depot, Lowe’s, Ace Hardware, and True Value currently have significantly more stores than we do. Discount retailers such as Walmart, Costco, Target and Kmart, and multi-line retailers such as Sears, Roebuck also compete with us in certain product areas. In addition, our garden centers compete against smaller local nurseries and Armstrong Garden Centers in Southern California. Online and catalog businesses, which handle similar lines of merchandise, also compete with us.

Seasonality

Our business is seasonal. Our highest sales volume typically occurs in our second fiscal quarter, and the lowest volume typically occurs during our fourth fiscal quarter.

Distribution and Systems Infrastructure

Our leased distribution center in Tracy, California, stocks the majority of products that are offered in our stores and cross-docks additional products to provide our stores with approximately 68% of our merchandise needs. The remainder of our merchandise, including all of our live goods, goes directly from our vendors or distributors to our stores. We operate a private fleet of leased trucks and owned and leased trailers to deliver merchandise to most of our Northern California stores. We contract with a third party common carrier to deliver our merchandise to selected coastal and more distant Northern California, Southern California and Oregon stores.

Compliance with Environmental Laws

The Company’s compliance with the federal, state and local laws and regulations which have been enacted or adopted and which regulate the discharge of materials into the environment or otherwise related to the protection of the environment is not expected to have a material adverse effect upon the Company’s financial position or results of operations.

Service Marks and Trademarks

We have registered several service marks and trademarks with the United States Patent and Trademark Office, including our service marks “Orchard”, “Orchard Supply Hardware” and “Orchard Supply Hardware Est.1931” and trademarks “Aqua Vista,” “Seasons Tradition”, “OSH”, and “Western Hawk”. We believe that these service marks and trademarks are important components of our marketing and merchandising strategies.

Employees

As of February 2, 2013, we employed 5,360 persons, approximately 533 of whom were at our corporate offices, our distribution center, or part of our field operations. The remaining employees were store management and hourly store personnel, of which approximately 30.4% were full-time. Our employees are not covered by a collective bargaining agreement. We consider our employee relations to be good.

Executive Officers

We have recruited an experienced executive management team with the objective of increasing our profitability and stimulating our growth. Our executive management team has an average of over 20 years of retail-related experience and an average of 8 years in the home improvement industry. The names of our executive officers, their respective ages and positions as of April 22, 2013 and descriptions of their business experience are set forth below. There are no family relationships among any of the executive officers named below.

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Mark R. Baker, President and Chief Executive Officer, age 55

Mr. Baker has been President and Chief Executive Officer and a member of our Board since March 2011. From September 2008 to September 2010, Mr. Baker served as President and Chief Operating Officer of The Scotts Miracle-Gro Co., a leading manufacturer and marketer of branded consumer lawn and garden products. From September 2002 to September 2008, Mr. Baker served as Chief Executive Officer and President of Gander Mountain Company, an outdoor retailer specializing in hunting, fishing and camping gear. From May 1996 to August 2001, Mr. Baker held various positions with The Home Depot, lastly serving as Chief Merchandising Officer and Executive Vice President of Merchandising.

Chris D. Newman, Executive Vice President, Chief Financial Officer and Treasurer, age 47

Mr. Newman has been Executive Vice President, Chief Financial Officer and Treasurer since November 2011. From March 2006 to July 2011, Mr. Newman was Chief Financial Officer, Senior Vice President and Secretary of Restoration Hardware, Inc., a chain of home furnishings, functional and decorative hardware, and related merchandise.

Steven L. Mahurin, Executive Vice President, Merchandising, age 53

Mr. Mahurin has been Executive Vice President, Merchandising since May 2011 and a member of our Board since December 2011. From March 2008 to April 2011, Mr. Mahurin was Executive Vice President of Merchandising for Office Depot. From March 2004 to March 2008, Mr. Mahurin was Senior Vice President, Chief Merchandising Officer for True Value Company, a $2 billion hardware cooperative.

David I. Bogage, Senior Vice President, Human Resources, age 59

Mr. Bogage has been Senior Vice President of Human Resources since April 2011. From February 2009 to January 2011, Mr. Bogage was Senior Vice President, Talent and Organizational Development of The Scotts Miracle-Gro Co., a leading manufacturer and marketer of branded consumer lawn and garden products. From August 2003 to March 2008, he was Senior Vice President, Human Resources and Organizational Development for The Haskell Company.

Michael W. Fox, Senior Vice President, General Counsel and Secretary, age 54

Mr. Fox has been Senior Vice President, General Counsel and Secretary since October 2011. From 2005 to 2011, Mr. Fox held various positions with Jamba, Inc., a leading restaurant retailer of smoothies and other beverage and food offerings, lastly serving as Senior Vice President, General Counsel and Secretary.

Available Information

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available on our website at www.osh.com, after we electronically file such reports with the SEC. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information that we file electronically with the SEC at http://www.sec.gov. Information on our website is not incorporated into this Annual Report on Form 10-K. Stockholders may request free copies of these documents from:

Corporate Secretary

Orchard Supply Hardware Stores Corporation

6450 Via Del Oro

San Jose, California 95119

(408) 281-3500

We included the certifications of the Chief Executive Officer and the Chief Financial Officer of Orchard relating to the quality of our public disclosure, as required by Section 302 of Sarbanes-Oxley and related rules, in this Annual Report on Form 10-K as Exhibits 31.1 and 31.2 hereto.

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Item 1A. Risk Factors

Our business, prospects, financial condition, operating results and the trading price of our Class A Common Stock and Preferred Stock could be materially adversely affected by any of the following risks, as well as other risks not currently known to us or that we currently consider immaterial. In assessing the risks described below, you should also refer to the other information contained in this Annual Report on Form 10-K, including Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and the consolidated financial statements and the related notes in Part II, Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. These risks and uncertainties could also cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this report, other filings with the SEC, news releases, reports, proxy statements, registration statements, and other written communications, as well as oral forward-looking statements made from time to time by representatives of the Company.

Risks Relating to Our Financing

We will need to refinance or modify our capital structure or obtain an additional waiver and/or amendment of our term loan by June 30, 2013 or otherwise raise capital to repay our term loan debt, and if an additional waiver and/or amendment or refinancing is not obtained, we expect that we will be in violation of our leverage ratio covenant in our term loan facility, which would result in a default thereunder, and could lead to an acceleration of our obligations under this facility and other indebtedness which would have a material adverse impact on our business, including preventing us from continuing our operations.

The decline in our operating results during fiscal 2012, increased costs associated with being a public company independent from Sears Holdings, the impact of paying rent on properties previously owned but sold pursuant to multiple sale leaseback transactions, together with continued economic weakness in the markets in which we operate, have adversely impacted our ability to comply with the financial covenants under our financial arrangements, including our leverage ratio covenant in the Senior Secured Term Loan. We would not have satisfied the leverage ratio covenant under the Senior Secured Term Loan were we not able to obtain a waiver from our term loan lenders for the periods ended October 27, 2012 and February 2, 2013 (see Notes 2 and 6 to our consolidated financial statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”). In addition to waiving compliance with the leverage ratio covenant with respect to our quarter ended February 2, 2013, the latest waiver entered into on February 14, 2013 also waived compliance for the first fiscal quarter of 2013, ending May 4, 2013, resulting in the next applicable measurement date for the leverage ratio covenant compliance being August 3, 2013, subject to our continued compliance with the terms and conditions of the waiver.

In connection with the February 14, 2013 waiver, the Senior Secured Term Loan lenders imposed several requirements upon us, including achieving a mutually acceptable agreement with the lenders by May 1, 2013 with regard to refinancing or modifying our capital structure. On April 26, 2013, the lenders extended such date to June 30, 2013. Failure to comply with the terms and conditions of the waiver would cause a default and, as a result, the lenders under our Senior Secured Term Loan could declare the outstanding indebtedness to be due and payable, in acceleration of the current maturity dates of December 21, 2013 and December 21, 2015. As a result of the cross-default provisions in our debt agreements, a default under the Senior Secured Term Loan could result in a default under, and the acceleration of, payments in the Senior Secured Credit Facility. In addition, our lenders would be entitled to proceed against the collateral securing the indebtedness.

We continue to explore all financial and strategic alternatives to maintain our business as a going concern including, but not limited to, one or more transactions that may include a comprehensive financial reorganization of our company or a transaction such as a sale or merger. We may also acquire funding through the issuance of additional debt, equity or a combination of these instruments. While we are currently in discussions to refinance our term loan, we cannot assure you that we will be able to accomplish any necessary financing on terms that are

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acceptable, if at all, or obtain any required amendments or waivers from our lenders. Moreover, even if we raise additional equity or debt financing or obtain further amendments and/or waivers to our term loan, such actions may result in more restrictive terms, higher capital costs or lower levels of liquidity, and there are no assurances that we will have sufficient liquidity to fund any ongoing debt service obligations, working capital investments and capital expenditures. Our inability to restructure or modify our debt and capital structure, obtain any required amendments or waivers, to generate sufficient cash flows to satisfy such obligations, or to refinance our obligations on commercially reasonable terms, would adversely affect our results of operations, financial condition and cash flows, and our ability to operate our business, which could prevent us from continuing our ongoing operations.

The report of our independent registered public accounting firm includes an explanatory paragraph which states there is substantial doubt about the Company’s ability to continue as a going concern.

The terms of any additional debt or equity funding that we require may not be favorable to us or our stockholders and may result in significant dilution to our stockholders.

Our restructuring efforts to increase our liquidity and decrease our leverage may involve public or private equity offerings and/or debt financings, which may not be available on acceptable terms, if at all. If we raise additional funds by issuing equity securities, the new equity securities may have rights, preferences or privileges senior to those of existing holders of our equity securities and our stockholders may experience significant dilution or even a complete loss of their investment. Any debt financing will likely involve agreements that include representations, warranties, fees, affirmative and negative covenants, and default provisions significantly limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends, and may also require us to issue equity to the lenders in the form of warrants or other convertible securities, which may result in significant dilution to our stockholders or even a complete loss of their investment.

We have substantial debt. Any failure to obtain suitable replacement financing upon the maturing of our existing financing arrangements would adversely affect our business and results of operations.

Our business and results of operations depend substantially on our ability to obtain financing for our operations. We currently have the following secured financing arrangements, the outstanding total debt of which is classified as a current liability as of February 2, 2013:

Current economic conditions have generally adversely impacted the availability, cost and terms of debt financing. There can be no assurance that we will be able to replace our existing financing upon the maturity of our Senior Secured Credit Facility and Senior Secured Term Loan on commercially acceptable terms, or at all. If we are not able to renew or replace our existing financial arrangements when they become due, our costs for borrowings will likely increase and our revenues may decrease, or we could be precluded from continuing our operations at current levels. If we are unable to refinance our Senior Secured Credit Facility and Senior Secured Term Loan prior to their respective maturity dates, we cannot guarantee that we will generate enough cash flow from operations or be able to obtain enough capital to repay our outstanding indebtedness on such dates. In such event, we may need to close or sell stores, sell assets, reduce the number and/or frequency of store openings and improvements, issue capital stock or securities convertible into capital stock or issue debt securities to repay our

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indebtedness. If implemented, these actions could negatively impact our business, operating results or dilute our capital stock.

We may not have sufficient cash to repay our debt obligations on the occurrence of an event of default resulting from a change in control trigger.

Our Senior Secured Credit Facility and Senior Secured Term Loan 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 the Company to persons other than ACOF, ESL and Sears Holdings; (ii) adoption of a plan of liquidation of the Company; (iii) 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 voting capital stock and Sears Holdings, ESL and ACOF collectively holding less than such person or group; and (iv) our Board of Directors not consisting of continuing Directors (“Change in Control”). Neither ESL nor ACOF has agreed to maintain their shareholdings in the Company. If one or both of ESL and ACOF dispose of all or part of their shareholdings in the Company such that a single person or group holds directly or indirectly at least 40% of the total voting power of all shares of our voting capital stock and Sears Holdings, ESL and ACOF collectively hold less than such person or group, this may trigger a Change in Control event of default under the Senior Secured Credit Facility and Senior Secured Term Loan. An event of default could trigger certain acceleration clauses and cause those and our other obligations to become immediately due and payable and we may not have sufficient cash funds available to repay our debt obligations upon such a Change in Control.

Unexpected costs or delays in the construction of tenant improvements in certain of our sale leaseback stores could cause us to repurchase the property and affect our cash flows.

Under the master lease agreements covering properties subject to sale leaseback transactions that occurred during fiscal 2012, we rely upon tenant improvement allowances for hiring contractors and performing work to refurbish or renovate certain of the stores subject to such leases. Any delays or cost overruns which prevent us from completing the refurbishment or renovations within the anticipated budget and timeline could have an adverse effect upon our business. In particular, failure to complete the agreed upon tenant improvements under any one of the applicable leases within contractual time limits could allow the landlord under the lease to require us to purchase the properties and improvements subject to the lease from the landlord in accordance with the repurchase terms specified in the subject lease. Under such circumstances, we may not have sufficient available funds to purchase such property and improvements.

Increases in interest rates could adversely affect our operating results.

An increase in prevailing interest rates could adversely affect our operating results. At February 2, 2013, we had approximately $208.2 million aggregate principal amount of variable interest rate indebtedness under our Senior Secured Credit Facility and Senior Secured Term Loan. The variable interest rates applicable to this indebtedness are based on several interest rate indexes that fluctuate on a regular basis, including the London Interbank Offered Rate (“LIBOR”) and the prime rate as publicly announced by certain of our lenders and the U.S. federal funds rate. If interest rates increase, our debt service obligations on this variable rate indebtedness would increase even though the amount borrowed would remain the same, and our net income would decrease. In the future, we may enter into interest rate swaps or cap contracts to reduce interest rate volatility. Such additional agreements as we may enter into to reduce interest rate volatility may be unfavorable to us depending on rate movements and may not completely protect us from increased interest expense in particular situations.

Our substantial leverage may place us at a competitive disadvantage in our industry.

We are substantially leveraged and have significant debt service obligations. At February 2, 2013, our outstanding debt (excluding capital leases) was approximately $208.2 million. Our significant debt and debt

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service requirements could adversely affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities. For example, our high level of debt presents the following risks:

Servicing our debt requires a significant amount of cash and our ability to generate cash may be affected by factors beyond our control.

We may be unable to generate sufficient cash flow from operations or to obtain future borrowings under our credit facilities or otherwise in an amount sufficient to enable us to pay our debt or to fund our other liquidity needs. Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If we do not have sufficient liquidity, we may need to refinance or restructure all or a portion of our debt on or before maturity, seek equity financing, sell assets, or borrow more money, which we may not be able to do on terms satisfactory to us or 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. We cannot assure you that our business will generate sufficient cash flow from operations or that future sources of funding will be available to us in amounts sufficient to enable us to fund our liquidity needs. If we are unable to meet our obligations with respect to our debt, we could be forced to restructure or refinance our debt, seek equity financing or sell assets.

Credit rating downgrades would increase our financing costs and negatively affect our access to capital.

Our credit ratings may affect our cost of financing and our ability to access financing sources. In October 2012, Moody’s Investors Service downgraded the Company’s senior secured term loan to Caa1 from B3. In March 2013, Moody’s Investors Service downgraded the Company’s corporate family rating to Caa2 from Caa1. In April 2013, Standard and Poor’s Ratings Services downgraded the Company’s corporate credit rating to CCC- from CCC. Rating agencies revise their ratings for the companies that they follow from time to time and our ratings may be revised or withdrawn in their entirety at any time. Any further credit rating downgrade would increase our financing costs under a portion of our Senior Secured Term Loan and could limit our access to financing sources.

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Restructuring Risks

We may not be successful in restructuring our term loan debt

In connection with our inability to maintain our leverage covenants under our Senior Secured Term Loan for our fiscal quarters ended October 27, 2012 and February 2, 2013, we obtained waivers from our Senior Secured Term Loan lenders, whereby the Senior Secured Term Loan lenders waived, among other things, 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 us to comply with the maximum adjusted leverage ratio covenant contained in the Senior Secured Term Loan for the respective fiscal quarters. The waiver provided for the fiscal quarter ended February 2, 2013, also provided for a waiver for our fiscal quarter ending May 4, 2013, and conditioned the waiver in its entirety on our continued compliance with certain terms and conditions, including achievement of a mutually acceptable agreement with the term loan lenders by May 1, 2013 relating to refinancing or modifications to our capital structure in a way that serves the best interests of all of our stakeholders. On April 26, 2013, such date was extended to June 30, 2013. Total long-term debt of $208.2 million has been classified as current liabilities as of February 2, 2013.

While we are addressing the terms of our restructuring with our Senior Secured Term Loan lenders, we cannot provide you with any assurances that we will reach agreement on the definitive terms of any restructuring. In addition, the completion of any out-of-court restructuring may require an amendment to our certificate of incorporation that would need to be approved by our stockholders. We cannot provide you with any assurances that any restructuring can be completed out-of-court or whether we will be required to implement a restructuring under the supervision of a bankruptcy court.

In addition, while we anticipate continued compliance with the terms and conditions of the waiver while we address the terms of our restructuring, failure to comply with the terms and conditions of the waiver could cause the effectiveness of the waiver to terminate. In the event the waiver terminates, there would be a default under the Senior Secured Term Loan and, as a result, the lenders under the Senior Secured Term Loan could declare the outstanding indebtedness to be due and payable, in acceleration of the current maturity dates of December 21, 2013 and December 21, 2015. As a result of the cross-default provisions in our debt agreements, a default under the Senior Secured Term Loan could result in a default under, and the acceleration of, payments in the Senior Secured Credit Facility. If payments under our credit facilities were to be accelerated, we anticipate that we would seek protection under the Bankruptcy Code.

Our business and operations are subject to certain risks relating to the restructuring of our term loan debt.

Our business and operations are subject to various risks relating to the restructuring of our term loan debt, some of which may be the result of our suppliers, employees or others being concerned about the Company’s ability to continue as a going concern, and others which would result if we were to curtail our operations in whole or in part. These risks include, but not limited to, the following:

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Risks Relating to Our Business

If we fail to offer merchandise and services that our customers want, our revenues may be limited, which would reduce our revenues and profits.

In order for our business to be successful, we must identify, obtain supplies of, and offer to our customers attractive, innovative and high-quality merchandise on a continuous basis. Our products and services must satisfy the desires of our customers, whose preferences may change in the future. If we misjudge either the demand for products and services we sell or our customers’ purchasing habits and tastes, we may be faced with excess inventories of some products and missed opportunities for products and services we chose not to offer. In addition, our revenues may decline or we may be required to sell the merchandise we have obtained at lower prices. This would have a negative effect on our business and results of operations.

If we are unable to compete effectively in the highly competitive home improvement retail industry, our business and our results of operations could be materially adversely affected.

The home improvement retail industry is highly competitive with few barriers to entry. We compete against a diverse group of retailers, both small and large, including warehouse home centers and local hardware stores. We consider The Home Depot, Lowe’s, Ace Hardware and True Value as our primary competitors. Discount retailers such as Wal-Mart, Target and Kmart, and multi-line retailers such as Sears, Roebuck, also compete with us in certain product areas. In addition, our garden centers compete against smaller local nurseries. Online and catalog businesses, which handle similar lines of merchandise, also compete with us. Many of our competitors have a larger number of stores, more products available online, substantially greater financial, distribution and marketing resources, larger market shares and a more widespread, national presence. Such factors may provide our competitors with greater financial resources to expand, grow and allow for stronger relationships and aggressive pricing with vendors and third-party suppliers. Furthermore, some of our competitors have been aggressively building new stores in locations with high concentrations of our stores and in locations we have targeted for expansion. We expect that as the home improvement retail industry market grows, new competitors will enter the market and competition from established companies will increase.

Our success depends on our ability to differentiate ourselves from our competitors and remain competitive with respect to shopping convenience, availability of merchandise in-stock and customer service. The performance of our competitors, as well as changes in their pricing policies, marketing activities, new store openings and other business strategies, could have a material adverse effect on our business, financial condition and results of operations.

Our business has been and will continue to be affected by worldwide economic conditions and, in particular, California economic conditions; a failure of the economy to sustain its recovery, a renewed decline in consumer-spending levels and other conditions, including inflation, could lead to reduced revenues and gross margins, and negatively impact our liquidity.

Many economic and other factors are outside of our control, including consumer and commercial credit availability, consumer confidence and spending levels, inflation, employment levels, housing sales and remodels, consumer debt levels, fuel costs and other challenges currently affecting the global economy, the full impact of which on our business, results of operations and financial condition cannot be predicted with certainty. The

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California economy, in particular, has recently been susceptible to slowdowns and recessions. These economic conditions adversely affect the disposable income levels of, and the credit available to, our customers, which could lead to reduced demand for our merchandise. Also affected are our vendors, upon which we depend to provide us with financing on our purchases of inventory and services. Our vendors could seek to change either the availability of vendor credit to us or other terms under which they sell to us, or both, which could negatively impact our liquidity. In addition, the inability of vendors to access liquidity, or the insolvency of vendors, could lead to their failure to deliver inventory or other services. Certain of our vendors also are experiencing increases in the cost of various raw materials, such as copper, steel and resin, which could result in increases in the prices that we pay for merchandise, particularly in our plumbing, industrial and electrical categories.

In addition to credit terms from vendors, our liquidity needs are funded by our operating cash flows and, to the extent necessary, borrowings under our credit agreements. The availability of financing depends on numerous factors, including economic and market conditions, our credit ratings and financial performance, and lenders’ assessments of our prospects and the prospects of the retail industry in general. The lenders under our credit facilities may not be able to meet their commitments if they experience shortages of capital and liquidity and there can be no assurance that our ability to otherwise access the credit markets will not be adversely affected by changes in the financial markets and the global economy.

Continued high rates of unemployment, depressed home prices, reduced access to credit and the domestic and international political situation also adversely affect consumer confidence. Low consumer confidence and the threat, outbreak, or escalation of terrorism, military conflicts or other hostilities may lead to reduced consumer spending, particularly by our customers on many of the discretionary items we sell that relate to home and garden improvement projects. These factors could cause us to increase inventory markdowns and promotional expenses, thereby reducing our gross margins and operating results.

If we do not successfully manage our inventory levels, our operating results will be adversely affected.

We must maintain sufficient inventory levels to operate our business successfully. However, we also must guard against accumulating excess inventory as we seek to maintain in-stock levels and to minimize out-of-stock levels across all product categories. We obtain a portion of our inventory from vendors located outside the United States. Some of these vendors often require lengthy advance notice of our requirements in order to be able to supply products in the quantities we request. This usually requires us to order merchandise, and enter into purchase orders for the purchase and manufacture of such merchandise, well in advance of the time these products will be offered for sale. As a result, we may experience difficulty in responding to a changing retail environment. If we do not accurately anticipate the future demand for a particular product or the time it will take to obtain new inventory, our inventory levels will not be appropriate and our results of operations may be negatively impacted.

Adverse changes in economic factors specific to the home improvement industry may negatively impact the rate of growth of our revenues and comparable store sales.

Sales of many of our product categories and services are driven by housing turnover and activity level of home and garden improvement projects. Steep declines over recent years in home prices, the increasing number of households with negative equity, increasing mortgage delinquency and foreclosure rates, reduction in the availability of mortgage financing, fluctuations in interest rates on variable rate mortgages, fewer housing starts and significantly lower housing turnover have limited, and may continue to limit, consumers’ discretionary spending. The overall housing environment and related economic factors have diminished consumer confidence levels, which in turn has adversely affected consumer spending on home and garden improvement projects. The impact of these economic factors specific to the home and garden improvement industry is exacerbated by what is expected to be a gradual and prolonged period of economic recovery with slow employment growth.

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Our revenues may fluctuate for a variety of reasons, which could adversely affect our results of operations.

Our business is sensitive to customers’ spending patterns, which in turn are subject to prevailing economic conditions. Our revenues and results of operations have fluctuated in the past, and we expect them to continue to fluctuate in the future. A variety of other factors affect our revenues and financial performance, including:

Accordingly, our results for any one quarter are not necessarily indicative of the results to be expected for any other quarter, and comparable store sales for any particular future period may increase or decrease. For more information on our results of operations, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Extended cold or wet weather in California, particularly in the spring, can have an adverse effect on our operating results.

The sale of a substantial portion of our merchandise depends upon our customers undertaking repair, maintenance and improvement projects in their home and garden. We believe that our customers are more likely to begin such projects during periods of warm and dry weather. Accordingly, we have historically realized a significant portion of our revenues and earnings for the year in the spring selling season, which includes March, April, May and June. In fiscal 2012 and 2011, we generated 30% of our revenues in the second fiscal quarter. Wet, windy and/or cold weather conditions can reduce foot traffic in our stores. Extended cold or wet weather conditions in California, particularly during the spring months, can significantly reduce our revenues and have a material adverse effect on our results of operations and our liquidity. Furthermore, lower than anticipated revenues during the spring selling season may cause us to increase inventory markdowns and promotion expenses, thereby reducing our gross margins and operating results.

If our stores, our distribution center or our store support center experience catastrophic damage and loss due to natural disasters, our operations would be seriously harmed.

Each of our stores, our distribution center and our store support center are located in California in areas that are susceptible to earthquakes and other natural disasters, such as wildfires, floods and tsunamis. If any of our facilities, and in particular our distribution facility in Tracy, California, were to experience catastrophic damage and loss, it could disrupt our store operations, delay shipments of our merchandise, reduce our revenue and result in large expenses to repair or replace our facilities. The occurrence of any of these natural disasters could have a material adverse impact on our business, results of operations and financial condition.

We currently rely on a single distribution center. The loss or disruption of operations at our centralized distribution center or our failure in the future to expand or add additional distribution facilities could have an adverse effect on our business, operations and operating results.

A majority of our inventory is shipped directly from our suppliers to a single centralized distribution center that we lease in Tracy, California, where the inventory is then received, sorted and shipped to our stores. Our operating results depend on the orderly operation of our receiving and distribution processes, which in turn depend upon our private fleet of leased tractors, leased and owned trailers, third-party common carriers and the

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effective management of our distribution facilities. We may not anticipate all the changing demands that our expanding operations will impose on our receiving and distribution system, and events beyond our control, such as disruptions in operations due to fire, earthquakes or other catastrophic events. In addition, shipping problems or labor disagreements may result in delays in the delivery of merchandise to our stores.

If we expand our retail store base, we may need to expand our distribution facilities, therefore we may need to acquire, construct or lease additional distribution facilities in other geographic locations to accommodate a planned expansion. An expansion of our distribution facilities will require significant capital investment, costs and time and could place increased demands on our financial, managerial and operational resources. We may also need to invest in additional information technology to achieve a unified receiving and distribution system.

While we maintain insurance, in the event our distribution center were to be shut down for any reason or if we were to incur higher costs and longer lead times in connection with a disruption at our distribution center, our insurance may not be sufficient, and insurance proceeds may not be timely paid to us.

We rely extensively on computer systems to process transactions, summarize results and manage our business. Disruptions in these systems could harm our ability to run our business.

Given the number of individual transactions we have each year, it is critical that we maintain uninterrupted operation of our computer and communications hardware and software systems. Our systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer viruses, security breaches, including breaches of our transaction processing or other systems that result in the compromise of confidential customer data, catastrophic events such as fires, tornadoes and hurricanes, and usage errors by our employees. If our systems are breached, damaged or cease to function properly, we may have to make a significant investment to fix or replace them, we may suffer interruptions in our operations in the interim, we may face costly litigation, and our reputation with our customers may be harmed. Our ability to maintain sufficient inventory levels in our stores is critical to our success and largely depends upon the efficient and uninterrupted operation of our computer and communications hardware and software systems. Any material interruption in our computer operations may have a material adverse effect on our business or results of operations.

A failure or breach of our security systems or infrastructure as a result of cyber-attacks could disrupt our business, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.

Information security risks have significantly increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists and other external parties. These threats may derive from fraud or malice on the part of our employees or third parties, or may result from human error or accidental technological failure. These threats include cyber-attacks such as computer viruses, malicious code, phishing attacks or information security breaches.

To date, we have not experienced any material impact relating to cyber-attacks or other information security breaches. Any actual attacks could lead to damage to our reputation, additional costs (such as repairing systems and investigation or compliance costs), penalties, financial losses to both us and our customers and partners and the loss of customers and business opportunities. If such attacks are not detected immediately, their effect could be compounded. As cyber-threats continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any information security vulnerabilities. Any of the risks described above could materially adversely affect our overall business and results of operations.

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We rely on third parties to provide us with services in connection with the administration of certain aspects of our business.

We have entered into agreements with third-party service providers (both domestic and international) to provide processing and administrative functions over a range of areas, and we may continue to do so in the future. These areas include credit card processing, e-commerce services, payroll and product returns. Services provided by third parties could be interrupted as a result of many factors, such as acts of God or contract disputes. Any failure by third parties to provide us with these services on a timely basis or within our service level expectations and performance standards could result in a disruption of our business and have an adverse effect on our business and operating results.

We have incurred and may continue to incur charges due to impairment of intangible and long-lived assets.

As of February 2, 2013 we had intangible asset balances of $29.7 million, which are subject to testing for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Our intangible assets consist of $11.5 million of our trade names and $18.2 million of favorable leasehold rights. During fiscal 2012, we recognized total non-cash trade name impairment charges of $96.1 million due to the decline in our market cap, lower forecasted future revenues, difficulties in meeting our loan agreement covenant, recurring losses from operations, our negative working capital position and the substantial doubt about our ability to continue as a going concern. Failure to achieve sufficient levels of future cash flows could result in further impairment charges for our trade names. If the decline in our revenues continues, this could have a material effect on our trade name valuation and could result in additional impairment charges. Our long-lived assets, primarily property and equipment at our stores and favorable leasehold rights, are also subject to testing for impairment. A significant amount of judgment is involved in our impairment assessment. Failure to achieve sufficient levels of cash flow could result in impairment charges for intangible assets or property and equipment, which could have a material adverse effect on our results of operations.

Our failure to retain our senior management team and to continue to attract qualified new personnel could adversely affect our results of operations.

We depend on the talents and continued efforts of our senior management team. We do not maintain key-man life insurance on any of our executives and our executives are employed on an “at will” basis. The loss of one or more of the members of our senior management team may disrupt our business and materially adversely affect our results of operations. Furthermore, our ability to manage any further expansion will require us to continue to train, motivate and manage our employees and to attract, motivate and retain additional qualified managerial and store personnel. We believe that having store personnel who are knowledgeable and experienced in home repair matters has been an important factor in our historical success and we believe it will continue to be important to growing our business. Competition for these types of personnel is intense, and we may not be successful in attracting, assimilating and retaining the personnel required to grow and operate our business profitably.

We may be subject to product liability claims if people or properties are harmed by the products we sell or the services we offer.

Some of the products we sell may expose us to product liability claims relating to personal injury, death, or property damage caused by such products, and may require us to take actions such as product recalls. We also provide various services, which could also give rise to such claims. Although we maintain liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on economically reasonable terms, or at all. Product liability claims can be expensive to defend and can divert the attention of management and other personnel for significant periods, regardless of the ultimate outcome. Claims of this nature, as well as product recalls, could also have a negative impact on customer confidence in the products we stock and in our reputation, our business and our operating results.

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We may be subject to periodic litigation and other regulatory proceedings. These proceedings may be affected by changes in laws and government regulations or changes in the enforcement thereof.

From time to time, we may be involved in lawsuits and regulatory actions relating to our business or products we sell or have sold. These proceedings may be in jurisdictions with reputations for aggressive applications of laws and procedures against corporate defendants. We are impacted by trends in litigation, including class-action allegations brought under various consumer protection and employment laws, including wage and hour laws. Due to the inherent uncertainties of litigation and regulatory proceedings, we cannot accurately predict the ultimate outcome of any such proceedings. An unfavorable outcome could have a material adverse impact on our business, financial condition and results of operations. In addition, regardless of the outcome of any litigation or regulatory proceedings, these proceedings could result in substantial costs and may require that we devote substantial resources to defend our Company and could affect the future premiums we would be required to pay on our insurance policies. Further, changes in governmental regulations could have adverse effects on our business and subject us to additional regulatory actions.

Our new store format may not be successful; and opening and remodeling stores could strain our resources and have a material adverse effect on our business and financial performance.

Our future growth depends in part on our ability to successfully remodel existing stores resulting in higher sales volumes and open and operate new stores profitably. By the end of fiscal 2013, we expect to have approximately 20 stores in the new neighborhood store format. We cannot predict that the new neighborhood store format will be successful. Remodeling new stores and opening new stores will require us to invest significant financial resources and place increased demands on our management, operational and administrative infrastructure. In addition, our planned remodels and new stores will require us to increase continually the number of people we employ, as well as to expand and upgrade our management information, inventory tracking and other systems. Successfully remodeling and opening a new store is a significant operational and administrative challenge. It is possible that we may not foresee all of the problems that could arise during a store remodel or opening or realize the expected benefits of remodeling or opening a particular store. If we fail to meet these increased demands and operating complexities of remodeling or opening new stores, it could have a material adverse effect on our business, financial condition and results of operations. New stores opened outside of the Company’s existing markets may be less profitable than existing stores in our core markets, which could adversely affect the Company and our results of operations.

We are subject to regulations that impact our business and a failure to comply with such regulations could lead to lawsuits or regulatory actions against us.

Operating primarily in California exposes us to a particularly challenging regulatory environment, with aggressive enforcement efforts by private litigators in several areas of law, including, without limitation, environmental laws, consumer protection laws, employment laws, anti-discrimination laws, and wage and hour regulations and laws. This strict regulatory and litigation environment requires the Company to maintain a heightened compliance effort and exposes us to defense costs, possible fines and penalties, and liability to private parties for monetary recoveries and attorneys’ fees, any of which could have an adverse effect on our business and results of operations.

California and federal employment and labor laws govern our relationship with our employees and affect our operating costs. These laws include minimum wage requirements, overtime pay, unemployment tax rates, workers’ compensation rates, citizenship requirements and sales taxes. We are currently, and from time to time in the past have been, the subject of lawsuits by certain of our employees alleging various violations of these regulations, including suits alleging that we wrongfully denied certain of our employees overtime wages or that we unlawfully deducted costs for workers compensation expenses. A determination that we do not comply with these laws or other related laws could harm our profitability or business reputation. Future government-imposed increases in minimum wages, overtime pay, paid leaves of absence or mandated health benefits could also materially and adversely affect us.

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From time to time we are subject to claims of employment discrimination, unlawful employment practices and Americans with Disabilities Act claims.

If we do not maintain the security of our customer, associate or company information, we could damage our reputation, incur substantial additional costs and become subject to litigation.

Any significant compromise or breach of customer, associate or company data security either held and maintained by us or our third-party providers could significantly damage our reputation and result in additional costs, lost sales, fines and lawsuits. The regulatory environment related to information security and privacy is increasingly rigorous, with new and constantly changing requirements applicable to our business, and compliance with those requirements could result in additional costs. We may be subject to unauthorized access to secured data and there is no guarantee that the procedures we have implemented are adequate to safeguard against all data security breaches. If we cannot remediate security issues, we may experience a security data breach that could negatively impact our business and our results of operations.

If we are unable to renew or enter into new leases on competitive terms our revenue or results of operations could be negatively impacted.

As of February 2, 2013, we leased 84 store locations, our distribution center and our store support center under long-term agreements. If our cost of leasing increases, we may be unable to maintain our existing store locations, distribution center and store support center as leases expire. Our profitability may decline if we fail to enter into new leases on competitive terms or at all, or we may not be able to locate suitable alternative store locations or additional sites for our new store expansion in a timely manner. Furthermore, approximately 68 of our leases will expire within the next 10 years and some do not grant us any rights to renew the lease. A failure to renew our existing leases or enter into new leases could reduce our revenue and negatively impact our results of operations.

We are required to comply with increasingly stringent federal, state and local environmental laws and regulations, the cost of which is likely to increase and may adversely affect our results of operations, cash flow or financial condition.

Our operations, properties and the products we sell are subject to various federal, state and local environmental laws and regulations. These laws and regulations not only govern our current operations, properties and the products we sell, but also impose potential liability on us for our past operations. We expect environmental laws and regulations to impose increasingly stringent requirements upon our industry and us in the future. Our costs to comply with these laws and regulations may increase as these requirements become more stringent in the future, and these increased costs may adversely affect our results of operations, cash flow or financial condition.

Changes in existing or new laws and regulations or regulatory enforcement priorities could adversely affect business.

Laws and regulations at the local, regional, state, federal and international levels change frequently and the changes can impose significant costs and other burdens of compliance on our business and our vendors. Any changes in regulations, the imposition of additional regulations, or the enactment of any new legislation that affect employment/labor, trade, product safety, transportation/logistics, energy costs, health care, cyber-security or tax could have an adverse impact, directly or indirectly, on our financial condition and results of operations. Changes in enforcement priorities by governmental agencies charged with enforcing existing laws and regulations can increase our cost of doing business.

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If we fail to timely and effectively obtain shipments of product from our vendors and deliver merchandise to our customers, our operating results will be adversely affected.

We cannot control all of the various factors that might affect our timely and effective procurement of supplies of product from our vendors and delivery of merchandise to our customers. As we progress through our restructuring process, vendor concerns about our financial condition may cause them to restrict ordinary credit terms, require financial assurances of performance or otherwise refrain entirely from providing goods and services to us. Furthermore, a majority of the products that we purchase, domestically or overseas, must be shipped to our distribution center in Tracy, California. Our utilization of foreign imports also makes us vulnerable to risks associated with products manufactured abroad, including, among other things, risks of damage, destruction or confiscation of products while in transit to our distribution center, work stoppages including as a result of events such as longshoremen strikes, transportation and other delays in shipments including as a result of heightened security screening and inspection processes or other port-of-entry limitations or restrictions in the United States, lack of freight availability and freight cost increases. In addition, if we experience a shortage of a popular item, we may be required to arrange for additional quantities of the item, if available, to be delivered to us through airfreight, which is significantly more expensive than standard shipping by sea. As a result, we may not be able to obtain sufficient freight capacity on a timely basis or at favorable shipping rates and, therefore, we may not be able to timely receive merchandise from our vendors or deliver our products to our customers.

We rely upon proprietary and third-party land-based carriers for merchandise shipments to our facility in Tracy, California and from this facility to our stores. Accordingly, we are subject to the risks, including labor disputes, union organizing activity, inclement weather and increased transportation costs, associated with such carriers’ ability to provide delivery services to meet our inbound and outbound shipping needs. In addition, if the cost of fuel continues to rise or remains at current levels, the cost to deliver merchandise from the distribution center to our stores may rise which could have an adverse impact on our profitability. Failure to procure and deliver merchandise either to us or to our customers in a timely, effective and economically viable manner could damage our reputation and adversely affect our business. In addition, any increase in distribution costs and expenses could adversely affect our future financial performance.

We rely on foreign sources for merchandise, and our business may therefore be negatively affected by the risks associated with international trade.

Approximately 41.3% of our merchandise is purchased from foreign vendors, either directly by us or indirectly by our distributors who, in turn, sell this merchandise to us. We believe that in order to remain competitive we must maintain or increase the portion of merchandise purchased from such vendors. This reliance on foreign vendors results in our facing risks inherent in purchasing from foreign suppliers, including:

Any increase in cost to us of merchandise purchased from foreign vendors or restriction on the merchandise made available to us by such vendors could have an adverse effect on our business and operating results.

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If our relationships with our vendors were to be impaired, it could have a negative impact on our competitive position and our business and financial performance.

Most of our vendor arrangements are not long-term agreements, and, therefore, our success depends on maintaining good relations with our vendors. Our growth strategy depends to a significant extent on the willingness and ability of our vendors to supply us with sufficient inventory to stock our new stores. If we fail to strengthen our relations with our existing vendors or to enhance the quality of merchandise they supply us, or if we cannot maintain or acquire new vendors of favored brand name merchandise, our ability to obtain a sufficient amount and variety of merchandise at acceptable prices may be limited, which would have a negative impact on our competitive position. In addition, our inability to stock our stores with new and desired merchandise at attractive prices could result in lower revenues and decreased customer interest in our stores, which, in turn, would adversely affect our financial performance. In addition, we may not be able to develop relationships with new vendors, and products from alternative sources, if any, may be of a lesser quality and more expensive than those we currently purchase. Merchandise supplied to stores by our top ten suppliers accounted for approximately 22.9% of our total purchases. The loss of or a reduction in the amount of merchandise made available to us by our key vendors could have an adverse effect on our business and operating results.

As a public company, we have increased expenses and administrative burdens, in particular to bring our Company into compliance with certain provisions of Sarbanes-Oxley and related laws and regulations.

As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. These increased costs and expenses arise from various factors, including financial reporting, costs associated with complying with federal securities laws (including compliance with Sarbanes-Oxley), tax administration, legal and human resources related functions. As a result of becoming a public company, we needed to create or revise the roles and duties of our Board committees, adopt additional internal controls and disclosure controls and procedures, retain a transfer agent and adopt corporate governance policies in compliance with our obligations under the securities laws.

We are investing resources to comply with evolving laws, regulations and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and our business may be harmed. The costs of compliance or our failure to comply with these laws, rules and regulations could adversely affect our reputation, financial condition, results of operations and the price of our Class A Common Stock and Preferred Stock.

We are a smaller reporting company as well as an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to such companies makes our Class A Common Stock or Preferred Stock less attractive to investors.

We are a smaller reporting company as well as an emerging growth company and, for so long as we remain a smaller reporting company or an emerging growth company, we may choose to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not smaller reporting companies or emerging growth companies including, but not limited to, the auditor attestation requirements of Section 404 of Sarbanes-Oxley, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot assess if investors find our Class A Common Stock or Preferred Stock less attractive for so long as we are able and choose to rely on these exemptions. If some investors find our Class A Common Stock or Preferred Stock less attractive as a result of our choice to reduce disclosure, there may be a less active trading market for the stock and our trading price may be more volatile.

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Failure to achieve and maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley could lead to a loss of confidence by investors in the accuracy and completeness of our financial reports and have a material adverse effect on the market price of our Class A Common Stock and Preferred Stock.

As a public company, we are required to maintain internal controls over financial reporting in order to satisfy the requirements of Section 404 of Sarbanes-Oxley, which requires annual management assessments of the effectiveness of our internal control over financial reporting beginning with this report for the fiscal year ended February 2, 2013. During the course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet our deadline for compliance with Section 404. Testing and maintaining internal controls can divert our management’s attention from other matters that are also important to the operation of our business. We also expect that the compliance with these regulations will increase our legal and financial administration costs and make some activities more difficult, time consuming and costly. We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. If our Chief Executive Officer or Chief Financial Officer determine that our controls over financial reporting are not effective, as defined under Section 404, investor perceptions may be adversely affected and could cause a decline in the market price of our Class A Common Stock and Preferred Stock. It may also impair our ability to raise additional capital, or jeopardize our continued listing on the NASDAQ Capital Market or any other stock exchange on which our Class A Common Stock and Preferred Stock may be listed. In connection with our year-end financial statement audit we have identified certain matters involving our internal controls over financial reporting that constitute material weaknesses under standards established by the Public Company Accounting Oversight Board. The material weaknesses identified by us results from a lack of comprehensive accounting policies and procedures environment, inadequate application of generally accepted accounting principles, an inadequate financial reporting process, an inadequate process for accounting for income taxes and weak controls over spreadsheets. See Item 9A—Controls and Procedures. Failure to remediate such material weaknesses may have an adverse effect on the Company’s stock price and results of our operations.

Risks Relating to the Spin-Off

If the Distribution or certain internal transactions undertaken as a result of the Spin-Off are determined to be taxable for U.S. federal income tax purposes, our stockholders could incur significant U.S. federal income tax liabilities.

Sears Holdings received an IRS Ruling substantially to the effect that, for U.S. federal income tax purposes, the Distribution, except to the extent of any cash received in lieu of fractional shares of our Class A Common Stock and Preferred Stock, will qualify as tax-free under Section 355 of the Internal Revenue Code of 1986, as amended (the “Code”). The IRS Ruling also provides that certain internal transactions undertaken in anticipation of the Distribution will qualify for nonrecognition tax treatment under the Code. The IRS Ruling is binding upon the Internal Revenue Service, but its continued validity is subject to factual representations that we and Sears Holdings made to the Internal Revenue Service concerning certain conditions that are necessary to obtain tax-free treatment under the Code have been satisfied. In addition, the Internal Revenue Service will not rule on whether a distribution satisfies certain requirements necessary to obtain tax-free treatment under Section 355 of the Code. Therefore, in addition to obtaining the IRS Ruling, Sears Holdings received an opinion from its tax counsel as to the satisfaction of these required qualifying conditions. An opinion of counsel is not binding on the Internal Revenue Service. Accordingly, the Internal Revenue Service may reach conclusions with respect to the Spin-Off that are different from the conclusions reached in the opinion. The opinion was based on certain facts and assumptions, and certain representations and undertakings, which, if incomplete, incorrect or not satisfied, could alter counsel’s conclusions.

If the Distribution ultimately is determined to be taxable, the Distribution could be treated as a taxable dividend or capital gain for U.S. federal income tax purposes to our stockholders who received stock in the Distribution, and these stockholders could incur significant U.S. federal income tax liabilities.

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Dispositions or redemptions of our Preferred Stock may have less favorable tax consequences than dispositions or redemptions of our Class A Common Stock.

Any Preferred Stock received by a Sears Holdings stockholder in the Distribution constitutes “Section 306 stock” for U.S. federal income tax purposes. As a result, any cash received by a Sears Holdings stockholder in lieu of fractional shares of Preferred Stock generally will be treated as ordinary dividend income.

Furthermore, subsequent dispositions or redemptions of our Preferred Stock generally will also be treated as ordinary dividend income, even if such proceeds would otherwise have resulted in capital gain or do not exceed such stockholder’s basis in our Preferred Stock, unless our Preferred Stock is disposed or redeemed in a transaction that terminates the stockholder’s entire interest in us (including any of our Class A Common Stock and taking into account certain constructive ownership rules).

The rules relating to Section 306 stock are complicated and stockholders are urged to consult their own tax advisors regarding the application of those rules.

We might not be able to engage in desirable strategic transactions and equity issuances following the Distribution because of restrictions relating to U.S. federal income tax requirements for tax-free distributions.

Our ability to engage in significant equity transactions are limited or restricted after the Distribution in order to preserve for U.S. federal income tax purposes the tax-free nature of the Distribution by Sears Holdings. Even if the Distribution otherwise qualifies for tax-free treatment under Section 355 of the Code, it may be taxable to Sears Holdings if 50% or more, by vote or value, of shares of our Class A Common Stock and Preferred Stock or Sears Holdings’ common stock are acquired or issued as part of a plan or series of related transactions that includes the Distribution. For this purpose, any acquisitions or issuances of Sears Holdings’ common stock within two years before the Distribution, and any acquisitions or issuances of our Class A Common Stock and Preferred Stock or Sears Holdings’ common stock within two years after the Distribution, generally are presumed to be part of such a plan, although we or Sears Holdings may be able to rebut that presumption.

Under the Distribution Agreement, there are restrictions on our ability to take actions that could cause the Distribution to fail to qualify for favorable treatment under the Code. These restrictions may prevent us from entering into transactions which might be advantageous to us or our stockholders.

Our historical consolidated financial information is not necessarily representative of the results we would have achieved as a publicly traded company independent from Sears Holdings and may not be a reliable indicator of our future results.

Our historical financial performance may not reflect what our results of operations, financial position and cash flows would have been had we been a publicly traded company independent from Sears Holdings during the periods presented, or what our results of operations, financial position and cash flows will be in the future now that we are independent from Sears Holdings. This is primarily because:

Following the Spin-Off, we are responsible for the additional costs associated with being a publicly-traded company independent from Sears Holdings, including costs related to corporate governance and public reporting. Accordingly, there can be no assurance that our historical financial performance will be indicative of our future results.

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Risks Relating to Our Class A Common Stock and Preferred Stock and the Securities Market

We do not expect to pay dividends for the foreseeable future.

We do not expect to pay cash dividends on our Class A Common Stock or any other shares of our capital stock for the foreseeable future. In addition, the terms of the Preferred Stock do not entitle the holders thereof to any dividends. We currently intend to retain any future earnings for use in the business. Further, our current credit arrangements generally prohibit our paying of cash dividends. As a result, you may not receive any return on an investment in our capital stock in the form of dividends. The terms of the Preferred Stock provide that dividends and other distributions may not be paid on any shares of our capital stock until all outstanding shares of the Preferred Stock have been redeemed or repurchased unless such dividend or distribution (i) has been unanimously approved by our Board of Directors, (ii) relates to a “poison pill” stockholder rights plan or (iii) is a distribution of cash in lieu of fractional shares made in connection with the Distribution.

Our Class A Common Stock and Preferred Stock may have a low trading volume and limited liquidity, resulting from a lack of analyst coverage and institutional interest.

Our Class A Common Stock and Preferred Stock may receive limited attention from market analysts. Lack of up-to-date analyst coverage may make it difficult for potential investors to fully understand our operations and business fundamentals, which may limit our trading volume. In addition, if neither ESL nor ACOF is actively trading our Class A Common Stock, our trading volume may be limited. Such limited liquidity may impede the development of institutional interest in our Class A Common Stock and Preferred Stock, and could limit the value of our Class A Common Stock and Preferred Stock. Additionally, low trading volumes and lack of analyst coverage may limit a stockholders’ ability to resell stock. Low trading volume may be particularly pronounced in the case of shares of our Preferred Stock because such shares will only be quoted on the OTCQB, where there is generally less liquid trading and less participation by market makers.

Our principal stockholders have substantial control over us and, among other things, they could delay or prevent a change in corporate control and may have interests different than yours.

We have four classes of capital stock:

As of February 2, 2013, ESL owned approximately 40% of our outstanding Class A Common Stock, representing approximately 40% of Class A Common Stock voting power and approximately 32% of the general voting power of our outstanding capital stock, and owns approximately 61% of our outstanding Preferred Stock, which is our outstanding nonvoting capital stock. As of February 2, 2013, ACOF owned 100% of our outstanding Class C Common Stock, representing approximately 100% of the collective voting power of our Class B Common Stock and Class C Common Stock voting together and approximately 20% of the voting power of our outstanding capital stock. Pursuant to our Amended and Restated Certificate of Incorporation, at any time that ACOF owns a number of shares of our Class B Common Stock and Class C Common Stock representing in the aggregate a percentage of our outstanding common stock that is less than 10% but equal to or greater than 5% (calculated without reference to any shares of capital stock issued or issuable after the Distribution), then the Class C Common Stock, voting together with the Class B Common Stock as a single class, shall have the right to

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elect only one director. If at any time ACOF owns a number of shares of our Class B Common Stock and Class C Common Stock representing in the aggregate a percentage of our outstanding common stock that is less than 5% (calculated without reference to any shares of capital stock issued or issuable after the Distribution), then there shall no longer be separate classes of Directors and all classes of our capital stock entitled to vote for Directors would vote together as a single class.

As a result of their respective capital stock ownership, ESL and ACOF acting together have the ability to control the outcome of certain matters on which holders of all classes of our capital stock vote together as a single class, including, among other things, approving mergers or other business combinations and effecting certain amendments to our Amended and Restated Certificate of Incorporation. In addition, ESL holds a significant portion of the stock that votes in the election of those members of our Board of Directors elected by the holders of our Class A Common Stock and ACOF has the power to control the election of the two members of our Board of Directors elected by the Class B Common Stock and Class C Common Stock stockholders (the outstanding shares of our Class B Common Stock collectively have less than 0.5% of the voting power of our capital stock). This concentration of ownership might harm the market price of our Class A Common Stock and Preferred Stock by discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us. In addition, the interests of ESL and ACOF may differ from or be opposed to the interests of our other stockholders.

In addition, ACOF has preemptive rights over our issuance of certain debt pursuant to the Stockholders’ Agreement. Unless otherwise consented to by ACOF, such preemptive rights require us to notify ACOF of the terms of certain debt that we wish to issue and provide them the opportunity to purchase up to 100% of such debt, depending on the time such event occurs and on other circumstances. Complying with this process could hinder our ability to timely take advantage of favorable market conditions to obtain debt financing on advantageous terms.

Further, so long as ACOF, together with its affiliates and transferees, beneficially owns shares of Class B and/or C Common Stock that represent at least 15% of the total voting shares, the Stockholders’ Agreement provides our Class B/C Directors with consent rights over certain corporate activities, including any change in control, certain changes in the number of Directors constituting our Board of Directors, any redemption of our Series A Preferred Stock, certain changes to our Charter or Bylaws, issuances by us of stock (other than in connection with stock plans or similar arrangements), rights offerings and any liquidation of our corporate assets. For so long as ESL holds more shares of our common stock than ACOF, the Stockholders’ Agreement also provides that a non-management Class A Director designated by a majority vote of our Class A Directors will have a consent right over certain corporate activities, including our issuance of any capital stock (other than in connection with stock plans or similar arrangements) and our engaging in any rights offering. These consent rights may limit our ability to enter into the corporate activities subject to such consent rights.

Our Class A Common Stock and Preferred Stock prices may decline if ESL or ACOF alter their strategy with respect to their ownership of our capital stock.

ESL and ACOF have advised us that they have not reached any decision regarding whether or for how long they will retain their stock ownership in us and what form, if any, the disposition or distribution of their stock in us will take. ESL and ACOF will, in their sole discretion, determine the timing and terms of any transactions with respect to their shares in us, taking into account business and market conditions and other factors that they deem relevant. Neither ESL nor ACOF are subject to any contractual obligation to maintain their ownership position in us, although they may be subject to certain transfer restrictions imposed by securities laws and the Stockholders’ Agreement. Consequently, we cannot assure you that either ESL or ACOF will maintain their ownership of our capital stock. Any announcement by ESL or ACOF that they have reached a determination regarding what to do with their shares of our capital stock, or the perception by the investment community that ESL or ACOF has reached such a determination, could have an adverse impact on the price of our Class A Common Stock and Preferred Stock.

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An active trading market may not develop for our Class A Common Stock and Preferred Stock. If our share price fluctuates, investors could lose all or a significant part of their investment.

We cannot predict the prices at which our Class A Common Stock and Preferred Stock may trade in the future. The market price of our Class A Common Stock and Preferred Stock may fluctuate widely, depending on many factors, some of which may be beyond our control, including:

In addition, the stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of companies like us. These broad market and industry factors may materially reduce the market price of the Class A Common Stock and Preferred Stock, regardless of our operating performance.

Substantial sales of Class A Common Stock and Preferred Stock may occur in the future, which could cause the price of our Class A Common Stock and Preferred Stock to decline.

Although we have no actual knowledge of any plan or intention on the part of any significant stockholder to sell our capital stock, it is likely that some stockholders, possibly including our significant stockholders, will sell shares of our capital stock if, for reasons such as our business profile or market capitalization as a company independent from Sears Holdings, we do not fit their investment objectives.

The Class A Common Stock and Preferred Stock held by ESL and our “affiliates,” the Class B Common Stock and the Class C Common Stock may be sold in the public market only if registered or if the holders thereof qualify for an exemption from registration under Rule 144 under the Securities Act. Individuals who may be considered our affiliates include individuals who control, are controlled by or are under common control with us, as those terms generally are interpreted for federal securities law purposes. These individuals may include some or all of our Directors and executive officers. Individuals who are our affiliates will be permitted to sell their shares of Class A Common Stock and Preferred Stock only pursuant to an effective Registration Statement under

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the Securities Act, or an exemption from the registration requirements of the Securities Act, such as the exemptions afforded by Section 4(1) of the Securities Act or Rule 144 thereunder. Pursuant to the Stockholders’ Agreement we entered into with ESL and ACOF, we granted registration rights to ESL and ACOF.

Sales of a substantial number of shares of Class A Common Stock or Preferred Stock could adversely affect the market price of the Class A Common Stock and Preferred Stock and could impair our future ability to raise capital through an offering of our equity securities. In addition, our Class C Common Stock constitutes approximately 20% of the voting power of our capital stock, automatically converts to an equal number of shares of Class A Common Stock in the event ACOF transfers such shares to any person or entity that is not affiliated with ACOF or if at any time ACOF owns a number of shares of our Class B Common Stock and Class C Common Stock representing in the aggregate a percentage of our outstanding common stock that is less than 5% (calculated without reference to any shares of capital stock issued or issuable after the Distribution). As a result, sales of a substantial number of shares of Class C Common Stock by ACOF to an unaffiliated third party could also adversely affect the market price of shares of the Class A Common Stock. Additionally, the Class C Common Stock may be converted into Class A Common Stock on the basis of one share of Class A Common Stock for each share of Class C Common Stock upon the approval of our Board of Directors and subsequent approval of (i) our stockholders voting as a separate class and (ii) the holders of a majority of the voting power of the Class C Common Stock voting as a separate class.

Investors’ percentage ownership in us may be diluted in the future.

Investors’ percentage ownership in us may be diluted in the future because of additional equity awards that we expect will be granted to our Directors, officers and employees in the future. We have established our 2011 Equity Incentive Plan that provides for the grant of common stock-based equity awards to our Directors, officers and other employees. Further, shares of Class C Common Stock held by ACOF will automatically convert into an equal number of shares of Class A Common Stock in certain circumstances. In addition, we may issue equity in order to raise capital or in connection with future acquisitions and strategic investments, which would dilute investors’ percentage ownership.

Provisions in our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws and of Delaware law may prevent or delay an acquisition of the Company, which could decrease the trading price of our Class A Common Stock and Preferred Stock.

Our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws and Delaware law contain provisions that are intended to deter coercive takeover practices and inadequate takeover bids by making such practices or bids unacceptably expensive to the raider and to encourage prospective acquirers to negotiate with our Board of Directors rather than to attempt a hostile takeover. These provisions include rules regarding how stockholders may present proposals or nominate Directors for election at stockholder meetings and the right of our Board to issue preferred stock without stockholder approval.

We believe these provisions protect our stockholders from coercive or otherwise unfair takeover tactics by requiring potential acquirers to negotiate with our Board and by providing our Board with more time to assess any acquisition proposal. However, these provisions apply even if the offer may be considered beneficial by some stockholders and could delay or prevent an acquisition that our Board determines is not in the best interests of our company and our stockholders. Accordingly, in the event that our Board determines that a potential business combination transaction is not in the best interests of our Company and our stockholders but certain stockholders believe that such a transaction would be beneficial to the Company and its stockholders, such stockholders may elect to sell their shares in the Company and the trading price of our Class A Common Stock and Preferred Stock could decrease.

Similarly, until the market has fully evaluated our business, the price at which shares of our Class A Common Stock and Preferred Stock trade may fluctuate significantly.

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Our Preferred Stock is quoted on the OTCQB rather than listed on a national securities exchange, there may be limited liquidity in our Preferred Stock and the quote of our Preferred Stock may be volatile, all of which could limit investors’ ability to sell their Preferred Shares.

Although our Class A Common Stock is listed on the NASDAQ Capital Market, our Preferred Stock is quoted on the OTCQB, and will not be listed on any national securities exchange, which may limit the trading volume of our Preferred Stock. There is a greater chance for market volatility for securities that are quoted on an OTC quotation system as opposed to a national securities exchange. This volatility may be caused by a variety of factors, including the lack of readily available quotations, the absence of consistent administrative supervision of “bid” and “ask” quotations, and generally lower trading volume. The OTC quotation system is a regulated quotation service that displays real-time quotes, last-sale prices and volume information for shares of stock that are not listed on a national securities exchange. Trades in OTC quotation system securities will be displayed only if the trade is processed by an institution acting as a market maker for those securities. There can be no assurance that any institution will be acting as a market maker for our Preferred Stock at any time. If there is no market maker for our shares and no trades in those shares are reported, it may be difficult for you to dispose of your Preferred Shares or even to obtain accurate quotations as to the market price of your shares. Moreover, because the order handling rules adopted by the SEC that apply to shares listed on a national securities exchange do not apply to OTC quotation system shares, no market maker will be required to maintain an orderly market in our shares. Accordingly, an order to sell our shares placed with a market maker may not be processed until a buyer for the shares is readily available, if at all, which may further limit your ability to sell your shares at prevailing market prices.

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Item 1B—Unresolved Staff Comments

None.

Item 2—Properties

Our store support center is located at 6450 Via Del Oro, San Jose, California. This facility is occupied under a 15-year lease for approximately 76,000 square feet. We operate one distribution center and warehouse located in Tracy, California. This facility is occupied under a 20-year lease, with three 5-year extensions, for approximately 517,000 square feet.

The following table reflects the aggregate square footage and number of (a) leased, (b) owned properties and (c) owned improvements subject to ground lease for our stores as of February 2, 2013:

All of our stores are located within California. In late April 2013, we opened two stores in the state of Oregon. Our stores average approximately 36,000 square feet of interior selling space and approximately 8,000 square feet of exterior nursery and garden space. Our lease agreements generally range from 15 to 20 year initial terms with two to four 5-year extension options.

Item 3—Legal Proceedings

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.

Item 4—Mine Safety Disclosures

Not applicable.

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Part II

Item 5—Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our Class A Common Stock has been listed and traded on NASDAQ under the symbol “OSH” since January 3, 2012. As of April 18, 2013, there were 8,815 Class A stockholders of record, four Class B stockholders of record and one Class C stockholder of record. Shares of our Class B Common Stock and Class C Common Stock are not publicly traded and there is no market for these securities. Our Class C Common Stock can be converted, on a share for share basis, into our Class A Common Stock. Our Series A Preferred Stock has been quoted on the OTCQB under the symbol “OSHSP” since January 3, 2012. As of April 18, 2013, there were 8,958 record holders of Series A Preferred Stock. Prior to January 3, 2012, there was no public market for our capital stock. The last reported sale price of the common stock on NASDAQ on April 18, 2013 was $1.66.

The following table sets forth, for the periods indicated, the high and low sale prices of our common stock, as quoted on the NASDAQ.

Equity Compensation Plan Information

Information regarding securities authorized for issuance under equity compensation plans is incorporated by reference to the information in our 2013 Proxy Statement to Stockholders to be filed pursuant to Regulation 14A under the Exchange Act no later than 120 days after the end of the Company’s 2012 fiscal year or will be included in an amendment to this Form 10-K filed with the SEC no later than 120 days after the end of the Company’s 2012 fiscal year. See Note 10, “Stock-Based Compensation” of notes to consolidated financial statements for information regarding our equity compensation plans.

Dividend Policy

We do not expect to pay any dividends on our Class A Common Stock, Class B Common Stock, Class C Common Stock or Preferred Stock for the foreseeable future. The terms of the Preferred Stock do not entitle the holders thereof to any dividends. In addition, our Preferred Stock provides that dividends and other distributions may not be paid on any shares of our capital stock until all outstanding shares of Preferred Stock have been redeemed or repurchased unless such dividend or distribution (i) has been unanimously approved by our Board of Directors or (ii) relates to a “poison pill” stockholder rights plan. Furthermore, the terms of our debt agreements restrict us from paying dividends on our capital stock.

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Stock Performance Graph

The following graph compares the percentage change in the cumulative total stockholder return on our Class A Common Stock during the period beginning January 3, 2012 (the closing price of $23.53 on the first day of trading on the NASDAQ following our becoming an independent, publicly traded company as a result of Sears Holdings’ distribution of its shares of the Company to Sears Holdings’ stockholders on December 30, 2011) and ending on February 2, 2013, with (i) the NASDAQ Composite Index and (ii) the NASDAQ Retail Trade Index. The graph assumes that the value of the investment in the Class A Common Stock and each index (including reinvestment of dividends) was $100 on January 3, 2012 in the case of our Class A Common Stock and an investment in an index. The closing price as of February 1, 2013 (the closing price closest to our fiscal 2012 year-end) was $7.06.

Prepared by Zacks Investment Research, Inc. Used with permission. All rights reserved. Copyright 1980-2013

The stock price performance included in this graph is not necessarily indicative of future stock price performance.

This performance graph shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or incorporated by reference into any of our filings, as amended, with the Securities and Exchange Commission, except as shall be expressly set forth by specific reference in such filing.

Unregistered Sales of Equity Securities

In December 2011, in connection with the Distribution, we issued 4,806,000 shares of Series A Preferred Stock, par value $0.00001 per share, to Sears, Roebuck. Sears, Roebuck is a subsidiary of Sears Holdings, and at the time of the issuance of the Preferred Stock, the Company was a majority-owned subsidiary of Sears Holdings. No solicitation was made and no underwriting discounts were given or paid in connection with the issuance of the Preferred Stock. The Company believes that the issuance of the Preferred Stock in connection with the Distribution was exempt from registration with the SEC pursuant to Section 4(2) of the Securities Act of 1933, as amended.

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Item 6.—Selected Financial Data

The following selected financial data are derived from the Consolidated Financial Statements of the Company. The selected historical consolidated financial and other financial data presented below should be read in conjunction with our consolidated financial statements and accompanying notes and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Form 10-K. The consolidated financial information may not be indicative of our future performance and does not necessarily reflect what our financial position and results of operations would have been had we operated as an unaffiliated publicly traded company independent from Sears Holdings during the periods presented, including changes that will occur in our operations and capitalization as a result of the Spin-off from Sears Holdings. See Note 1 “Basis of Presentation” and Note 12 “Related Party Agreements” of notes to consolidated financial statements for a further discussion.

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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. Comparable sales metrics discussed above are intended only as supplemental information and are not a substitute for information presented in accordance with generally accepted accounting principles.

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Item 7.—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 Part II, Item 6 “Selected Financial Data” and our audited consolidated financial statements and the related notes thereto included in Item 8 “Financial Statements and Supplementary Data.” In addition to historical consolidated financial information, this discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Actual results could differ from these expectations as a result of factors including those described under Item 1A, “Risk Factors,” “Special Note Regarding Forward-Looking Statements” and elsewhere in this Form 10-K.

ORCHARD SUPPLY HARDWARE STORES CORPORATION OVERVIEW

Orchard Supply Hardware Stores Corporation, through its wholly-owned subsidiary, Orchard Supply Hardware LLC, operates neighborhood hardware and garden stores focused on paint, repair and the backyard. Founded as a purchasing cooperative in San Jose, California in 1931, as of February 2, 2013, we operated 89 stores in California and had leases signed to open four new stores in fiscal 2013, two in Oregon and two in California.

Our stores average approximately 36,000 square feet of interior selling space and approximately 8,000 square feet of exterior nursery and garden space. 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.

On December 30, 2011, through the Spin-Off, we became an independent, publicly-traded company as a result of Sears Holdings’ distribution of its shares of Orchard to Sears Holdings’ stockholders where Sears Holdings’ stockholders of record as of the Record Date received one share of Orchard’s Class A Common Stock and one share of Orchard’s Series A Preferred Stock for every 22.141777 shares of Sears Holdings’ common stock held.

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 Orchard’s outstanding capital stock, respectively. The outstanding shares of Preferred Stock represent 100% of Orchard’s 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.”

Fiscal Year

Our fiscal year end is the Saturday closest to January 31 each year. Fiscal 2012 consisted of 53 weeks and fiscal 2011, 2010, 2009 and 2008 all consisted of 52 weeks. Each of our fiscal quarters consists of 13 weeks except the fourth quarter of fiscal 2012, which consisted of 14 weeks. Unless otherwise stated, references to years in this report relate to fiscal years rather than to calendar years.

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EXECUTIVE OVERVIEW

Key Overall Strategies

At the beginning of fiscal 2012, we defined five key priorities which we remain keenly focused on executing. These priorities are:

These strategic priorities support our mission to be the neighborhood hardware store, committed to providing customers with the best selection of repair and maintenance, backyard, and paint and home products with superior customer service and helpful advice.

Fiscal 2012 Financial Summary

Fiscal 2012 Challenges

Our ability to comply with the leverage ratio covenants under our financial arrangements has been adversely impacted by a decline in operating results during fiscal 2012, increased costs associated with being a public company independent from Sears Holdings, the impact of paying rent on properties previously owned, but sold

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pursuant to multiple sale leaseback transactions, and continued economic weakness in the markets in which we operate. As a result, during fiscal 2012, we implemented several actions to improve our liquidity, reduce our cost structure, and improve our operating results. We also explored several alternatives to refinance our Senior Secured Term Loan and engaged legal and financial advisors to assist us as we explored issuing debt and/or equity and discussed modifications to our Senior Secured Term Loan with our lenders.

For more information regarding our financial condition, liquidity and risks and uncertainties regarding our future liquidity given the uncertainties surrounding our ability to repay in full the amounts due under our Senior Secured Term Loan with a maturity date of December 21, 2013, as well as our inability to maintain compliance with the leverage ratio covenant under the Senior Secured Term Loan and our requirement to agree upon a mutually acceptable refinancing or modifications to our capital structure with the Senior Secured Term Loan lenders, see “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Fiscal 2012 Accomplishments

Despite the challenges posed with complying with our leverage ratio covenant under our financial arrangements and refinancing our Senior Secured Term Loan, we made strong progress in several areas. Comparable store sales were essentially flat in fiscal 2012, despite experiencing challenging weather-driven sales volatility in the first quarter. We are also pleased with the performance of our new and remodeled stores. During fiscal 2012, we opened two new stores and remodeled five existing stores so that we had 10 stores operating in the neighborhood store format at the end of fiscal 2012. In fiscal 2013, we expect to open four new stores and remodel at least six additional existing stores so that by the end of fiscal 2013 we expect to have 20 stores operating in the new format.

We also continued to make progress in our merchandising efforts, including improved product profitability analysis and upgrades to the selection, quality, and presentation of our merchandise.

Accomplishments in our operations efforts include refining and improving our store standards, strengthening our store culture of helping the customer, improving processes and tools to assist us in ongoing inventory shrink reduction efforts, and applying greater resources to the hiring, training, and retention of qualified associates.

In fiscal 2013, we will continue to focus on executing our strategic priorities which we believe will provide the foundation for improved sales and profitability in the long-term.

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RESULTS OF OPERATIONS

The discussion that follows should be read in conjunction with the consolidated financial statements and notes thereto. Our consolidated results of operations for fiscal years 2012, 2011, and 2010 are summarized below and in the tables that follow (dollars and shares in millions except per share amounts and store counts).

Fiscal 2012 Compared to Fiscal 2011

Net sales

Net sales decreased $3.2 million to $657.3 million for fiscal 2012, as compared to $660.5 million for the prior year. The decrease in net sales was primarily attributable to an approximate $13.2 million impact related to the Appliances Agreement (see definition of comparable store sales above) and to a lesser extent, the decrease of approximately $7.8 million in our repair and maintenance category and approximately $1.0 million in our paint and home category. These decreases were offset by the $9.4 million impact of the 53^rd week in fiscal 2012 as compared to the prior year, an approximate $7.6 million increase in our backyard category and by $1.4 million of gift card breakage income. Comparable stores sales decreased slightly by 0.2%, comprised of a decrease in comparable transactions of 3.2% offset by a 3.0% increase in average ticket comparables.

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Gross margin

Gross margin decreased $13.0 million to $206.5 million, or 31.4% of net sales, for fiscal 2012, as compared to $219.5 million, or 33.2% of net sales, for the prior year. The decrease of 180 basis points in gross margin was driven by 120 basis points of higher occupancy costs primarily as a result of paying rent on properties previously owned prior to the sale leaseback transactions and as a result of higher ongoing rent, distribution center and other occupancy costs and 80 basis points decline in merchandise margin as a result of higher markdowns to drive sales and clear inventory. These were partially offset by gift card breakage income of $1.4 million or 20 basis points.

Selling and administrative

Selling and administrative expenses increased $14.0 million to $187.7 million, or 28.5% of net sales, for fiscal 2012, as compared to $173.7 million, or 26.3% of net sales, for the prior year. The increase in selling and administrative expenses is primarily due to (a) $4.0 million increase in operating costs associated with being an independent public company, (b) $2.1 million legal accruals reversed in fiscal 2011 as a result of a settlement, (c) $1.7 million increase in legal and financial advisory costs, (d) $1.1 million increase in stock compensation, (e) $1.0 million impact of the 53^rd week on fiscal 2012 and (f) $2.8 million increase in payroll and other expenses associated with Store Support Center initiatives.

Depreciation and amortization

Depreciation and amortization increased $3.1 million to $32.5 million in fiscal 2012, or 10.5%, as compared to $29.4 million in the prior year. The increase of depreciation and amortization expense was primarily due to accelerated depreciation on stores that were remodeled in fiscal 2012 or will be remodeled in fiscal 2013.

Impairment charges

Non-cash impairment charges recognized during fiscal 2012 of $111.1 million include $96.1 million for trade names impairment and $15.0 million related to the write-down of store assets that were disposed or were determined to be impaired as compared to the $3.5 million write-down of store assets that were disposed or were determined to be impaired in fiscal 2011.

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Loss on sale of real property

During fiscal 2012, we recorded a non-cash loss of $1.0 million in connection with the consummation for accounting purposes of sale leaseback transactions involving three stores in San Jose and Pismo Beach, California that were originally sold in fiscal 2011. The leaseback agreements of these three stores included provisions for the remodeling of the stores for which the landlord was to reimburse the Company for the costs of tenant improvements, and the sale leasebacks could not be consummated until the tenant improvements were completed and all amounts spent were fully reimbursed to the Company by the landlord. These provisions were satisfied in the fourth quarter of 2012 and the sales were consummated for accounting purposes. This loss was partially offset by a non-cash gain of $0.6 million in connection with a sale leaseback transaction involving our store in San Lorenzo, California and a parcel of land in San Jose, California in the first quarter of fiscal 2012. During fiscal 2011, we recorded a non-cash loss of $14.8 million in connection with the sale leaseback transactions involving our distribution center in Tracy, California and a store located in Hollywood, California.

Interest expense, net

Interest expense increased $1.3 million to $24.7 million in fiscal 2012, or 5.6%, as compared to $23.4 million in the prior year. The $1.3 million increase in interest expense was primarily due to the $1.2 million write-off of unamortized deferred financing costs related to the early pay off of the Real Estate Term Loan and the higher interest rates associated with amendment to our Senior Secured Term Loan and Real Estate Secured Term Loan, as well as additional interest expense on capital lease properties. These increases were offset by the reduction of $1.7 million in derivative lease liabilities in the third quarter.

Income tax benefit

Income tax benefit was $31.5 million in fiscal 2012 as compared to an income tax benefit of $10.8 million recorded in the prior year. The effective tax rate benefit was 21.0% and 42.9% for fiscal 2012 and 2011, respectively. The change in our effective tax rate benefit was primarily due to the tax valuation allowance charge of $29.1 million in fiscal 2012.

Fiscal 2011 Compared to Fiscal 2010

Net sales

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Net sales decreased $0.2 million to $660.5 million for the fiscal 2011, as compared to $660.7 million for the prior year. The change in net sales was driven by growth in our repair and maintenance category of approximately $1.3 million, primarily driven by the hardware business, offset by declines in our lawn and garden and in-home categories of approximately $1.5 million. The lawn and garden category was driven by declines during the first fiscal quarter where we experienced unseasonably wet weather. The in-home category was primarily driven by reduced demand for housewares. Our comparable store sales decreased by 0.6% for fiscal 2011, attributable to a decrease in comparable transaction volume of 4.5%, partially offset by an increase of 3.9% in average ticket comparables as compared to the prior year.

Gross margin

Gross margin decreased $9.4 million to $219.5 million, or 33.2% of net sales, for fiscal 2011, as compared to $228.9 million, or 34.6% of net sales, for the prior year. The decrease of 140 basis points in gross margin was primarily due to: (a) higher occupancy costs of approximately 70 basis points as a result of paying rent on properties previously owned prior to sale leaseback transactions, renegotiated leases, and increases in store maintenance expenses; (b) higher shrink expenses of approximately 50 basis points; and (c) lower vendor subsidies of approximately 20 basis points due to the elimination of certain promotional events.

Selling and administrative

Selling and administrative expenses increased $8.0 million to $173.7 million, or 26.3% of net sales, for fiscal 2011, as compared to $165.7 million, or 25.1% of net sales, for the prior year. The increase in selling and administrative expenses is primarily due to (a) an accrual of future rent payments of $1.2 million on closed stores, (b) severance payments of approximately $1.2 million, (c) increased payroll and other expenses of approximately $3.0 million to improve store execution, (d) a $3.7 million increase in legal and professional expenses associated with becoming an independent public company, (e) a $4.9 million investment in enhanced capabilities, and (f) $1.5 million in higher insurance and other operating costs. This is partially offset by a net $7.8 million reduction in legal expenses compared to the prior year as a result of the Save Mart Supermarkets legal settlement. In fiscal 2010, we recorded a $5.6 million legal liability pursuant to the Save Mart case which was settled in fiscal 2011. As a result of the settlement, we recorded a $2.1 million reduction to this liability in fiscal 2011.

Depreciation and amortization

Depreciation and amortization decreased $1.8 million to $29.4 million in fiscal 2011, or 5.8%, as compared to $31.2 million in the prior year. The decrease of depreciation and amortization expense was primarily due to an increase in fully depreciated assets, and the reduction to property and equipment due to the sale leaseback transactions.

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Impairment charges

Non-cash impairment charges recognized during fiscal 2011 are due to the $3.5 million write-down of store assets, including capitalized favorable leases of $2.7 million that were disposed or were determined to be impaired in fiscal 2011 as compared to the $0.3 million write-down of store assets that were determined to be impaired in fiscal 2010.

Loss on sale of real property

During fiscal 2011, we recorded a non-cash loss of $14.8 million in connection with the sale leaseback transactions involving our distribution center in Tracy, California and a store located in Hollywood, California. There was no sale of real property in the prior year.

Interest expense, net

Interest expense increased $6.0 million to $23.4 million in fiscal 2011, or 34.5%, as compared to $17.4 million in the prior year. The $6.0 million increase in interest expense was primarily due to higher interest rates associated with the amendments to our Senior Secured Term Loan and Real Estate Secured Term Loan which together accounted for $4.3 million of the increase. In addition, the Company recorded $1.2 million higher amortization of deferred financing costs which increased during fiscal 2011 as a result of these amendments and $1.1 million due to higher capital lease assets.

Income tax (benefit) expense

Income tax benefit was $10.8 million in fiscal 2011 as compared to an income tax expense of $5.6 million recorded in the prior year. The effective tax rate (benefit) provision was (42.9)% and 39.0% for fiscal 2011 and 2010, respectively. The change in our effective tax rate was primarily due to differences in tax credits applicable year over year.

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LIQUIDITY AND CAPITAL RESOURCES

Cash Flow. Our cash flows for our fiscal years 2012, 2011 and 2010 were as follows (in millions):

Cash Flows (used in) provided by operating activities

The primary source of our liquidity is our cash flows generated from our operating activities. Net cash used in operating activities was $29.5 million in fiscal 2012, a decrease of $61.4 million compared to cash provided by operating activities of $31.9 million in fiscal 2011. The decrease in cash provided by operating activities is primarily due to changes in working capital, including $13.7 million higher merchandise inventories due to earlier deliveries in anticipation of the spring selling season, a decrease of $14.6 million in payables and accruals as we worked with vendors in improving payment timing and, to a lesser extent, a $6.0 million increase in prepaid and other assets and a $15.5 million decline in operating results as adjusted for non-cash charges during fiscal 2012 compared to fiscal 2011.

Net cash provided by operating activities decreased by $20.6 million to $31.9 million in fiscal 2011 compared to fiscal 2010 primarily due to the decline in gross margins of approximately $9.4 million and higher selling and administrative cost including investments associated with becoming an independent public company. In addition, changes in our cash flows from working capital decreased by $7.7 million as compared to fiscal 2010 primarily due to the timing of our payables, offset by a decrease in inventory purchases.

Cash Flows provided by (used in) investing activities

Net cash provided by investing activities decreased $7.8 million to $33.6 million in fiscal 2012 as compared to $41.4 million in fiscal 2011. The decrease of $7.8 million was primarily due to $35.4 million in proceeds from the sale of our distribution center and our Hollywood, California store in fiscal 2011 as compared to $6.7 million in net proceeds from the sale-leaseback transaction involving one of our stores and the sale of a parcel of land in fiscal 2012. This decrease was offset in part by $41.5 million received and held as deposits from the sale leaseback transaction of six store properties in fiscal 2012 as compared to $21.5 million of net proceeds received and held as deposits for three stores in fiscal 2011.

Net cash provided by investing activities increased by $53.4 million to $41.4 million in fiscal 2011 as compared to net cash used in investing activities of $12.0 million in fiscal 2010 primarily due to $56.5 million in net proceeds from the two sale leaseback transactions involving our distribution center and our Hollywood, California store and net proceeds received and held as deposits for three stores which were consummated as sale leaseback transactions for accounting purposes in fiscal 2012 as described in Note 7, “Sale Leaseback Transactions” of notes to consolidated financial statements. In fiscal 2011, we spent $15.5 million in cash to purchase property and equipment, allocated as follows: 53% for relocated and remodeled stores and other initiatives as well as our support center, 26% for store maintenance and improvements, 15% for core technology, and 6% for merchandising fixtures.

Cash flows used in financing activities

Net cash used in financing activities decreased $75.0 million to $5.7 million in fiscal 2012 compared to $80.7 million of cash used in fiscal 2011. The decrease was primarily due to net increased borrowings on our Senior Secured Credit Facility and lower principal payments on our Senior Secured Term Loan relative to amounts paid down in fiscal 2011 offset by the pay-off of our Real Estate Term Loan.

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Net cash used in financing activities increased $46.8 million to $80.7 million in fiscal 2011 as compared to $33.9 million in fiscal 2010 primarily due to the use of net proceeds from transactions involving our distribution center and four stores to pay down debt of $56.5 million offset by approximately $10.0 million of net lower other pay downs relative to fiscal 2010.

Liquidity

As of February 2, 2013, we had cash and cash equivalents of $6.5 million and total debt and capital lease obligations of $261.4 million. As of April 22, 2013, the Company had $17.4 million available to borrow on its credit facility. Our liquidity is dependent upon our cash and cash equivalents, cash flows provided by operating activities and the continued availability of borrowings under our financing arrangements. The financing arrangements require us to maintain compliance with certain financial covenants including a leverage ratio covenant in our Senior Secured Term Loan.

Our ability to comply with the leverage ratio covenants under our financial arrangements has been adversely impacted by, among other things: a decline in operating results during fiscal 2012, as we incurred a net loss of $118.4 million in fiscal 2012; increased costs associated with being a public company independent from Sears Holdings; the impact of paying rent on properties previously owned, but sold pursuant to multiple sale leaseback transactions; and continued economic weakness in the markets in which we operate. At the end of the second fiscal quarter on July 28, 2012, we would not have been in compliance with the leverage ratio covenant under our senior secured term loan agreement (the “Senior Secured Term Loan”) had we not completed a six-store sale leaseback transaction. At the end of the third fiscal quarter on October 27, 2012, we were not in compliance with the leverage ratio covenant under our Senior Secured Term Loan, but received a waiver of this covenant for that measurement date.

During fiscal 2012, we implemented several actions to improve our liquidity, reduce our cost structure, and improve our operating results. We also explored several alternatives to refinance our Senior Secured Term Loan and engaged legal and financial advisors to assist us as we explored issuing debt and/or equity and discussed modifications to our Senior Secured Term Loan with our lenders.

At the end of the 2012 fiscal year, we were not in compliance with the leverage ratio covenant under the Senior Secured Term Loan. On February 14, 2013, the lenders under the Senior Secured Term Loan waived compliance with the leverage ratio covenant with respect to our quarter ended February 2, 2013, as well as for the first fiscal quarter of 2013 ending May 4, 2013, subject to our continued compliance with the terms and conditions of the waiver, including achieving a mutually acceptable agreement with the lenders by June 30, 2013, as described below. Under the provisions of the waiver, and subject to our continued compliance with the terms and conditions of the waiver, our next applicable measurement date for the leverage ratio covenant compliance is August 3, 2013.

In connection with the waiver obtained on February 14, 2013, the Senior Secured Term Loan lenders imposed several requirements upon us, including achieving a mutually acceptable agreement with them by May 1, 2013 with regard to refinancing or modifications to our capital structure. On April 26, 2013, such date was extended by the lenders to June 30, 2013. We continue to explore all financial and strategic alternatives to maintain our business as a going concern including, but not limited to, one or more transactions that may include a comprehensive financial reorganization of our company or a transaction such as a sale or merger of the Company. We may also acquire funding through the issuance of debt, equity, additional real estate sale or sale leaseback transactions, or a combination of these items.

Failure to comply with the terms and conditions of the waiver would cause a default and, as a result, the lenders under our Senior Secured Term Loan could declare the outstanding indebtedness to be due and payable, in acceleration of the current maturity dates of December 21, 2013 ($54.8 million) and December 21, 2015 ($74.6 million). As a result of the cross-default provisions under our 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 revolving credit facility (“Senior Secured Credit Facility”) of $78.8 million. In addition, our lenders would be

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entitled to proceed against the collateral securing the indebtedness. If any of our indebtedness were to be accelerated, it would adversely affect our ability to operate our business, which could prevent us from continuing our ongoing operations.

While we continue to seek refinancing and modifications to our capital structure to increase our liquidity and decrease our leverage on a basis which may be acceptable to the Senior Secured Term Loan lenders, there can be no assurances that we will be successful in our efforts. Pending implementation of these objectives, we anticipate that these uncertainties may cause risks to our short-term liquidity. Implementation of any of these strategies is likely to result in very significant dilution to our stockholders or even a complete loss of their investment.

Going Concern Uncertainty

The accompanying fiscal 2012 consolidated financial statements have been prepared assuming we will continue as a going concern. There are significant uncertainties surrounding: our recurring losses from operations, our negative working capital as of the end of fiscal 2012, our ability to repay in full the amounts due under our Senior Secured Term Loan; our inability to maintain compliance with the leverage ratio covenant under the Senior Secured Term Loan; our ability to comply with the terms and conditions of the waiver described above, noncompliance with which would cause a default and, as a result, the lenders under the Senior Secured Term Loan and the Senior Secured Credit Facility could declare the outstanding indebtedness of $208.2 million of February 2, 2013 to be due and payable; and our requirement by June 30, 2013 to agree upon a mutually acceptable refinancing or modifications to our capital structure with the Senior Secured Term Loan lenders. These uncertainties raise substantial doubt as to our ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this going concern uncertainty. Our plans to deal with this uncertainty are discussed in the footnotes to our consolidated financial statements included herein. For more information regarding our financial condition, liquidity and risks and uncertainties regarding our future liquidity, see “Risk Factors.”

The report of our independent registered public accounting firm includes an explanatory paragraph which states there is substantial doubt about the Company’s ability to continue as a going concern.

Our debt is comprised of the following credit facilities:

Senior Secured Term Loan—Our Senior Secured Term Loan consists of two tranches. The first tranche was with lenders who elected not to extend the maturity beyond December 21, 2013 (“non-extended lenders”), of which $54.8 million was outstanding as of February 2, 2013. The second tranche was with lenders who elected to extend the maturity date to December 21, 2015 (“extended lenders”), of which $74.6 million (of principal and accrued PIK interest) was outstanding as of February 2, 2013.

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 February 2, 2013, our interest rate under the Senior Secured Term Loan for non-extended loans was 5.5%.

Eurodollar loans owing to extended lenders have both cash and PIK interest components. Such loans bear interest at LIBOR (which shall be deemed to be equal to at least 1.25%), plus 5.75%. As of February 2, 2013, our cash interest rate under the Senior Secured Term Loan for extended loans was 7.0%. In addition, our 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 our 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 our credit rating to Caa1 from B3. As of February 2, 2013, the Company’s PIK interest rate was 4.50% based on our credit rating. Additional interest rate increases may also apply as a result of entering into the Waiver and Amendment No. 1 due to our noncompliance with our maximum adjusted leverage ratio covenant as of October 27, 2012, as discussed below.

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In addition to the required quarterly principal payments of $0.4 million, we have to make periodic repayments on the Senior Secured Term Loan equal to a defined percentage rate (determined based on our leverage ratio and ratings) of excess cash flows, which ranges between 25% and 100%. We did not make any such prepayments during fiscal 2012.

In the event of a sale of a property owned by us, we are required to make repayments on the Senior Secured Term Loan equal to 75% of the proceeds, net of fees, cash tax, and other mandatory debt repayments. Pursuant to the sale leaseback of the six collateralized stores properties, we made a $7.6 million prepayment under this requirement on August 24, 2012. Pursuant to the sale leaseback of the collateralized store located in San Lorenzo, California, we made $1.2 million in prepayments under this requirement on May 18, 2012.

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 Adjusted EBITDA (as defined in the Senior Secured Term Loan). The following table provides our maximum adjusted leverage ratio from October 27, 2012, the date of the first lender waived event of default, and through the remaining term of the Senior Secured Term Loan:

As of October 27, 2012, our maximum adjusted leverage ratio was 7.64:1, which was not in compliance with the covenant above. As a result of this non-compliance we entered into Waiver and Amendment No. 1 to the Senior Secured Term Loan whereby the lenders waived our non-compliance in exchange for our agreement to, (a) reduce the outstanding balances owed to the non-extended lenders and the extended lenders prior to January 31, 2013, or, if such balances were not paid down (b) pay an additional 50 basis point in PIK interest to the non-extended lenders and the extended lenders, as applicable, until such time as the balances have been appropriately reduced. As of January 31, 2013, the balances owed to non-extended lenders and extended lenders had not been reduced and, as a result, the Company now pays an additional 50 basis points of PIK interest to both the non-extended lenders and the extended lenders.

As of February 2, 2013, our leverage ratio was 13.48:1, which was not in compliance with the Senior Secured Term Loan covenants enumerated above. As a result of this noncompliance, on February 14, 2013 we entered into a waiver which required the Company’s continued compliance with the terms and conditions set forth therein, including achievement of a mutually acceptable agreement with the Term Loan lenders by May 1, 2013 relating to refinancing or modifications to the Company’s capital structure in a way that serves the best interests of all of the Company’s stakeholders. On April 26, 2013, such date was extended by the lenders to June 30, 2013.

Senior Secured Credit Facility—The Company’s amended and restated Senior Secured Credit Facility has a revolving loan facility of $120.0 million, and 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. Unless the non-extend lenders under the Senior Secured Term Loan are repaid, or the maturity of such loans is extended, the Senior Secured Credit Facility will mature on September 23, 2013. As of February 2, 2013, $78.8 million was outstanding under the credit facility. As of April 22, 2013, the Company had $17.4 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.

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On February 11, 2013, the Company further amended the Senior Secured Credit Facility to, among other things, extend certain financial accommodations to the Company to increase the size of the credit facility by up to $17.5 million through the addition of a Supplemental Term Loan, increasing the total facility size to $145.0 million.

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 February 2, 2013, the Company’s interest rate was 2.0%. 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, including, but not limited to compliance with the maximum leverage ratio covenant contained in the Senior Secured Term Loan, as described above and an excess availability covenant which requires us to maintain excess availability of at least the greater of (i) 13.3% of Maximum Revolving Availability and (ii) $16.0 million which reduces our ability to borrow under the Senior Secured Credit Facility. Pursuant to a waiver dated February 14, 2013 to the Senior Secured Term Loan we are in compliance with the maximum leverage ratio covenant in the Senior Secured Term Loan, which means we remain in compliance for purposes of the Senior Secured Credit Facility.

Real Estate Secured Term Loan—In October 2010, we entered into a $50.0 million real estate secured loan with a group of lenders. On July 27, 2012 we completed a sale leaseback transaction for six properties, and entered into a leaseback agreement with respect to the sale. 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 consolidated financial statements, at the end of the fiscal year on February 2, 2013, we were not in compliance with the maximum adjusted leverage ratio covenant under our Senior Secured Term Loan. On February 14, 2013, the lenders under the Senior Secured Term Loan waived compliance with the maximum adjusted leverage ratio covenant with respect to our quarter ended February 2, 2013, as well as for the first fiscal quarter of 2013 ending May 4, 2013, subject to our continued compliance with the terms and conditions of the waiver. Under the provisions of the waiver, our next applicable measurement date for the leverage ratio covenant compliance is August 3, 2013.

Non-compliance with the maximum adjusted leverage ratio covenant as of the next measurement date would cause a default under the financing arrangements. A default could result in our lenders under the Senior Secured Term Loan declaring the outstanding indebtedness ($129.4 million as of February 2, 2013) to be due and payable. As a result of the cross-default provisions in our debt agreements, a default under the Senior Secured Term Loan would result in a default under, and the acceleration of, payments in our Senior Secured Credit Facility. A default could result in our lenders under the Senior Secured Credit Facility declaring the outstanding indebtedness ($78.8 million as of February 2, 2013) to be due and payable. 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 February 2, 2013.

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CONTRACTUAL OBLIGATIONS

The following table summarizes our known contractual obligations as of February 2, 2013 (in millions).

Certain reserves and contractual obligations were excluded from the table above due to the uncertainty in timing or amounts of such payments. These include $7.2 million of self insurance reserves and variable interest on our long-term debt. If both interest rates and debt remain constant, we expect interest obligations to be $13.2 million within the next 12 months. A 100 basis points change in interest rates, assuming consistent borrowings, could result in a $2.1 million change in interest obligations annually. A $1.0 million change in debt, assuming consistent interest rates, could result in a $0.1 million change in interest obligations annually. In the past 12 months, we have experienced a 109 basis points change in interest rate and a $8.7 million change in debt. If we were to experience the same interest fluctuation in the following 12 months, it could potentially change our interest obligations by approximately $2.9 million or approximately 22.1% of the $13.2 million in expected interest obligations.

OFF-BALANCE SHEET ARRANGEMENTS

Other than in connection with executing operating leases and purchase commitments, we do not have any other off-balance sheet financing that has, or is reasonably likely to have, a material current or future effect on our financial condition, cash flows, results of operations, liquidity, capital expenditures or capital resources.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of our financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management has discussed the development and selection of these critical accounting policies and estimates with the Audit Committee of our Board of Directors, and believes the assumptions and estimates, as set forth in our Annual Report on Form 10-K for fiscal 2012, are significant to reporting our results of operations and financial position.

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We believe that the current assumptions and other considerations used to estimate amounts reflected in the consolidated financial statements are appropriate. However, if actual experience differs from the assumptions and the considerations used in estimating amounts, the resulting changes could have a material adverse effect on our consolidated results of operations, and in certain situations, could have a material adverse effect on our financial condition.

The following is a summary of our most Critical Accounting Policies and Estimates.

Merchandise Inventories

Our inventory is valued at the lower of cost or market, with cost determined primarily using the retail inventory method (“RIM”). RIM is an averaging method that is commonly used in the retail industry. To determine inventory cost under RIM, inventory at its retail selling value is segregated into groupings of merchandise having similar characteristics, which are then converted to a cost basis by applying specific average cost factors for each grouping of merchandise. Cost factors represent the average cost-to-retail ratio for each merchandise group based upon the year’s purchasing activity for each store location. Accordingly, a significant assumption under the retail method is that inventory in each group is similar in terms of its cost-to-retail relationship and has similar turnover rates. We monitor the content of merchandise in these groupings to prevent distortions that would have a material effect on inventory valuation.

Our housewares, hardware, and garden inventories are valued under the RIM using a last-in, first-out (“LIFO”) cost flow assumption. To estimate the effects of changing prices in inventory, we utilize external price indices determined by an outside source, the Bureau of Labor Statistics.

Vendor Rebates and Allowances

We receive various vendor-funded rebates and allowances through a variety of programs and arrangements intended to offset our 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. For fiscal 2012, 2011 and 2010, we earned vendor rebates and allowances of $30.1 million, $29.5 million and $30.3 million, respectively.

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 considers both positive and negative evidence to determine if a portion or all of the deferred tax assets will not be realized in the future. The recoverability of the deferred tax assets is based on historical and anticipated earnings levels and the ability to carry back any taxable losses and claim 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 negative 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 tax assets. In the second fiscal quarter of 2012, the Company concluded that the negative evidence outweighed the positive evidence, and accordingly, it is more likely than not that the Company would not be able to realize all of its federal and state deferred tax assets. Therefore, in fiscal 2012, the Company recorded a charge of $29.1 million to income tax expense to establish a valuation allowance against its deferred tax assets. At February 2, 2013, the Company’s valuation allowance was $29.1 million.

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Accounting 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 (see Note 3), which require management to make estimates about future cash flows. The Company estimates the amount and timing of future cash flows based on historical experience and knowledge of the retail market in which each store operates. The Company recorded $15.0 million and $3.5 million of property and equipment impairment charges in connection with store assets during fiscal 2012 and 2011, respectively.

Trade Name Asset Impairment

The Company’s trade name assets, OSH and Orchard 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 circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of the trade names with their carrying amount. The Company uses the relief 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.

As of October 27, 2012, the Company tested its trade names for possible impairment, due to the decline in its 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). This analysis, which included reduced royalty rates, resulted in a fair value of trade names of $47.3 million, and, accordingly, the Company recognized non-cash trade name impairment of $60.3 million in the 13 weeks ended October 27, 2012.

As of February 2, 2013, the Company again tested its trade names for possible impairment, due to the continued significant decline in its market capitalization, lowered forecasted future revenues, its difficulties in meeting its loan agreement covenants and financing needs, its recurring losses from operations, its negative working capital position, and the substantial doubt about the Company’s ability to continue as a going concern. This analysis, which included reduced royalty rates, resulted in a fair value of trade names of $11.5 million, and, accordingly, the Company recognized additional an non-cash trade name impairment of $35.8 million in the 14 weeks ended February 2, 2013.

Lease Accounting

The Company leases certain stores, office facilities, computers, and transportation equipment. The determination of operating and capital lease obligations is based upon the terms of the lease, estimated fair value of the leased assets, estimated useful life of the leased assets, 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 on the sale of the asset would be recognized immediately.

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We also must evaluate sales of our properties which occur in sale leaseback transactions to determine the proper accounting for the proceeds of such sales either as a sale or a deposit. This evaluation requires certain judgments in determining whether or not clauses in the lease or any related agreements constitute continuing involvement. For those sale leasebacks that are accounted for as financing transactions, we must estimate our incremental borrowing rate, or another rate in cases where the incremental borrowing rate is not appropriate to utilize, for purposes of determining interest expense and the resulting amortization of the lease financing obligation. Changes in the determination of the incremental borrowing rates or other rates utilized in connection with the accounting for lease financing transactions could have a significant effect on the interest expense and underlying balance of the lease financing obligations.

Self Insurance Reserves

We have insurance contracts for exposures incurred after that date with third-party insurance companies for a number of risks including workers’ compensation and general liability claims. We record insurance reserves based on the expected ultimate settlement value of claims filed and claims incurred but not yet reported. Our estimated claim amounts are discounted using a risk-free rate based on the duration that approximates the expected period to settle such claims. The discount rate used was 2% in fiscal 2012 and 4% in each of fiscal 2011 and 2010. A 50 basis point change in the risk-free rate would change our reserve by approximately $0.1 million. In estimating this liability, we utilized loss trend factors based on company-specific data to project the future loss rate. Loss estimates are adjusted based upon actual claims settlements and reported claims. These projections are subject to a high degree of variability based upon future inflation rates, litigation trends, legal interpretations, benefit level changes, and claim settlement patterns.

Although we do not expect the amounts ultimately paid to differ significantly from our estimates, insurance reserves could be affected if future claim experience differs significantly from the historical trends and the actuarial assumptions.

New Accounting Pronouncements—Under the Jumpstart Our Business Startups Act, or JOBS Act, 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 pursuant to Section 107(b) of the JOBS Act.

Item 7A.—Quantitative and Qualitative Disclosures About Market Risk

We face market risk exposure in the form of interest rate risk. These market risks arise from our debt obligations. We have no international operations. Our exposure to foreign currency fluctuations is not significant to our financial condition or results of operations.

Interest Rate Risk

All interest-rate derivative instruments are considered non-trading. At February 2, 2013, 79.6% of our total debt portfolio, including capital leases, was variable rate. Based on the size of this variable rate debt portfolio at February 2, 2013, which totaled approximately $208.2 million, an immediate 100 basis points change in interest rates would have affected annual pretax funding costs by $2.1 million.

We do not enter into derivative financial contracts for trading purposes. Derivative financial instruments embedded in our store leases related to Consumer Price Index (“CPI”) are recorded at fair value. At February 2, 2013, the fair value of the derivative financial instruments embedded in our leases was $3.6 million. A 1% increase in CPI will increase interest expense by approximately $0.2 million.

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ITEM 8.—Financial Statements and Supplemental Data

ORCHARD SUPPLY HARDWARE STORES CORPORATION AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS