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

EXECUTIVE OVERVIEW

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

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

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

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

2012 Third Quarter Financial Highlights

• For the third quarter of fiscal 2012, net sales were $155.2 million, a decrease of $3.5 million, or 2.2%, as compared to net sales of $158.7 million for the third quarter of fiscal 2011. Net sales declined due to the impact of the Appliances Agreement and softer sales attributed to changes in advertising cadence at the beginning of the quarter offset by increased sales from our remodeled stores which were completed toward the end of the third quarter.

• Comparable store sales for the third quarter of fiscal 2012 were flat (see the definition of comparable store sales below, which addresses the impact of the Appliance Agreement), decreasing 0.1%, due to a decline in comparable transaction volume of 3.5% offset by a 3.4% increase in average ticket comparables.

• Gross margin was $45.0 million, or 29% of net sales, for the third quarter of fiscal 2012, a decrease of $6.5 million, or 12.6%, as compared to $51.5 million, or 32.5% of net sales, for the third quarter of fiscal 2011. The decrease in gross margin was primarily due to an increase in markdowns taken to help drive sales and clear inventory as well as higher occupancy costs as a result of paying rent on properties previously owned prior to the sale-leaseback transactions.

• Merchandise inventory was $173.8 million at the end of the third quarter of fiscal 2012, an increase of $12.6 million, or 7.8%, as compared to merchandise inventory of $161.2 million at the end of the third quarter of fiscal 2011. The increase in merchandise inventory was primarily due to lower than anticipated levels of sales and increased inventory in our seasonal merchandise to support year round selling activities.

2012 Third Quarter Business Highlights

The Company is focused against five key strategic priorities:

• Strengthen our financial position;

• Project a consistent and compelling brand identity;

• Drive sales through merchandising and marketing initiatives;

• Improve operational efficiencies;

• Align resources and talent.

Key accomplishments during the third quarter of fiscal 2012 included:

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

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

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

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

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

RESULTS OF OPERATIONS

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

                                                                     13 Weeks Ended                                                              39 Weeks Ended
                                           October 27,         % of Net          October 29,         % of Net          October 27,         % of Net          October 29,         % of Net
                                              2012              Sales               2011              Sales               2012              Sales               2011              Sales
NET SALES                                 $       155.2            100.0 %      $       158.7            100.0 %      $       504.2            100.0 %      $       518.9            100.0 %

COST OF SALES AND EXPENSES:
Cost of sales (excluding depreciation
and amortization)                                 110.2             71.0                107.2             67.5                342.6             67.9                346.4             66.8
Gross Margin                                       45.0             29.0                 51.5             32.5                161.5             32.1                172.5             33.2
Selling and administrative                         45.5             29.3                 40.8             25.8                141.1             28.0                131.1             25.3
Depreciation and amortization                       8.6              5.5                  7.7              4.9                 24.0              4.8                 22.4              4.3
Trade name and property and equipment
impairment                                         65.1             41.9                   -                -                  72.8             14.4                   -                -
Loss (gain) on sale of real property                 -                -                  14.3              9.0                 (0.6 )           (0.1 )               14.3              2.8

Total cost of sales and expenses                  229.4            147.7                170.1            107.2                579.9            115.0                514.2             99.2

OPERATING (LOSS) INCOME                           (74.2 )          (47.7 )              (11.4 )           (7.2 )              (75.7 )          (15.0 )                4.7              0.8
INTEREST EXPENSE, NET                               4.0              2.6                  5.7              3.6                 18.3              3.6                 16.8              3.1

LOSS BEFORE TAXES                                 (78.2 )          (50.3 )              (17.1 )          (10.8 )              (94.0 )          (18.6 )              (12.1 )           (2.3 )
INCOME TAX EXPENSE                                (24.6 )          (15.9 )               (7.0 )           (4.4 )               (9.2 )           (1.8 )               (4.9 )           (0.9 )

NET LOSS                                  $       (53.6 )          (34.4 )%     $       (10.1 )           (6.4 )%     $       (84.8 )          (16.8 )%     $        (7.2 )           (1.4 )%


Basic and diluted loss per share          $       (8.88 )                       $       (1.68 )                       $      (14.08 )                       $       (1.20 )
Basic and diluted weighted average
common shares outstanding                           6.0                                   6.0                                   6.0                                   6.0

OTHER DATA:
STORE COUNT                                          89                                    89                                    89                                    89

Comparable store sales

Comparable sales figures are defined as follows:

1. Comparable store sales. Measured by the increase or decrease in net sales year over year, excluding new and closed stores and E-commerce. Additionally, and because of an agreement the Company entered into with Sears Holdings (the "Appliances Agreement") on October 26, 2011 whereby the Company now sells appliances on a consignment basis and receives commission income for sales of such appliances and related protection agreements, comparable store sales also exclude approximately $4.1 million and $12.7 million of sales of Sears Holdings branded appliances in the third quarter and year-to-date period, respectively, of fiscal 2011 and approximately $0.4 million and $1.3 million of commission income in the third quarter and year-to-date period, respectively, of fiscal 2012.

2. Comparable transaction volume. Derived from the increase or decrease in the number of transactions year over year, excluding new and closed stores, appliance sales, and E-commerce.

3. Average ticket comparables. Derived using net sales divided by the number of transactions year over year.

A store is included in the calculation of comparable metrics above if it has been open 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.

13 week period ended October 27, 2012 compared to 13 week period ended October 29, 2011

Net sales

13 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Net sales $ 155.2 $ 158.7 (3.5 ) (2.2 )%

Net sales decreased $3.5 million, or 2.2%, to $155.2 million for the third quarter of fiscal 2012, as compared to $158.7 million for the third quarter of fiscal 2011. The decline in net sales is primarily attributed to a $4.1 million impact of the Appliances Agreement (see the definition of comparable store sales above). The decline in net sales was offset in part by a $1.4 million in gift card breakage income. Comparable store sales were essentially flat for the quarter.

Gross Margin

Gross margin decreased $6.5 million to $45.0 million, or 29.0% of net sales, for the third quarter of fiscal 2012, as compared to $51.5 million or 32.5% of net sales, for the third quarter of fiscal 2011. The decrease of 350 basis points was driven by an approximate 300 basis points decline in merchandise margin as a result of higher markdowns to drive sales and clear inventory and 140 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 the deleverage of occupancy and distribution center costs due to lower net sales. These items were partially offset by gift card breakage income of $1.4 million or 90 basis points.

Selling and administrative

                                                    13 Weeks Ended                            Increase (Decrease)
                                      October 27, 2012           October 29, 2011             $                %
Selling and administrative          $               45.5        $             40.8              4.7              11.4 %
Percent of net sales                                29.3 %                    25.8 %

Selling and administrative expenses increased $4.7 million to $45.5 million or 29.3% of net sales, for the third quarter of fiscal 2012, as compared to $40.8 million or 25.8% of net sales, for the third quarter of fiscal 2011. The increase in selling and administrative expenses was primarily due to (a) a $0.6 million increase in operating costs directly associated with being an independent public company, (b) a $1.1 million increase in legal and financial advisory costs (c) a $1.6 million legal accrual reversed in the third quarter of 2011 and (d) a $1.0 million increase in payroll and other expenses associated with Store Support Center initiatives.

Impairment charges

13 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Impairment charges $ 65.1 $ 0.0 65.1 100.0 %

Impairment charges recognized in the third quarter of 2012 include a non-cash charge of $60.3 million for trade name impairment and $4.8 million of non-cash charges related to the write-down of store assets that were determined to be impaired.

Loss on sale of real property

13 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Loss on sale of real property $ 0.0 $ 14.3 (14.3 ) (100.0 )%

In the third quarter of fiscal 2011 we sold our distribution center located in Tracy, California and recorded a non-cash loss of $14.3 million in connection with the sale.

Interest expense, net

13 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Interest expense, net $ 4.0 $ 5.7 (1.7 ) (29.8 )%

Interest expense decreased $1.7 million to $4.0 million, or 29.8%, for the third quarter of fiscal 2012, as compared to $5.7 million for the third quarter of fiscal 2011. The $1.7 million decrease in interest expense was due primarily to the reduction of $1.7 million in derivative lease liabilities.

Income tax benefit

13 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Income tax benefit $ (24.6 ) $ (7.0 ) 17.6 251.4 % Effective tax rate 31.5 % 40.8 %

Income tax benefit was $24.6 million for the third quarter of fiscal 2012 as compared to an income tax benefit of $7.0 million recorded for the third quarter of fiscal 2011. The current period results reflect the reversal of deferred tax liabilities resulting from the $60.3 million trade name impairment charge.

39 week period ended October 27, 2012 compared to 39 week period ended October 29, 2011

Net sales

39 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Net sales $ 504.2 $ 518.9 $ (14.7 ) (2.8 )%

Net sales decreased $14.7 million, or 2.8%, to $504.2 million for the current 39-week period ended October 27, 2012 as compared to $518.9 million for the prior 39-week period ended October 29, 2011. The decrease in net sales was attributable to (a) an approximate $12.7 million impact related to the Appliances Agreement (see the definition of comparable store sales above) and
(b) a decrease of 0.7% in comparable store sales, comprised of a decrease in comparable transactions of 2.9%, partially offset by a 2.2% increase in average ticket comparables. These declines in net sales were offset in part by a $1.4 million for gift card breakage income.

Gross margin

39 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Gross Margin $ 161.6 $ 172.5 $ (10.9 ) (6.3 )% Percent of net sales 32.0 % 33.2 %

Gross margin decreased $10.9 million to $161.6 million, or 32.0% of net sales, for the current 39-week period ended October 27, 2012 as compared to $172.5 million or 33.2% of net sales, for the prior 39-week period ended October 29, 2011. The decrease of 120 basis points in gross margin was primarily due to approximately 140 basis points of higher occupancy costs as a result of paying rent on properties previously owned prior to the sale-leaseback transactions and as a result of deleverage of occupancy and distribution center costs due to lower net sales. These were partially offset by gift card breakage income of $1.4 million or 30 basis points

Selling and administrative

                                                   39 Weeks Ended                           Increase (Decrease)
                                     October 27, 2012          October 29, 2011             $                 %
Selling and administrative          $            141.1        $            131.1        $     10.0              7.6 %
Percent of net sales                              28.0 %                    25.3 %

Selling and administrative expenses increased $10.0 million to $141.1 million, or 28.0% of net sales, for the current 39-week period ended October 27, 2012, as compared to $131.1 million or 25.3% of net sales, for the prior 39-week period ended October 29, 2011. The increase in selling and administrative expenses was primarily due to (a) $3.4 million increase in operating costs associated

with being an independent public company, (b) $2.1 million legal accruals reversed in the prior 39-week period ended October 29, 2011, (c) a $1.1 million increase in legal and financial advisory costs and (d) a $2.6 million increase in payroll and other expenses associated with Store Support Center initiatives.

Impairment charges

39 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Impairment charges $ 72.8 $ 0.0 72.8 100 %

Impairment charges recognized in the thirty-nine weeks ended October 27, 2012 include a non-cash charge of $60.3 million for trade name impairment and $12.4 million of non-cash charges related to the write-down of store assets that were determined to be impaired.

(Gain) loss on sale of real property

39 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % (Gain) loss on sale of real
property $ (0.6 ) $ 14.3 $ (14.9 ) (104.2 )%

During the current 39-week period ended October 27, 2012, we recorded a non-cash gain of $0.6 million in connection with the sale-leaseback transactions involving our store in San Lorenzo, California and a parcel of land in San Jose, California. In the 39-week period ended October 24, 2011, we sold our distribution center located in Tracy, California and recorded a non-cash loss of $14.3 million in connection with the sale.

Depreciation and amortization

39 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Depreciation and amortization $ 24.0 $ 22.4 $ 1.6 7.1 %

Depreciation and amortization increased $1.6 million to $24.0 million, or 7.1%, for the current 39 week period ended October 27, 2012, as compared to $22.4 million for the prior 39 week period ended October 29, 2011. The increase in depreciation and amortization expense was primarily due to accelerated depreciation on stores currently being remodeled.

Interest expense, net

39 Weeks Ended Increase (Decrease) October 27, 2012 October 29, 2011 $ % Interest expense, net $ 18.3 $ 16.8 $ 1.5 8.9 %

Interest expense increased $1.5 million to $18.3 million, or 8.9%, for the current 39 week period ended October 27, 2012, as compared to $16.8 million for the prior 39 week period ended October 29, 2011. The $1.5 million increase in interest expense was due to (a) $1.2 million write-off of unamortized deferred financing costs related to the early pay off of the Real Estate Term Loan at the end of the second quarter and (b) the higher interest rates associated with amendments 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

                                                    39 Weeks Ended                            Increase (Decrease)
                                      October 27, 2012           October 29, 2011             $                %
Income tax benefit                  $               (9.2 )      $             (4.9 )      $     4.3              87.8 %
Effective tax rate                                   9.8 %                    40.5 %

Income tax benefit was $9.2 million for the current 39-week period ended October 27, 2012 as compared to an income tax benefit of $4.9 million recorded for the prior 39 week period ended October 29, 2011. The current period results reflect the effects of the tax benefit of $24.6 million relating to the reversal of deferred tax liabilities resulting from the $60.3 million trade name impairment charge, and a tax valuation allowance charge of $18.4 million . . .