WEF

Will the inventory provision materially affect the company’s debt covenants or credit metrics?

Created August 07, 2025 at 08:38 PM

Short answer:

Yes – the $3.6 million inventory‑provision expense that drives Western’s Adjusted EBITDA down to only $0.5 million in Q2 2025 is likely to have a material impact on the company’s debt‑covenant calculations and on the credit‑metric ratios that lenders monitor (e.g., leverage, interest‑coverage, and minimum‑EBITDA thresholds). Whether the impact is “material” in a strict legal sense depends on the exact wording of the covenants, but the magnitude of the change in earnings makes a breach or a near‑breach a realistic scenario.

1. Why the provision matters for covenants

Typical covenant base	How the provision affects it
EBITDA‑based leverage ratios (e.g., Debt / EBITDA ≤ x)	EBITDA is the denominator. A drop from $9.4 M (Q2 2024) to $0.5 M (Q2 2025) raises the leverage ratio dramatically, even if the total debt balance has not changed.
Interest‑coverage ratio (EBITDA / Interest expense)	With EBITDA at $0.5 M, any modest interest bill will push the coverage well below the usual 1.5‑2.0 × minimum.
Minimum Adjusted EBITDA (e.g., “Adjusted EBITDA must be ≥ $2 M each quarter”)	The $0.5 M figure is far below a typical $2 M floor, so the covenant would be breached outright.
Liquidity or Net‑Working‑Capital covenants	The $3.6 M provision is a non‑cash expense that reduces net‑working‑capital (inventory is written down). While it does not affect cash flow directly, it reduces the balance‑sheet “net‑working‑capital” metric that some lenders use.
Cash‑EBITDA or Operating‑Cash‑Flow covenants	If the covenant is defined on a cash‑EBITDA basis, the provision may be excluded (because it is non‑cash). In that case the impact would be less material, but many loan documents still reference “Adjusted EBITDA” that includes such provisions.

2. Quantitative illustration

Assume (illustrative) covenant thresholds that are common for a mid‑size, resource‑based company:

Metric	Threshold	Q2 2024 (actual)	Q2 2025 (actual)	% change
Adjusted EBITDA	≥ $2 M per quarter	$9.4 M	$0.5 M	‑95 %
Debt / EBITDA	≤ 3.0 x	Debt / $9.4 M ≈ 0.8 x	Debt / $0.5 M ≈ 15 x	+1,775 %
EBITDA / Interest	≥ 1.5 ×	$9.4 M / $0.8 M ≈ 11.8 ×	$0.5 M / $0.8 M ≈ 0.6 ×	‑95 %

The numbers above are for illustration only; the actual debt and interest balances are not disclosed in the press release. The point is that a *$3.6 M provision** reduces the EBITDA denominator enough to push any covenant that uses EBITDA into a breach zone.*

3. How the covenant language determines “materiality”

If the covenant explicitly references “Adjusted EBITDA” (the same definition used in the press release), the provision is included and the covenant will be materially affected.
If the covenant uses “GAAP EBITDA” or “Cash‑EBITDA” that excludes non‑cash inventory write‑downs, the provision may be excluded. In that case the impact is less material, but the covenant still may be strained because the cash‑EBITDA will also be lower (inventory write‑downs often signal weaker operating performance and can affect cash generation indirectly).
If the covenant has a “floor” on the provision itself (e.g., “no inventory provision greater than 5 % of revenue”), the $3.6 M expense could trigger a separate breach.

Because the news release does not disclose the exact covenant language, we can only infer that most senior lenders would treat the $3.6 M provision as part of the Adjusted EBITDA calculation, making the impact material for a typical credit‑agreement.

4. Potential downstream consequences

Potential outcome	Explanation
Technical default	If a minimum Adjusted EBITDA or leverage ratio is breached, the loan may go into technical default, triggering reporting, waivers, or even an acceleration of repayment.
Waiver request	The company may have to request a covenant waiver from lenders, which could come with higher interest spreads, additional fees, or tighter reporting covenants.
Credit‑rating downgrade	Credit agencies (e.g., S&P, Moody’s) often look at EBITDA trends. A 95 % drop in Adjusted EBITDA would likely prompt a downgrade, raising borrowing costs.
Liquidity strain	Even if the provision is non‑cash, the write‑down reduces the balance‑sheet value of inventory, potentially tightening any asset‑based borrowing facilities that use inventory as collateral.
Future financing	A covenant breach in Q2 2025 could make the company a higher‑risk borrower for any subsequent term‑loans, revolving credit, or bond issuance.

5. Take‑away for management and lenders

For Western’s management	For lenders
Immediate action: Quantify the exact covenant breach risk and, if needed, prepare a waiver request with a clear plan to restore EBITDA (e.g., inventory turnover, cost‑control, price‑recovery).	Covenant review: Verify the exact definition of “Adjusted EBITDA” in the loan documents. If the covenant is based on cash‑EBITDA, calculate the cash‑EBITDA impact to confirm whether the provision is excluded.
Communication: Provide lenders with a detailed explanation of the price‑driven inventory write‑down, the temporary nature of the provision, and the expected recovery path (e.g., Q3‑Q4 2025 market rebound).	Monitoring: Tighten monitoring of leverage and interest‑coverage ratios on a rolling‑basis, given the volatility of the lumber market.
Balance‑sheet management: Consider whether any asset‑based facilities can be re‑structured to use a higher‑quality collateral base while inventory is being written down.	Risk‑pricing: If a waiver is granted, expect higher spread or additional covenants (e.g., tighter cash‑flow coverage, mandatory amortisation of excess cash).

6. Bottom line

Yes, the $3.6 M inventory provision is material to the company’s debt‑covenant and credit‑metric calculations, because it drives Adjusted EBITDA down to a level that is far below typical covenant floors and inflates leverage and interest‑coverage ratios dramatically.
The exact legal impact hinges on the covenant wording (Adjusted vs. cash EBITDA, inclusion/exclusion of inventory provisions). In most standard loan agreements, the provision is included and therefore creates a high probability of a covenant breach.
Management should proactively assess the breach risk, engage lenders early, and outline a recovery plan to mitigate the potential for a technical default or a credit‑rating downgrade.