Patterson Companies (PDCO) Risk Factors

We are subject to a variety of litigation incidental to our business, including product liability claims, intellectual property claims, employment claims, commercial disputes, putative class actions under the California Labor Code Private Attorneys General Act, and other matters arising out of the ordinary course of our business, including securities litigation. From time to time we are named as a defendant in cases as a result of our distribution of products. Additionally, purchasers of private-label products may seek recourse directly from us, rather than the ultimate product manufacturer, for product-related claims. Another potential risk we face in the distribution of products is liability resulting from counterfeit or tainted products infiltrating the supply chain. In addition, some of the products that we transport and sell are considered hazardous materials. The improper handling of such materials or accidents involving the transportation of such materials could subject us to liability or legal action that could harm our reputation. From time to time, we also receive and respond to governmental inquiries and investigations, including subpoenas for the production of documents. Defending against such claims, and responding to such governmental inquiries and investigations, may divert our resources and management's attention over lengthy periods of time, may be expensive, and may require that we pay substantial monetary awards or settlements, pay fines or penalties, or become subject to equitable remedies (including but not limited to the revocation of or non-renewal of licenses). We may be subject to claims in excess of available insurance or not covered by insurance or indemnification agreements, or claims that result in significant adverse publicity. Furthermore, the outcome of litigation is inherently uncertain.

Our practice management products and services include electronic information technology systems that store and process personal health, clinical, financial and other sensitive information of individuals. Both we and our customers are subject to numerous and evolving laws, regulations and industry standards, such as HIPAA and the Payment Card Industry Data Security Standards, which require the protection of the privacy and security of those records. The legal environment surrounding data privacy is demanding with the frequent imposition of new and changing regulatory requirements. Furthermore, our products may be used as part of our customers' comprehensive data security programs, including in connection with their efforts to comply with applicable privacy and security laws. We are also subject to non-healthcare-specific requirements of the countries and states in which we operate which govern the handling, storage, use and protection of personal information, such as the California Consumer Privacy Act, or CCPA, which is a state statute intended to enhance privacy rights and consumer protection for residents of California, the California Privacy Rights Act, or CPRA, that became effective on January 1, 2023, and the pan-European General Data Protection Regulation, or GDPR. Additionally, nearly all other states have passed, proposed, or are considering comprehensive privacy legislation, and privacy bills have been proposed at the federal level that may result in additional legal requirements that impact our business. In addition, the FDA has become increasingly active in addressing the regulation of computer software intended for use in health care settings, and has developed and continues to develop policies on regulating clinical decision support tools and other types of software as medical devices. Certain of our software and related products support practice management, and it is possible that the FDA or foreign government authorities could determine that one or more of our products is a medical device, which could subject us or one or more of our businesses to substantial additional requirements, costs and potential enforcement actions or liabilities for noncompliance with respect to these products. Both in the U.S. and abroad, these laws and regulations continue to evolve and remain subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain. If we fail to comply with such laws and regulations, we could be required to make significant changes to our products or services, or incur substantial fines, penalties, or other liabilities. The costs of compliance with, and the other burdens imposed by, new or existing laws or regulatory actions may prevent us from selling the products or services we distribute, or increase the costs of doing so, and may affect our decision to distribute such products or services. Also, evolving laws and regulations in this area could restrict the ability of our customers to obtain or use patient information, or could require us to incur significant additional costs to conform to these legal requirements. In addition, the products and services we distribute may be vulnerable to breakdown, wrongful intrusions, data breaches and malicious attack. Perceived or actual security vulnerabilities in these products or services, or the perceived or actual failure by us or our customers who use these products or services to comply with applicable legal or contractual data privacy or security requirements, may not only cause reputational harm and loss of business, but may also lead to claims against us by our customers and/or governmental agencies and involve substantial damages, fines, penalties and other liabilities and expenses and costs for remediation.

We are subject to uncertain macro-economic conditions that affect the economy and the economic outlook of the United States and other parts of the world in which we operate. In particular, recessionary or inflationary conditions and depressed levels of consumer and commercial spending may cause dental and animal health customers to reduce, modify, delay or cancel plans to purchase the products we distribute and services we provide, may cause dental and animal health professionals to decrease or stop investing in their practices, and may cause suppliers to reduce their output or change their terms of sale. Increased fuel and energy costs (for example, the price of gasoline) and recent and prospective banking failures may adversely affect consumer confidence and, thereby, reduce dental and veterinary office visits. The impacts of efforts by federal, state and local governments to combat inflation are unpredictable and could have an adverse impact on consumer spending. Current interest rates have also created some tightening in the credit markets. Continued tight credit markets or credit market volatility may cause financing difficulties, which in turn may cause dental and animal health customers to reduce, modify, delay or cancel plans to purchase the products we distribute and services we provide. In addition, the average interest rate in our contract portfolio may not increase at the same rate as interest rate markets, resulting in a reduction of gain on contract sales as compared to the gain that would be realized if the average interest rate in our portfolio were to increase at a rate more similar to the interest rate markets. Tension between the U.S. and China, as well as conflicts involving Russia, Ukraine, Israel and Gaza, and other unrest, also are creating increased global and economic uncertainty, which could adversely affect spending on the dental and animal health products and services we distribute. Global political and/or trade issues also could adversely impact the ability of U.S. producers to export finished protein products to other countries in the world. Furthermore, although inflation did not materially impact our results of operations in fiscal 2024, cost inflation during fiscal 2024, including wage inflation, generally increased our operating costs, including our cost of goods, transportation costs, labor costs and other administrative costs. We may face higher and sustained rates of inflation, with subsequent increases in operational costs that we may be unable to pass through to our dental and animal health customers.

There are a number of risks inherent in foreign operations, including the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, complex regulatory requirements, staffing and management complexities, import and export costs, other economic factors and political considerations, all of which are subject to unanticipated changes. Our foreign operations also expose us to foreign currency fluctuations. Because our financial statements are denominated in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies will have an impact on our income. Currency exchange rate fluctuations may adversely affect our results of operations and financial condition. Furthermore, we generally do not hedge translation exposure with respect to foreign operations.

Anti-takeover provisions of our articles of incorporation, bylaws, and Minnesota law could diminish the opportunity for shareholders to participate in acquisition proposals at a price above the then-current market price of our common stock. For example, while we have no present plans to issue any preferred stock, our Board of Directors, without further shareholder approval, may issue up to approximately 30 million shares of undesignated preferred stock and fix the powers, preferences, rights and limitations of such class or series, which could adversely affect the voting power of our common stock. Further, as a Minnesota corporation, we are subject to provisions of the Minnesota Business Corporation Act regarding "control share acquisitions" and "business combinations." We may also, in the future, consider adopting additional anti-takeover measures. In addition, certain equity plans predating our Omnibus Incentive Plan provide for acceleration of awards thereunder upon a change in control or other events of acceleration, as defined in those plans. The foregoing, and any future anti-takeover measures adopted by us, may, in certain circumstances, delay, deter or prevent takeover attempts and other changes in control of our company.

The covenants under our credit agreements impose restrictions on our business and financing activities, subject to certain exceptions or the consent of our lenders, including, among other things, limits on our ability to incur additional debt, create liens, enter into certain merger, acquisition and divestiture transactions, pay dividends and engage in transactions with affiliates. The credit agreements contain certain customary affirmative covenants, including requirements that we maintain a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio, pursuant to which we may be affected by changes in interest rates, and customary events of default. The terms of agreements governing debt that we may incur in the future may also contain similar covenants. Our ability to comply with these covenants may be adversely affected by events beyond our control, including economic, financial and industry conditions. A covenant breach may result in an event of default, which could allow our lenders to terminate the commitments under the credit agreement, declare all amounts outstanding under the credit agreement, together with accrued interest, to be immediately due and payable, and exercise other rights and remedies, and, through cross-default provisions, would entitle our other lenders to accelerate their loans. If this occurs, we may not be able to refinance the accelerated indebtedness on acceptable terms, or at all, or otherwise repay the accelerated indebtedness. In addition, borrowings under certain of our debt instruments are made at variable rates of interest and expose us to interest rate volatility. If interest rates increase again in the future, as they did in 2023, our debt service obligations on variable rate indebtedness would again increase.

As a part of our business strategy, we acquire and dispose of assets and businesses in the ordinary course. Maintaining or improving our price-to-earnings ratio, of which the market price of our common stock is commonly thought to be a function, requires effective execution of our growth strategy, including achieving inorganic earnings per share growth. Acquisitions and dispositions can involve a number of risks and challenges, any of which could cause significant operating inefficiencies and adversely affect our growth and profitability, and may not result in the expected benefits. Acquisition risks and challenges include underperformance relative to our expectations and the price paid for the acquisition; unanticipated demands on our management and operational resources; difficulty in integrating personnel, operations and systems; retention of customers of the combined businesses; assumption of contingent liabilities; acquisition-related earnings charges; and acquisition-related cybersecurity risks. Our ability to continue to make acquisitions will depend upon our success in identifying suitable targets, which requires substantial judgment in assessing their values, strengths, weaknesses, liabilities and potential profitability, as well as the availability of suitable candidates at acceptable prices, whether restrictions are imposed by anti-trust or other regulations, and compliance with the terms and conditions of our credit agreement. Additionally, when we decide to sell assets or a business, we may encounter difficulty in finding buyers or executing alternative exit strategies on acceptable terms in a timely manner, which could delay the accomplishment of our strategic objectives. Alternatively, we may dispose of assets or a business at a price or on terms that are less than we had anticipated. Dispositions may also involve continued financial involvement in a divested business, such as through continuing equity ownership, transition service agreements, guarantees, indemnities or other current or contingent financial obligations. Under these arrangements, performance by the acquired or divested business, or other conditions outside our control, could affect our future financial results. As we operate through two strategic business units, we consolidate the distribution, information technology, human resources, financial and other administrative functions of those business units jointly to meet their needs while addressing distinctions in the individual markets of those segments. We may not be able to do so effectively and efficiently. In addition, if we acquire technology, manufacturing or other businesses ancillary to our core distribution operations, any such newly acquired business may require the investment of additional capital and significant involvement of our senior management to integrate such business with our operations, which could place a strain on our management, other personnel, resources and systems. The acquisition of businesses in which we lack operational and market experience may be more difficult, time-consuming or costly than expected. Further, we may not ultimately strengthen our competitive position or achieve desired synergies as a result of our acquisitions, and they could be viewed negatively by our customers, securities analysts and investors.

Our growth depends on our investment in the development of software and e-services products and the market traction achieved by such offerings. If we fail to accurately predict future customer needs and preferences or fail to produce viable software and e-services products, we may invest heavily in product commercialization that does not lead to significant sales, which would adversely affect our profitability. Even if we successfully innovate and develop new and enhanced software and e-services products, we may incur substantial costs in doing so, and our profitability may suffer. Furthermore, our software and e-services products also may contain undetected errors or bugs when introduced, or as new versions are released. Any such defects may result in increased expenses and could adversely affect our reputation and our relationships with the customers using such products. We do not have any patents on our software or e-services products, and rely upon copyright, trademark and trade secret laws, as well as contractual and common-law protections. We cannot provide assurance that such legal protections will be available, adequate or enforceable in a timely manner to protect our software or e-services products. Our software and e-services products may fail to remain competitive and may fail to anticipate market demands for functionality. In addition, the cost to replace defective products may not generate commensurate benefit.

We rely on information systems in our business to obtain, rapidly process, analyze and store customer, product, supplier, and employee data to conduct our business, including to, among other things: maintain and manage systems to facilitate the purchase and distribution of inventory items from numerous distribution centers; receive, process and ship orders on a timely basis; manage accurate billing and collections for our customers; process payments to suppliers; provide products and services that maintain certain of our customers' electronic records; and maintain and manage corporate human resources, compensation and payroll systems. Certain of our information systems store sensitive personal and financial information, such as information related to our employees and our third-party business partners, that is confidential and in some cases subject to privacy laws. Our information systems are vulnerable to natural disasters, power losses, computer viruses, telecommunication failures, cybersecurity threats, and other problems. From time to time, we have had to address non-material security incidents and we expect to experience security incidents in the future. Despite our efforts to ensure the integrity of our systems, as cybersecurity threats evolve and become more difficult to detect and successfully defend against, one or more cybersecurity threats or other events that could impact the security, reliability and availability of our systems might defeat the measures that we or our vendors take to anticipate, detect, avoid or mitigate such threats. In addition, hardware, software or applications developed internally, acquired through acquisitions or procured from third parties may contain defects in design or manufacture or other problems that could unexpectedly compromise information security. We may also incur substantial costs as we update, integrate and enhance our cybersecurity defense systems, and those of acquired entities, to meet evolving challenges. We take steps designed to detect, mitigate, and remediate vulnerabilities in our information security systems (such as our hardware and/or software, including that of third parties with whom we work), but we may not be able to detect, mitigate, and remediate all such vulnerabilities. For example, we have identified certain vulnerabilities in our information systems, and we are taking steps designed to mitigate the risks associated with known vulnerabilities. Such steps may include increasing monitoring of systems and applying standardized enterprise solutions, controls and process. Despite our efforts, there can be no assurance that these vulnerability mitigation measures will be effective. Moreover, we may also experience delays in developing and deploying remedial measures and patches designed to address any identified vulnerabilities. Vulnerabilities could be exploited and result in a security incident. Data breaches and any unauthorized access or disclosure of our information could compromise our intellectual property and expose sensitive business information. Cybersecurity attacks or other similar events that could impact the security, reliability and availability of our systems could also cause us to incur significant remediation costs, disrupt key business operations, adversely impact our financial accounting and reporting of results of operations, divert attention of management, and adversely impact our results of operation. For example, in October 2023, a cybersecurity attack on Henry Schein, Inc., one of our key competitors, disrupted its key business operations, adversely impacted its financial results for the fourth quarter and full year 2023, diverted the attention of its management, caused it to incur significant remediation costs, and resulted in litigation. Further, our suppliers, our customers, including purchasers of our software products, and other market participants are similarly subject to information system and cybersecurity risk, and a material disruption in their business could result in reduced revenue for us. For example, in February 2024, Change Healthcare, a subsidiary of UnitedHealth Group and the largest clearinghouse for medical claims in the U.S., was the subject of a cyberattack that required it to take offline its computer systems that handle electronic payments and insurance claims. This outage negatively impacted our business in the fourth quarter of fiscal 2024, may continue to affect our business, and has generated litigation. Similar cybersecurity events that disrupt the healthcare system upon which our business relies could adversely affect our business if such disruption is widespread and continues for an extended period of time. In addition, compliance with evolving privacy and information security laws and standards may result in significant additional expense due to increased investment in technology and the development of new operational processes. We could be subject to liability if we fail to comply with these laws and standards, fail to protect information, or fail to respond appropriately to an incident or misuse of information, including use of information for unauthorized marketing purposes. Cybersecurity attacks in particular are becoming more sophisticated and include, but are not limited to, malicious software, attempts to gain unauthorized access to data, and other electronic security breaches that could lead to disruptions in critical systems, disruption of our customers' operations, loss or damage to our data delivery systems, corruption of data, and increased costs to prevent, respond to or mitigate cybersecurity events. Cybersecurity attacks against our IT systems or third-party providers' IT systems, such as cloud-based systems, could result in exposure of confidential information, the modification of critical data, and/or the failure of critical operations. Furthermore, due to geopolitical tensions and remote and hybrid working conditions, the risk of cyber-attacks may be elevated. With artificial intelligence (AI) tools, threat actors may have additional tools to automate breaches or persistent attacks, evade detection or generate sophisticated phishing emails. Our use of AI and the use of AI by our business partners may lead to novel cybersecurity risks. In addition, certain cyber incidents, such as advanced persistent threats, may remain undetected for an extended period. Our technologies, systems and networks, and those of our customers, suppliers and business partners, may become the target of cyberattacks or information security breaches. Our information systems or the software products we sell may fail for extended period of time. Despite any precautions we take, damage from fire, floods, hurricanes, power loss, telecommunications failures, computer viruses, break-ins and similar events at our various computer facilities could result in interruptions in the flow of data to our servers. We may need to expend additional resources in the future to continue to protect against, or to address problems caused by, any business interruptions or data security breaches. A security breach and/or perceived security vulnerabilities in our information systems, products or services could also cause significant loss of business and reputational harm, and actual or perceived vulnerabilities may lead to claims against us by our customers and/or governmental agencies.

We have and are continuing to incorporate AI, including machine learning, in certain of our internal operations and may in the future incorporate AI into certain of our products and services, with the intent to enhance their operation and effectiveness. For example, we have incorporated machine-learning into certain of our software to provide AI analysis of dental patient images designed to enhance a dentist's own analysis. Flaws, biases or malfunctions in these systems could lead to operational disruptions, data loss, or erroneous decision-making, impacting our operations, financial condition and reputation. Ethical and legal challenges may arise, including biases or discrimination in AI outcomes, non-compliance with data protection regulations, and lack of transparency. The legal and regulatory landscape and industry standards surrounding AI technologies is rapidly evolving and uncertain, and compliance may impose significant operational costs and may limit our ability to develop, deploy or use AI technologies. Furthermore, the deployment of AI systems could expose us to increased cybersecurity threats, such as data breaches and unauthorized access leading to financial losses, legal liabilities, and reputational damage. We also face competitive risks if we fail to adopt AI or other machine-learning technologies in a timely manner.

Demand for our production animal health products can be negatively influenced by factors including: weather conditions (including those that may be related to climate change), varying weather patterns and weather-related pressures from pests; changes in consumer preferences away from food animal products, including increased promotions and publicity for food products containing plant-based protein; supply chain disruptions including due to cyberattack, or actions by animal rights activists; and outbreaks of diseases affecting animals, any of which could reduce herd sizes or affect consumer preferences, and regulations related to food-producing animals. Reductions in herd size would ultimately decrease the demand for the products we distribute, including micro feed ingredients, animal health products, and dairy sanitation solutions, as well as the development and implementation of systems for feed, health, information and production animal management. In recent years, outbreaks of various diseases, including African Swine Fever, avian influenza, foot-and-mouth disease, bovine spongiform encephalopathy (otherwise known as BSE or mad cow disease) and porcine epidemic diarrhea virus (otherwise known as PEDv), have impacted the animal health business. The discovery of additional cases of any of these, or new diseases may result in additional restrictions on animal proteins, reduced herd sizes, or reduced demand for animal protein. There has been consumer concern and consumer activism with respect to additives (including, without limitation, antibiotics and growth promotants) used in the production of animal products, including growing consumer sentiment for proteins and dairy products produced without the use of antibiotics or other products intended to increase animal production. These concerns have resulted in increased regulation and changing market demand. If there is an increased public perception that consumption of food derived from animals that utilize additives we distribute poses a risk to human health, there may be a further decline in the production of those food products and, in turn, our sales of those products. Furthermore, regulatory restrictions and bans could result in the removal from market of products in these categories, which would adversely affect our sales. In addition, the market for our animal health products could be negatively impacted by the introduction and/or market acceptance of newly-developed or alternative products, which could include products perceived as "healthy" or "holistic." Farm animal producers depend on the availability of natural resources, including large supplies of fresh water. Their animals' health and their ability to operate could be adversely affected if they experience a shortage of fresh water due to human population growth or floods, droughts or other weather conditions. In the event of adverse weather conditions or a shortage of fresh water, veterinarians or farm animal producers may purchase less of our products. Further, heat waves may cause stress in animals and lead to increased vulnerability to disease, reduced fertility rates and reduced milk production. Droughts may threaten pasture and feed supplies by reducing the quality and amount of forage available to grazing livestock, while climate change may increase the prevalence of parasites and diseases that affect farm animals. Veterinary hospitals and practitioners depend on visits from the animals under their care. Veterinarians' patient volume and ability to operate could be adversely affected if there is a reduction in the companion animal population, such as due to disease outbreak. Furthermore, the industry is facing a veterinarian and veterinary technician labor shortage and new regulations permitting non-economic and punitive damages for pet owners in case of wrongful death or injury.

Our future success depends partly on the continued service of our highly qualified and well-trained key personnel, including executive officers. Any unplanned turnover or our failure to develop an adequate succession plan for key positions could reduce our institutional knowledge base and erode our competitive advantage. While our Board of Directors and management actively monitor our succession plans and processes for our executive leadership team, our business could be adversely impacted if we lose key personnel unexpectedly. Competition for senior management is intense and we may not be successful in attracting and retaining key personnel. In addition, reduced employment pools have contributed to increased labor shortages and employee turnover within our organization. These trends have led to, and could in the future lead to, increased costs, such as labor inflation and increased overtime to meet demand.

We obtain substantially all of the products we distribute from third parties. If a supplier is unable to deliver product in a timely and efficient manner, whether due to financial difficulty, natural disaster, pandemic, the failure to comply with applicable government requirements or other reasons, we could experience lost sales. We have experienced, and may continue to experience, disruptions in the supply chains for third-party manufacturing of certain products we distribute, including delays in obtaining or inability to obtain raw materials, inflated price of product inputs, disruptions in operations of logistics service providers and resulting delays in shipments. Customers may be unwillingness to accept such delays. The suppliers on which we rely also may be adversely affected by a serious breach of their quality assurance or quality control procedures, deterioration of their quality image, impairment of customer or consumer relationships or failure to adequately protect the relevance of brands, and related litigation, all of which could impair our ability to obtain product in a timely and efficient manner. Our cost of goods also may be adversely impacted by unanticipated price increases due to factors such as inflation, including wage inflation, or to supply restrictions beyond our control or the control of our suppliers. If current suppliers fail to supply sufficient goods or materials to us on a timely basis, or at all, we could experience inventory shortages and disruptions in our distribution of products. In addition, there is considerable concentration within our animal health and dental businesses with a few key suppliers. A portion of the products we distribute is sourced, directly or indirectly, from countries outside the U.S. including China. Our ability or the ability of our suppliers to successfully source materials may be adversely affected by changes in U.S. laws, including trade tariffs on the importation of certain products from China as a result trade tensions between the U.S. and China. We may experience a disruption in the flow of imported product from China, or an increase in the cost of those goods attributable to increased tariffs, restrictions on trade, or other changes in laws and policies governing foreign trade. In addition, political or financial instability, currency exchange rates, labor unrest, pandemic or other events could slow distribution activities and adversely affect foreign trade beyond our control. We generally do not have long-term contracts with our suppliers, so they may be discontinued or changed abruptly. Changes in the structure of purchasing relationships might include changing from a "buy/sell" to an agency relationship (or the reverse), or changing the method in which products are taken to market, including the possibility of manufacturers creating or expanding direct sales forces or otherwise reducing their reliance on third-party distribution channels. We compete with certain manufacturers, including some of our own suppliers, that sell directly to customers as well as to wholesale distributors and online businesses that compete with price transparency. An extended interruption in the supply of products would have an adverse effect on our results of operations, and a reduction in our role as a value-added service provider would result in reduced margins on product sales.