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MEDCO/DIAGNOSTEK MERGER AGREEMENT RUNS AGROUND

Executive Summary

MEDCO/DIAGNOSTEK MERGER AGREEMENT RUNS AGROUND on "material" problems at Albuquerque, N.M.-based Diagnostek. Medco Containment Services announced Nov. 12 that the Aug. 28 stock-for-stock merger agreement was terminated due to "material breaches" of the definitive agreement by Diagnostek. Medco's announcement followed Nov. 9 statements from both companies indicating that Medco was re-evaluating the merger on the heels of Diagnostek's downward revision of its fiscal first quarter financial figures. Diagnostek responded Nov. 12 saying it has filed suit in Delaware chancery court against Medco for wrongful termination of the merger and is seeking to "enforce its rights under the merger agreement." Medco said it "intends to pursue its remedies" under the agreement "based upon" Diagnostek's alleged material breaches. On Nov. 9, Diagnostek announced revised earnings of $2.8 mil. for the quarter ended June 30, down $798,000 from the previously reported amount. The company cited "errors in the recording of inventory and in the recording of a customer refund" to explain the discrepancy. The mistake was found, Diagnostek said, while preparing financial results for the second quarter. Medco Containment issued a press release the same day to say it was "re-evaluating the previously announced stock-for-stock merger of a newly-formed Medco subsidiary with Diagnostek." Although the two companies had held discussions regarding a decrease in the amount of Medco common stock Diagnostek stockholders would receive in a swap, Medco said there was "no assurance" that the two companies would reach an agreement on revised terms or that any transaction at all would be completed. Diagnostek acknowledged that although it "believes it has an enforceable merger agreement," it had nevertheless "held discussions with Medco during the weekend in order to come to mutually satisfactory terms, including a reduced exchange ratio." In its Nov. 12 announcement, the company reported that it has been named as a defendant in a number of class-action suits resulting from the decline in price of the company's stock following the first of the series of announcements about re-evaluation and eventual termination of the deal. The definitive merger agreement, dated Aug. 28, would have moved Medco into the pharmacy management business and given it access to patients in what Medco called the fourth-largest U.S. mail-order pharmacy provider ("The Pink Sheet" Sept. 7, p. 17). The deal had an estimated value of over $400 mil.

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