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March, 2002



“If you accept my offer of $11 million dollars, the employment agreement
will allow you and your sister to remain as managers for the next ten
years. You will be able to continue to define the styles and tastes of Stone
Creek’s red and white table wines, just as you have been doing for the last
9 years and you will be able to implement plans for developing and
expanding these brands throughout the United States. Yet, you will be
relieved of ownership and financing responsibilities. Together we will
continue to build our brands, expand our production and distribution, and
move towards producing fine wines for the higher end of the premium
market segment.”

This was the essence of the proposal made by Mr. Arthur Malone and a small group of
investors to Sally and Nancy Stone, majority owners of Stone Creek Vineyards. He had
contacted the Stones after hearing from a mutual acquaintance that they were interested
in exploring financial options due to the tremendous success of their recent vintages.
Selling these wine operations was an option that had been discussed over the dinner table
in Sally Stone’s house for the last few years, but it was always eliminated when final
decisions were made, especially after talking to Sally’s sister, Nancy, minority owner of
the remainder of the firm.

The timing of Mr. Malone’s proposal came just after everyone at Stone Creek had
participated in the harvest of 1999. From mid-September throughout the month of
October, every available employee worked long hours to ensure that the grapes were
picked at just the right time, carefully transported to the winery, and crushed at their peak
of flavor. The result was a record harvest, in terms of volume, and the Stone sisters had
every reason to be pleased after another excellent growing season. Although they were
physically exhausted, they were also quite optimistic about the quality of this year’s
products and continued acceptance of their wines in the marketplace.

Stone Creek Vineyards had experienced strong growth in its business in the second half
of the 1990’s. Revenues had been expanding by approximately 20 percent per year since
fiscal 1995 and 2000 was expected to continue this trend. Of all the relatively small
vineyards in the Napa Valley of California, its performance was exceptional. Sally and
Nancy had attended numerous industry trade events over the years. While private winery
owners were quite secretive about their operating characteristics and results, the sisters
had recently concluded that Stone Creek was quite competitive with its peers. Profit
margins for most firms were in the single digit range while most wineries had
experienced revenue growth of 5 to 10 percent per year in the 1990’s. Stone Creek’s

success could be traced to careful and skillful choices of grapes planted in different areas
with different soil characteristics. The Stone sisters had compiled an enviable record of
premium product development as well as increased market acceptance, primarily in
California and other western markets.

Despite being profitable for the last 14 years the company constantly seemed to be facing
a strained cash position and continuously found it necessary to increase its borrowings
from the First National Bank of Napa, up to the current level of just over $3.7 million in
January of 2000. Since $3.8 million was the limit for the bank to lend to any one
borrower, individual, or business, with or without guarantees, the Stones would either
have to rely on expanded trade credit or move their account to a larger regional bank. In
the last year, First National of Napa had also required the Stones to guarantee the current
loan personally. At the time of the proposal from Mr. Malone, Sally Stone had been
actively seeking another banking relationship in which she would be able to negotiate a
higher loan limit that did not include a personal guarantee.


There were hundreds of wine producers operating in the U.S. in the 1980’s. Most were
relatively small and located primarily in California. By the late 1990’s, more than 1500
wineries were in business, yet the top 20 produced approximately 90 percent of all
American wine, by volume, and 85 percent, by value, at wholesale. Of these larger firms,
a few were publicly held, with readily recognizable names: Robert Mondavi, Beringer,
and Canadaigua. Probably the most well-known large firm was the privately owned and
operated E & J Gallo Wine Company. Best known for its large production of less
expensive wine labels, the firm had been expanding into the premium varietial market
segment with it’s widely acclaimed winery, Gallo of Sonoma.

Consolidation among wineries began to accelerate in the early 1990’s, as larger producers
decided to buy smaller ones in order to achieve greater economies of scale in marketing
and economies of scope in gaining access to more varied distribution channels. Larger
wineries could then become more effective in negotiating favorable selling terms with the
small number of large, regional distributors. The “consolidators” were generally public
firms that were able to offer predominantly family-run wine businesses a means to
greater liquidity of their investment in larger, more diversified operations. Concurrently,
the attractiveness of California’s wine industry to entrepreneurs continued unabated as
new, small operations were started each year.

The wine industry was capital intensive. In addition to land and vineyards, a firm needed
investments in crushing facilities, fermentation tanks, and barrels for aging their product.

Business risks were also substantial. Weather conditions could affect the quantity and
quality of grape production. Insect damage and disease could affect the grape vines.
New vines take 4 to 5 years before commercial production of grapes can be expected.

When the grapes are ready, they are picked and carefully brought from the fields to the
crushing facility. There is only one crop per year and crushing takes from one to two
months. Therefore the investment in this facility is idle at least 10 months of the year.
Since all the grapes in a region mature at approximately the same time, there is no way to
rent out crushing capacity to other wineries at other times of the year.

Fermentation takes place in stainless steel tanks that are temperature controlled. This
process takes only weeks after the crush, so this investment also is idle more than 85
percent of the time.

From the fermentation tanks, the wine is put into oak barrels for aging. These barrels are
quite costly, at $600 to $700 each and, due to quality concerns, are used for only 4 to 5
years, at which time their value is negligible. A barrel aging facility is a large open space
that also must be climate controlled. During the aging process, some wine is lost due to
evaporation through the oak. Over a two year period, about 5% of wine value is lost.


The internal structure of the wine industry in America had been undergoing fundamental
changes in the 1980’s and 1990’s. In terms of product, the most significant developments
were observed in the table wine category. As the largest segment of production and value
of shipments at more than 80 percent in the late 1990’s, these products had been
responding to changes in the tastes and preferences of consumers for higher quality,
premium wines. (Exhibit 1)

The grapes used to produce table wines are of varying quality. Varietals are delicate,
thin-skinned grapes whose vines usually take approximately four years to begin bearing
fruit. As defined by the Bureau of Alcohol, Tobacco, and Firearms, truth in labeling
standards, one variety – the name of a single grape – may be used if not less than 75
percent of the wine was derived from grapes of that variety, the entire 75 percent of
which was grown in the labeled appellation of origin. Appellation denoted that “at least
75 percent of a wine’s volume was derived from fruit or agricultural products and grown
in place or region indicated.”∗ To develop the typical varietal characteristics that result in

Title 27, Part 4, of the Code of Federal Regulations, Bureau of Alcohol, Tobacco, and Firearms,
Regulatory Agency, United States Department of the Treasury.

enhanced flavor, taste, and finish could take another 2-3 years after the four years it takes
for newly planted vines to bear fruit. These additional growing periods increased both
investment levels, operating expenses, and product quality.

“Table” wines are those with 7 to 14 percent alcohol content by volume and are
traditionally consumed with food. This is in contrast to other wine products such as
sparkling wines (champagnes), wine coolers, pop wines, and fortified wines, which are
typically consumed as stand-alone beverages. Table wines that retail for less than $3.00
per 750 ml. bottle are generally considered to be generic or “jug” wines, while those
selling for more than $3.00 per bottle are considered premium wines.

Premium wines generally have a vintage date on their labels. This means that the product
was made with at least 95 percent of grapes harvested, crushed, and fermented in the
calendar year shown on the label and used grapes from an appellation of origin (i.e. Napa
Valley, Sonoma Valley, Central Coast, etc.). Within the premium wine category, a
number of market segments have emerged, based on retail price points. Popular premium
wines generally sell for $3.00 to $7.00 per bottle, while super premium wines retail for
$7.00 $14.00. The ultra premium category sells for $14.00 to $20.00 per bottle while any
retail price above $20.00 per bottle is considered to be luxury premium. (Exhibit 2)

Table wine production in the United States has generally followed the tastes and
preferences of the American consumer. Per capita consumption peaked in 1986, at just
over two gallons, and then trended downward to just under 1.5 gallons in 1992. Since
that year, growth has continued, to an estimated 1.9 gallons in 1999. The real story
behind these trends is the changing mix of consumption away from the lower priced
product and toward the higher premium categories.


Stone Creek Vineyards was purchased by Sally Stone’s parents in the early 1950’s. They
ran the operations with little growth or expansion in mind – it was more of a hobby and
labor of love for Sally’s father, Andrew, who left his position as Vice President of a
prestigious investment banking firm in the East, in 1953. Andrew and his wife, Shirley,
moved west with their two daughters, Sally and Nancy, settled in the Napa Valley and
started Stone Creek Vineyards on 45 acres of prime land on the Rutherford bench. They
succeeded in producing increasing quantities of highly acclaimed Cabernet Sauvignon
and were very content with their life styles.

In order to address estate tax concerns, Andrew and Shirley decided to slowly sell partial
ownership in the company to Sally and Nancy. By the time their estates probated in
1991, the sisters owned over 90 percent of the common stock of Stone Creek.

Both women graduated from the University of California at Davis. Sally majored in
chemistry and then went on for her MBA at Stanford, graduating cum laude in 1987.
Nancy majored in marketing, receiving her BBA in 1989. Both were married with young
families and husbands whose careers were in other fields of endeavor. They lived in
separate homes on the original land purchased by their father.


When the Stone sisters took over effective control and management of winemaking
operations in 1991, they were faced with some significant challenges. Although their
parents truly loved the wine making business they had not been keeping up with many
important aspects of its operation. While wine quality remained high, control of grape
supply was slipping, as well as grape yields in their owned vineyards. For example, in
1980, an average of 4 ½ tons of grapes per acre were being produced, while in 1989 the
comparable figure was just under 3 tons. Total production rose in the period only
because additional acreage was purchased and developed. The net effects were reduced
margins and a business that was on the verge of losing money on an annual basis.

A major decision had to be addressed, and quickly. If the sisters decided against
continuing the business, it would have to be sold and its value was declining due to
operating expenses rising more rapidly than revenues. If they decided to keep the
business, a major commitment of talent, energy, and personal funding would be required,
perhaps even more quickly! They decided to arrange a weekend at a Bed and Breakfast
in Mendocino with their husbands and without their children. At the end of that
weekend, a decision would have to be made.

The Stone sisters had grown up in the Napa Valley. Many of their friends and associates
were involved in the wine business. They were aware of the declining competitiveness of
their parents winery and were quite confident that they could turn it into a model of
modern, progressive wine production, marketing and distribution. Since its current value
was quite low, except for the land, selling out now would not generate any substantial
funds for their families. Turning the business around and enhancing its position in the
industry would create benefits for all concerned.

They were also aware of the risks they would be accepting if they took over management
and ownership of Stone Creek. Wine making and grape growing were subject to a
variety of agricultural risks. Various diseases and pests as well as extreme weather
conditions could materially and adversely affect the quality and quantity of grapes
available to the winery.

Competition in the premium table wine business was significant, not only from domestic
producers but also from growing product imports. Demand was also seasonal, being
affected by holiday periods and the date that price changes went into effect.

Currently, approximately 70 percent of Stone Creek sales went to commercial accounts,

direct to hotels, restaurants, resorts, etc. The remaining 30 percent went into the
wholesale distribution channel. If the firm were to expand production significantly,
wholesalers would be the most efficient way to distribute product both locally and
throughout the U.S. Their buying power could adversely affect margins as sales
continued to grow.

These and other aspects of the business as well as the sisters personal lives and ambitions,
were discussed during long walks on the beach, as well as a cycling trip up the coast. As

they sat down to their last meal in Mendocino, they arrived at their decision. They would
stay in the business and develop it into an operation that would make everyone associated
with Stone Creek proud to be a part of that organization!

All the employees were informed of their decision at a June 1991 afternoon meeting two
days after their return. A hearty round of applause was heard from everyone:
winemakers, field hands, administrative personnel, and their husbands!

During the next few years, major improvements were made to the vineyards and the
winery. Over fifty acres of vineyards were purchased bringing their total acreage under
production to 87 by 1993. Another 165 acres were leased from their owners, with control
over planting, maintenance, and harvesting in the hands of Stone Creek employees. The
results were significant increases in output, requiring a substantial expansion of crushing
and processing capacity at the winery. By 1994, almost $2 million had been invested in
these aspects of operations, financed with a combination of mortgages and internally
generated funds.

Grape supply came from three main sources, vineyards owned by Stone Creek or leased
to Stone Creek and vineyards owned by other growers, who would plant and maintain
grape vines in accordance with guidelines set by Stone Creek managers. If additional
wine was needed to meet sales contracts, it would be purchased in bulk from other
wineries. In contrast, if more wine was produced than needed, or its quality was not up to
Stone Creek standards, it would be sold in the bulk market.

Within the winery, new stainless steel holding tanks were purchased and installed. Barrel
aging and warehouse space were acquired and expanded in 1994, just down the road from
the winery. With this space in place, capital expenditures for new oak barrels (at $625
each) could be timed to coincide with product demand and growing production.
Although they still contracted for the bottling of their wines, an in-house capability was
on the drawing boards. Both of these initiatives would contribute to enhancing operating
efficiencies and expanding profit and cash flow margins. Although the in-house bottling
operation was planned for 2003, it did not affect revenue or marketing expectations.

In 1996, a wine tasting room, small retail shop, and expanded parking lot were built along
the Silverado Trail within site of travelers and tourists driving though the valley. To their
amazement, people seemed to stream into the facility almost from the day it first opened.
Summer weekends were especially busy, with all employees working in a number of
areas. Although sales through the tasting room and retail shop were only 3 percent of
revenues in 1999, with slightly higher profit margins, their major strategic benefit to the
firm was word-of-mouth marketing of their products.

Even Ellen Kruger, Stone Creek’s accountant and comptroller, expanded her activities by
conducting the Tuesday and Saturday 2 PM wine tour and tasting. “It’s good to get out
of the office and be involved with other aspects of the business. Winemaking is an
exciting operation and a better understanding of the activities and individuals behind the
numbers allows me to make more informed and intelligent decisions for Stone Creek.”


Major product categories of Stone Creek were Chardonnay and Sauvignon Blanc for
white wine lovers, and Merlot and Cabernet Sauvignon for those choosing a hearty red
wine. During the period through 1985, most sales were made locally, to restaurants,
retailers, and friends. Some expansion on a geographic basis took place over the next
few years, but growth really started to accelerate in the 1990’s, under the direction of
Nancy Stone.

Marketing of Stone Creek wines took on a strategically planned approach in 1992.

Specific market segments were identified and promotions were designed to maximize the
response of each area. Sales reps had been used and they were supplemented with a
small, in-house, sales team. Promotions were held periodically, dinners sponsored, and
organizations contacted to include Stone Creek products at their functions. Wine tasting
sessions were entered regularly and slowly the quality of Stone Creek wines was being
recognized by wholesalers, retailers, and the press. When one of the firm’s Cabernet
Sauvignon’s was ranked first at a San Francisco tasting contest in the Fall of 1994, and an
article in a leading, national newspaper extolled its virtues, growth accelerated in a
manner that no one anticipated or was quite ready to accept.

From literally no growth in production or sales volumes in the late 1980’s, a 5 percent per
year expansion was realized through 1994. However, after that year growth accelerated
to the high teens in terms of volume and the 20 percent level, as measured by revenues
(Exhibit 3). All of the efforts of Sally, Nancy, and the employees of Stone Creek
blossomed in the strong and expanding market for premium wines in the late 1990’s.

A large distribution firm in the southwest was signed on in 1997 and almost $500,000
worth of sales were made in the first full year of that relationship. By late 1999,
negotiations were being finalized with a southeastern distributor to expand sales from

Texas east to Florida and as far north as the Carolinas. It seemed that national
distribution potential was little more than two years away.

Nancy had recently been exploring the marketing potential of a Stone Creek website.
Her research efforts through surveys of current customers, especially vacationers to the
valley, convinced her that on-line sales could easily reach the $1 million level in less than
three years. Their products were well received wherever they could be tasted and repeat
business was exceptionally high. Accessibility of supply in large population centers of

the northeast and midwest regions of the U.S. could result in substantial incremental

Internal projections of on-line sales activities suggested to Nancy that they could achieve
profit margins of at least 10 percent, compared with current levels of 6 percent in 1999.
Distributor profits would be eliminated while shipping and transportation costs would
increase along with modest growth in personnel to process orders. One variable that
could influence these projections was the proposed taxation of Internet sales. However,
there was no way to effectively factor in this possibility, as to either size or timing.


The growing demand for Stone Creek wines was a mixed blessing for Sally and Nancy.
Not only had the business become more than a full-time job for both of them, but
financing pressures seemed to be growing, even though the firm was profitable.
Financial data in Exhibits 4 and 5 show quite clearly how assets and debt levels have
grown in the last five years.

The growth of Stone Creek assets had taken advantage of market opportunities in all
phases of the business. Property, plant and equipment expanded by 23.4 percent over the
last five years (Exhibit 6). A growing percentage of grape supplies were grown on
company owned acreage (Exhibit 7). The fastest growing asset category has been
inventory; wine in bulk as well as final, bottled product in warehouses or at retail (Exhibit

At a recent wine tasting dinner party sponsored by the company at an up-scale restaurant,
Sally was getting reacquainted with a high school classmate, Jeannie Foster-Serrano, who
she had not seen in more than 20 years. Jeannie was there accompanied by her husband
José Serrano. While reminiscing about their fond memories of growing up in the valley,
Jeannie mentioned that her family had only recently moved back to San Francisco, after
being in San Antonio, Texas. Mr. Serrano had taken a position as Vice-President and
Corporate Loan Officer at Wells Fargo. He became quite interested in the business of
Stone Creek and, after hearing of Sally’s current challenges, concluded that his bank
clearly had the capacity to meet her firm’s financing needs. As a devoted consumer of
red wines, Mr. Serrano appreciated the 1994 Cabernet Sauvignon served at the party that

As the party ended and the guests were leaving, Sally reflected on the future of the family
business. Continuing on its current business path was exciting and challenging, as well
as personally and professionally rewarding. All of the initiatives made by Sally and
Nancy were bearing fruit. Products were being accepted in new market areas. The Stone
Creek label was gaining status and prestige in wine tasting competitions around the state.
Orders were flowing in from distributors, as well as restaurants, and their newly formed
wine club.

All these activities pointed to the strong probability of continued revenue growth in the
20 percent neighborhood. Translating these top line projections into a viable and
efficient financial strategy was at the top of her agenda as she drove home with her
husband after the party. Yet in the back of her mind was the offer from Mr. Malone.


Since the prime use of funds from a bank loan would be to finance current assets, Mr.
Serrano suggested a revolving secured line of credit for up to $4.3 million, including
standard commitments applying to such a loan. He explained that general bank
guidelines at that time were that a revolving credit agreement would be structured based
on loan levels of up to 85 percent of accounts receivable, 75 percent of finished goods
inventory (cased wine) and 50 percent of other inventory (bulk wine), subject to an
annual review of operations by bank representatives.

In addition, there would be the requirement that restrictions on additional borrowing

would be imposed, net working capital would have to be maintained at an agreed upon
level, additional investments in fixed assets could be made only with prior approval of
the bank, and withdrawal of funds from the business by either Sally or Nancy would be
limited to their current salaries. Interest would be set on a floating rate basis at 1 ½
percentage points over the prime rate, which would be approximately 10.5 percent in
early 2000. Finally, all other financial relations with any other banks would be
terminated if the agreement with Wells Fargo took place.


Sally and Nancy now faced perhaps the biggest decision in their lives. Mr. Malone’s
offer was quite tempting. It would allow them to “cash out” of the business while still
being “involved.” Their new salaries would be comparable to those of professional
managers in a similar sized winery, approximately $135,000 each in calendar year 1999.
They could also expect increases of 5 to 10 percent for each of the next three years.

In contrast, if they went with a loan from Wells Fargo, it would allow them to continue
operating as they had been for almost the last decade. Success in the marketplace was
very satisfying, but there were also risks. Weather conditions were always critical to
grape quality and grape supply. Consumer demand could prove to be fleeting or at least
cyclical and they knew all too well that the wine business was capital intensive. A slower
growth rate, perhaps well under 10 percent per year, could take pressure off their
financing needs, but their recent success in every aspect of the business after so many
years and memories of mediocre performance, was intoxicating. Was there any way to
balance their business expectations with the financial realities of winemaking operations?

It was time for another critical meeting between the sisters. Sally was quite sure of what
position Nancy would take. She had been strongly in favor of continuing on a growth
path that seemed to be accelerating. Nancy’s marketing initiatives were being accepted
in the marketplace and she was eager to see “just how far we can go with this business.”

Sally was more concerned about the financial pressures and requirements created by
Stone Creek’s recent, current, and continued operating characteristics. The business had
responded to changing market conditions for premium wine production and consumption.
Yet, even with a solid profit margin on sales and return on equity, she was constantly
arranging for additional funds to support operations. “How long would it be before these
financial pressures subside? We are finally going to repay the loan from our uncle, Bob
Wagner, but it seems as if we are just replacing it with more funds from our bank. Are
there any other alternative ways to run this business? I’d also like to spend more time
with my family and Mr. Malone’s offer would allow that to take place very soon.”

In early March 2000, Sally and Nancy left the valley for a weekend at Yosemite, this time
without their husbands. As they drove down Route 29 towards San Francisco, their
husbands and their children left for the beach wondering what plans and decisions the
sisters might bring back to their families in the next two days.

Five hours later the sisters arrived at the park. Instead of staying at the Ahwahnee Hotel
in Yosemite Valley and strolling to the base of El Capitan, Half Dome, and Yosemite
Falls, they continued south another 30 miles to the town of Wawona. Located on the
southern edge of the park, the Wawona Hotel was their final destination. Their
momentous decision would be made strolling through the Mariposa Grove of Giant

Exhibit 1

Exhibit 1
Stone Creek Vineyards
California Table Wine Shipments
In the United States
(in millions of cases)

Popular Super Ultra Luxury Total Total

Year Jug
Premium Premium Premium Premium Premium Shipments
1998 67.8 48.1 21.4 4.5 1.1 75.1 142.9
1997 70.3 46.1 18.7 4.1 .9 69.8 140.1
1996 68.8 44.6 16.8 3.8 .8 66.0 134.8
1995 65.8 41.0 14.5 3.4 .6 59.5 125.3
1994 63.3 37.5 12.3 3.2 .5 53.5 116.8
1993 62.9 35.5 10.7 2.9 .4 49.5 112.4
1992 66.3 34.3 9.7 2.7 .3 47.0 113.3
1991 65.3 28.7 8.5 2.6 .2 40.0 105.3
1990 73.4 24.5 8.0 2.3 .2 35.0 108.4
1989 79.1 21.9 6.1 2.0 .2 30.2 109.3
1988 83.8 20.7 5.6 1.9 .1 28.3 112.1
1987 84.8 17.7 5.0 1.6 .1 24.4 109.2
1986 86.3 14.4 4.7 1.5 .1 45.1 107.0
1985 89.7 11.1 3.9 1.1 .1 16.2 105.9

Note: A case contains 9 liters of product.

Source: The Wine Institute;

Gomberg, Fredrikson, and Associates, San Francisco, California

Exhibit 2
Stone Creek Vineyards
California Table Wine Revenues
(in billions of dollars)

Popular Super Ultra Luxury Total Total

Year Jug
Premium Premium Premium Premium Premium Shipments
1998 $1.071 $1.836 $1.428 $.542 $.274 $4.080 $5.151
1997 1.033 1.673 1.427 .501 .237 3.838 4.920
1996 .981 1.540 1.210 .415 .180 3.345 4.326
1995 .921 1.394 1.015 .351 .130 2.890 3.811
1994 .887 1.238 .849 .320 .101 2.508 3.395
1993 .865 1.154 .728 .287 .079 2.248 3.113
1992 .912 1.096 .650 .269 .059 2.074 2.986
1991 .898 .918 .570 .251 .046 1.785 2.683
1990 .863 .686 .528 .224 .036 1.474 2.337
1989 .811 .591 .399 .193 .029 1.212 2.023
1988 .841 .538 .364 .178 .024 1.104 1.945
1987 .848 .443 .320 .149 .020 .932 1.780
1986 .875 .360 .290 .138 .018 .806 1.681
1985 .905 .271 .234 .106 .015 .626 1.531

Note: The following price ranges apply to the above categories, as defined by Gomberg,
Fredrikson, and Associates, a well known consulting firm to the wine industry:
Jug – Under $3 per bottle (750 ml)
Popular Premium – $3 - $7 per bottle (750 ml)
Super Premium – $7 - $14 per bottle (750 ml)
Ultra Premium – $14 - $20 per bottle (750 ml)
Luxury Premium – $ above $20 per bottle (750 ml)

Source: The Wine Institute;

Gomberg, Fredrikson, and Associates, San Francisco, California

Exhibit 3
Stone Creek Vineyards
Consolidated Statement of Earnings
(in thousands)

1995 1996 1997 1998 1999
Gross Revenue $4,230 $5,086 $6,101 $7,329 $8,755
Less Excise Taxes 199 249 296 364 397

Net Revenue $4,031 $4,837 $5,805 $6,965 $8,358

Cost of Goods Sold 2,417 2,909 3,609 4,260 5,132

Gross Profit $1,614 $1,928 $2,196 $2,705 $3,226
Operating Expenses 1,145 1,365 1,537 1,819 2,035
Operating Income (EBIT) $469 $563 $659 $886 $1,191

Interest Expense 330 448 506 570 646

Net Income Before Taxes $139 $115 $153 $316 $545

Provision for Income Taxes $37 $28 $43 $114 $196

Net Income $102 $87 $110 $202 $349

Cases Sold 61,690 70,900 81,560 92,360 105,500

Average Revenue per case $65.34 $68.22 $71.17 $75.36 $79.22

Notes: 1. Operating Expenses (Marketing, General and Administrative Expenses) include a

cash salary to each Stone sister, Nancy and Sally, of $125,000 in 1995, $145,000
in 1996, $170,000 in 1997, $190,000 in 1998, and $215,000 in 1999

2. Tax rates payable by a Sub-Chapter S Corporation:

Up to $50,000 @15%
Next $25,000 @25%
Next $25,000 @34%
Over $100,000 @39%

3. A Sub Chapter S Corporation does not pay corporate income taxes. Owners of
the corporation (the Stone sisters) pay the amount of the “Provision for
Income Taxes” from company funds. The remainder, “Net Income” is
effectively retained earnings that are reinvested into the business by the
Exhibit 4
Stone Creek Vineyards
Balance Sheets at Year End
(in thousands)

1995 1996 1997 1998 1999


Cash $67 $75 $83 $92 $107
Accounts Receivable (Net) 372 440 526 626 764
Inventories 2,979 3,550 4,297 5,170 6,381
Prepaid and Other Expenses 19 22 25 28 32
Total Current Assets $3,437 $4,087 $4,931 $5,916 $7,284

Property, Plant, and Equipment $3,755 $4,088 $4,314 $4,511 $4,663
Less: Accumulated Depreciation and
Amortization 432 470 486 501 561
Net Property, Plant and Equipment $3,323 $3,618 $3,828 $4,010 $4,102
Other Assets (net) 10 11 12 14 16
Total Fixed Assets $3,333 $3,629 $3,840 $4,024 $4,118
Total Assets $6,770 $7,716 $8,771 $9,940 $11,402


Accounts Payable $203 $232 $272 $299 $352
Accrued Expenses 221 256 301 327 385
Bank Line of Credit(a) 1,535 1,987 2,484 2,970 3,620
Note Payable to Mr. Wagner
(Current Portion) 100 100 100 100 100
Trade Notes 214 348 497 610 728
Long Term Debt (Current Portion) 100 114 134 152 174
Total Current Liabilities $2,373 $3,037 $3,788 $4,458 $5,359

Long Term Debt(b) $1,730 $2,025 $2,319 $2,696 $3,007

Note Payable to Mr. Wagner(c) 500 400 300 200 100
Total Long Term Liabilities 2,230 2,425 2,619 2,896 3,107
Net Worth $2,167 $2,254 $2,364 $2,586 $2,936

Total Liabilities and Capital $6,770 $7,716 $8,771 $9,940 $11,402

Notes: (a) Prime +1½% on average outstanding balance

(b) Average of 9%
(c) Fixed at 11% of year end balance payable the following year

Exhibit 5
Stone Creek Vineyards
Statement of Cash Flows
(in thousands)

1996 1997 1998 1999

Net Income $87 $110 $202 $349
Depreciation 38 16 15 60
Increase in Receivables (net) (68) (86) (100) (138)
Increase in Inventories (571) (747) (853) (1,211)
Increase in Prepaid and Other Expenses (3) (3) (3) (4)
Increase in Accounts Payable 29 40 27 53
Increase in Accrued Expense 35 45 26 58
Increase in Trade Notes 134 149 113 118
Net Cash Provided (used) by Operating
Expenses ($319) ($476) ($573) ($715)


Purchase of Property, Plant, and Equipment ($333) ($226) ($197) ($151)
Other Assets (net) (1) (1) (2) (2)
Net Cash Used for Investing Activities ($334) ($227) ($199) ($153)


Increase (decrease) from Bank Line of Credit $452 $497 $486 $650
Increase (decrease) in Long Term Debt (Current
Portion) 14 20 18 22
Increase (decrease) in Long Term Debt 295 294 377 311
Payment to Mr. Wagner (100) (100) (100) (100)
Net Cash Provided (used) by Financing
Activities $661 $711 $781 $883

Net Increase in Cash $8 $8 $9 $15

Cash at the Beginning of the Year $67 $75 $83 $92
Cash at the End of the Year $75 $83 $92 $107

Exhibit 6
Stone Creek Vineyards
Property, Plant, and Equipment
Year End Balances

Gross Value 1995 1996 1997 1998 1999

Land $465 $698 $528 $767 $1,070

Acres Owned 89 93 90 95 99

Vineyards 1,171 962 1,075 1,023 933

Machines and Equipment 686 700 845 860 880

Buildings 437 628 545 688 740

Leasehold Improvements 486 474 634 421 230

Vineyards Under Development 510 626 687 752 810

Total Gross Value $3,755 $4,088 $,4,314 $4,511 $4,663

Less: Accumulated Depreciation 432 470 486 501 561

Net Property, Plant, and Equipment $3,323 $3,618 $3,828 $4,010 $4,102

Exhibit 7
Stone Creek Vineyards
Grape Supply
(in percents)

1995 1996 1997 1998 1999

Owned Land 31% 33% 36% 39% 41%

Leased Land 19% 21% 20% 18% 18%

Purchased from Other Growers, Company

Controlled 50% 46% 44% 43% 41%

Totals 100% 100% 100% 100% 100%

Exhibit 8
Stone Creek Vineyards
Inventory Positions at Year End
(in thousands)

1995 1996 1997 1998 1999

Bulk Wine $1,116 $1,392 $1,757 $2,161 $2,744

Cased Wine
(in warehouse and retail) 1,607 1,845 2,145 2,544 3,063

Crop Costs and Supplies 256 313 395 465 574

Total Inventory $2,979 $3,550 $4,297 $5,170 $6,381

Appendix A

The Serrano Report

Part I

Executive Summary of an Analysis of Financing Alternatives Available to the Owners of

Stone Creek Vineyards
December, 1999

Pursuant to our recent discussion concerning financing the operations of Stone Creek
Vineyards, I have prepared the following report for your evaluation. I believe it will
prove helpful in making a decision of utmost importance to both of you personally, as
well as members of your families.

1. The operating and financial performance of Stone Creek Vineyards over the last
five years has been outstanding. You seem to have met challenges and taken
advantage of opportunities in an efficient and effective manner. However, your
revenue growth rate of 20 percent per year has clearly strained your finances.
Continuing to grow at this rate for the next few years will require additional
external financing and Wells Fargo has the capability to meet those needs.

2. In order to reduce external financing needs you may want to consider postponing
some of your new market initiatives and development plans. It is quite
conceivable that reducing expected revenue growth to an average of
approximately 10 percent annually could achieve this goal. Expansion would still
take place, but it would be more focused on those aspects of operations that are
most important to the owners of Stone Creek.

3. We have estimated that, based on projections using constant profit margins and
commensurate internally generated cash flows, Stone Creek could grow its
revenues at approximately five percent per year for at least the next three years.
Geographic expansion would need to be contained, the web initiative postponed,
and company operations focused on current market segments. External financing
would be more manageable than it has been over the last few years.

Part II

Evaluation of the offer of Mr. Arthur Malone to purchase Stone Creek Vineyards for $11
million, with employment agreements for Sally and Nancy Stone.

In collaboration with the staff of the Wells Fargo corporate valuation department, the
following information is presented for your review and consideration.

1. Mr. Malone’s offer of $11 million represents a price-earnings multiple of 31 times

the latest (1999) earnings of Stone Creek Vineyards. In the public equity markets,
average equity multiples have been in the 24 to 27 range, using average stock
prices and trailing 12 month earnings per share (EPS). In the packaged food and
beverage industry, price-earnings ratios have been under 20 times (excluding
Coca Cola, a unique, global enterprise.) There are only a handful of public
companies devoted solely or primarily to the wine industry (Beringer, Mondavi,
Canandaigua, Chalone) and their valuations generally fall in the range of 14 to 18.

2. Using a price/book value of equity, the offer amounts to 3.77 times. One reason
for this relatively high valuation on a historical basis for this industry is that the
current value of company assets is probably higher than their historical book
value. The price is also based on expected operations rather than historical costs.

3. Land values in the Napa Valley have increased significantly in the last decade,
reaching levels of $80,000 to $105,000 per acre in the last year. Currently, Stone
Creek has 99 acres in production, which would equate to a market value of
between $7.92 million and $10.395 million. Inventories of wine of approximately
$6.4 million are assumed to have a comparable market value. Other assets, after
adjustments to current market values, are estimated at $2.2 million. Therefore,
total assets amount to between $16.520 million and $18.995 million. After
eliminating liabilities of $8.459 million as of year end 1999, Stone Creek equity
amounts to between $8.061 and $10.536 million.