SCHEDULE 14A
(RULE 14A-101)

INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION

PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE
SECURITIES EXCHANGE ACT OF 1934

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Pacific Financial Corporation

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        (Name of Registrant as Specified in its Charter)

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         (Name of Person(s) Filing Proxy Statement if Other Than the Registrant)

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March 21, 2007

 

 

Dear Shareholder:

You are cordially invited to attend the Annual Meeting of Shareholders of Pacific Financial Corporation (the "Company"), to be held at the Company's administrative headquarters located at 1101 South Boone Street, Aberdeen, Washington, on Wednesday, April 18, 2007, at 7:00 p.m.

The Notice of Annual Meeting of Shareholders and Proxy Statement on the following pages describe the formal business to be transacted at the meeting. Directors and officers of the Company, as well as a representative of Deloitte & Touche, LLP, the Company's independent auditors, will be present to respond to any questions our shareholders may have.

Please vote by signing, dating, and returning the enclosed proxy card by mail, or by voting via the Internet or by telephone. The enclosed proxy statement includes instructions for voting via the Internet at www.proxyvoting.com/PFLC or by telephone by calling 1-866-540-5760. If you vote on line or by phone, you do NOT need to complete and mail your proxy card. If you plan on attending the meeting, we still encourage you to vote in advance by mail, through the Internet or by phone. In the event you desire to change your vote you may do so by voting in person at the meeting.

We look forward to seeing you at the meeting.

Sincerely,

 

 

 

1101 S. Boone Street • Aberdeen, WA 98520 • (360) 533-8870

 

 

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PACIFIC FINANCIAL CORPORATION

1101 S. Boone Street

Aberdeen, Washington 98520

(360) 533-8870

 

 

 

NOTICE IS HEREBY GIVEN that the 2007 Annual Meeting of Shareholders of Pacific Financial Corporation (the "Company") will be held at the Company's Administrative Headquarters located at 1101 S. Boone Street, Aberdeen, Washington, on Wednesday, April 18, 2007, at 7:00 p.m., local time, for the following purposes:

The Board of Directors is not aware of any other business to come before the meeting.

Any action may be taken on the foregoing proposals at the Annual Meeting or any subsequent adjournments. Shareholders of record at the close of business on March 16, 2007, are entitled to notice of and to vote at the meeting and any adjournments or postponements.

Please vote via the Internet or by telephone in accordance with instructions provided under the heading "Voting by Internet or Telephone" on page 1 of this proxy statement, or by promptly completing, signing, and mailing the enclosed form of proxy in the envelope provided. If you vote by any of these methods and you also attend the meeting, you do not need to vote in person at the meeting, unless you want to change your earlier vote.

 

 

Aberdeen, Washington

March 21, 2007

 

 

 

 

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This Proxy Statement is furnished in connection with the solicitation of proxies by the Board of Directors of Pacific Financial Corporation (the "Company"), the holding company for Bank of the Pacific (the "Bank"), to be used at the 2007 Annual Meeting of Shareholders of the Company. The Annual Meeting will be held at the Company's administrative headquarters located at 1101 South Boone Street, Aberdeen, Washington, on Wednesday, April 18, 2007, at 7:00 p.m., local time. This Proxy Statement and the enclosed proxy card are being mailed to shareholders on or about March 21, 2007.

VOTING AND PROXY PROCEDURE

Record Ownership; Quorum. Shareholders of record as of the close of business on March 16, 2007, are entitled to one vote for each share of Common Stock of the Company then held. As of March 16, 2007, the Company had 6,559,182 shares of Common Stock issued and outstanding and eligible to be voted at the Annual Meeting. The presence, in person or by proxy, of at least a majority of the total number of outstanding shares of Common Stock entitled to vote is necessary to constitute a quorum at the Annual Meeting.

Solicitation of Proxies. The enclosed proxy is solicited by and on behalf of the Board of Directors of the Company, with the cost of solicitation borne by the Company. Solicitation may also be made by directors and officers of the Company and the Bank. In addition to mailing proxy materials, the directors, officers and employees may solicit proxies in person, by telephone or otherwise. The Board of Directors solicits proxies so that each shareholder has the opportunity to vote on the proposal to be considered at the Annual Meeting. When a proxy card is returned properly signed and dated, the shares represented by the proxy will be voted in accordance with the instructions on the proxy card. Where no instructions are indicated, proxies will be voted FOR the proposal set forth below. If a shareholder attends the Annual Meeting, he or she may vote in person.

Voting by Internet or Telephone. You may vote by Internet, telephone, or mail. Voting by Internet or telephone authorizes the named proxies to vote your shares in the same manner as if you marked, signed, and returned your proxy by mail. To vote via the Internet, access the following Web site: www.proxyvoting.com/PFLC. To vote by telephone, call 1-866-540-5760 and follow the instructions. You should have your proxy card with you when voting via the Internet or telephone to facilitate voting. If you vote via the Internet or by telephone, you do not need to mail your proxy card.

Revocation of Proxies. Shareholders who execute proxies retain the right to revoke them at any time. Proxies may be revoked by written notice delivered in person or mailed to the Corporate Secretary of the Company or by filing a later proxy prior to a vote being taken on the election of directors at the Annual Meeting. Attendance at the Annual Meeting will not automatically revoke a proxy.

Voting for Directors. The four nominees for election as directors at the Annual Meeting who receive the highest number of affirmative votes will be elected. Shareholders are not permitted to cumulate their votes for the election of directors. Votes may be cast for or withheld from the directors as a group, or from each individual nominee. Votes that are withheld and broker non-votes will have no effect on the outcome of the election because directors will be elected by a plurality of votes cast. A broker "non-vote" occurs when a nominee holding shares for a beneficial owner does not have discretionary voting power with respect to the matter being considered and has not received instructions from the beneficial owner.

 

 

 

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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Persons and groups who beneficially own in excess of 5% of the Company's Common Stock are required to file reports disclosing such ownership pursuant to the Securities Exchange Act of 1934, as amended ("Exchange Act"). Based on such reports, the Company knows of no person who owned more than 5% of the outstanding shares of Common Stock as of the record date for the Annual Meeting.

Beneficial ownership is a technical term broadly defined by the Securities and Exchange Commission (the "SEC") to mean more than ownership in the economic sense. In general, beneficial ownership includes voting or investment power over shares, as well as shares that a person has the right to acquire within 60 days. Except as otherwise noted, the shareholders named in the table below have sole voting and investment power over all shares shown as beneficially owned by them.

The following table sets forth, as of March 16, 2007, information as to the shares of the Common Stock beneficially owned by each director, by each executive officer of the Company during 2006, and by all current executive officers and directors of the Company as a group.

 

 

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Messrs. Archer, Ferlin, Rust, and Thomas, 5,000 shares; Mr. Worrell, 4,000 shares; each of Messrs. Forcum and Ms. Freese, 2,000 shares; each of Messrs. Hagstrom, Ketel, Malik, Rognlin, and Schermer, 1,000 shares; and all current executive officers and directors as a group, 282,992 shares.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Exchange Act requires the Company's executive officers and directors, and persons who beneficially own more than 10% of any registered class of the Company's equity securities, to file with the SEC initial reports of beneficial ownership and reports of changes in beneficial ownership of shares of common stock and other equity securities of the Company. Executive officers, directors and greater than 10% shareholders are required by regulation to furnish the Company with copies of all Section 16(a) forms they file. To the Company's knowledge, based solely upon a review of the copies of Forms 3, 4 and 5 (and amendments thereto) furnished to the Company or otherwise in its files, all of the Company's officers, directors and 10% shareholders complied with all applicable Section 16(a) filing requirements during 2006, except that three executive officers, Bruce D. MacNaughton, Denise Portmann and Philippe Swaab, each filed one report disclosing the grant of a stock option after it was due.

CURRENT EXECUTIVE OFFICERS

The following summary sets forth the age, position, and the business experience during the past five years of those current executive officers of the Company who are not also directors of the Company.

Bruce D. MacNaughton (53) is the Vice President of the Company. He was appointed Executive Vice President and has served as Chief Credit Officer of the Bank since January 2002. Mr. MacNaughton has been employed in the commercial banking industry for over 33 years in various capacities. He was employed by U.S. Bank from 1983 to 2001. From 1989 to 2001, Mr. MacNaughton was a Business Banking Team Leader for U.S. Bank in central Oregon. In 2001, Mr. MacNaughton was promoted to Senior Lender of U.S. Bank with expanded responsibilities for the central and eastern Oregon region, managing a $185 million commercial and agriculture loan portfolio through a network of 21 branch offices and a staff of 18 commercial loan officers.

Denise Portmann (33) is the Chief Financial Officer of the Company and of the Bank. Ms. Portmann was also named Executive Vice President of the Bank in January 2006. She has served as Chief Financial Officer of the Company since January 2005. Ms. Portmann joined the Bank in 2001, serving as Treasurer of the Company and Senior Vice President and Cashier of the Bank. From 1995 to 1999, she was employed in the public accounting and auditing sector, specializing in the financial institutions industry. Ms. Portmann is a CPA and holds a B.S. degree in accounting from Central Washington University.

John Van Dijk (59) is the Corporate Secretary of the Company. Mr. Van Dijk has also served as President and Chief Operating Officer of the Bank since November 2004. He has served as Corporate Secretary of the Company since 1997 and previously served as Executive Vice President, Chief Financial Officer of the Bank since May 1996. Previously, Mr. Van Dijk was employed in the thrift industry for 18 years. He served as Senior Vice President, Chief Financial Officer of Olympia Federal Savings, Olympia, WA, from May 1991 to May 1996. From November 1988 to May 1991, he served as Vice President and Controller for Sterling Financial

 

 

 

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Group, Spokane, WA. Mr. Van Dijk served as Senior Vice President and Chief Operating Officer of Central Evergreen Savings Bank, Chehalis, WA, from March 1978 to November 1988.

PROPOSAL NO. 1 – ELECTION OF DIRECTORS

The Company's Board of Directors (the "Board") is presently composed of 13 members. Each also serves as a director of the Bank. The Company's articles and bylaws provide that directors will be elected for three-year staggered terms with approximately one-third of the directors elected each year. At the Annual Meeting, four directors will be elected to the class of directors whose terms end in 2010.

Messrs. Archer, Forcum, Schermer and Ms. Freese, all of whom presently serve as directors of the Company, have been nominated for election for a three-year term ending in 2010.

It is intended that the proxies solicited by the Board of Directors will be voted for the election of the above named nominees. If any nominee is unable to serve, the shares represented by all valid proxies will be voted for the election of such substitute as the Board of Directors may recommend. At this time the Board of Directors knows of no reason why the nominees might be unavailable to serve.

The Board of Directors recommends a vote "FOR" the election of Ms. Freese and Messrs. Archer, Forcum, and Schermer.

The following table sets forth certain information regarding the nominees for election at the Annual Meeting, as well as information regarding those directors continuing in office after the Annual Meeting. The Board of Directors has determined that each director listed below, other than Mr. Long, is "independent" as defined in Rule 4200(a)(15) of the listing standards for companies quoted on The Nasdaq Stock Market. No other individual served as a director of the Company during 2006. There are no family relationships among the directors and executive officers of the Company.

 

 

 

 

 

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The present principal occupation and other business experience during the last five years of each nominee for election and each director continuing in office is set forth below:

G. Dennis Archer is the founder of Archer Group, PS, and has been its director of tax services for more than the past five years. Mr. Archer holds both a Bachelor of Arts and Masters of Business Administration in finance from the University of Washington, and a law degree from Seattle University. Mr. Archer is a CPA, Personal Financial Specialist and Certified Financial Planner. Mr. Archer has practiced public accounting and served in the tax management field since 1976.

John R. Ferlin has been President and General Manager of Brooks Manufacturing Co., a wood products company specializing in engineered wood products for the electric utility industry, for more than the past five years. Mr. Ferlin currently serves on the Board of Directors of Brooks Manufacturing Co. and Sound Forest Products. Mr. Ferlin received a B.A. degree from the University of California at Berkeley and a law degree from Hastings College of Law.

Gary C. Forcum was appointed Chairman of the Board of the Company in October 2006. He was the President of Pettit Oil Company, a fuel service company, until he retired in January 1999. Mr. Forcum is a private investor.

Susan C. Freese is a pharmacist and was the co-owner of Peninsula Pharmacies, Inc., located in Long Beach, Ocean Park, and Ilwaco, Washington, for more than five years until 2006.

Duane E. Hagstrom was named Chief Executive Officer of the Bank in 1985 and President in 1986, capacities in which he served until his retirement in August 1997. Prior to joining the Bank, he spent 30 years at Rainier National Bank and its predecessor, where he served in various management positions.

Edwin Ketel is a veterinarian and has owned the Oceanside Animal Clinic in Seaview, Washington, for more than the past five years.

Dennis A. Long currently serves as President and Chief Executive Officer of the Company and Chief Executive Officer of the Bank. Mr. Long previously served as President and Chief Executive Officer of the Bank from July 1997 until December 1999. In December 1999, he was appointed President of the Company and became President and Chief Executive Officer in May 2001. Mr. Long previously served as President of the Southern Puget Sound District of Key Bank, N.A., Tacoma, Washington, from July 1996 to April 1997. From April 1995 to July 1996, Mr. Long served as Retail Project Leader for KeyCorp, the parent company of Key Bank, N.A. He served as Executive Vice President and Retail Banking Manager of Key Bank of Washington, Seattle, Washington, from September 1993 to April 1995.

Joseph A. Malik served as Chairman of the Board of the Company from December 1999 until October 2006 and has been a director of the Bank since January 1979. He served as the President of Grays Harbor Community College from 1972 until June 1989, following which he was the Executive Director of the Commission on Colleges until his retirement in 1997. Mr. Malik serves on the Board of Trustees of the Colorado Institute of Art and chairs the Board of Trustees of the Portland Institute of Art.

Randy Rognlin is a local construction contractor and has been the President and co-owner of Rognlin, Inc., located in Aberdeen, Washington, for more than the past five years.

Randy Rust was owner of Westport Shipyards, which builds ocean-going luxury yachts, until 2002 when he sold the company. Mr. Rust is currently a private investor.

 

 

 

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Douglas M. Schermer is a local construction contractor and has been the President and owner of Schermer Construction located in Hoquiam, Washington, for more than the past five years.

Stewart L. Thomas has been Chairman of the Board of Bellingham Cold Storage, a company that stores all forms of frozen food products and distributes them worldwide, for more than the past five years. Mr. Thomas recently served on the Board of Directors of United for Washington, Washington Food Processors Council and IARW Insurance Group. Mr. Thomas attended Pacific University in Forest Grove, Oregon.

Robert J. Worrell Mr. Worrell served as President and Chief Executive Officer, and as a director, of The Bank of Grays Harbor from 1982, and as Chief Executive Officer of the Company from January 2000 until his retirement in May 2001. He previously served as President and Chief Executive Officer of the Company from 1997 until December 1999.

OTHER MATTERS

The Board of Directors is not aware of any business to come before the Annual Meeting other than those matters described above in this Proxy Statement. However, if any other matters should properly come before the Annual Meeting, it is intended that proxies in the accompanying form will be voted in respect thereof in accordance with the judgment of the person or persons voting the proxies.

MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS

The Board of Directors of the Company conducts its business through meetings of the Board and through Board committees. During 2006, the Board of Directors held 11 meetings. Each director attended at least 75 percent of the aggregate of (i) the total number of meetings of the Board of Directors, and (ii) the total number of meetings held by all committees on which that director served.

The Company does not have a policy regarding attendance at annual shareholder meetings by directors. All of the individuals who were then directors attended the 2006 annual meeting of shareholders.

Committees

The Board of Directors has established, among others, an Audit Committee, a Governance and Nominating Committee, a Compensation and Management Development Committee, and an Executive Committee.

Audit Committee. The principal functions of the Audit Committee are to be directly responsible for the appointment, compensation, and oversight of the independent auditors and the internal audit department; review and approve any major accounting policy changes affecting operating results; review the arrangements for and scope of the independent audit and the results of the audit and internal audits; review the scope of non-audit services performed by the independent auditors; ensure that the auditors are in fact independent; establish and oversee compliance with policies to prohibit unethical, questionable, or other illegal activities by officers and employees of the Company; and establish and monitor procedures for the receipt, retention and treatment of complaints regarding accounting or auditing matters. The Audit Committee also is responsible for reviewing the annual and other reports filed with the SEC and the annual report to shareholders. The Audit Committee met ten times during 2006.

Current members of the Audit Committee are Messrs. Archer, Forcum, Hagstrom (Chairman), and Malik. The Board has determined that each member of the Audit Committee is "independent" as defined in Rule 4200(a)(15) of the listing standards for companies quoted on The Nasdaq Stock Market

 

 

 

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and in Rule 10A-3 adopted by the SEC under the Exchange Act. The Board has also determined that each of Messrs. Archer, Forcum and Hagstrom is qualified to be an "audit committee financial expert" as defined in the SEC's rules. A written charter for the Audit Committee was adopted by the Board during 2002 and is available on our website at www.thebankofpacific.com in the "Stockholder Info & CEO's Newsletter" section.

Governance and Nominating Committee. The primary responsibilities of the Governance and Nominating Committee (the "Nominating Committee") are to identify individuals qualified to become members of the Board; recommend to the Board the slate of director nominees to be elected by shareholders; recommend directors to be elected by the Board to fill any vacancies; develop and recommend to the Board the corporate governance practices of the Board; oversee compliance with the Board's policies regarding ethical conduct and conflicts of interest of directors; and handle other matters as the Board or the Nominating Committee Chairman deems appropriate. The Nominating Committee met once during 2006. The Board has determined that each current member of the Nominating Committee, Messrs. Ferlin, Ketel, Rust, and Malik (Chairman), is "independent" as defined in Rule 4200(a)(15) of the listing standards for companies quoted on The Nasdaq Stock Market. The Board has adopted a written charter for the Nominating Committee which is available on the Company's website at www.thebankofpacific.com in the "Stockholder Info & CEO's Newsletter" section.

The Nominating Committee continually evaluates the current Board composition to determine what attributes are desirable in new director candidates. The Nominating Committee looks for candidates who, as a group, meet the Company's strategic needs, possess the highest personal values, judgment and integrity, have the time and the willingness to understand the regulatory and policy environment in which the Company operates, and have diverse experience in key business, financial, and other challenges that face the Company. The Nominating Committee does not have any minimum requirements for director nominee qualifications. When the Nominating Committee has a need to identify new candidates, because of a vacancy on the Board or otherwise, it polls the current directors for suggested candidates. To date, the Company has not engaged third-party search firms to identify candidates. Any candidates identified for further consideration are typically interviewed and the Nominating Committee conducts such investigation of the candidate's background as deemed appropriate.

The Nominating Committee will consider director candidates recommended by shareholders for nomination by the Board. Potential nominees recommended by shareholders are evaluated by the same criteria as other candidates considered by the Nominating Committee and based on the needs of the Board at the time. Shareholders may make recommendations to the Nominating Committee by sending a written recommendation, including a description of the candidate's qualifications and evidence of share ownership, to Joseph A. Malik, Chairman, Nominating Committee, Pacific Financial Corporation, P.O. Box 1826, Aberdeen, WA 98520.

Under the Company's articles, shareholders are also permitted to nominate director candidates directly, subject to certain notice provisions described in more detail under the heading "SHAREHOLDER PROPOSALS AND SHAREHOLDER NOMINATIONS FOR DIRECTOR" below.

Compensation and Management Development Committee. The current members of the Compensation and Management Development Committee (the "Compensation Committee") are Messrs. Archer (Chairman), Forcum, Hagstrom, Rognlin, Rust, and Thomas. The Board has determined that each of these members is "independent" as defined in Rule 4200(a)(15) of the listing standards for companies quoted on The Nasdaq Stock Market. The Compensation Committee held seven meetings during 2006.

The responsibilities of the Compensation Committee are set forth in a written charter which is available on the Company's website at www.thebankofpacific.com in the "Stockholder Info & CEO's

 

 

 

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Newsletter" section. Under its charter, the Compensation Committee is charged with carrying out the Board's overall responsibilities relating to compensation of the Company's executive officers and directors. Its specific duties include reviewing the Company's bonus and equity programs, the succession plan for key officers including the Chief Executive Officer (the "CEO"), and director compensation arrangements, and recommending changes to the Board as it deems appropriate, as well as recommending to the Board the annual compensation, including salary, bonus and equity awards, for the CEO.

The CEO annually reviews the performance of each executive officer (other than himself) and makes recommendations to the Compensation Committee regarding salary adjustments and annual awards of stock options and cash incentive bonuses for the executive officers. The Compensation Committee is responsible for annually evaluating the CEO's performance and presenting its conclusions and recommendations regarding his compensation to the full Board for approval. The CEO does not participate in deliberations by the Compensation Committee or the Board regarding his compensation. The Compensation Committee exercises its own discretion in accepting or modifying the CEO's recommendations regarding the performance and compensation of the Company's other executive officers prior to consideration by the Board.

The Compensation Committee has authority under its charter to retain outside compensation consultants and other advisors, to approve the terms of their retention, including fees for their services, and to terminate any such engagement, subject to approval by the Board. During 2006, the Compensation Committee retained Milliman, Inc., an outside human resources consulting and actuary firm, to provide advice to the Committee regarding executive compensation matters. Milliman was asked to provide its assessment of the Company's executive incentive compensation program compared to peer groups of banks, including performance comparisons, relative cost, strengths and weaknesses, and appropriate performance benchmarks. As part of the process, Milliman was requested to interview the senior executive team, as well as the Chair and Vice-Chair of the Board, and to present its findings orally and in writing to the Compensation Committee.

Executive Committee. During the intervals between meetings of the Board of Directors, the Executive Committee may exercise the power of the Board except with respect to a limited number of matters which include amending the Company's articles or bylaws, adopting an agreement of merger or consolidation for the Company or any of its subsidiaries and recommending to the shareholders a merger of the Company or any of its subsidiaries, sale of all or substantially all its assets or the dissolution of the Company. Current members of the Committee are Messrs. Archer, Ferlin, Forcum, Malik, and Worrell.

SHAREHOLDER COMMUNICATIONS WITH THE BOARD

The Board of Directors encourages shareholders to send communications directly to the Board. Should a shareholder wish to communicate with the Board of Directors, the communications should be mailed to Gary C. Forcum, Chairman, Board of Directors, Pacific Financial Corporation, P.O. Box 1826, Aberdeen, WA 98520. Communications may also be directed to individual directors at the same address.

Your communications should indicate that you are a shareholder. We will forward the communication to whom it was addressed (if addressed to a certain director) or to the appropriate director or committee. We will not forward communications that appear primarily commercial in nature or relate to an improper or irrelevant topic. Correspondence marked confidential and properly addressed will not be opened prior to forwarding to the Board or individual director.

 

 

 

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DIRECTOR COMPENSATION FOR 2006

The following table summarizes compensation paid to the Company's directors for services during 2006, including services as directors of the Bank. No outside director received perquisites or other personal benefits with a total value exceeding $10,000 during 2006.

 

 

 

 

 

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Ms. Freese, 3,000 shares; Mr. Hagstrom, 2,000 shares; Mr. Ketel, 2,000 shares; Mr. Malik, 2,000 shares; Mr. Rognlin, 2,000 shares; Mr. Rust, 5,000 shares; Mr. Schermer, 2,000 shares; Mr. Thomas, 5,000 shares; and Mr. Worrell, 5,000 shares. The options have an exercise price equal to fair market value on the date of grant and become exerciseable cumulatively in five equal annual installments beginning one year after the date of grant, which was January 23, 2003, in the case of all directors except Messrs. Archer, Ferlin, Rust and Thomas. The vesting of options granted to these four directors was accelerated in 2005 in order to minimize compensation expense reported by the Company under SFAS 123R because the options were out of the money at that time. All options have a ten-year term.

 

 

 

 

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EXECUTIVE COMPENSATION

Compensation Committee Report

The Compensation Committee is charged with carrying out the Board's overall responsibilities relating to compensation of the Company's executive officers. The Compensation Committee has reviewed the following section entitled "Compensation Discussion and Analysis" and has discussed its contents with members of the Company's management. Based on its review and discussions, the Compensation Committee has been recommended to the Board of Directors that the following section be included in the proxy statement, as well as in the Company's Annual Report on Form 10-K for the year ended December 31, 2006, through its incorporation by reference from the proxy statement.

Submitted by the Compensation Committee of the Board of Directors:

 

 

Compensation Discussion and Analysis

Compensation Philosophy and Objectives. The Compensation Committee (for purposes of this section, the "Committee") has responsibility for establishing, implementing and continually monitoring adherence with the Company's compensation philosophy. The goal of the Committee is to ensure that the total compensation paid to the Company's executive officers is fair, reasonable and competitive.

The Committee believes that the most effective executive compensation program is one that is designed to reward the achievement of specific annual or long-term strategic goals by the Company, and which aligns executives' interests with those of the shareholders by rewarding performance above established goals with the ultimate objective of improving shareholder value. The principles underlying our compensation policies are:

Benchmarking. As discussed under "Meetings and Committees of the Board of Directors" above, during 2006 the Committee retained Milliman, Inc. ("Milliman"), an outside compensation consulting firm, to perform a review of its total compensation program for the CEO as well as for other key executives. Milliman provided the Committee with relevant market data and alternatives to consider when making compensation decisions for the CEO and, on the CEO's recommendations, for the rest of the executive management team.

In making compensation decisions, the Committee compares each element of total compensation against a peer group of publicly-traded banks operating in the Northwest. In 2006, with the research and

 

 

 

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advice of Milliman, the Committee selected a group of comparable companies, including Columbia Bancorp, Cowlitz Bancorporation, FirstBank NW Corp. (since acquired by Sterling Financial Corporation), Heritage Financial Corporation, Northwest Bancorporation, Inc., and Rainier Pacific Financial Group, Inc. For comparison purposes, the Bank's annual revenues, assets and employee count places it slightly higher than the 25^th percentile of such banks. Because of the large variance in size among the companies comprising the initial selection of the Bank's peer group, Milliman made the following selection from the total peer group based upon comparable income, assets and employees, which the Committee approved as the Company's Compensation Peer Group:

 

 

The Bank ‘s salary structure was determined to be competitive with the Comparison Peer Group when combined with annual cash incentive bonuses. Salary levels for all executive positions in 2006 were at approximately the 50^th percentile of the salary ranges for each position analyzed. The fact that a significant portion of potential cash compensation is in the form of incentive bonuses facilitates the Committee's goal of providing executives with a significant incentive if the Company's performance goals are met. Variations may occur as dictated by the experience level of the individual and market factors.

There is no pre-established policy or target for the allocation between cash and non-cash or short-term and long-term incentive compensation. Rather, the Committee reviews information provided by its own research or on advice and counsel of consultants such as Milliman to determine the appropriate level and mix of incentive compensation.

2006 Executive Compensation Components. For the fiscal year ended December 31, 2006, the principal components of compensation for executive officers were:

Base Salary

During its review of base salaries for executives, the Committee primarily considers:

Salary levels are typically reviewed annually as part of the Committee's performance review process, as well as upon a promotion or other change in job responsibility. Merit-based salary increases for executive officers are based on the Committee's assessment of the individual's performance. As of January 1, 2006, the Committee approved increases in executive officer salaries as follows:

 

 

 

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In May 2006, the Committee approved an increase in Mr. Swaab's base salary by $10,000 to $130,000 in connection with a shift in his incentive cash compensation from the program for the Bank's Mortgage Division to the program applicable to senior management.

Performance-Based Cash Incentive Compensation

The targets and parameters of the Company's Senior Officer Incentive Plan (the "Cash Incentive Plan") are approved by the Committee, following review of prior year results, in the early spring of each year. The plan provides for annual cash bonuses under a formula based on the Company's equity as of the beginning of the year. Beginning in 2006, no bonuses are paid unless the Company's after-tax return on equity for the year, before taking into account income taxes, accrual for incentive payments, extraordinary revenues or expenses not directly associated with normal bank operations, and certain other adjustments, exceeds the 50^th percentile of a peer group published by BancIntelligence of approximately 1,300 banks nationwide with an asset size ranging from $250 to $750 million. The Bank's 2006 after-tax return on equity was 12.17%, which exceeded the BancIntelligence 50^th percentile for the Bank's peer group of 11.12%. Consequently, under the provisions of the Cash Incentive Plan, the bonus pool for 2006 was $747,429, an increase of approximately $73,000 from 2005, which represents the sum of 5% of pre-tax earnings producing a 17.25% pretax return on equity ($344,103) and 10% of pre-tax earnings producing between 17.25% and 28% of pre-tax return on equity ($403,326). The bonus pool is apportioned among officers and employees based on their levels of responsibility. The percentage participation by the Company's executive officers in the bonus pool ranged from approximately 4% to 18% for 2006.

Long-Term Equity Incentive Compensation

In 2006 and prior years, the Committee has granted stock options to executive officers and other key employees under the 2000 Stock Incentive Compensation Plan. Stock options are intended to provide employees with increased motivation and incentive to exert their best efforts on behalf of the Company by:

Options granted to employees have an exercise price equal to or greater than the market value of the Common Stock on the date of grant. The amount of options granted to an executive officer is based on his or her performance and relative responsibilities within the Company, and may be modified based on market data or competitive pressures. Annual awards of stock options to executive officers are made at the Committee's regularly scheduled meeting in May. Stock options may be granted to a newly-hired executive officer only after approval by the Committee at its next regularly scheduled meeting following the officer's hire date.

 

 

 

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Retirement and Other Benefits

Employees, including executive officers, may participate in the Company's 401(k) defined contribution plan. The Company matches each employee's contribution at a rate of $.75 per dollar of salary deferred up to a maximum of 7.5% of the employees' salary. Executive officers are also provided with the use of company automobiles and reimbursement of country club dues.

Each executive officer has an employment agreement with the Bank providing for severance benefits upon termination without cause or following a change in control as described under "Potential Payments upon Termination or Change in Control" below.

Deductibility of Executive Compensation. The Committee reviews and considers the deductibility of executive compensation under Section 162(m) of the Internal Revenue Code, which limits the deductibility for federal income tax purposes of annual compensation totaling more than $1,000,000 paid to certain executive officers, with exceptions for qualifying performance-based compensation. The Company believes that compensation paid to its executive officers is fully deductible for federal income tax purposes.

 

 

 

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Summary Compensation Table

The following table sets forth the compensation received by the Chief Executive Officer, the Chief Financial Officer, and the other three executive officers of the Company for services rendered in all capacities during 2006. The Bank pays all compensation of the executive officers.

 

 

 

 

 

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performance during 2006 has not yet been determined. Mr. Swaab participated in the Mortgage Division Incentive Plan for the first five months of 2006 and in the Cash Incentive Plan for the remainder of the year. Additional information regarding the Cash Incentive Plan appears under the heading "Compensation Discussion and Analysis" above and in the following table.

Incentive Compensation

The following table sets forth information regarding awards under the Cash Incentive Plan and the 2000 Stock Incentive Compensation Plan to the named executive officers during the year ended December 31, 2006.

Grants of Plan-Based Awards During 2006

 

 

 

 

 

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The following information with respect to stock options exercised during the fiscal year ended December 31, 2006, is presented for the named executive officers.

Option Exercises and Stock Vested During 2006

 

 

The table below provides information regarding outstanding stock options held by the named executive officers at the end of 2006.

Outstanding Equity Awards at December 31, 2006

 

 

 

 

 

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Equity Compensation Plan Information

The following table summarizes share and exercise price information about the Company's equity compensation plans as of December 31, 2006.

 

 

(1) Excludes 18,819 shares under outstanding options, with a weighted average per share exercise price of $6.15, granted by the Company pursuant to a merger agreement in substitution of BNW Bancorp, Inc. options.

 

 

 

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Potential Payments upon Termination or Change in Control

Each current executive officer is a party to an employment agreement with the Bank. The agreements automatically renew for an additional year on each one-year anniversary unless the Bank provides notice of termination or nonrenewal. Notice of nonrenewal by the Bank results in severance obligations to the employee as described in more detail below.

The employment agreements provide that if (a) the employee is terminated by the Bank without cause or receives notice of nonrenewal, the employee will be entitled to receive salary from the date of the notice for the balance of the then current term or for twelve months from the date of notice, whichever is longer, or (b) the employee is terminated by the Bank within two years after a change in control (or, in Mr. Long's case, within two years after or nine months prior to a change in control) other than by reason of death or disability or for cause, the employee will be entitled to receive a payment equal to (i) in the case of Mr. Long, three times the highest amount of annual compensation reported for tax purposes during the prior three calendar years, (ii) in the case of Mr. Van Dijk, three times the base compensation paid during the prior calendar year, (iii) in the case of Mr. MacNaughton, a payment equal to two times the base compensation paid during the prior calendar year, and (iv) in the case of Ms. Portmann, a payment equal to 1.5 times the base compensation paid during the prior calendar year. A change in the employee's position without his or her consent following a change in control will be deemed a termination by the Bank.

The employment agreements provide that any stock options held by the employee will be immediately vested in full upon termination of employment by the Bank other than for cause, including by reason of death or disability. Amounts payable under the employment agreements are subject to reduction to the extent that such payments would be deemed excess parachute payments under Section 280G of the Internal Revenue Code of 1986, as amended (the "Code").

A "change in control" means a change in ownership or effective control of the Bank or ownership of a substantial portion of its assets as defined in Section 280G of the Code. "Cause" includes dishonesty; fraud; commission of a felony or of a crime involving moral turpitude; deliberate violation of statutes, regulations, or orders; destruction or theft of Bank property or assets of customers of the Bank; and the employee's refusal to perform or gross negligence in the performance of his duties or misconduct materially injurious to the Bank.

Philippe Swaab, who ceased to be an executive officer on March 9, 2007, was also a party to an employment agreement with the Bank. Mr. Swaab will remain an employee of the Bank through June 6, 2007, and will continue to be paid his monthly salary at the rate of $11,917, or a total of $35,750, through that date. The Bank may choose to extend the non-compete provisions of Mr. Swaab's agreement, as described below, for up to an additional 24 months through the payment of monthly installments of $11,917.

The employment agreements include a prohibition on disclosure of confidential information concerning the Bank at any time as well as an agreement not to compete with the Bank for up to two years in the counties in which it is operating. With respect to Mr. Swaab, the noncompete provisions will remain in place only for so long as the Bank continues to make monthly payments equal to his monthly base salary at the time of termination. The Bank is entitled to receive payment for each breach of these provisions as follows:

 

 

 

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The Bank may also seek injunctive relief from a court to enforce the provisions.

If an employee provides written notice of termination of employment or nonrenewal of his or her employment agreement less than 90 days prior to the termination date or expiration of the then current term, the agreement requires the employee to pay liquidated damages to the Bank ranging from $15,000 to $25,000.

The following table shows estimated potential pay-outs to the Company's current executive officers, assuming that his or her employment was terminated by the Bank other than for cause, death or disability (except that unvested stock options will also vest in full upon death or disability), and that termination occurred on the last business day of 2006.

 

 

(1) Payable in equal monthly installments in accordance with the Bank's ordinary payroll policies and procedures.

(2) Reflects reduction in the estimated amount of $114,366 in order to avoid characterization as excess parachute payments under Section 280G of the Code.

(3) Represents the value of in-the-money stock options that had not vested on December 29, 2006, based on the difference between the closing sale price of the Common Stock on the Over-the-Counter Bulletin Board on that date, $16.95 per share, and the per share exercise price. See "Outstanding Equity Awards at December 31, 2006."

AUDIT COMMITTEE REPORT

The Audit Committee has met with management and the Company's independent auditors, Deloitte & Touche, LLP, to review the Company's accounting functions and the audit process and to discuss the audited financial statements for the year ended December 31, 2006. The Audit Committee discussed and reviewed with its independent auditors all matters that the independent auditors were required to communicate and discuss with the Audit Committee under applicable auditing standards, including those regarding communications with

 

 

 

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audit committees. The Audit Committee also discussed with the independent auditors their independence and obtained a formal written statement relating to independence consistent with Independence Standards Board Standard No. 1, "Independence Discussions with Audit Committees."

Based on its review and discussions with management and the Company's independent auditors, the Audit Committee recommended to the Board that the audited financial statements be included in the Company's Annual Report on Form 10-K for the year ended December 31, 2006, for filing with the Securities and Exchange Commission.

Submitted by the Audit Committee of the Board of Directors:

Duane E. Hagstrom (Chairman), G. Dennis Archer, Gary C. Forcum, Joseph A. Malik

AUDITORS

The Audit Committee has selected Deloitte & Touche LLP ("Deloitte") as the Company's independent registered public accounting firm to examine the financial statements of the Company for the fiscal year ending December 31, 2007.

Deloitte served as the Company's independent auditors for 2006, and performed the audit of the Consolidated Financial Statements of the Company for the year ended December 31, 2006. A representative of Deloitte is expected to be present at the Annual Meeting to respond to appropriate questions from shareholders and will have the opportunity to make a statement if he or she so desires.

On May 23, 2006, the Company dismissed its previous independent accountants, McGladrey & Pullen LLP ("McGladrey"), and selected Deloitte as the Company's new principal independent registered public accounting firm to audit its financial statements. The Audit Committee directed the review process and made the final decision to dismiss McGladrey and select Deloitte. The reports of McGladrey on the Company's financial statements for the fiscal years ended December 31, 2005 and 2004 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.

During the fiscal years ended December 31, 2004 and 2005, and the subsequent interim period through May 23, 2006, the Company had no disagreement with McGladrey on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreement, if not resolved to the satisfaction of McGladrey, would have caused McGladrey to make reference to the subject matter of the disagreement in connection with its report on the Company's financial statements for such fiscal years. During the period from January 1, 2004 through May 23, 2006, no "reportable events," as described in Item 304(a)(1)(v) of Regulation S-K promulgated by the SEC, occurred with respect to the Company.

During the period from January 1, 2004 through May 23, 2006, the Company did not consult with Deloitte regarding (1) the application of accounting principles to a specified transaction, whether completed or proposed, (2) the type of audit opinion that might be rendered with respect to the Company's financial statements, or (3) any matter that was either the subject of a "disagreement" or a "reportable event" (as such terms are defined in Items 304(a)(1)(iv) and (v) of Regulation S-K).

 

 

 

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Fees Paid to Auditors

Fees paid to Deloitte for the fiscal year ended December 31, 2006, were as follows:

 

 

Audit Fees. Represents the aggregate fees, including out-of-pocket expenses, for professional services rendered for (i) the audit of the Company's annual financial statements during the year ended December 31, 2006, (ii) review of financial statements included in the Company's quarterly reports on Form 10-Q, and (iii) preparation for internal control reports and related attestation services required by Section 404 of the Sarbanes-Oxley Act of 2002.

Audit Related Fees. Represents fees, including out-of-pocket expenses, billed for services related to regulatory compliance reviews.

All Other Fees. Represents fees related to analyzing information technology controls and procedures.

The Audit Committee determined that the provision of these audit related and other services was compatible with maintaining the independence of the Company's independent auditors.

Pre-Approval of Fees

The Audit Committee pre-approved 100% of the fees described above. All fees and services (including audit and permissible non-audit services) of the Company's independent auditors are required to be reviewed and approved at a meeting of the Audit Committee prior to the engagement. All fees incurred in 2006 were pre-approved by the Audit Committee.

CODE OF ETHICS

The Company adopted a Code of Ethics that applies to our Chief Executive Officer and Chief Financial Officer and the President, Chief Financial Officer, and Chief Credit Officer of the Bank. The Code of Ethics is available on our website at www.thebankofpacific.com in the "Stockholder Info & CEO's Newsletter" section.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

Messrs. Archer, Forcum, Hagstrom, Malik, Rognlin, Rust, Thomas, and Worrell served on the Compensation Committee during 2006. Mr. Hagstrom was Chief Executive Officer and President of the Bank for more than 10 years until his retirement in 1997. Mr. Worrell was Chief Executive Officer of the Company until his retirement in 2001.

RELATED PERSON TRANSACTIONS

Under applicable federal banking regulations, all loans or extensions of credit to executive officers and directors must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and must not involve more than the

 

 

 

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normal risk of repayment or present other unfavorable features. The Bank is therefore prohibited from making any new loans or extensions of credit to executive officers and directors at different rates or terms than those offered to the general public and has adopted a policy to this effect. From time to time, the Bank has made loans to executive officers and directors that meet the requirements described above.

Each director and executive officer of the Company is required to notify the Audit Committee of any transaction that may present a conflict of interest with the Company or in which the insider may benefit directly or indirectly. Under the Company's written conflict of interest and business ethics policies, the Board of Directors has final authority to approve any transaction between a director or officer (or a related party) and the Company. The nature of the transaction must be fully disclosed to the Board. The affected insider must abstain from the approval process and will not be counted in determining a quorum of directors. The Board will approve only those transactions that are fair and reasonable to the Company and as to which a more advantageous arrangement was not reasonably available under the circumstances. Transactions in which the total fees and payments do not exceed $10,000 and which are entered into in the ordinary course of business are excepted from the requirement of Board approval.

SHAREHOLDER PROPOSALS AND SHAREHOLDER

NOMINATIONS FOR DIRECTOR

Shareholder Proposals. In order to be eligible for inclusion in the proxy materials of the Company for the 2008 Annual Meeting of Shareholders, any shareholder proposal to take action at such meeting must be received at the Company's administrative headquarters at 1101 S. Boone Street, Aberdeen, Washington, no later than November 22, 2007. Any such proposals shall be subject to the requirements of the SEC's proxy rules. In addition, if the Company receives notice of a shareholder proposal after February 5, 2008, the persons named as proxies in such proxy statement and form of proxy will have discretionary authority to vote on such shareholder proposal.

Nomination of Candidate for Director. Shareholders may directly nominate director candidates only in accordance with the prior notice provisions contained in the Company's articles. These notice provisions, require, among other things, that a shareholder provide the Company with written notice not less than 14 days nor more than 60 days prior to the date of the annual meeting (or, if the Company provides less than 21 days' notice of such meeting, no later than seven days after the date on which notice was mailed to shareholders).

MISCELLANEOUS

The Company's 2006 Annual Report to Shareholders has been mailed along with this Proxy Statement to all shareholders of record as of the close of business on March 16, 2007. Any shareholder that has not received a copy of such annual report may obtain a copy by writing to the Company. Such annual report is not to be treated as part of the proxy solicitation material or as having been incorporated herein by reference.

A copy of the Company's Form 10-K as filed with the SEC will be furnished without charge to shareholders, including beneficial owners, of the common stock as of March 16, 2007, upon written request to Sandra Clark, Executive Secretary, Pacific Financial Corporation, 1101 S. Boone Street, P.O. Box 1826, Aberdeen, Washington 98520.

 

 

 

 

 

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PROXY

PACIFIC FINANCIAL CORPORATION

Annual Meeting of Stockholders—April 18, 2007

THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS OF THE COMPANY

The undersigned hereby appoints Dennis Long and John Van Dijk, and each of them, with power to act without the other and with power of substitution, as proxies and attorneys-in-fact and hereby authorizes them to represent and vote, as provided on the other side, all the shares of Pacific Financial Corporation Common Stock which the undersigned is entitled to vote, and, in their discretion, to vote upon such other business as may properly come before the Annual Meeting of Stockholders of the company to be held April 18, 2007 or at any adjournment or postponement thereof, with all powers which the undersigned would possess if present at the Meeting.

(Continued and to be marked, dated and signed, on the other side)

 

 

 

FOLD AND DETACH HERE

 

You can now access your Pacific Financial Corporation account online.

Access your Pacific Financial Corporation shareholder account online via Investor ServiceDirect® (ISD).

Mellon Investor Services LLC, Transfer Agent for Pacific Financial Corporation, now makes it easy and convenient to get current information on your shareholder account.

 

 

Visit us on the web at http://www.melloninvestor.com

For Technical Assistance Call 1-877-978-7778 between 9am-7pm

Monday-Friday Eastern Time

 

 

 

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Investor ServiceDirect® is a registered trademark of Mellon Investor Services LLC

****TRY IT OUT****

www.melloninvestor.com/isd/

Investor ServiceDirect®

Available 24 hours per day, 7 days per week

TOLL FREE NUMBER:     1-800-370-1163

 

 

 

 

 

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o          Please Mark Here for Address

Change or Comments

(SEE REVERSE SIDE)

THIS PROXY WILL BE VOTED AS DIRECTED, OR

IF NO DIRECTION IS INDICATED, WILL BE VOTED

"FOR" THE ELECTION OF DIRECTORS.

 

 

Signature _________________________ Signature _________________________ Date ___________

NOTE: Please sign as name appears hereon. Joint owners should each sign. When signing as officer, attorney-in-fact, executor, administrator, trustee or guardian, please give full title as such.

 

FOLD AND DETACH HERE

 

WE ENCOURAGE YOU TO TAKE ADVANTAGE OF INTERNET OR TELEPHONE VOTING, BOTH ARE AVAILABLE 24 HOURS A DAY, 7 DAYS A WEEK.

 

Internet and telephone voting is available through 11:59 PM Eastern Time

the day prior to annual meeting day.

 

 

 

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Your Internet or telephone vote authorizes the named proxies to vote your shares in

the same manner as if you marked, signed and returned your proxy card.

 

 

If you vote your proxy by Internet or telephone, you do NOT need to mail back your proxy card. To vote by mail, mark, sign and date your proxy card and return it in the enclosed postage-paid envelope.