U.S. SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                ----------------

                                    FORM 10-Q

(Mark One)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

     For the quarterly period ended December 31, 2001

     OR

[ ]  TRANSITION  REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES
     EXCHANGE ACT OF 1934

     For the transition period from ______ to ______

                         Commission file number: 0-25859

                             1ST STATE BANCORP, INC.
--------------------------------------------------------------------------------
             (Exact Name of Registrant as Specified in Its Charter)


         VIRGINIA                                             56-2130744
-------------------------------                           ------------------
(State or Other Jurisdiction of                           (I.R.S. Employer
 Incorporation or Organization)                           Identification No.)


445 S. MAIN STREET, BURLINGTON, NORTH CAROLINA                 27215
--------------------------------------------------------------------------------
(Address of Principal Executive Offices)                     (Zip Code)


Registrant' s Telephone Number, Including Area Code (336) 227-8861
                                                    --------------

                                       N/A
--------------------------------------------------------------------------------
               Former Name, Former Address and Former Fiscal Year,
                          if Changed Since Last Report

     Indicate by check mark  whether the  registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes X      No
                                              ----     ----

     As of February 14, 2002,  the issuer had  3,289,607  shares of common stock
issued and outstanding.

<PAGE>



                                    CONTENTS

                                                                            PAGE
                                                                            ----

PART I.  FINANCIAL INFORMATION
         ---------------------

Item 1.  Financial Statements

         Consolidated Balance Sheets as of December 31, 2001 (unaudited)
            and September 30, 2001............................................1

         Consolidated Statements of Income for the Three Months Ended
           December 31, 2001 and 2000 (unaudited).............................2

         Consolidated Statements of Stockholders' Equity and
           Comprehensive Income for the Three Months Ended December 31,
           2001 and 2000 (unaudited)..........................................3

         Consolidated Statements of Cash Flows for the Three Months Ended
           December 31, 2001 and 2000 (unaudited).............................4

         Notes to Consolidated Financial Statements...........................6

Item 2.  Management's Discussion and Analysis of Financial Condition
           and Results of Operations..........................................9

Item 3.  Quantitative and Qualitative Disclosures About Market Risk..........15


PART II.  OTHER INFORMATION
          -----------------

Item 1.  Legal Proceedings...................................................16

Item 2.  Changes in Securities and Use of Proceeds...........................16

Item 3.  Defaults Upon Senior Securities.....................................16

Item 4.  Submission of Matters to a Vote of Security Holders.................16

Item 5.  Other Information...................................................16

Item 6.  Exhibits and Reports on Form 8-K....................................16


SIGNATURES...................................................................17

<PAGE>
                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS

                    DECEMBER 31, 2001 AND SEPTEMBER 30, 2001

                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                                   AT               AT
                                                                             DECEMBER 31,      SEPTEMBER 30,
                                                                                2001               2001
                                                                             ------------      -------------
                                                                             (Unaudited)
                                      ASSETS
<S>                                                                         <C>                   <C>
Cash and cash equivalents                                                    $   14,279           $  25,981
  Investment securities:
     Held to maturity (fair value of $11,798 and $12,495
         at December 31, 2001 and September 30, 2001, respectively)              11,622              12,169
     Available for sale (cost of $83,797 and $54,689
         at December 31, 2001 and September 30, 2001, respectively)              83,503              55,527
Loans held for sale, at lower of cost or fair value                              10,764               3,291
Loans receivable (net of allowance for loan losses of $3,588
    and $3,612 at December 31, 2001 and September 30, 2001,
   respectively)                                                                213,617             222,285
Federal Home Loan Bank stock, at cost                                             1,650               1,650
Real estate owned                                                                 2,328               1,981
Premises and equipment                                                            8,347               8,414
Accrued interest receivable                                                       2,069               2,542
Other assets                                                                      3,008               2,952
                                                                             ----------           ---------
Total assets                                                                 $  351,187             336,792
                                                                             ==========           =========

                LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
  Deposit accounts                                                           $  257,274             248,370
  Advances from Federal Home Loan Bank                                           25,000              20,000
  Advance payments by borrowers for property taxes and insurance                    258                  82
  Dividend payable                                                                  263                 263
  Other liabilities                                                               4,455               4,433
                                                                             ----------           ---------
          Total liabilities                                                     287,250             273,148
                                                                             ----------           ---------

Stockholders' Equity:
   Preferred stock, $0.01 par value, 1,000,000 shares authorized;
         none issued                                                                 --                  --
   Common stock, $0.01 par value, 7,000,000 shares authorized;
         3,289,607 shares issued and outstanding                                     33                  33
   Additional paid-in capital                                                    35,596              35,588
   Unearned ESOP shares                                                          (4,202)             (4,373)
   Unearned compensation - management recognition plan                             (324)               (518)
   Deferred compensation                                                          4,324               4,173
   Treasury stock for deferred compensation                                      (4,324)             (4,173)
   Retained income - substantially restricted                                    33,013              32,404
   Accumulated other comprehensive income/(loss) - net unrealized
        gain/(loss) on investment securities available for sale                    (179)                510
                                                                             ----------           ---------
        Total stockholders' equity                                               63,937              63,644
                                                                             ----------           ---------
        Total liabilities and stockholders' equity                           $  351,187             336,792
                                                                             ==========           =========
</TABLE>

See accompanying notes to the consolidated financial statements.

                                       1
<PAGE>


                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                        CONSOLIDATED STATEMENTS OF INCOME

              FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000

                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                 FOR THE THREE MONTHS ENDED
                                                                         DECEMBER 31,
                                                                 ---------------------------
                                                                  2001                 2000
                                                                 ------               ------
<S>                                                              <C>                  <C>
Interest income:
   Interest and fees on loans                                    $3,889               5,090
   Interest and dividends on investments                          1,222               1,217
   Overnight deposits                                                89                 203
                                                                 ------              ------
         Total interest income                                    5,200               6,510
                                                                 ------              ------

Interest expense:
    Deposit accounts                                              2,094               2,977
    Borrowings                                                      276                 303
                                                                 ------              ------
         Total interest expense                                   2,370               3,280
                                                                 ------              ------

         Net interest income                                      2,830               3,230

Provision for loan losses                                            60                  60
                                                                 ------              ------
         Net interest income after provision for loan losses      2,770               3,170
                                                                 ------              ------

Other income:
   Service fees on loans sold                                        22                  20
   Customer service fees                                            249                 156
   Commissions from sales of annuities and mutual funds             122                 111
   Mortgage banking income,  net                                    416                 128
   Other                                                             50                  42
                                                                 ------              ------
         Total other income                                         859                 457
                                                                 ------              ------
Operating expenses:
   Compensation and related benefits                              1,564               1,543
   Occupancy and equipment                                          303                 277
   Deposit insurance premiums                                        12                  12
   Real estate operations, net                                       18                  --
   Other expenses                                                   360                 411
                                                                 ------              ------
         Total operating expenses                                 2,257               2,243
                                                                 ------              ------
         Income before income taxes                               1,372               1,384

Income taxes                                                        527                 483
                                                                 ------              ------
         Net income                                              $  845                 901
                                                                 ======              ======

Earnings per share:
         Basic                                                   $ 0.28              $ 0.30
         Diluted                                                 $ 0.27              $ 0.29
</TABLE>

See accompanying notes to the consolidated financial statements.

                                       2
<PAGE>

                             1ST STATE BANCORP, INC.
    CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
        FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000 (UNAUDITED)
                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                              ADDITIONAL    UNEARNED       UNEARNED
                                                   COMMON      PAID-IN        ESOP       COMPENSATION      DEFERRED
                                                    STOCK      CAPITAL       SHARES           MRP        COMPENSATION
                                                    -----      -------       ------           ---        ------------
<S>                                              <C>            <C>           <C>            <C>              <C>
Balance at September 30, 2000                    $     33       35,587        (4,950)        (1,296)          2,679

Comprehensive income:
     Net income                                         --           --            --             --              --
     Other comprehensive income-unrealized
       gain on securities available-for-sale,
       net of income taxes of $68                       --           --            --             --              --


Total comprehensive income
Allocation of ESOP shares                               --          (8)          137              --              --
Deferred compensation                                   --           --            --             --            249
Treasury stock held for deferred compensation           --           --            --             --              --
Vesting of MRP shares                                   --           --            --           195               --
Cash dividend declared                                  --           --            --             --              --
Cash dividend on unallocated ESOP shares
     and unvested MRP shares                            --           --            --             --              --
                                                 ---------   ----------   -----------   ------------    ------------
Balance at December 31, 2000                     $     33       35,579        (4,813)        (1,101)          2,928
                                                 =========   ==========   ===========   ============    ============

Balance at September 30, 2001                    $     33        35,588       (4,373)          (518)          4,173

Comprehensive income:
     Net income                                         --           --            --             --              --
     Other comprehensive loss-unrealized
       loss on securities available-for-sale,
       net of income taxes of $443                      --           --            --             --              --


Total comprehensive income
Allocation of ESOP shares                               --            8          171              --              --
Deferred compensation                                   --           --            --             --            151
Treasury stock held for deferred compensation           --           --            --             --              --
Vesting of MRP shares                                   --           --            --           194               --
Cash dividend declared                                  --           --            --             --              --
Cash dividend on unallocated ESOP shares
     and unvested MRP shares                            --           --            --             --              --
                                                 ---------   ----------   -----------   ------------    ------------
Balance at December 31, 2001                     $     33       35,596        (4,202)          (324)           4,324
                                                 =========   ==========   ===========   ============    ============

<CAPTION>
                                                      TREASURY                        ACCUMULATED
                                                     STOCK FOR                           OTHER           TOTAL
                                                      DEFERRED        RETAINED       COMPREHENSIVE   STOCKHOLDERS'
                                                    COMPENSATION       INCOME        INCOME (LOSS)      EQUITY
                                                    ------------       ------        -------------      ------
<S>                                                     <C>              <C>                <C>          <C>
Balance at September 30, 2000                           (2,679)          29,999             (164)        59,209
                                                                                                              --
Comprehensive income:                                                                                         --
     Net income                                              --              901               --           901
     Other comprehensive income-unrealized
       gain on securities available-for-sale,
       net of income taxes of $68                            --               --             102            102
                                                                                                    -----------

Total comprehensive income                                                                                1,003
Allocation of ESOP shares                                    --               --               --           129
Deferred compensation                                        --               --               --           249
Treasury stock held for deferred compensation             (249)               --               --          (249)
Vesting of MRP shares                                        --               --               --           195
Cash dividend declared                                       --            (263)               --          (263)
Cash dividend on unallocated ESOP shares
     and unvested MRP shares                                 --              22                --            22
                                                   ------------   --------------    -------------   -----------
Balance at December 31, 2000                            (2,928)           30,659             (62)        60,295
                                                   ============   ==============    =============   ===========

Balance at September 30, 2001                           (4,173)          32,404               510         63,644
                                                                                                              --
Comprehensive income:                                                                                         --
     Net income                                              --              845               --           845
     Other comprehensive loss-unrealized
       loss on securities available-for-sale,
       net of income taxes of $443                           --               --            (689)          (689)
                                                                                                    ------------

Total comprehensive income                                                                                  156
Allocation of ESOP shares                                    --               --               --           179
Deferred compensation                                        --               --               --           151
Treasury stock held for deferred compensation             (151)               --               --          (151)
Vesting of MRP shares                                        --               --               --           194
Cash dividend declared                                       --            (263)               --          (263)
Cash dividend on unallocated ESOP shares
     and unvested MRP shares                                 --              27                --            27
                                                   ------------   --------------    -------------   -----------
Balance at December 31, 2001                            (4,324)           33,013            (179)        63,937
                                                   ============   ==============    =============   ===========
</TABLE>
See accompanying notes to the consolidated financial statements.

                                       3
<PAGE>

                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

              FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000

                                   (UNAUDITED)

                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                                FOR THE THREE MONTHS ENDED
                                                                                        DECEMBER 31,
                                                                                ----------------------------
                                                                                  2001                2000
                                                                                --------            --------
<S>                                                                             <C>                 <C>
Cash flows from operating activities:
   Net income                                                                   $    845                 901
   Adjustment to reconcile net income to net cash provided by
       (used in) operating activities:
           Provision for loan losses                                                  60                  60
           Depreciation                                                              153                 146
           Deferred tax expense (benefit)                                            155                 (38)
           Amortization of premiums and discounts, net                               (13)                 (5)
           Deferred compensation                                                      92                  68
           Release of  ESOP shares                                                   179                 129
           Vesting of MRP shares and dividends on unearned MRP shares                260                 263
           Loan origination fees and unearned discounts
               deferred, net of current amortization                                 (54)                 44
           Net loss on sale of loans                                                 211                  63
           Proceeds from sales of loans held for sale                             25,264               6,195
           Originations of loans held for sale                                   (32,948)             (5,164)
           Decrease in other assets                                                  232                 111
           Decrease in accrued interest receivable                                   473                  90
           Decrease in other liabilities                                            (287)             (1,643)
                                                                                --------             -------
                         Net cash provided by (used in) operating activities      (5,378)              1,220
                                                                                --------             -------

Cash flows from investing activities:
    Purchase of investment securities available for sale                         (46,326)                 --
    Purchases of investment securities held to maturity                           (2,454)                 --
    Proceeds from maturities of investment securities available for sale          17,231                  60
    Proceeds from maturities of investment securities
        held to maturity                                                           3,001                 530
    Net decrease (increase) in loans receivable                                    8,315              (5,608)
    Purchases of premises and equipment                                              (86)               (402)
                                                                                --------             -------
                         Net cash used in investing activities                   (20,319)             (5,420)
                                                                                --------             -------

                                                                                                   (Continued)
</TABLE>

                                       4
<PAGE>

                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

              FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND 2000

                                   (UNAUDITED)

                                 (IN THOUSANDS)
<TABLE>
<CAPTION>
                                                                               FOR THE THREE MONTHS ENDED
                                                                                       DECEMBER 31,
                                                                              ------------------------------
                                                                                2001                 2000
                                                                              ----------           ---------
<S>                                                                           <C>                  <C>
Cash flows from financing activities:
   Net increase in deposits                                                   $    8,904           $   3,665
   Advances from the Federal Home Loan Bank                                        5,000               5,000
   Return of capital dividend payment                                                 --             (17,007)
   Purchase of treasury stock for deferred compensation                              151                 249
   Dividends paid on common stock                                                   (236)               (241)
   Increase in advance payments by borrowers for
       property taxes and insurance                                                  176                 203
                                                                              ----------           ---------
                    Net cash provided by (used in)  financing activities          13,995              (8,131)
                                                                              ----------           ---------

        Net decrease in cash and cash equivalents                                (11,702)            (12,331)

Cash and cash equivalents at beginning of period                                  25,981              33,107
                                                                              ----------           ---------

Cash and cash equivalents at end of period                                    $   14,279           $  20,776
                                                                              ==========           =========

Payments are shown below for the following:
       Interest                                                               $    2,375           $   3,342
                                                                              ==========           =========
       Income taxes                                                           $       68           $      27
                                                                              ==========           =========

Noncash investing and financing activities:

     Unrealized gains (losses) on investment securities
          available for sale                                                  $   (1,132)          $     170
                                                                              ==========           =========
     Cash dividends declared but not paid                                     $      236           $     241
                                                                              ==========           =========
     Cash dividends on unallocated ESOP shares                                $       24           $      16
                                                                              ==========           =========
     Transfer from loans held for sale to loans receivable                    $       --           $     686
                                                                              ==========           =========
      Transfer from loans to real estate acquired in settlement of loans      $      347           $      --
                                                                              ==========           =========
</TABLE>

See accompanying notes to the consolidated financial statements.

                                       5
<PAGE>
                     1ST STATE BANCORP, INC. AND SUBSIDIARY

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

              DECEMBER 31, 2001 (UNAUDITED) AND SEPTEMBER 30, 2001

NOTE 1.  NATURE OF BUSINESS

     1st State Bancorp,  Inc. (the "Company") was incorporated under the laws of
the Commonwealth of Virginia for the purpose of becoming the holding company for
1st State Bank (the  "Bank") in  connection  with the Bank's  conversion  from a
North Carolina-chartered mutual savings bank to a North Carolina-chartered stock
savings bank (the  "Converted  Bank")  pursuant to its Plan of  Conversion  (the
"Stock Conversion"). Upon completion of the Stock Conversion, the Bank converted
from  a  North  Carolina-chartered  stock  savings  bank  to  a  North  Carolina
commercial bank (the "Bank Conversion"),  retaining the name 1st State Bank (the
"Commercial  Bank"),  and the Commercial Bank succeeded to all of the assets and
liabilities of the Converted Bank. The Stock  Conversion and the Bank Conversion
were  consummated  on April 23,  1999.  The common  stock of the  Company  began
trading on the Nasdaq  National  Market  System under the symbol "FSBC" on April
26, 1999.

NOTE 2.  BASIS OF PRESENTATION

     The accompanying  consolidated  financial  statements (which are unaudited,
except for the  consolidated  balance  sheet at  September  30,  2001,  which is
derived from the September 30, 2001 audited consolidated  financial  statements)
have been prepared in accordance with accounting  principles  generally accepted
in the United States of America for interim  financial  information and with the
rules and  regulations of the Securities and Exchange  Commission.  Accordingly,
they do not include all of the information and footnotes  required by accounting
principles  generally  accepted  in the United  States of America  for  complete
financial  statements.  In the opinion of management,  all adjustments  (none of
which  were  other  than  normal  recurring   accruals)  necessary  for  a  fair
presentation of the financial position and results of operations for the periods
presented have been included.

     The results of  operations  for the three month period  ended  December 31,
2001 are not  necessarily  indicative of the results of  operations  that may be
expected for the year ended  September 30, 2002. The preparation of consolidated
financial statements in accordance with accounting principles generally accepted
in the United States of America requires  management to make certain  estimates.
These amounts may be revised in future  periods  because of changes in the facts
and circumstances underlying their estimation.

     Certain amounts in the December 31, 2000 consolidated  financial statements
(which are unaudited) have been  reclassified  to conform with the  presentation
adopted  in  2001.  Such   reclassifications   did  not  change  net  income  or
stockholders' equity as previously reported.

NOTE 3.  EARNINGS PER SHARE

     Earnings  per  share  computations  have  been  made  only for the  periods
subsequent  to the  Conversion.  For  purposes  of  computing  basic and diluted
earnings per share,  weighted average shares  outstanding  excludes  unallocated
ESOP  shares  that  have  not  been  committed  to  be  released.  The  deferred
compensation  obligation  discussed  in note 5 that is funded with shares of the
Company's  common  stock has no net impact on the  Company's  earnings per share
computations.  Diluted  earnings  per share  includes the  potentially  dilutive
effects of the Company's benefit plans. There were no antidilutive stock options
for the three months ended December 31, 2001 and 2000. A  reconciliation  of the
denominators  of the basic and diluted  earnings  per share  computations  is as
follows:
<TABLE>
<CAPTION>
                                                                                  2001              2000
                                                                                  ----              ----
         <S>                                                                    <C>               <C>
         Average shares issued and outstanding                                  3,289,607         3,289,607
         Less: Unvested MRP shares                                                (42,156)          (84,319)
         Less: Unallocated ESOP shares                                           (232,123)         (198,258)
                                                                                ---------         ---------

         Average basic shares for earnings per share                            3,015,328         3,007,030

         Add: Unvested MRP shares                                                  42,156            84,319
         Add: Potential common stock pursuant to stock
               option plan  (See Note 7)                                           88,550            60,936
                                                                                ---------         ---------
         Average dilutive shares for earnings per share                         3,146,034         3,152,285
                                                                                =========         =========
</TABLE>

                                       6
<PAGE>

NOTE 4.  EMPLOYEE STOCK OWNERSHIP PLAN ("ESOP")

     The Company  sponsors an employee stock ownership plan (the "ESOP") whereby
an aggregate  number of shares amounting to 253,050 or 8% of the stock issued in
the  conversion was purchased for future  allocation to employees.  The ESOP was
funded by an 11 year term loan from the Company in the amount of $4,899,000. The
loan is secured by the shares of stock purchased by the ESOP. In connection with
the special cash  dividend,  the ESOP  received  $1,308,000 on its shares of the
Company's  stock.  The ESOP  purchased  an  additional  64,415  shares with this
dividend.  During the three months ended  December 31, 2001 and 2000,  8,696 and
7,097 shares of stock were committed to be released and  approximately  $179,000
and $129,000 of compensation expense was recognized, respectively.

NOTE 5.  DEFERRED COMPENSATION

     Directors  and  certain  executive  officers   participate  in  a  deferred
compensation plan, which was approved by the Board of Directors on September 24,
1997.  This plan  generally  provides  for fixed  payments  beginning  after the
participant  retires.  Each  participant is fully vested in his account  balance
under the plan. Directors may elect to defer their directors' fees and executive
officers may elect to defer 25% of their salary and 100% of bonus compensation.

     Prior to the Conversion,  amounts deferred by each participant  accumulated
interest  at a rate equal to the  highest  rate of  interest  paid on the Bank's
one-year   certificates   of  deposit.   In  connection   with  the  Conversion,
participants  in the plan were given the opportunity to  prospectively  elect to
have their  deferred  compensation  balance  earn a rate of return  equal to the
total  return of the  Company's  stock.  All  participants  elected  this option
concurrent  with the  Conversion,  so the Company  purchases its common stock to
fund this  obligation.  Refer to the Company's notes to  consolidated  financial
statements,  incorporated  by reference in the  Company's  2001 Annual Report on
Form 10-K for a discussion  of the Company's  accounting  policy with respect to
this deferred  compensation plan and the related treasury stock purchased by the
Company to fund this obligation.

     The expense  related to this plan for the three months  ended  December 31,
2001 and 2000 was $92,000 and $68,000, respectively. This expense is included in
compensation expense.

NOTE 6.  MANAGEMENT RECOGNITION PLAN

     The Company has a Management  Recognition  Plan  ("MRP")  which serves as a
means of providing existing directors and officers of the bank with an ownership
interest in the  company.  On June 6, 2000,  restricted  stock awards of 126,482
shares  were  granted.  The  shares  awarded  under  the MRP  were  issued  from
authorized but unissued shares of common stock at no cost to the recipients. The
shares vest at a rate of 33 1/3% per year with a one-third immediate vest on the
date of the grant and annually thereafter.  Compensation expense of $260,000 and
$263,000  associated  with the MRP was  recorded  during the three  months ended
December 31, 2001 and 2000, respectively.

NOTE 7.  STOCK OPTION AND INCENTIVE PLAN

     On June 6, 2000 the Company's  stockholders approved the 1st State Bancorp,
Inc. 2000 Stock Option and Incentive Plan (the "Plan"). The purpose of this plan
is to  advance  the  interests  of the  Company  through  providing  select  key
employees and directors of the Bank with the opportunity to acquire  shares.  By
encouraging  such stock  ownership,  the Company  seeks to  attract,  retain and
motivate  the  best   available   personnel   for   positions   of   substantial
responsibility  and to provide  incentives to the key  employees and  directors.
Under the Plan, the Company  granted  316,312  options to purchase its $0.01 par
value common stock in fiscal year 2000. The exercise price per share is equal to
the fair market value per share on the date of the grant.  Options granted under
the Stock Option Plan are 100% vested on the date of the grant,  and all options
expire 10 years from the date of the  grant.  As a result of the  one-time  cash
dividend of $5.17 paid on October 2, 2000,  the  exercise  price for the options
repriced from $18.44 to $14.71.


                                       7
<PAGE>

NOTE 8. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

     In June  1998  the  Financial  Accounting  Standards  Board  (FASB)  issued
Statement of Financial  Accounting  Standards  (SFAS) No. 133,  "Accounting  for
Derivative  Instruments and Certain  Hedging  Activities." In June 1999 the FASB
issued SFAS No. 138, "Accounting for Certain Derivative  Instruments and Certain
Hedging  Activities,  an  Amendment  of SFAS 133." SFAS No. 133 and SFAS No. 138
require  that all  derivative  instruments  be recorded on the balance  sheet at
their  respective fair values.  Changes in the fair values of those  derivatives
will be reported in earnings or other comprehensive  income depending on the use
of the  derivative and whether the  derivative  qualifies for hedge  accounting.
SFAS No.  133 and SFAS No. 138 are  effective  for all  fiscal  quarters  of all
fiscal years beginning after June 30, 2000; the Company adopted SFAS No. 133, as
amended by SFAS No. 138, on October 1, 2000.

     On October 1, 2000,  the  Company had no  embedded  derivative  instruments
requiring separate accounting treatment and had identified fixed rate conforming
mortgage loan commitments as its only freestanding  derivative  instrument.  The
fair value of these  commitments  was not material and therefore the adoption of
SFAS No. 133 on October 1, 2000, did not have a material impact on the Company's
consolidated financial statements.  On December 31, 2001 and September 30, 2001,
the Company had no embedded derivative instruments requiring separate accounting
treatment  and  had  identified   commitments  to  originate  fixed  rate  loans
conforming to secondary  market  standards as its only  freestanding  derivative
instruments.  The Company does not currently engage in hedging  activities.  The
commitments  to  originate  fixed rate  conforming  loans  totaled  $925,000 and
$2,157,000 at December 31, 2001 and September 30, 2001,  respectively.  The fair
value of these  commitments  was less than $ 5,000 on these dates and  therefore
the impact of applying  SFAS 133 at December 31, 2001 and September 30, 2001 was
not material to the Company's consolidated financial statements.

NOTE 9. MORTGAGE SERVICING RIGHTS

     The rights to service  mortgage  loans for  others  are  included  in other
assets on the consolidated balance sheet. Mortgage servicing rights ("MSRs") are
capitalized  based on the allocated cost which is determined when the underlying
loans are sold. MSRs are amortized over a period which  approximates the life of
the underlying loan as an adjustment of servicing income.  Impairment reviews of
MSRs are performed on a quarterly  basis.  As of December 31, 2001 and September
30, 2001,  MSRs totaled  $266,000 and $209,000,  respectively,  and no valuation
allowance was required.


                                       8
<PAGE>

ITEM 2. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

FORWARD-LOOKING STATEMENTS

     When used in this Form 10-Q,  the words or phrases  "will  likely  result,"
"are expected to," "will continue," "is anticipated,"  "estimate,"  "project" or
similar expressions are intended to identify "forward-looking statements" within
the  meaning of the  Private  Securities  Litigation  Reform  Act of 1995.  Such
statements are subject to certain risks and  uncertainties  including changes in
economic  conditions  in our market  area,  changes in  policies  by  regulatory
agencies,  fluctuations in interest rates,  demand for loans in our market area,
and  competition  that could  cause  actual  results to differ  materially  from
historical  earnings and those  presently  anticipated or projected.  We wish to
caution you not to place undue reliance on any such forward-looking  statements,
which  speak  only as of the date made.  We wish to advise you that the  factors
listed above could affect our financial  performance  and could cause our actual
results for future periods to differ  materially from any opinions or statements
expressed with respect to future periods in any current statements.

     We do not undertake, and specifically disclaim any obligation,  to publicly
release  the result of any  revisions  which may be made to any  forward-looking
statements to reflect events or circumstances  after the date of such statements
or to reflect the occurrence of anticipated or unanticipated events.

GENERAL

     1st State Bancorp,  Inc. was formed in November 1998 and became the holding
company  for 1st State Bank on April 23,  1999.  As a result,  portions  of this
discussion  (as of dates and for periods  prior to April 23, 1999) relate to the
financial condition and results of operations of 1st State Bank.

     Our business consists  principally of attracting  deposits from the general
public and investing these funds in loans secured by  single-family  residential
and commercial real estate,  secured and unsecured commercial loans and consumer
loans. Our  profitability  depends primarily on our net interest income which is
the  difference  between  the  income  we  receive  on our loan  and  investment
securities  portfolios and our cost of funds, which consists of interest paid on
deposits  and  borrowed  funds.  Net  interest  income  also is  affected by the
relative amounts of interest-earning  assets and  interest-bearing  liabilities.
When interest-earning assets approximate or exceed interest-bearing liabilities,
any  positive  interest  rate spread will  generate  net  interest  income.  Our
profitability  also is  affected  by the  level of other  income  and  operating
expenses.  Other income consists of miscellaneous  fees related to our loans and
deposits,  mortgage  banking income and commissions  from sales of annuities and
mutual funds. Operating expenses consist of compensation and benefits, occupancy
related  expenses,   federal  deposit  insurance   premiums,   data  processing,
advertising and other expenses.

     Our operations are influenced  significantly  by local economic  conditions
and by policies of financial  institution  regulatory  authorities.  Our cost of
funds is  influenced  by interest  rates on competing  investments  and by rates
offered on similar investments by competing financial institutions in our market
area, as well as general market interest rates.  Lending activities are affected
by the demand for  financing  of real estate and other types of loans,  which in
turn is affected by the interest  rates at which such  financing may be offered.
The primary manner in which the economy impacts our business is our credit risk.
Most of our customers are small businesses in our immediate market area that are
more vulnerable to recent declines in the economy than larger,  more diversified
companies  whose  revenues are supported by customers in a variety of locations.
Our customer base includes  textile  companies  that are  continuing to feel the
negative  impact  of the NAFTA  legislation  and the  downturn  in our local and
regional economy. Such changes may impact future operations and earnings.

     Our business emphasis has been to operate as a well-capitalized, profitable
and independent  community-oriented financial institution dedicated to providing
quality customer service. We are committed to meeting the financial needs of the
communities  in which we operate.  We believe  that we can be more  effective in
servicing our  customers  than many of our nonlocal  competitors  because of our
ability to quickly  and  effectively  provide  senior  management  responses  to
customer needs and inquiries.  Our ability to provide these services is enhanced
by the stability of our senior management team.

     Beginning  in the late  1980's,  we have sought to  gradually  increase the
percentage of our assets  invested in commercial  real estate loans,  commercial
loans and consumer loans, which have shorter terms and adjust more frequently to
changes in interest rates than single-family residential mortgage loans.

                                       9
<PAGE>

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2001 AND SEPTEMBER 30, 2001

     Total  assets  increased  by $14.4  million or 4.3% from $336.8  million at
September  30,  2001 to $351.2  million  at  December  31,  2001.  Increases  in
investment securities and loans held for sale were partially offset by decreases
in cash and loans  receivable,  net.  Asset  growth was funded by  increases  in
deposits and borrowed money.

     Cash and cash  equivalents  decreased  $11.7  million,  or 45.0% from $26.0
million at September 30, 2001 to $14.3 million at December 31, 2001.  Because of
the decrease in the  overnight  interest  rate to 1.75% during the quarter ended
December  31,  2001,  we invested  excess cash in short term  government  agency
securities to increase our yield on these funds.

     Investment securities available for sale increased $28.0 million from $55.5
million at September 30, 2001 to $83.5 million at December 31, 2001.  During the
quarter ended  December 31, 2001, we purchased  $46.3 million of securities  and
received  $17.2  million  in  proceeds  from  maturities  and  issuer  calls  of
investment securities available for sale. We shifted funds from interest-bearing
overnight  funds into investment  securities  during the quarter to increase our
yield.

     Loans  receivable,  net  decreased by $8.7  million,  or 3.9%,  from $222.3
million at  September  30, 2001 to $213.6  million at December  31,  2001.  This
decrease was offset somewhat by a $7.5 million  increase in loans held for sale.
Loans held for sale increased  227.3% from $3.3 million at September 30, 2001 to
$10.8  million at December 31,  2001.  This  increase  resulted  from  increased
lending activity and timing differences in the funding of loan sales. During the
quarter  our  mortgage  originations  and  prepayments  were at  record  levels.
Mortgage  rates  declined  to record low levels  during  the  quarter,  and many
borrowers  took  advantage  of this  opportunity  to  refinance  their  existing
mortgage loans.

     Stockholders'  equity increased by $300,000 from $63.6 million at September
30,  2001 to $63.9  million at  December  31,  2001 as a result of net income of
$845,000,  release  of ESOP  shares of  $179,000,  and  vesting of MRP shares of
$194,000. These increases were offset by cash dividends declared of $236,000 and
a change in unrealized  losses on available for sale securities of $689,000.  In
the aftermath of the September 11, 2001 terrorist strikes, bond prices increased
sharply  that  created  the  Company's  unrealized  gain on  available  for sale
securities of $510,000 at September 30, 2001.  During the quarter ended December
31, 2001,  bond prices backed down to their previous  levels and the Company had
an unrealized  loss on available for sale securities of $179,000 at December 31,
2001.

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 AND
2000

     Net Income.  We  recorded  net income of  $845,000  for the  quarter  ended
December 31, 2001,  as compared to $901,000 for the quarter  ended  December 31,
2000,  representing  a decrease of $56,000,  or 6.2%. For the three months ended
December  31, 2001,  basic and diluted  earnings per share were $0.28 and $0.27,
respectively.  The Company reported basic and diluted earnings per share for the
quarter ended December 31, 2000 of $0.30 and $0.29,  respectively.  The decrease
in net  income  resulted  primarily  from  decreased  net  interest  income  and
increased income taxes that were offset partially by increased other income. The
decline in net interest income resulted from lower net interest  margins.  These
decreased  margins resulted  primarily from the eleven interest rate cuts by the
Federal Reserve during calendar 2001. These rate cuts caused a greater reduction
in the average yield on earning assets than in the average rate paid on interest
bearing liabilities.

     Net Interest Income.  Net interest income,  the difference between interest
earned  on  loans  and  investments   and  interest  paid  on   interest-bearing
liabilities,  decreased by $400,000 or 12.4% for the three months ended December
31, 2001,  compared to the same quarter in the prior year. This decrease results
from a $1.3 million decrease in interest income that was partially offset by the
$910,000  decrease in total  interest  expense.  The average net  interest  rate
spread  decreased 37 basis points from 3.15% for the three months ended December
31, 2000 to 2.78% for the quarter ended December 31, 2001.

     Interest Income. The decrease in interest income for the three months ended
December  31,  2001 was the  result of an  increase  of $4.6  million in average
interest-earning  assets compared to the same quarter in the prior year that was
offset by a decrease in yield on interest-earning assets of 1.72% from 8.08% for
the three  months  ended  December  31, 2000 to 6.36% for the three months ended
December 31,  2001.  The  increased  volume of average  interest-earning  assets
increased  interest  income by  approximately  $30,000 and the  decreased  yield
decreased interest income by approximately $1.3 million.  An increase in average
investment  securities  of $6.8  million  coupled  with an  increase  in average
interest-bearing  overnight  funds of $4.9  million  increased  interest-earning
assets for the quarter  compared to the prior year.  These increases were offset
in part

                                       10
<PAGE>

by a decrease in average loans receivable of $7.2 million.  Our average mortgage
loans  decreased by $11.2  million  during the quarter  ended  December 31, 2001
compared to the quarter ended December 31, 2000. We experienced  unusually heavy
prepayments  during the quarter as borrowers  took  advantage of the  attractive
mortgage  rates and  refinanced  existing  mortgage  loans.  The majority of the
mortgage loans originated  during the quarter were sold in the secondary market.
Average  commercial  loans increased $4.8 million for the quarter ended December
31, 2001 as compared to the same quarter in the prior year.

     Interest  Expense.  Interest  expense  decreased  in the three months ended
December 31, 2001 due to a decrease in average  interest-bearing  liabilities of
$1.7 million and a decrease in the cost of  interest-bearing  liabilities of 135
basis points from 4.93% for the three  months  ended  December 31, 2000 to 3.58%
for the three months ended December 31, 2001. Average interest-bearing  deposits
decreased by $98,000 and average FHLB  advances  decreased  $1.6 million for the
three months ended  December 31, 2001  compared to the same quarter in the prior
year. The decrease in average  interest-bearing  liabilities  decreased interest
expense  by  approximately  $23,000  and the  decrease  in the  average  cost of
interest-bearing   liabilities   decreased  interest  expense  by  approximately
$887,000.  During the quarter  ended  December  31, 2001,  average  money market
investment accounts increased by $9.8 million over the comparable quarter in the
prior year.  The lower rate  environment  caused some  depositors  to shift from
longer term fixed rate certificates of deposit into the more liquid money market
accounts. We have continued to attract some commercial customers that had excess
liquidity  during the quarter  ended  December  31, 2001 which they  invested in
money market accounts. Average certificates of deposit decreased $9.8 million in
the three months ended December 31, 2001 compared to the previous quarter in the
prior year. The level of  certificates  of deposits  obtained from  governmental
units depends upon many factors  including  the level of interest  rates and the
Bank's loan demand.  The average  balance of time deposits held by  governmental
units decreased $13.6 million in the quarter ended December 31, 2001 as compared
with the same quarter in the prior year.  This was offset in part by an increase
of $3.8 million in the average balance of other certificates of deposits.


                                       11
<PAGE>
The following table presents average  balances and average rates  earned/paid by
the Company  for the quarter  ended  December  31, 2001  compared to the quarter
ended December 31, 2000.
<TABLE>
<CAPTION>
                                                      THREE MONTHS ENDED                       THREE MONTHS ENDED
                                                        DECEMBER 31, 2001                       DECEMBER 31, 2000
                                                                             DOLLARS IN THOUSANDS
                                                   AVERAGE                 YIELD/        AVERAGE                 YIELD/
                                                   BALANCE    INTEREST      COST         BALANCE   INTEREST       COST
<S>                                                <C>         <C>          <C>          <C>         <C>          <C>
Assets:
Loans receivable (1)                               $224,268    $3,889        6.94%       $231,424    $5,090        8.80%
Investment securities (2)                            85,387     1,222        5.72          78,560     1,217        6.20
Interest-bearing overnight deposits                  17,288        90        2.08          12,340       203        6.59
                                                   --------    ------        ----        --------    ------        ----
  Total interest-earning assets (4)                 326,943     5,201        6.36         322,324     6,510        8.08
Non interest-earning assets                          21,785                                21,881
                                                   --------                              --------
  Total assets                                     $348,728                              $344,205
                                                   ========                              ========

Liabilities and stockholders' equity
Interest bearing checking                            30,839        15        0.19          30,469        92        1.21
Money market investment accounts                     28,732       144        2.00          18,912       255        5.40
Passbook and statement savings                       26,218       111        1.69          26,718       159        2.38
Certificates of deposit                             158,868     1,824        4.59         168,656     2,471        5.86
FHLB advances                                        20,054       276        5.51          21,630       303        5.60
                                                   --------    ------        ----        --------    ------        ----
  Total interest-earning liabilities                264,711     2,370        3.58         266,385     3,280        4.93
Non interest-earning liabilities                     20,101                                17,995
                                                   --------                              --------
  Total liabilities                                 284,812                               284,380
Stockholders' equity                                 63,916                                59,825
                                                   --------                              --------
  Total liabilities and stockholders' equity       $348,728                              $344,205
                                                   ========                              ========

Net interest income                                             2,831                                 3,230
Interest rate spread                                                         2.78%                                 3.15%
Net interest margin (3)                                                      3.46%                                 4.01%
Ratio of average interest-earning assets                                   123.51%                               121.00%
<FN>
(1)  Includes  nonaccrual  loans and loans held for sale,  net of discounts  and
     allowance for loan losses.
(2)  Includes FHLB of Atlanta stock.
(3)  Represents  net  interest   income  divided  by  the  average   balance  of
     interest-earning assets.
(4)  Due to immateriality, the interest income and yields related to certain tax
     exempt assets have not been adjusted to reflect a fully taxable  equivalent
     yield.
</FN>
</TABLE>
     Provision for Loan Losses. We charge provisions for loan losses to earnings
to maintain the total allowance for loan losses at a level we consider  adequate
to absorb  probable  losses based on prior loss  experience,  volume and type of
lending we conduct,  industry standards,  current economic conditions,  past due
loans in our loan  portfolio  and  other  factors.  Provisions  for loan  losses
totaled $60,000 for both the three months ended December 31, 2001 and 2000.

     Other Income. Other income increased $402,000,  or 88.0%, from $457,000 for
the quarter ended  December 31, 2000 to $859,000 for the quarter ended  December
31, 2001.  Mortgage banking income, net increased $288,000 from $128,000 for the
quarter ended  December 31, 2000 to $416,000 for the quarter ended  December 31,
2001.  During the quarter ended December 31, 2001, we sold  fixed-rate  mortgage
loans held for sale of $25.3 million and recognized net gains of $416,000 on the
sale of these  loans.  During the  quarter  ended  December  31,  2000,  we sold
fixed-rate mortgage loans held for sale of $6.2 million and recognized net gains
of  $128,000  from the sale of these  loans.  Customer  service  fees  increased
$93,000,  or 59.6% from  $156,000  for the quarter  ended  December  31, 2001 to
$249,000 for the quarter ended  December 31, 2000.  This  increase  results from
growth in the number of transaction accounts and increased service charges.

                                       12
<PAGE>

     Operating  Expenses.  Total  operating  expenses  were $2.3 million for the
quarter ended  December 31, 2001, an increase of $14,000,  or 0.6% over the $2.2
million  recorded for the three months ended  December 31, 2000.  Occupancy  and
equipment expense increased $26,000, or 9.4% from $277,000 for the quarter ended
December 31, 2000 to $303,000  for the quarter  ended  December  31, 2001.  This
increase was primarily the result of increased depreciation expense from the new
check imaging  hardware and software,  which was not present in the same quarter
of the prior year. Expenses incurred in operating real estate owned were $18,000
for the three months ended December 31, 2001 which were not present in the prior
year.

     Income Tax Expense.  Income tax expense  increased $44,000 from tax expense
of $483,000 for the quarter ended  December 31, 2000 to $527,000 for the quarter
ended  December 31, 2001.  The  effective tax rates were 38.4% and 34.9% for the
quarters  ended  December 31, 2001 and 2000,  respectively.  The increase in the
effective rate was primarily due to an increase in non-deductible  expenses over
the prior period.

ASSET QUALITY

     At December 31, 2001, we had  approximately  $2.7 million in non-performing
assets  (nonaccrual  loans and real estate owned) or 0.77% of total  assets.  At
September  30, 2001,  non-performing  assets were $2.9 million or 0.85% of total
assets. At December 31, 2001 and September 30, 2001, impaired loans totaled $3.7
million and $2.5  million,  respectively,  as defined by  Statement of Financial
Accounting  Standards  No. 114,  "Accounting  by Creditors  for  Impairment of a
Loan." The  impaired  loans at  December  31,  2001  result  from two  unrelated
commercial loan  customers,  both of which have loans secured by commercial real
estate and business assets in Alamance County. At December 31, 2001, none of the
impaired  loans is on  non-accrual  status,  and their related  reserve for loan
losses totaled $150,000.  There was no impact on the provision as management had
already  anticipated  the loans'  performance  in setting the allowance for loan
losses in previous  periods.  The average  carrying  value of impaired loans was
$3.0 million during the three months ended December 31, 2001. Interest income of
$59,000 has been recorded on impaired  loans in the three months ended  December
31, 2001. The Bank's net chargeoffs for the three months ended December 31, 2001
and 2000 were $84,000 and $32,000,  respectively.  The allowance for loan losses
was $3.6  million or 1.65% of  outstanding  loans at  December  31,  2001.  This
compares to 1.60% at September  30, 2001 and 1.53% at December  31,  2000.  As a
result of our continued shift toward higher risk  commercial,  consumer and home
equity loans and the recent runoff of residential  mortgage loans as well as the
continued decline in the local and regional economy,  the ratio of the allowance
for the loan losses to total loans,  net of loans in process and  deferred  loan
fees  increased to 1.65% at December 31, 2001 compared to 1.60% at September 30,
2001.

     The following table presents an analysis of our nonperforming assets:
<TABLE>
<CAPTION>
                                                           At                      At                      At
                                                      December 31,            September 30,           December 31,
                                                          2001                    2001                    2000
                                                          ----                    ----                    ----
<S>                                                      <C>                    <C>                   <C>
Nonperforming loans:

Nonaccrual loans                                         $   380                $    878              $   2,963
Loans 90 days past due and accruing
                                                               -                       -                      -
Restructured loans
                                                               -                       -                      -

Total nonperforming loans
                                                             380                     878                  2,963

Other real estate                                          2,328                   1,981                     70
                                                         -------                 -------                -------

Total nonperforming assets                               $ 2,708                $  2,859                $ 3,033
                                                         =======                ========                =======

Nonperforming loans to loans receivable, net                0.18%                   0.39%                  1.29%
Nonperforming assets as a percentage
 of loans and other real estate owned                       1.25%                   1.27%                  1.32%
Nonperforming assets to total assets                        0.77%                   0.85%                  0.87%
</TABLE>

                                       13
<PAGE>

Regulations  require that we classify our assets on a regular  basis.  There are
three  classifications  for problem assets:  substandard,  doubtful and loss. We
regularly   review  our  assets  to   determine   whether  any  assets   require
classification or re-classification.  At December 31, 2001, we had $ 3.3 million
in classified  assets  consisting of $957,000 in substandard  and loss loans and
$2.3 million in real estate owned.

In addition to regulatory classifications, we also classify as "special mention"
and "watch"  assets  that are  currently  performing  in  accordance  with their
contractual  terms but may  become  classified  or  nonperforming  assets in the
future. At December 31, 2001, we have identified  approximately  $4.6 million in
assets classified as special mention and $33.2 million as watch. Included in the
watch asset total are five loans with an aggregate  outstanding  balance of $3.8
million at December 31, 2001 to a company  affiliated with one of our directors.
In addition,  the director has the ability to borrow an additional $246,000 from
us under a line of  credit.  All the loans are  secured  by a first  lien on all
company assets, including accounts receivable,  inventory,  equipment, furniture
and real  property  occupied by the  borrower.  In  addition,  the  director has
personally  guaranteed  repayment of the loans. At December 31, 2001, such loans
were  current  with  respect  to their  payment  terms  and were  performing  in
accordance  with  the  related  loan  agreements.  Based on an  analysis  of the
borrower's current financial statements received in January 2002, management has
concerns  that the borrower may have  difficulty  in complying  with the present
loan repayment  terms on an ongoing basis.  Accordingly,  this loan may become a
nonperforming  asset in future  periods.  Management  will  continue  to closely
monitor the performance of these loans in future periods.

LIQUIDITY AND CAPITAL RESOURCES

     The Bank must meet certain liquidity requirements  established by the State
of North Carolina Office of the Commissioner of Banks (the  "Commissioner").  At
December  31, 2001,  the Bank's  liquidity  ratio  exceeded  such  requirements.
Liquidity generally refers to the Bank's ability to generate adequate amounts of
funds to meet its cash needs.  Adequate  liquidity  guarantees  that  sufficient
funds are available to meet deposit withdrawals, fund loan commitments, maintain
adequate reserve  requirements,  pay operating expenses,  provide funds for debt
service, pay dividends to stockholders and meet other general commitments.

     Our primary sources of funds are deposits,  principal and interest payments
on loans, proceeds from the sale of loans, and to a lesser extent, advances from
the FHLB of Atlanta.  While  maturities and scheduled  amortization of loans are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by general interest rates, economic conditions and local competition.

     Our most liquid assets are cash and cash  equivalents.  The levels of these
assets  are  dependent  on  our  operating,  financing,  lending  and  investing
activities  during  any  given  period.  At  December  31,  2001,  cash and cash
equivalents  totaled $14.3 million. We have other sources of liquidity should we
need additional funds. During the three months ended December 31, 2001 and 2000,
we sold loans totaling $25.3 million and $6.2 million, respectively.  Additional
sources of funds  include FHLB of Atlanta  advances.  Other sources of liquidity
include loans and investment  securities designated as available for sale, which
totaled $94.3 million at December 31, 2001.

     We  anticipate  that we will have  sufficient  funds  available to meet our
current  commitments.  At December 31, 2001, we had $11.7 million in commitments
to originate new loans,  $59.0 million in unfunded  commitments to extend credit
under  existing  equity  lines and  commercial  lines of credit and  $220,000 in
standby letters of credit. At December 31, 2001,  certificates of deposit, which
are scheduled to mature within one year, totaled $131.5 million. We believe that
a significant portion of such deposits will remain with us.

     The FDIC requires the Bank to meet a minimum leverage  capital  requirement
of Tier I capital to assets ratio of 4%. The FDIC also requires the Bank to meet
a ratio of total capital to  risk-weighted  assets of 8%, of which 4% must be in
the form of Tier I capital.  The Commissioner  requires the Bank at all times to
maintain  certain minimum  capital  levels.  The Bank was in compliance with all
capital  requirements of the FDIC and the  Commissioner at December 31, 2001 and
is deemed to be "well capitalized."

     The Federal Reserve also mandates capital  requirements on all bank holding
companies,  including 1st State  Bancorp,  Inc. These capital  requirements  are
similar to those  imposed by the FDIC on the Bank.  At December  31,  2001,  the
Company was in compliance with the capital requirements of the Federal Reserve.

     On October 2, 2000, the Company paid a one-time  special cash  distribution
of $5.17 to its stockholders.  The distribution was made to manage the Company's
capital and enhance  shareholder  value.  Returning  capital to the stockholders
reduced the


                                       14
<PAGE>

Company's  equity to asset ratio from 21.2% to 17.2%.  The  Company's  equity to
asset  ratio at December  31, 2001 was 18.2%.  The  Company's  capital  level is
sufficient to support future growth.

     The Company has declared cash  dividends per common share of $0.08 for each
of the three months ended December 31, 2001, September 30, 2001 and December 31,
2000. The Company's  ability to pay dividends is dependent  upon  earnings.  The
Company's  dividend  payout ratio for the three months ended  December 31, 2001,
September  30,  2001  and  December  31,  2000  was  29.6%,   32.0%  and  27.6%,
respectively.

ACCOUNTING ISSUES

     The FASB has issued  Statements of Accounting  Standards No. 141,  Business
Combinations  (SFAS 141) and No. 142, Goodwill and Other Intangible Assets (SFAS
142).  SFAS 141 requires that the purchase  method of accounting be used for all
business  combinations  initiated  after June 30,  2001 as well as all  purchase
method  business  combinations  completed after June 30, 2001. SFAS 141 requires
that intangible  assets that meet certain criteria be recognized as assets apart
from  goodwill.  SFAS 142  addresses  financial  accounting  and  reporting  for
acquired goodwill and other intangible assets. SFAS 142 addresses how intangible
assets that are acquired  individually  or with a group of other assets (but not
those acquired in a business  combination)  should be accounted for in financial
statements  upon their  acquisition.  SFAS 142 also  addresses  how goodwill and
other  intangible  assets should be accounted for after they have been initially
recognized  in the  financial  statements.  SFAS 142 is  required  to be applied
starting  with  fiscal  years  beginning  after  December  15,  2001,  and early
application  is permitted for entities with fiscal years  beginning  after March
31,  2001,  under  certain  conditions.   Impairment  losses  for  goodwill  and
intangible  assets with  indefinite  useful  lives that arise due to the initial
application of SFAS 142 (resulting from a transitional  impairment  test) are to
be  reported  as the  cumulative  effect  of a change in  accounting  principle.
Adoption of SFAS 141 and SFAS 142 are not expected to have a material  impact on
the Company's consolidated financial statements.

     On October 3, 2001,  the FASB  issued  Statement  of  Financial  Accounting
Standards  No. 144,  Accounting  for the  Impairment  or Disposal of  Long-Lived
Assets (SFAS No. 144),  which addresses  financial  accounting and reporting for
the impairment or disposal of long-lived  assets.  While SFAS No. 144 supersedes
SFAS No. 121 (Accounting  for the Impairment of Long-Lived  Assets and for Long-
Lived Assets to Be Disposed Of), it retains many of the  fundamental  provisions
of SFAS No. 121.

     SFAS No. 144 also  supersedes the  accounting  and reporting  provisions of
FASB Opinion No. 30 (Reporting the Results of Operations - Reporting the Effects
of  Disposal  of a  Segment  of  a  Business,  and  Extraordinary,  Unusual  and
Infrequently Occurring Events and Transactions) for the disposal of a segment of
a  business.  However,  it retains the  requirement  in Opinion No. 30 to report
separately  discontinued  operations and extends the reporting to a component of
an entity  that  either  has been  disposed  of (by sale,  abandonment,  or in a
distribution  to owners) or is classified  as held for sale.  By broadening  the
presentation of discontinued  operations to include more disposal  transactions,
the FASB has enhanced  management's  ability to provide  information  that helps
financial statement users to assess the effects of disposal  transactions on the
ongoing  operations of an entity.  The  provisions of SFAS No. 144 are effective
for financial  statements  issued for fiscal years  beginning after December 15,
2001, and interim periods within those fiscal years. Adoption of SFAS No. 144 is
not expected to have a material impact on the Company's  consolidated  financial
statements.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The Company  monitors whether material changes in market risk have occurred
since September 30, 2001. The Company does not believe that any material adverse
changes in market risk exposures occurred since September 30, 2001.


                                       15
<PAGE>

                           PART II. OTHER INFORMATION

         ITEM 1.  LEGAL PROCEEDINGS

         None

         ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

         None

         ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

         None

         ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         None

         ITEM 5.  OTHER INFORMATION

         None.

         ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

         (a.)     Exhibits. None.


         (b.)     Reports on Form 8-K.  During the quarter ended December 31,
                  2001, the registrant did not file any current reports on
                  Form 8-K.


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<PAGE>
                                   SIGNATURES



     Pursuant to the  requirements  of the Exchange Act, the  registrant  caused
this  report to be  signed on its  behalf  by the  undersigned,  thereunto  duly
authorized.

                                    1ST STATE BANCORP, INC.


                                    /s/ James C. McGill
Date:  February 14, 2002            ---------------------------------------
                                    James C. McGill
                                    President and Chief Executive Officer
                                    (Principal Executive Officer)


                                    /s/ A. Christine Baker
Date:  February 14, 2002            ---------------------------------------
                                    A. Christine Baker
                                    Executive Vice President
                                    Treasurer and Secretary
                                    (Principal Financial and Accounting Officer)


                                       17