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 June 30, 2003


 [ ]     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
                                             ----   ----
     Indicate by check mark whether the registrant is an  accelerated  filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

     As of August 8,  2003,  the  issuer had  2,973,066  shares of common  stock
issued and outstanding.


<PAGE>

                                    CONTENTS
                                                                           PAGE
                                                                           -----

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

Item 1.  Financial Statements

         Consolidated Balance Sheets as of June 30, 2003 (unaudited)
          and September 30, 2002...............................................3

         Consolidated Statements of Income for the Three Months
          Ended June 30, 2003 and 2002 (unaudited).............................4

         Consolidated Statements of Income for the Nine Months
          Ended June 30, 2003 and 2002 (unaudited).............................5

         Consolidated Statements of Stockholders' Equity and
          Comprehensive Income for the Nine Months Ended
          June 30, 2003 and 2002 (unaudited)...................................6

         Consolidated Statements of Cash Flows for the Nine Months
          Ended June 30, 2003 and 2002 (unaudited).............................7

         Notes to Consolidated Financial Statements............................9

Item 2.  Management's Discussion and Analysis of Financial Condition
          and Results of Operations...........................................13

Item 3.  Quantitative and Qualitative Disclosures About Market Risk...........24

Item 4.  Controls and Procedures..............................................25


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

Item 1.  Legal Proceedings....................................................26

Item 2.  Changes in Securities and Use of Proceeds............................26

Item 3.  Defaults Upon Senior Securities......................................26

Item 4.  Submission of Matters to a Vote of Security Holders..................26

Item 5.  Other Information....................................................26

Item 6.  Exhibits and Reports on Form 8-K.....................................26


SIGNATURES....................................................................27

                                       2
<PAGE>
                     1st STATE BANCORP, INC. AND SUBSIDIARY

                           CONSOLIDATED BALANCE SHEETS
                      JUNE 30, 2003 AND SEPTEMBER 30, 2002
                        (In Thousands, except share data)
<TABLE>
<CAPTION>

                                                                                   AT                    AT
                                                                                JUNE 30,           SEPTEMBER 30,
                                                                                  2003                  2002
                                                                           ------------------     ---------------

                                                                             (Unaudited)
                                      ASSETS
<S>                                                                             <C>                     <C>

Cash and cash equivalents                                                   $    32,058              18,865
Investment securities:
     Held to maturity (fair value of $15,527 and $11,558
         at  June 30, 2003 and September 30, 2002, respectively)                 15,098              11,114
     Available for sale (cost of $60,024 and $77,213
         at June 30, 2003 and September 30, 2002, respectively)                  60,739              78,572
Loans held for sale, at lower of cost or fair value                               9,484               6,798
Loans receivable (net of allowance for loan losses of $3,902
    and $3,732 at June 30, 2003 and September 30, 2002,
    respectively)                                                               223,661             220,047
Real estate owned                                                                    80                 183
Federal Home Loan Bank stock, at cost                                             1,000               1,750
Premises and equipment                                                            8,448               7,972
Accrued interest receivable                                                       1,549               2,272
Other assets                                                                      2,803               2,896
                                                                            -----------          ----------
             Total assets                                                   $   354,920             350,469
                                                                            ===========          ==========

                LIABILITIES AND STOCKHOLDERS' EQUITY

Liabilities:
  Deposit accounts                                                              260,211             260,667
  Advances from Federal Home Loan Bank                                           20,000              20,000
  Advance payments by borrowers for property taxes and insurance                    336                  54
  Dividend payable                                                                  297                 241
  Other liabilities                                                              10,953               7,938
                                                                            -----------          ----------
          Total liabilities                                                     291,797             288,900
                                                                            -----------          ----------

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;
         2,975,600 and 3,008,682 shares issued and outstanding
         at  June 30, 2003 and September 30, 2002, respectively                      33                  33
   Additional paid-in capital                                                    35,730              35,623
   Unallocated ESOP shares                                                       (3,291)             (3,739)
   Deferred compensation payable in treasury stock                                5,466               5,466
   Treasury stock                                                               (12,695)            (11,899)
   Retained income - substantially restricted                                    37,445              35,258
   Accumulated other comprehensive income - net unrealized
        gain on investment securities available for sale                            435                 827
                                                                            -----------          ----------

        Total stockholders' equity                                               63,123              61,569
                                                                            -----------          ----------
        Total liabilities and stockholders' equity                          $   354,920             350,469
                                                                            ===========          ==========

See accompanying notes to the consolidated financial statements.

</TABLE>
                                       3
<PAGE>
                     1st STATE BANCORP, INC. AND SUBSIDIARY

                        CONSOLIDATED STATEMENTS OF INCOME
                FOR THE THREE MONTHS ENDED JUNE 30, 2003 AND 2002
                      (In Thousands, Except per Share Data)

                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                          FOR THE THREE MONTHS ENDED
                                                                                  JUNE 30,
                                                                       ------------------------------
                                                                          2003                2002
                                                                       ----------         -----------
<S>                                                                          <C>              <C>
Interest income:
   Interest and fees on loans                                          $   3,097              3,502
   Interest and dividends on investments                                     982              1,413
   Overnight deposits                                                         43                 50
                                                                       ---------          ---------
         Total interest income                                             4,122              4,965
                                                                       ---------          ---------

Interest expense:
    Deposit accounts                                                       1,040              1,475
    Borrowings                                                               273                281
                                                                       ---------          ---------
         Total interest expense                                            1,313              1,756
                                                                       ---------          ---------

         Net interest income                                               2,809              3,209

Provision for loan losses                                                     60                 60
                                                                       ---------          ---------
         Net interest income after provision for loan losses               2,749              3,149
                                                                       ---------          ---------

Other income:
   Customer service fees                                                     218                209
   Commissions from sales of annuities and mutual funds                      100                131
   Mortgage banking income, net                                              457                171
   Securities gains, net                                                     103                 --
   Other                                                                      65                 47
                                                                       ---------          ---------
         Total other income                                                  943                558
                                                                       ---------          ---------

Operating expenses:
   Compensation and related benefits                                       1,348              1,512
   Occupancy and equipment                                                   353                315
   Real estate operations, net                                                (2)               (24)
   Other expenses                                                            443                376
                                                                       ---------          ---------
         Total operating expenses                                          2,142              2,179
                                                                       ---------          ---------

         Income before income taxes                                        1,550              1,528

Income taxes                                                                 562                542
                                                                       ---------          ---------

         Net income                                                    $     988                986
                                                                       =========          =========

         Earnings per share:

         Basic                                                         $    0.35          $    0.32
         Diluted                                                       $    0.34          $    0.31
</TABLE>

See accompanying notes to the consolidated financial statements.

                                       4
<PAGE>

                     1st STATE BANCORP, INC. AND SUBSIDIARY

                        CONSOLIDATED STATEMENTS OF INCOME
                FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
                      (In Thousands, Except per Share Data)

                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                         FOR THE NINE MONTHS ENDED
                                                                                  JUNE 30,
                                                                       ----------------------------
                                                                          2003               2002
                                                                       ----------         ---------
<S>                                                                    <C>                   <C>
Interest income:
   Interest and fees on loans                                          $   9,764             10,934
   Interest and dividends on investments                                   3,194              3,993
   Overnight deposits                                                        128                191
                                                                       ---------          ---------
         Total interest income                                            13,086             15,118
                                                                       ---------          ---------

Interest expense:
    Deposit accounts                                                       3,500              5,248
    Borrowings                                                               825                843
                                                                       ---------          ---------
         Total interest expense                                            4,325              6,091
                                                                       ---------          ---------

         Net interest income                                               8,761              9,027

Provision for loan losses                                                    180                180
                                                                       ---------          ---------
         Net interest income after provision for loan losses               8,581              8,847
                                                                       ---------          ---------

Other income:
   Customer service fees                                                     648                675
   Commissions from sales of annuities and mutual funds                      346                351
   Mortgage banking income, net                                            1,350                950
   Securities gains, net                                                     103                 47
   Other                                                                     183                153
                                                                       ---------          ---------
         Total other income                                                2,630              2,176
                                                                       ---------          ---------

Operating expenses:
   Compensation and related benefits                                       4,149              4,660
   Occupancy and equipment                                                 1,088                929
   Real estate operations, net                                                 7                (56)
   Other expenses                                                          1,282              1,153
                                                                       ---------          ---------
         Total operating expenses                                          6,526              6,686
                                                                       ---------          ---------

         Income before income taxes                                        4,685              4,337

Income taxes                                                               1,717              1,582
                                                                       ---------          ---------

Net income                                                             $   2,968              2,755
                                                                       =========          =========

Earnings per share:
         Basic                                                         $    1.06          $    0.91
         Diluted                                                       $    1.01          $    0.87

See accompanying notes to the consolidated financial statements.

</TABLE>
                                       5
<PAGE>



<TABLE>
<CAPTION>
                                                              1st STATE BANCORP, INC. AND SUBSIDIARY
                                          CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
                                                FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002 (UNAUDITED)
                                                                       (In Thousands)
                                                                                                           Deferred
                                                                                                         compensation
                                                             Additional   Unallocated       Unearned       payable in
                                                  Common       paid-in       ESOP         Compensation      treasury
                                                   stock       capital      shares            MRP           stock
                                                   -----       -------      ------            ---           ------

<S>                                                  <C>          <C>          <C>            <C>               <C>

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 $22                   --            --            --              --             --


     Total comprehensive income
Allocation of ESOP shares                           --            22           478              --             --
Deferred compensation                               --            --            --              --            298
Acquisition of treasury shares                      --            --            --              --             --
Vesting of MRP shares                               --            --            --             518             --
Cash dividends declared ($0.24 per share)           --            --            --              --             --
Cash dividends on unallocated ESOP shares
     and unvested MRP shares                        --            --            --              --             --
                                                   ---        ------       -------           -----          -----

Balance at June 30, 2002                           $33        35,610        (3,895)             --          4,471
                                                   ===        ======       =======           =====          =====

Balance at September 30, 2002                      $33        35,623        (3,739)             --          5,466

Comprehensive income:
     Net income                                     --            --            --              --             --
     Other comprehensive loss-unrealized
       loss on securities available-for-sale
       net of income taxes of $252                  --            --            --              --             --

     Total comprehensive income

Allocation of ESOP shares                           --           107           448              --             --

Acquisition of treasury shares                      --            --            --              --             --
Cash dividends declared ($0.28 per share)           --            --            --              --             --

Cash dividends on unallocated ESOP shares           --            --            --              --             --
                                                   ---        ------       -------           -----          -----

Balance at June 30, 2003                           $33        35,730        (3,291)             --          5,466
                                                   ===        ======       =======           =====          =====

<CAPTION>

                                                                                               Accumulated
                                                                                                  other           Total
                                                               Treasury        Retained       comprehensive   stockholders'
                                                                stock           Income        income (loss)      equity
                                                                ------          ------        -------------      ------
<S>                                                              <C>             <C>              <C>              <C>

Balance at September 30, 2001                                  (4,173)         32,404             510           63,644

Comprehensive income:

     Net income                                                    --           2,755              --            2,755
     Other comprehensive loss-unrealized
       loss on securities available-for-sale
       net of income taxes of $22                                  --              --             (32)             (32)
                                                                                                                ------
     Total comprehensive income                                                                                  2,723
Allocation of ESOP shares                                          --              --              --              500
Deferred compensation                                              --              --              --              298
Acquisition of treasury shares                                   (298)             --              --             (298)
Vesting of MRP shares                                              --              --              --              518
Cash dividends declared ($0.24 per share)                          --            (790)             --             (790)
Cash dividends on unallocated ESOP shares
     and unvested MRP shares                                       --              69              --               69
                                                             --------          ------             ---           ------

Balance at June 30, 2002                                       (4,471)         34,438             478           66,664
                                                             ========          ======             ===           ======

Balance at September 30, 2002                                 (11,899)         35,258             827           61,569

Comprehensive income:
     Net income                                                    --           2,968              --            2,968
     Other comprehensive loss-unrealized
       loss on securities available-for-sale net
       of income taxes of $252                                     --              --            (392)            (392)
                                                                                                                ------
     Total comprehensive income
                                                                                                                 2,576
Allocation of ESOP shares                                          --              --              --              555
Acquisition of treasury shares                                   (796)             --              --             (796)
Cash dividends declared ($0.28 per share)                          --            (834)             --             (834)
Cash dividends on unallocated ESOP shares                          --              53              --               53
                                                             --------          ------             ---           ------

Balance at June 30, 2003                                      (12,695)         37,445             435           63,123
                                                             ========          ======             ===           ======
</TABLE>
See accompanying notes to the consolidated financial statements.
                                       6
<PAGE>
                     1st STATE BANCORP, INC. AND SUBSIDIARY

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
                                   (UNAUDITED)

                                 (In Thousands)
<TABLE>
<CAPTION>
                                                                                FOR THE NINE MONTHS ENDED
                                                                                         JUNE 30,
                                                                                 2003               2002
                                                                              ---------          -----------

 <S>                                                                              <C>               <C>
Cash flows from operating activities:
   Net income                                                               $    2,968               2,755
   Adjustment to reconcile net income to net cash provided by
       operating activities:
           Provision for loan losses                                               180                 180
           Depreciation                                                            557                 474
           Deferred tax expense                                                    137                 495
           Amortization of premiums and discounts, net                             (34)                (23)
           Deferred compensation                                                   180                 236
           Release of ESOP shares                                                  555                 500
           Vesting of MRP shares and dividends on unvested MRP shares               --                 712
           Loan origination fees and unearned discounts
               deferred, net of current amortization                               (66)                (63)
           Loss (gain) on sale of other real estate                                 11                  (4)
           Securities gains, net                                                  (103)                (47)
           Net (gain) loss on sale of loans                                       (302)                227
           Proceeds from loans held for sale                                    73,457              49,134
           Originations of loans held for sale                                 (75,841)            (47,264)
           Decrease (increase) in other assets                                     208                 (41)
           Decrease in accrued interest receivable                                 723                 371
           Increase in other liabilities                                         2,835                 713
                                                                            ----------           ---------

                  Net cash provided by operating activities                      5,465               8,355
                                                                            ----------           ---------



  Cash flows provided by (used in) investing activities:
       Purchase of FHLB stock                                                     (268)               (100)
       Proceeds from redemption of FHLB stock                                    1,018                  --
       Purchases of investment securities held to maturity                      (5,998)             (3,958)
       Purchases of investment securities available for sale                   (80,239)            (78,127)
       Proceeds from sales of investment securities available for sale           1,103               1,811
       Proceeds from maturities and issuer calls of investment securities
           available for sale                                                   96,473              42,923
       Proceeds from maturities and issuer calls of investment securities
           held to maturity                                                      2,003               6,004
       Net decrease (increase) in loans receivable                              (3,728)              6,646
       Proceeds from disposal of real estate acquired in
           settlement of loans                                                      92                 107
       Purchases of premises and equipment                                      (1,033)               (134)
                                                                            ----------           ---------

               Net cash provided by (used in) investing activities               9,423             (24,828)
                                                                            ----------           ---------


                               (Continued)
</TABLE>

                                       7
<PAGE>

                     1st STATE BANCORP, INC. AND SUBSIDIARY
               CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

                FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002

                                   (UNAUDITED)
                                 (In Thousands)
<TABLE>
<CAPTION>

                                                                                  FOR THE NINE MONTHS ENDED
                                                                                            JUNE 30,
                                                                                     2003                2002
                                                                                 -----------        -------------
<S>                                                                                 <C>                 <C>

Cash flows from financing activities:
   Net increase (decrease) in deposits                                          $     (456)          $  10,877
   Advances from the Federal Home Loan Bank                                         13,000              29,000
   Repayments of advances from the Federal Home Loan Bank                          (13,000)            (29,000)
   Purchase of treasury stock                                                         (796)               (298)
   Dividends paid on common stock                                                     (725)               (721)
   Increase in advance payments by borrowers for
     property taxes and insurance                                                      282                 573
                                                                                ----------           ---------


 Net cash provided by (used in) financing activities                                (1,695)             10,431
                                                                                ----------           ---------

        Net increase (decrease) in cash and cash equivalents                        13,193              (6,042)

Cash and cash equivalents at beginning of period                                    18,865              25,981
                                                                                ----------           ---------

Cash and cash equivalents at end of period                                      $   32,058           $  19,939
                                                                                ==========           =========

Payments are shown below for the following:
       Interest                                                                 $    4,343           $   6,085
                                                                                ==========           =========

       Income taxes                                                             $    1,133           $   1,534
                                                                                ==========           =========

Noncash investing and financing activities:

  Deferred compensation to be settled in Company's stock                        $       --           $     298
                                                                                ==========           =========
  Unrealized losses on investment securities
       available for sale                                                       $     (644)          $     (54)
                                                                                ==========           =========

  Cash dividends declared but not paid                                          $      278           $     244
                                                                                ==========           =========

  Cash dividends on unallocated ESOP shares                                     $       53           $      69
                                                                                ==========           =========

  Transfer from loans to real estate acquired in settlement of loans            $       --           $     347
                                                                                ==========           =========

See accompanying notes to consolidated financial statements.
</TABLE>

                                       8
<PAGE>

                     1st STATE BANCORP, INC. AND SUBSIDIARY
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                JUNE 30, 2003 (UNAUDITED) AND SEPTEMBER 30, 2002

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 Converted 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,  2002,  which is
derived from the September 30, 2002 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 and nine month periods ended June
30, 2003 are not necessarily indicative of the results of operations that may be
expected for the year ended  September 30, 2003. 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 June 30, 2002 consolidated financial statements have
been  reclassified  to  conform  with the  presentation  adopted  in 2003.  Such
reclassifications   did  not  change  net  income  or  stockholders'  equity  as
previously reported.

NOTE 3.  EARNINGS PER SHARE

     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 fully  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  stock-based
benefit plans.  There were no antidilutive  stock options for the three and nine
months ended June 30, 2003 and 2002. A reconciliation of the denominators of the
basic and diluted earnings per share computations is as follows:

                                       9
<PAGE>
<TABLE>
<CAPTION>
                                                                            THREE MONTHS ENDED
                                                                                   JUNE 30,
                                                                          2003                2002
                                                                       ----------         -----------
<S>                                                                      <C>                <C>
Average shares issued and outstanding                                    2,976,652          3,289,607
Less: Unvested MRP shares                                                       --            (31,038)
Less: Unallocated ESOP shares                                             (176,174)          (216,108)
                                                                       -----------        -----------
Average basic shares for earnings per share                              2,800,478          3,042,461
Add: Unvested MRP shares                                                        --             31,038
Add: Potential common stock pursuant to stock option plan                  123,595             90,660
                                                                       -----------        -----------
Average dilutive shares for earnings per share                           2,924,073          3,164,159
                                                                       ===========        ===========
</TABLE>



<TABLE>
<CAPTION>
                                                                              NINE MONTHS ENDED
                                                                                   JUNE 30,
                                                                          2003                2002
                                                                       ----------         -----------

<S>                                                                      <C>                <C>
Average shares issued and outstanding                                    2,991,761          3,289,607
Less: Unvested MRP shares issued                                                --            (38,464)
Less: Unallocated ESOP shares                                             (181,034)          (224,280)
                                                                       -----------        -----------
Average basic shares for earnings per share                              2,810,727          3,026,863
Add: Unvested MRP shares                                                        --             38,464
Add: Potential common stock pursuant to stock option plan                  124,192             88,561
                                                                       -----------        -----------
Average dilutive shares for earnings per share                           2,934,919          3,153,888
                                                                       ===========        ===========
</TABLE>


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.  During the three
and nine  months  ended June 30,  2003 and 2002,  7,644 and 7,179 and 22,932 and
24,382 shares of stock were committed to be released and approximately  $185,000
and $172,000 and $555,000 and $500,000 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  2002 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.

                                       10
<PAGE>
     The expense  related to this plan for the three and nine months  ended June
30,  2003  and  2002  was  $60,000  and  $72,000  and  $180,000  and   $236,000,
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.  The Company recorded no compensation
expense  associated with the MRP during the three and nine months ended June 30,
2003 as all shares  became  fully vested in June 2002.  Compensation  expense of
$192,000 and $712,000  associated with the MRP was recorded during the three and
nine months ended June 30, 2002, 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 of the option.  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. No options were exercised or granted
during the three and nine months ended June 31, 2003 and 2002. At June 30, 2003,
316,312 options are outstanding, all of which are exercisable.

     In December 2002, the Financial Accounting Standards Board issued Statement
of  Financial   Accounting   Standards  No.  148   "Accounting  for  Stock-Based
Compensation  -  Transition  and  Disclosure"  (SFAS 148) an  amendment  of FASB
Statement No. 123,  "Accounting for Stock-Based  Compensation" (SFAS 123), which
provides  alternative  methods of transition for a voluntary  change to the fair
value based method of  accounting  for  stock-based  employee  compensation.  In
addition,  SFAS 148 amends the  disclosure  requirements  of SFAS 123 to require
prominent  disclosure in both annual and interim financial  statements about the
method of accounting for stock-based  compensation  and the effect of the method
on reported results. The Company does not have any plans to change its method of
accounting for stock-based employee  compensation.  There is no pro forma impact
for any of the periods presented or for either of the two prior fiscal years.

NOTE 8. 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 loans as an adjustment of income.  Impairment reviews of MSRs are
performed on a quarterly  basis. As of June 30, 2003 and September 30, 2002 MSRs
totaled  $526,000 and  $370,000,  respectively,  and no valuation  allowance was
required.

     Amortization expense totaled $126,000 and $43,000 for the nine months ended
June 30, 2003 and 2002, respectively.

                                       11
<PAGE>



NOTE 9. STANDBY LETTERS OF CREDIT

     In  November  2002,  the  FASB  issued  Interpretation  No.  45  (FIN  45),
"Guarantor's  Accounting and Disclosure  Requirements for Guarantees,  Including
Indirect  Guarantees of Indebtedness of Others",  which addressed the disclosure
to be made by a guarantor in its interim and annual  financial  statements about
its obligations under  guarantees.  FIN 45 requires the guarantor to recognize a
liability  for  the  non-contingent  component  of the  guarantee,  such  as the
obligation  to stand  ready to perform in the event  that  specified  triggering
events or conditions  occur.  The initial  measurement  of this liability is the
fair value of the guarantee at inception.  The  recognition  of the liability is
required even if it is not probable  that  payments  will be required  under the
guarantee or if the guarantee was issued with a premium  payment or as part of a
transaction  with  multiple  events.  The initial  recognition  and  measurement
provisions are effective for all guarantees within the scope of FIN 45 issued or
modified after  December 31, 2002. The Company issues standby  letters of credit
whereby the Company  guarantees  performance if a specified  triggering event or
condition occurs (primarily  nonperformance under construction contracts entered
into by construction customers). The guarantees generally expire within one year
and may be automatically  renewed  depending on the terms of the guarantee.  The
maximum  potential  amount of undiscounted  future  payments  related to standby
letters of credit at June 30, 2003 is $276,000. At June 30, 2003 the Company has
recorded no  liability  for the current  carrying  amount of the  obligation  to
perform as a guarantor  and no contingent  liability is considered  necessary as
such amounts are deemed immaterial.  Substantially all standby letters of credit
are secured by real estate  and/or  guaranteed by third parties in the event the
Company had to advance funds to fulfill the guarantee.


                                       12
<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.

     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  is also  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.  These  factors  can  cause
fluctuations in our net interest income and other income. 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.  In addition,  local economic  conditions can impact the credit risk of
our loan  portfolio,  in that  local  employers  may be  required  to  eliminate
employment  positions of many of our borrowers,  and small  businesses and other
commercial  borrowers may experience a downturn in their  operating  performance
and become unable to make timely payments on their loans.  Management  evaluates
these factors in estimating its allowance for loan losses,  and changes in these
economic  conditions could result in increases or decreases to the provision for
loan losses.

     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.

                                       13
<PAGE>

     Over the years, 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.  These  loans
generally carry added risk when compared to a single family residential mortgage
loan, so we have concurrently increased our allowance for loan losses as we have
originated these loans.

CRITICAL ACCOUNTING POLICIES

     The Company's  significant  accounting  policies are set forth in note 1 of
the consolidated  financial  statements as of September 30, 2002 which was filed
on Form 10-K. Of these significant  accounting  policies,  the Company considers
its policy  regarding  the  allowance  for loan  losses to be its most  critical
accounting policy,  because it requires management's most subjective and complex
judgments.  In addition,  changes in economic  conditions can have a significant
impact on the  allowance  for loan losses and  therefore  the provision for loan
losses and results of operations. The Company has developed appropriate policies
and  procedures  for  assessing  the adequacy of the  allowance for loan losses,
recognizing  that this process  requires a number of  assumptions  and estimates
with respect to its loan portfolio. The Company's assessments may be impacted in
future  periods by  changes in  economic  conditions,  the impact of  regulatory
examinations,  and the discovery of information  with respect to borrowers which
is not  known to  management  at the time of the  issuance  of the  consolidated
financial statements.

COMPARISON OF FINANCIAL CONDITION AT JUNE 30, 2003 AND SEPTEMBER 30, 2002

     Total  assets  increased  by $4.4  million or 1.3% from  $350.5  million at
September 30, 2002 to $354.9  million at June 30, 2003. As market rates remained
low during the nine months ended June 30, 2003,  many of the Company's  callable
investments were called by the issuers. The proceeds from investment  maturities
and calls totaled $98.5 million for the nine months ended June 30, 2003 compared
with  investment  purchases  of  $86.2  million;   therefore,  total  investment
securities  decreased  from  September  30,  2002.  Cash  and  cash  equivalents
increased  $13.2  million  from $18.9  million at  September  30,  2002 to $32.1
million at June 30, 2003 as a result of the decrease in  investment  securities.
Loans receivable, net and loans held for sale increased by $3.7 million and $2.7
million,  respectively.  Deposits  decreased by $456,000 from $260.7  million at
September 30, 2002 to $260.2 million at June 30, 2003.

     Investment securities available for sale decreased $17.9 million from $78.6
million at September 30, 2002 to $60.7 million at June 30, 2003. During the nine
months ended June 30, 2003, we purchased  $80.2 million of securities  available
for sale and received $96.5 million in proceeds from maturities and issuer calls
of investment  securities  available  for sale.  Investment  securities  held to
maturity  increased from $11.1 million at September 30, 2002 to $15.1 million at
June 30, 2003 as $6.0 million of  investment  securities  held to maturity  were
purchased during this period, and $2.0 million were called by the issuers.

     Loans  held for  sale  increased  by $2.7  million  from  $6.8  million  at
September  30, 2002 to $9.5  million at June 30,  2003.  Loans  receivable,  net
increased  $3.7  million  from $220.0  million at  September  30, 2002 to $223.7
million at June 30,  2003.  The  increase in loans held for sale  resulted  from
timing  differences  in the funding of loan sales.  During the nine months ended
June 30, 2003 our  mortgage  originations  and  prepayments  continued at record
levels.  Mortgage  rates  declined to record low levels during this period,  and
many borrowers took  advantage of this  opportunity to refinance  their existing
mortgage loans.  Mortgage loans secured by single family dwellings  decreased by
$16.8  million  during  this  period as a result of the  tremendous  refinancing
activity.  During this same period, increases in commercial and home equity line
loans more than offset this single family mortgage loan decrease.

     Stockholders'  equity  increased  by $1.5  million  from  $61.6  million at
September  30, 2002 to $63.1  million at June 30, 2003 as a result of net income
of $3.0 million and release of ESOP shares of  $555,000.  These  increases  were
offset by cash  dividends to  stockholders  declared of  $781,000,  purchases of
treasury  stock of $796,000 and a net decrease in  unrealized  gain on available
for sale securities of $392,000.




                                       14
<PAGE>

COMPARISON OF OPERATING RESULTS FOR THE THREE MONTHS ENDED JUNE 30, 2003
 AND 2002

     Net Income.  We recorded net income of $988,000 for the quarter  ended June
30,  2003,  as  compared  to  $986,000  for the  quarter  ended  June 30,  2002,
representing an increase of $2,000, or 0.2%. For the three months ended June 30,
2003, basic and diluted  earnings per share were $0.35 and $0.34,  respectively,
compared to the basic and diluted  earnings per share for the quarter ended June
30, 2002 of $0.32 and $0.31,  respectively.  The increase in net income resulted
primarily from increased other income and decreased operating expenses that were
offset  partially by  decreased  net interest  income and  increased  income tax
expense.  The decrease in net interest  income  resulted from lower net interest
margins. The average prime interest rate for the quarter ended June 30, 2003 was
4.24%,  a decrease of 51 basis points from 4.75% which was the average prime for
the quarter  ended June 30, 2002.  The  repricing of  certificates  of deposits,
savings and money market  investment  accounts  decreased the Company's  cost of
funds to partially  offset the decrease in asset yield which  resulted  from the
lower  prevailing  interest rates during the quarter ended June 30, 2003.  Basic
and diluted  earnings per share was favorably  impacted by the  Company's  stock
repurchase plan which was approved in August 2002.

     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 12.7% for the three months ended June 30,
2003, compared to the same quarter in the prior year. This decrease results from
a $843,000  decrease in interest  income that was offset in part by the $443,000
decrease in total interest  expense.  The net interest income as a percentage of
average earning assets decreased 44 basis points from 3.90% for the three months
ended June 30, 2002 to 3.46% for the quarter ended June 30, 2003.

     Interest Income. The decrease in interest income for the three months ended
June 30, 2003 was the result of a decrease in yield on  interest-earning  assets
of 95 basis  points from 6.03% for the three months ended June 30, 2002 to 5.08%
for the three months ended June 30, 2003 and a $5.0 million  decrease in average
interest earning assets.  Average loans receivable  increased $13.1 million from
$214.3  million  for the quarter  ended June 30, 2002 to $227.4  million for the
quarter  ended June 30, 2003.  Average  investment  securities  decreased  $19.6
million for the quarter  compared  to the prior year.  Average  interest-bearing
overnight  funds  increased  $1.6 million for the quarter  compared to the prior
year.  The decrease in asset yield  resulted from the lower rates  prevailing in
the  marketplace.  The decrease in average  interest  earning  assets  decreased
interest income by  approximately  $53,000 and the decrease in the average yield
on interest earning assets decreased interest income by approximately $790,000.

     Interest Expense. Interest expense decreased in the three months ended June
30, 2003 due to a decrease  in the cost of  interest-bearing  liabilities  of 60
basis  points from 2.61% for the three  months  ended June 30, 2002 to 2.01% for
the  three  months  ended  June  30,  2003.  Average  interest-bearing  deposits
decreased by $6.5 million while average FHLB advances decreased $1.6 million for
the three months  ended June 30, 2003  compared to the same quarter in the prior
year. The decrease in the average rate of interest-bearing liabilities decreased
interest  expense by  approximately  $385,000  and the  decrease  in the average
interest-bearing   liabilities   decreased  interest  expense  by  approximately
$58,000.


                                       15
<PAGE>



     The following table presents average balances and average rates earned/paid
by the Company for the quarter ended June 30, 2003 compared to the quarter ended
June 30, 2002.
<TABLE>
<CAPTION>

                                                    THREE MONTHS ENDED               THREE MONTHS ENDED
                                                       JUNE 30, 2003                    JUNE 30, 2002
                                                                   DOLLARS IN THOUSANDS
                                               AVERAGE               AVERAGE    AVERAGE             AVERAGE
                                               BALANCE    INTEREST YIELD/COST   BALANCE  INTEREST YIELD/COST
<S>                                             <C>          <C>        <C>        <C>      <C>        <C>

Assets:
Loans receivable (1)                             $227,367   $3,097     5.45%    $214,339   $3,502      6.54%
Investment securities (2)                          82,245      982     4.78      101,822    1,413      5.55

Interest-bearing overnight deposits                14,687       43     1.16       13,174       50      1.51
                                                 --------   ------     ----     --------   ------      ----
  Total interest-earning assets (4)               324,299    4,122     5.08      329,335    4,965      6.03
Non interest-earning assets                        20,109                         22,601
                                                 --------                       --------
  Total assets                                   $344,408                       $351,936
                                                 ========                       ========

Liabilities and stockholders' equity
Interest-bearing checking                         $34,322       27     0.31      $32,836       38      0.47
Money market investment accounts                   23,876       55     0.92       26,232       83      1.26
Passbook and statement savings                     30,823       65     0.85       28,457      102      1.44
Certificates of deposit                           151,748      894     2.36      159,727    1,252      3.14
FHLB advances                                      20,000      272     5.45       21,593      281      5.20
                                                 --------   ------     ----     --------      ---      ----
  Total interest-bearing liabilities              260,769    1,313     2.01      268,845    1,756      2.61
Non interest-bearing liabilities                   20,797                         17,450
                                                 --------                       --------
  Total liabilities                               281,566                        286,295
Stockholders' equity                               62,842                         65,641
                                                 --------                       --------
  Total liabilities and stockholders' equity     $344,408                       $351,936
                                                 ========                       ========

Net interest income                                         $2,809                         $3,209
                                                            ======                         ======
Interest rate spread                                                   3.07%                           3.42%
Net interest margin (3)                                                3.46%                           3.90%
Ratio of average interest-earning assets
 to average interest-bearing liabilities                             124.36%                         122.50%
</TABLE>

--------
 (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.

     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 provide for probable loan losses,  based on existing loan levels and types of
loans outstanding,  nonperforming loans, prior loss experience, general economic
conditions and other factors.  We estimate the allowance  using an allowance for
loan losses  model  which takes into  consideration  all of these  factors.  Our
policies  require  the review of assets on a regular  basis,  and we assign risk
grades to loans  based on the  relative  risk of the  credit,  considering  such
factors as  repayment  experience,  value of  collateral,  guarantors,  etc. Our
credit management systems have resulted in low loss experience;  however,  there
can be no assurances that such  experience will continue.  We believe we use the
best information available to make a determination with respect to the allowance
for loan losses,  recognizing that future adjustments may be necessary depending
upon a change in economic conditions.  The provision for loan losses was $60,000
and net  charge-offs  were $8,000 for the quarter  ended June 30, 2003  compared
with a provision of $60,000,  and net  charge-offs  of $0 for the quarter  ended
June 30, 2002.  Nonperforming  loans were $4.5 million at June 30, 2003 and $4.2
million  September 30, 2002. The

                                       16
<PAGE>

majority of the non-performing loans resulted from two unrelated, unique credits
which  are not  necessarily  indicative  of the  credit  quality  of the  entire
portfolio.  There was no  significant  impact on the  provision  for the periods
presented as a result of these loans as these loans are well secured by property
and  equipment.  The  provision for the quarter ended June 30, 2003 reflects the
shift in the loan portfolio to commercial loans which receive higher allocations
in the allowance for loan losses model. The Company made no significant  changes
to the allowance for loan losses  methodology  during the period which  impacted
the provision for loan losses.

     During the quarters ended June 30, 2003 and 2002 commercial and home equity
loans  continued  to increase as well as the  percentages  of these loans to the
total portfolio.  Although these loans normally have a relatively short maturity
management  believes that there is greater risk inherent in these loans than the
typical  one-to-four family  residential  mortgage loan.  Therefore,  management
assigns these types of loans a higher risk weighting in the analysis of the loan
loss reserve.  The commercial  loans that have been originated are loans made to
businesses  to either  produce a  product,  sell a product or provide a service.
Many of these loans are  asset-based  loans which are loans where  repayment  is
based  primarily  on the cash flow  from  operations  and  secondarily  on,  the
liquidation of assets such as inventory and accounts receivable.

     Other Income.  Other income increased  $385,000,  or 69%, from $558,000 for
the quarter ended June 30, 2002 to $943,000 for the quarter ended June 30, 2003.
Commissions from sales of annuities and mutual funds decreased $31,000, or 23.7%
from  $131,000  for the quarter  ended June 30, 2002 to $100,000 for the quarter
ended June 30, 2003.  This  decrease  results from lower sales of annuities  and
mutual funds.  Mortgage banking income, net increased $286,000 from $171,000 for
the quarter  ended June 30, 2002 to $457,000 for the quarter ended June 30, 2003
as a result of higher  loan  sales.  Proceeds  from the sale of  mortgage  loans
totaled  $24.7  million for the quarter  ended June 30, 2003 as compared to $7.2
million  for the  quarter  ended June 30,  2002.  The  increased  loan  activity
resulted from heavy mortgage loan  refinancing  activity which resulted from the
attractive  mortgage  loan  rates  available  in the  marketplace.  The  Company
recorded gains on the sale of investments of $103,000 for the quarter ended June
30, 2003 which were not present in the prior quarter.

     Operating  Expenses.  Total  operating  expenses  were $2.1 million for the
quarter  ended June 30, 2003 and $2.2  million  for the  quarter  ended June 30,
2002.  Compensation and related benefits  expense  decreased  $200,000 from $1.5
million  for the  quarter  ended June 30,  2002 to $1.3  million for the quarter
ended June 30, 2003.  Compensation  and related benefits expense for the quarter
ended June 30, 2002 included  $192,000 of expense  related to the vesting of the
restricted  stock awards which was not present in 2003 as the final vesting date
for the  restricted  stock  awards was June 6,  2002.  Occupancy  and  equipment
expense increased $38,000, or 12.1% from $315,000 for the quarter ended June 30,
2002 to  $353,000  for the  quarter  ended  June 30,  2003.  This  increase  was
primarily  the result of increased  depreciation  on new  equipment.  During the
quarter ended June 30, 2003,  the rent receipts on real estate owned  properties
exceeded operating expenses by $2,000, compared with $24,000 in the prior year.

     Income Tax Expense.  Income tax expense  increased $20,000 from tax expense
of  $542,000  for the quarter  ended June 30,  2002 to $562,000  for the quarter
ended  June 30,  2003.  The  effective  tax rates  were  36.3% and 35.5% for the
quarters  ended  June 30,  2003 and  2002,  respectively.  The  increase  in the
effective rate was primarily due to an increase in non-deductible  expenses over
the prior period.

COMPARISON OF OPERATING RESULTS FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002

     Net  Income.  We  recorded  net income of $3.0  million for the nine months
ended June 30,  2003,  an increase of  $200,000,  or 7.1% over the $2.8  million
reported in the nine months ended June 30, 2002.  For the nine months ended June
30,  2003,   basic  and  diluted  earnings  per  share  were  $1.06  and  $1.01,
respectively.  The Company reported basic and diluted earnings per share for the
nine months ended June 30, 2002 of $0.91 and $0.87,

                                       17
<PAGE>

respectively. The increase in net income resulted primarily from increased other
income  and  decreased  operating  expenses.  These  increases  in  income  were
partially  offset by decreased net interest  income and increased  income taxes.
The  decrease  in the net  interest  income  resulted  from  lower net  interest
margins. The average prime interest rate for the nine months ended June 30, 2003
was 4.32%, a decrease of 57 basis points from 4.89%, which was the average prime
for the nine months  ended June 30,  2002.  The rate  decrease  caused a greater
reduction  in the average  rate paid on  interest-bearing  liabilities  than the
average  yield on  earning  assets.  Basic and  diluted  earnings  per share was
favorably  impacted by the Company's stock repurchase plan which was approved in
August 2002.

     Net Interest Income.  Net interest income,  the difference between interest
earned  on  loans  and  investments   and  interest  paid  on   interest-bearing
liabilities,  decreased  by $266,000 or 2.9% for the nine months  ended June 30,
2003, compared to the same nine months in the prior year. This increase reflects
a $2.0 million decrease in interest income that was partially offset by the $1.8
million  decrease in total  interest  expense.  The average net interest  margin
decreased  10 basis points from 3.69% for the nine months ended June 30, 2002 to
3.59% for the nine months ended June 30, 2003.

     Interest Income.  The decrease in interest income for the nine months ended
June 30, 2003 was due to a decrease in the yield on  interest-earning  assets of
80 basis  points from 6.17% for the nine months ended June 30, 2002 to 5.37% for
the nine months  ended June 30,  2003 as well as a decrease  of $1.5  million in
average  interest-earning  assets compared to the same period in the prior year.
The  decreased  volume of average  interest-earning  assets  decreased  interest
income by  approximately  $69,000 and the  decreased  yield  decreased  interest
income by approximately  $2.0 million.  Average loans receivable  increased $9.8
million for the nine months  ended June 30, 2003  compared  with the prior year.
This increase was offset in part by a decrease in average investment  securities
of $11.2 million and a decrease of $9,000 in average interest bearing  overnight
funds.

     Interest Expense.  Interest expense decreased in the nine months ended June
30,  2003 due to a decrease  in  average  interest-bearing  liabilities  of $3.4
million and a decrease in the cost of  interest-bearing  liabilities of 85 basis
points from 3.05% for the nine months  ended June 30, 2002 to 2.20% for the nine
months  ended June 30,  2003.  Average  deposits  decreased  by $2.4 million and
average FHLB advances  decreased $1.0 million for the nine months ended June 30,
2003 compared to the same nine months in the prior year. The decrease in average
interest-bearing liabilities decreased interest expense by approximately $79,000
and the decrease in the average cost of interest-bearing  liabilities  decreased
interest expense by approximately $1.7 million.


                                       18
<PAGE>



     The following table presents average balances and average rates earned/paid
by the  Company for the nine  months  ended June 30,  2003  compared to the nine
months ended June 30, 2002.
<TABLE>
<CAPTION>

                                                        NINE MONTHS ENDED                           NINE MONTHS ENDED
                                                           JUNE 30, 2003                              JUNE 30, 2002

                                                                          DOLLARS IN THOUSANDS

                                                 AVERAGE              AVERAGE          AVERAGE              AVERAGE
                                                 BALANCE    INTEREST  YIELD/COST       BALANCE     INTEREST YIELD/COST
<S>                                                <C>          <C>    <C>              <C>           <C>    <C>
Assets:
Loans receivable (5)                             $227,694     $9,764        5.72%      $217,934   $10,934    6.69%
Investment securities (6)                          83,352      3,194        5.11         94,589     3,993    5.63
Interest-bearing overnight deposits                14,088        128        1.21         14,097       191    1.81
                                                 --------     ------        ----       --------   -------    ----
  Total interest-earning assets (8)               325,134     13,086        5.37        326,620    15,118    6.17
Non interest-earning assets                        20,094                                22,270
                                                 --------                              --------
  Total assets                                   $345,228                              $348,890
                                                 ========                              ========

Liabilities and stockholders' equity
Interest-bearing checking                         $33,686        101        0.40       $ 31,658       115    0.48
Money market investment accounts                   22,649        167        0.98         27,504       288    1.39
Passbook and statement savings                     29,784        227        1.01         27,232       316    1.55
Certificates of deposit                           155,675      3,005        2.57        157,852     4,530    3.83
FHLB advances                                      20,718        825        5.31         21,697       842    5.18
                                                 --------     ------        ----       --------    ------    ----
  Total interest-earning liabilities              262,512      4,325        2.20        265,943     6,091    3.05
Non interest-earning liabilities                   20,517                                18,176
                                                 --------                              --------
  Total liabilities                               283,029                               284,119
Stockholders' equity                               62,199                                64,771
                                                 --------                              --------
  Total liabilities and stockholders' equity     $345,228                              $348,890
                                                 ========                              ========

Net interest income                                            $8,761                              $ 9,027
                                                               ======                              =======
Interest rate spread                                                        3.17%                            3.12%
Net interest margin (7)                                                     3.59%                            3.69%
Ratio of average interest-earning assets to
average interest-bearing liabilities                                      123.85%                          122.82%

</TABLE>

(5)  Includes  nonaccrual  loans and loans held for sale,  net of discounts  and
     allowance for loan losses.
(6)  Includes FHLB of Atlanta stock.
(7)  Represents  net  interest   income  divided  by  the  average   balance  of
     interest-earning assets.
(8)  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.

     Provision  for Loan  Losses.  The  provision  for loan losses is charged to
earnings to maintain the total  allowance for loan losses at a level  considered
adequate to absorb  estimated  probable  losses  inherent in the loan  portfolio
based on  existing  loan  levels and types of loans  outstanding,  nonperforming
loans,  prior  loan  loss  experience,  general  economic  conditions  and other
factors.  Provisions for loan losses  totaled  $180,000 for both the nine months
ended June 30, 2003 and 2002.  The provision for loan losses in both periods was
impacted by the  continued  shift in the  portfolio  to  commercial  loans which
require a larger allocation of allowance for loan losses.

     Other Income. Other income increased $400,000, 18.2%, from $2.2 million for
the nine months  ended June 30, 2002 to $2.6  million for the nine months  ended
June 30, 2003. Mortgage banking income, net increased $400,000 from $950,000 for
the nine months  ended June 30, 2002 to $1.4  million for the nine months  ended
June 30, 2003.  During the nine months ended June 30, 2003,  we sold  fixed-rate
mortgage loans held for sale of $73.5 million  compared with loan sales of $49.1
million for the nine months  ended June 30, 2002.  Gains on sales of

                                       19
<PAGE>

investment  securities of $103,000 were recognized  during the nine months ended
June 30,  2003 while gains on sales of  investment  securities  of $47,000  were
recognized  during the nine months ended June 30, 2002. The non-interest  income
recognized in fiscal 2003 was positively impacted by the relatively low interest
rates which increased the mortgage  banking income and gains on investments over
the prior year.

     Operating Expenses. Total operating expenses were $6.5 million for the nine
months  ended June 30,  2003,  a  decrease  of  $200,000,  or 3.0% from the $6.7
million  recorded  for the nine months  ended June 30,  2002.  Compensation  and
related benefits expense decreased $500,000,  or 10.6% from $4.7 million for the
nine months  ended June 30, 2002 to $4.2  million for the nine months ended June
30, 2003.  Compensation  and related benefits for the nine months ended June 30,
2002 included  $712,000 of expense  related to the vesting of  restricted  stock
awards  which  was not  present  in  2003  as the  final  vesting  date  for the
restricted stock awards was June 6, 2002. Partially offsetting this decrease was
increased  personnel  expense  related to the increased  number of employees and
increased  salary and benefit  costs.  The Company  recognized  income from real
estate operations of $56,000 during the nine months ended June 30, 2002 compared
to expenses of $7,000 in the nine months ended June 30, 2003.

     Income Tax Expense.  Income tax expense increased $100,000 from tax expense
of $1.6  million for the nine months ended June 30, 2002 to $1.7 million for the
nine months ended June 30, 2003. The increase  resulted from a $348,000 increase
in income before income taxes.  The effective tax rates were 36.7% and 36.5% for
the nine months ended June 30, 2003 and 2002, respectively.

COMMITMENTS, CONTINGENCIES AND OFF-BALANCE SHEET RISK

     The Company is a party to financial instruments with off-balance sheet risk
including  commitments  to extend  credit  under  existing  lines of credit  and
commitments  to sell  loans.  These  instruments  involve,  to varying  degrees,
elements of credit and interest rate risk in excess of the amount  recognized in
the consolidated balance sheets.

     Off-balance  sheet financial  instruments  whose contract amount represents
credit and interest rate risk are summarized as follows:
<TABLE>
<CAPTION>

                                                              June 30, 2003             September 30, 2002
                                                              -------------             ------------------
                                                                        (dollars in thousands)
<S>                                                             <C>                             <C>

Commitments to originate new loans                               $    1,421                  $    1,435
Commitments to originate new loans held for sale                        881                          --
Unfunded commitments to extend credit under existing
     equity line and commercial lines of credit                      56,060                      56,200
Commercial letters of credit                                            276                         266
Commitments to sell loans held for sale                              20,169                      16,371
</TABLE>

     The Company  does not have any special  purpose  entities or other  similar
forms of off-balance sheet financing arrangements.

     Commitments  to originate new loans or to extend  credit are  agreements to
lend to a customer as long as there is no violation of any condition established
in the contract.  Loan  commitments  generally expire within 30 to 45 days. Most
equity line  commitments  are for a term of 15 years,  and  commercial  lines of
credit are generally  renewable on an annual basis.  Commitments  generally have
fixed expiration dates or other termination clauses and may require payment of a
fee.  Since many of the  commitments  are expected to expire without being drawn
upon, the total  commitment  amounts do not  necessarily  represent  future cash
requirements.  The  Company  evaluates  each  customer's  creditworthiness  on a
case-by-case basis. The amounts of collateral  obtained,  if deemed necessary by
the Company upon extension of credit, is based on management's credit evaluation
of the borrower.

     Commitments  to sell loans held for sale are  agreements to sell loans to a
third party at an agreed upon price. At June 30, 2003, the agreed-upon  price of
these  commitments  exceeded  the book  value of the loans to be sold.  The fair
value of these commitments at June 30, 2003 was not considered material.

                                       20
<PAGE>

CONTRACTUAL OBLIGATIONS

As of June 30, 2003

Payments due by period
----------------------

(Dollars in thousands)
----------------------
<TABLE>
<CAPTION>
                                        Less than
                                         1 year               1-3 years         4-5 years        Over 5 years      Total
                                    -----------------         ---------         ---------        ------------      -----
<S>                                          <C>                <C>              <C>                    <C>          <C>

Deposits                             $      229,410             20,883              9,918               --       260,211
Long-term borrowings                             --                 --             20,000               --        20,000
Lease obligations                                19                 56                 42               38           155
                                     --------------             ------             ------           ------       -------
Total contractual cash
    obligations                      $      229,429             20,939             29,960               38       280,366
                                     ==============             ======             ======           ======       =======
</TABLE>


ASSET QUALITY

     At June 30,  2003,  we had  approximately  $4.6  million in  non-performing
assets  (nonaccrual  loans and real estate owned) or 1.30% of total  assets.  At
September  30, 2002,  non-performing  assets were $4.4 million or 1.25% of total
assets.  At June 30, 2003 and  September 30, 2002,  impaired  loans totaled $3.8
million and $3.7  million,  respectively,  as defined by  Statement of Financial
Accounting  Standards  No. 114,  "Accounting  by Creditors  for  Impairment of a
Loan."  The  impaired  loans  at June  30,  2003  result  from  three  unrelated
commercial  loan  customers,  all of which have loans secured by commercial real
estate and business assets in Alamance County. At June 30, 2003, the entire $3.8
million of the impaired  loans were on  non-accrual  status,  and their  related
reserve for loan losses totaled $210,000. The average carrying value of impaired
loans was $3.8 million and $3.7  million  during the three and nine months ended
June 30, 2003,  respectively.  Interest  income of $42,000 and $159,000 has been
recorded  on impaired  loans on a cash basis in the three and nine months  ended
June 30, 2003,  respectively.  The Bank's net charge-offs for the three and nine
months  ended June 30, 2003 were $8,000 and  $10,000,  respectively.  The Bank's
allowance  for loan losses was $3.9 million at June 30, 2003  compared with $3.7
million at September  30, 2002 and $3.7 million at June 30, 2002. As a result of
our continued , gradual shift toward commercial, construction, consumer and home
equity loans,  the recent  decrease in residential  mortgage  loans,  the modest
increase in  non-performing  loans as a percentage of total loans as well as the
continued decline in the local and regional economy,  the ratio of the allowance
for loan losses to total loans,  net of loans in process and deferred  loan fees
increased to 1.71% at June 30, 2003 compared to 1.67% at September 30, 2002.

<TABLE>
<CAPTION>
         The following table presents an analysis of our nonperforming assets:
                                                                       (Dollars in thousands)
                                                              At                      At                    At
                                                          June 30,              September 30,            June 30,
                                                            2003                    2002                   2002
                                                            ----                    ----                   ----
<S>                                                        <C>                      <C>                      <C>
Nonperforming loans:
Nonaccrual loans                                           $4,501                 $  4,204              $  3,728
Loans 90 days past due and accruing                            --                       --                    --
Restructured loans                                             --                       --                    --
                                                           ------                 --------              --------
Total nonperforming loans                                   4,501
                                                                                     4,204                 3,728
Other real estate                                              80                      183                 2,226
                                                           ------                 --------              --------
Total nonperforming assets                                 $4,581                 $  4,387              $  5,954
                                                           ======                 ========              ========

Nonperforming loans to loans receivable, net                 2.01%                    1.91%                 1.73%
Nonperforming assets as a percentage
 of loans and other real estate owned                        2.05%                    1.99%                 2.74%
Nonperforming assets to total assets                         1.29%                    1.25%                 1.69%
</TABLE>

                                       21
<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 June 30, 2003, we had $5.0 million in
classified  assets  consisting of $4.9 million in substandard and loss loans and
$80,000 in real estate  owned.  At September  30,  2002,  we had $5.1 million in
substandard  assets  consisting of $4.9 million in loans and $183,000 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 June 30,  2003,  we have  identified  approximately  $1.1 million in
assets classified as special mention and $36.5 million as watch. Included in the
watch asset total are six loans with an  aggregate  outstanding  balance of $4.5
million at June 30, 2003 to entities  affiliated  with one of our directors.  In
addition,  the director has the ability to borrow an additional $403,000 from us
under line of credits.  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 June 30,  2003,  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 July 2003,  management  has concerns that the
borrower may have  difficulty in complying with the present loan repayment terms
on an ongoing basis.  Accordingly,  these loans 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
June 30, 2003, 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 June 30, 2003, cash and cash equivalents
totaled  $32.0  million.  We have  other  sources  of  liquidity  should we need
additional funds.  During the three and nine months ended June 30, 2003, we sold
loans totaling $24.7 million and $73.5 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
$70.2 million at June 30, 2003.

     We  anticipate  that we will have  sufficient  funds  available to meet our
current  commitments.  At June 30, 2003, we had $2.3 million in  commitments  to
originate  new loans,  $53.9  million in unfunded  commitments  to extend credit
under  existing  equity  lines and  commercial  lines of credit and  $276,000 in
standby letters of credit. At June 30, 2003,  certificates of deposit, which are
scheduled to mature within one year,  totaled $125.3 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 June 30, 2003 and is
deemed to be "well capitalized."


                                       22
<PAGE>

     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 June 30, 2003,  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 per share to its stockholders.  The distribution was made to manage the
Company's  capital  and  enhance  shareholder  value.  Returning  capital to the
stockholders  reduced the  Company's  equity to asset ratio from 21.2% to 17.2%.
The  Company's  equity to asset ratio at June 30, 2003 was 17.8%.  The Company's
capital level is sufficient to support future growth.

     The Company has declared cash  dividends  per common share of $0.10,  $0.08
and $0.08 for each of the three months ended June 30, 2003,  September  30, 2002
and June 30,  2002,  respectively.  The  Company's  ability to pay  dividends is
dependent  upon  earnings.  The  Company's  dividend  payout ratio for the three
months  ended June 30,  2003,  September  30,  2002 and June 30, 2002 was 29.4%,
26.4% and 25.8%, respectively.

ACCOUNTING MATTERS

     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 supercedes
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 Accounting  Principles  Board 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.  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 on
October 1, 2002 did not have a  material  impact on the  Company's  consolidated
financial statements.

     In June 2002, the FASB issued Statement of Financial  Accounting  Standards
No. 146 (SFAS No. 146),  "Accounting for Costs  Associated with Exit or Disposal
Activities,"  which  addresses  financial  accounting  and  reporting  for costs
associated with exit or disposal  activities and nullifies  Emerging Issues Task
Force  (EITF)  Issue No.  94-3,  "Liability  Recognition  for  Certain  Employee
Termination  Benefits  and Other  Costs to Exit an Activity  (including  Certain
Costs Incurred in a Restructuring)."  This Statement applies to costs associated
with an exit  activity  that does not  involve  an entity  newly  acquired  in a
business  combination  or with a  disposal  activity  covered  by SFAS No.  144,
"Accounting  for the  Impairment or Disposal of Long-Lived  Assets." Those costs
include, but are not limited to, the following: a) termination benefits provided
to current  employees  that are  involuntarily  terminated  under the terms of a
benefit arrangement that, in substance, is not an ongoing benefit arrangement or
an  individual  deferred  compensation  contract  (hereinafter  referred  to  as
one-time termination  benefits),  b) costs to terminate a contract that is not a
capital lease and c) costs to consolidate facilities or relocate employees. This
Statement does not apply to costs associated with the retirement of a long-lived
asset  covered by FASB  Statement  No.  143,  "Accounting  for Asset  Retirement
Obligations."  A  liability  for a cost  associated  with an  exit  or  disposal
activity  shall be  recognized  and measured  initially at its fair value in the
period in which the  liability is incurred.  A liability  for a cost  associated
with an exit or disposal activity is incurred when the definition of a liability
is met. The  provisions  of this  Statement  are  effective for exit or disposal
activities that are initiated  after December 31, 2002,  with early  application
encouraged.  This  statement will impact the Company to the extent it engages in
exit or disposal activities in future periods.


     In  November  2002,  the  FASB  issued  Interpretation  No.  45  (FIN  45),
"Guarantor's  Accounting and Disclosure  Requirements for Guarantees,  Including
Indirect  Guarantees of Indebtedness of Others",  which addresses the disclosure
to be made by a guarantor in its interim and annual  financial  statements about
its obligations under  guarantees.  FIN 45 requires the guarantor to recognize a
liability  for  the  non-contingent  component  of the  guarantee,  such  as the
obligation  to stand  ready to perform in the event  that  specified  triggering
events or conditions  occur.  The


                                       23
<PAGE>

initial  measurement  of this  liability  is the fair value of the  guarantee at
inception.  The  recognition  of the  liability  is  required  even if it is not
probable that payments will be required  under the guarantee or if the guarantee
was issued  with a premium  payment or as part of a  transaction  with  multiple
events.  The  disclosure  requirements  are  effective  for  interim  and annual
financial statements ending after December 15, 2002. The initial recognition and
measurement  provisions are effective for all guarantees within the scope of FIN
45 issued or modified  after  December  31,  2002.  The Company  issues  standby
letters of credit  whereby the  Company  guarantees  performance  if a specified
triggering   event  or  condition   occurs   (primarily   nonperformance   under
construction  contracts entered into by construction  customers.) The guarantees
generally expire within one year and may be automatically  renewed  depending on
the terms of the guarantee.  The maximum potential amount of undiscounted future
payments  related to standby letters of credit at June 30, 2003 is $276,000.  At
June 30, 2003,  the Company has recorded no liability  for the current  carrying
amount of the  obligation to perform as a guarantor and no contingent  liability
is considered  necessary,  as such amounts are deemed immaterial.  Substantially
all standby  letters of credit are secured by real estate  and/or  guaranteed by
third  parties  in the event the  Company  had to advance  funds to fulfill  the
guarantee.

     In December 2002, the Financial Accounting Standards Board issued Statement
of  Financial   Accounting   Standards  No.  148,   Accounting  for  Stock-Based
Compensation  -  Transition  and  Disclosure'  (SFAS 148) an  amendment  of FASB
Statement No. 123,  Accounting for Stock-Based  Compensation  (SFAS 123),  which
provides  alternative  methods of transition for a voluntary  change to the fair
value based method of  accounting  for  stock-based  employee  compensation.  In
addition,  SFAS 148 amends the  disclosure  requirements  of SFAS 123 to require
prominent  disclosures in both annual and interim financial statements about the
method of accounting for stock-based employee compensation and the effect of the
method used on reported results. The transition  provisions of the statement are
effective for financial  statements  for fiscal years ending after  December 15,
2002  while the  disclosure  requirements  are  effective  for  interim  periods
beginning  after  December  15, 2002,  with early  application  encouraged.  The
adoption of SFAS 148 have  resulted in enhanced  disclosures  for the  Company's
stock-based employee compensation plan effective January 1, 2003.

     In April 2003, the FASB issued Statement of Financial  Accounting Standards
No. 149 (SFAS No. 149),  "Amendment of Statement  133 on Derivative  Instruments
and Hedging  Activities,"  which amends and clarifies  financial  accounting and
reporting for derivative  instruments and for hedging activities under Statement
of  Financial  Accounting  Standards  No.  133 (SFAS No.  133).  This  statement
clarifies   when  a  contract   with  an  initial  net   investment   meets  the
characteristic of a derivative,  clarifies when a derivative instrument contains
a financing  component,  amends the definition of an underlying to conform it to
language used in Financial  Accounting  Standards Board  Interpretation  No. 45,
"Guarantor's  Accounting and Disclosure  Requirements for Guarantees,  Including
Indirect  Guarantees  of  Indebtedness  of  Others",  and amends  certain  other
existing pronouncements.  This Statement requires that contracts with comparable
characteristics be accounted for similarly. This Statement is effective for most
contracts  entered  into or  modified  after  June  30,  2003  and  for  hedging
relationships  designated  after  June 30,  2003.  For  contracts  with  forward
purchases or sales of TBA-type  securities or other  securities  that do not yet
exist, this Statement is effective for both existing contracts and new contracts
entered into after June 30, 2003.  All  provisions of this  Statement  should be
applied  prospectively.  Adoption of SFAS No. 149 on July 1, 2003 did not have a
material effect on the Company's consolidated financial statements.

     In May 2003, the FASB issued  Statement of Financial  Accounting  Standards
No. 150 (SFAS No.  150),  "Accounting  for Certain  Financial  Instruments  with
Characteristics of both Liabilities and Equity", which establishes standards for
how an  issuer  classifies  and  measures  certain  financial  instruments  with
characteristics  of both  liabilities  and equity.  It  requires  that an issuer
classify a financial  instrument  that is within its scope as a liability (or an
asset  in  some  circumstances).  This  Statement  is  effective  for  financial
instruments  entered  into or modified  after May 31,  2003,  and  otherwise  is
effective at the beginning of the first interim period  beginning after June 15,
2003. It is to be implemented by reporting the cumulative  effect of a change in
accounting principle for financial  instruments created before the issuance date
of the  Statement and still  existing at the beginning of the interim  period of
adoption.  Adoption  of SFAS No.  150 on July 1,  2003  did not have a  material
effect on the Company's consolidated financial statements.

                                       24

<PAGE>

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Market  risk is the  possible  chance of loss from  unfavorable  changes in
market prices and rates.  These changes may result in a reduction of current and
future period net interest income, which is the favorable spread earned from the
excess of interest income on  interest-earning  assets over interest  expense on
interest-bearing liabilities.

     The Company considers  interest rate risk to be its most significant market
risk, which could  potentially  have the greatest impact on operating  earnings.
The  structure  of the  Company's  loan and  deposit  portfolios  is such that a
significant decline in interest rates may adversely impact net market values and
net interest income.

     The Company  monitors whether material changes in market risk have occurred
since September 30, 2002. The Company does not believe that any material adverse
changes in market risk exposures occurred since September 30, 2002.

ITEM 4.  CONTROLS AND PROCEDURES

     As of the end of the  period  covered  by this  report,  management  of the
Company  carried  out  an  evaluation,   under  the  supervision  and  with  the
participation  of  the  Company's  principal  executive  officer  and  principal
financial officer, of the effectiveness of the Company's disclosure controls and
procedures.  Based on this evaluation, the Company's principal executive officer
and principal financial officer concluded that the Company's disclosure controls
and  procedures  are  effective  in  ensuring  that  information  required to be
disclosed  by the  Company  in  reports  that it  files  or  submits  under  the
Securities Exchange Act of 1934, as amended, is recorded, processed,  summarized
and reported,  within the time periods  specified in the Securities and Exchange
Commission's  rules  and  forms.  It  should  be noted  that the  design  of the
Company's  disclosure  controls  and  procedures  is based in part upon  certain
reasonable  assumptions about the likelihood of future events,  and there can be
no reasonable  assurance  that any design of disclosure  controls and procedures
will  succeed  in  achieving  its  stated  goals  under  all  potential   future
conditions,  regardless of how remote, but the Company's principal executive and
financial  officers have  concluded that the Company's  disclosure  controls and
procedures are, in fact, effective at a reasonable assurance level.

     In addition,  there have been no changes in the Company's  internal control
over financial reporting  identified in connection with the evaluation described
in the above  paragraph that occurred  during the Company's last fiscal quarter,
that has materially affected,  or is reasonably likely to materially affect, the
Company's internal control over financial reporting.


                                       25
<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.
     --------

     31.1 Rule 13a-14(a) Certification of Chief Executive Officer

     31.2 Rule 13a-14(a) Certification of Chief Financial Officer

     32   Certification  Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
          to Section 906 of the Sarbanes-Oxley Act of 2002

(b.) Reports on Form 8-K.
     -------------------

     The Registrant  filed the following  Current Reports on Form 8-K during the
     quarter ended June 30, 2003:

     DATE OF REPORT        ITEM(S) REPORTED           FINANCIAL STATEMENTS FILED
     --------------        ----------------           --------------------------

     January 28, 2003      7, 12                      N/A


                                       26
<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.


Date:  August 14, 2003              /s/James C. McGill
                                    --------------------------------------------
                                    James C. McGill
                                    President and Chief Executive Officer
                                    (Principal Executive Officer)


Date:  August 14, 2003              /s/A. Christine Baker
                                    --------------------------------------------
                                    A. Christine Baker
                                    Executive Vice President
                                    Treasurer and Secretary
                                    (Principal Financial and Accounting Officer)





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