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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q (Mark One) þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2005 or o
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: 333-119800 FIRST STATE FINANCIAL CORPORATION   Florida
    
    65-07714145(State or other jurisdiction or incorporation or organization)
    
    (I.R.S. Employer Identification No.)22 S. Links Avenue, Sarasota, FL
    
    34236(Address of principal executive offices)
    
    (Zip code)
 941-929-9000
(Registrants telephone number, including area code) 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 þ      No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act.) Yes o      No þ Indicate the number of shares outstanding of each of the issuers classes of common stock, as of
the latest practicable date. As of May 10, 2005, the registrant had outstanding 5,856,265 shares of common stock.




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TABLE OF CONTENTS PAGEPART I
 FINANCIAL INFORMATIONItem 1 - Condensed Consolidated Financial StatementsCondensed Consolidated Balance Sheets
    
    
    1Condensed Consolidated Statements of Income
    
    
    2Condensed Consolidated Statements of Changes in Stockholders Equity
    
    
    3Condensed Consolidated Statements of Cash Flows
    
    
    4Notes to Condensed Consolidated Financial Statements
    
    
    5Item 2 - Managements Discussion and Analysis
    
    
    6Item 3 - Quantitative and Qualitative Disclosures About Market Risk
    
    
    12Item 4 - Controls and Procedures
    
    
    13PART II  OTHER INFORMATIONItem 1 -Legal Proceedings
    
    
    13Item 2 -Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    13Item 3 -Defaults Upon Senior Securities
    
    
    13Item 4 -Submission of Matters to Vote of Securities Holders
    
    
    13Item 5 -Other Information
    
    
    13Item 6 -Exhibits
    
    
    14Signatures
    
    
    15Exhibit 31.1
    
    
    16Exhibit 31.2
    
    
    17Exhibit 32.1
    
    
    18Exhibit 32.2
    
    
    19EX-31.1: SECTION 302 CERTIFICATION OF CEOEX-31.2: SECTION 302 CERTIFICATION OF CFOEX-32.1: SECTION 906 CERTIFICATION OF CEOEX-32.2: SECTION 906 CERTIFICATION OF CFO




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FIRST STATE FINANCIAL CORPORATION 
 CONSOLIDATED BALANCE SHEET
March 31, 2005 (unaudited) and December 31, 2004
 March 31, 2005
    
    
    December 31, 2004ASSETSCash and due from financial institutions
    
    $
    8,107
    
    
    $
    4,901Federal funds sold
    
    
    14,984
    
    
    
    19,951Cash and cash equivalents
    
    
    23,091
    
    
    
    24,852Interest bearing deposits in other financial institutions
    
    
    150
    
    
    
    150Securities, available for sale
    
    
    17,067
    
    
    
    16,577Loans, net of allowance of $2,739 and $2,727
    
    
    248,490
    
    
    
    224,395Federal Home Loan Bank stock
    
    
    908
    
    
    
    1,234Premise and equipment, net
    
    
    4,312
    
    
    
    4,283Accrued interest and other assets
    
    
    2,846
    
    
    
    2,513Total Assets
    
    $
    296,864
    
    
    $
    274,004LIABILITIES and STOCKHOLDERS EQUITYDepositsNon-interest bearing
    
    $
    39,465
    
    
    $
    28,386Interest bearing
    
    
    205,632
    
    
    
    183,998Total deposits
    
    
    245,097
    
    
    
    212,384Accrued interest payable and other liabilities
    
    
    1,399
    
    
    
    1,466Federal Home Loan Bank advances
    
    
    8,000
    
    
    
    18,000Other borrowings
    
    
    1
    
    
    
    1Total Liabilities
    
    
    254,497
    
    
    
    231,851Stockholders EquityCommon stock, $1 par value; 25,000,000 shares authorized;
5,856,265 shares issued
    
    
    5,856
    
    
    
    5,856Additional paid-in capital
    
    
    31,751
    
    
    
    31,860Retained earnings
    
    
    5,070
    
    
    
    4,566Accumulated other comprehensive income (loss)
    
    
    (310
    )
    
    
    (129
    )Total Stockholders Equity
    
    
    42,367
    
    
    
    42,153Total Liabilities and Stockholders Equity
    
    $
    296,864
    
    
    $
    274,004
 See Notes to Condensed Consolidated Financial Statements 1




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FIRST STATE FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended March 31, 2005 and 2004
 2005
    
    
    2004Interest and Dividend IncomeLoans, including fees
    
    $
    3,935
    
    
    $
    3,002Taxable securities
    
    
    153
    
    
    
    161Tax exempt securities
    
    
    3
    
    
    
    Federal funds sold and other
    
    
    130
    
    
    
    144,221
    
    
    
    3,177Interest expenseDeposits
    
    
    1,269
    
    
    
    1,069Federal Home Loan Bank advances and other borrowings
    
    
    134
    
    
    
    891,403
    
    
    
    1,158Net Interest Income
    
    
    2,818
    
    
    
    2,019Provision for loan losses
    
    
    
    
    
    
    144Net interest income after provision for loan losses
    
    
    2,818
    
    
    
    1,875Non-interest incomeService charges and other fees
    
    
    229
    
    
    
    213Mortgage banking fees
    
    
    252
    
    
    
    132Other
    
    
    7
    
    
    
    5488
    
    
    
    350Non-interest expenseSalaries and employee benefits
    
    
    1,226
    
    
    
    881Occupancy and equipment
    
    
    266
    
    
    
    245Data processing
    
    
    122
    
    
    
    124Professional services
    
    
    36
    
    
    
    27Stationery and supplies
    
    
    37
    
    
    
    30Advertising and marketing
    
    
    76
    
    
    
    39Other
    
    
    250
    
    
    
    1852,013
    
    
    
    1,531Income before income taxes
    
    
    1,293
    
    
    
    694Income tax expense
    
    
    496
    
    
    
    274Net Income
    
    $
    797
    
    
    $
    420Earnings per shareBasic
    
    $
    0.14
    
    
    $
    0.13Diluted
    
    $
    0.14
    
    
    $
    0.13Average common shares outstandingBasic
    
    
    5,856,265
    
    
    
    3,175,733Diluted
    
    
    5,878,387
    
    
    
    3,189,655Dividends per share
    
    $
    0.05
    
    
    $
    0.00
 See Notes to Condensed Consolidated Financial Statements 2




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FIRST STATE FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Three Months Ended March 31, 2005 and 2004
 AccumulatedAdditional
    
    
    
    
    
    
    OtherCommon
    
    
    Paid-in
    
    
    Retained
    
    
    ComprehensiveShares
    
    
    Stock
    
    
    Capital
    
    
    Earnings
    
    
    Income(Loss)
    
    
    TotalBalance at December 31, 2003:
    
    
    3,086,240
    
    
    $
    3,086
    
    
    $
    5,651
    
    
    $
    2,494
    
    
    $
    (121
    )
    
    $
    11,110Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    420
    
    
    
    
    
    
    
    420Change in net unrealized gain
(loss) on investment
securities available for sale,
net of tax effects
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    62
    
    
    
    62Total Comprehensive Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    482Issuance of common stock
    
    
    300,000
    
    
    
    300
    
    
    
    1,560
    
    
    
    
    
    
    
    
    
    
    
    1,860Balance at March 31, 2004
    
    
    3,386,240
    
    
    $
    3,386
    
    
    $
    7,211
    
    
    $
    2,914
    
    
    $
    (59
    )
    
    $
    13,452Balance at December 31, 2004:
    
    
    5,856,265
    
    
    $
    5,856
    
    
    $
    31,860
    
    
    $
    4,566
    
    
    $
    (129
    )
    
    $
    42,153Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    797
    
    
    
    
    
    
    
    797Change in net unrealized gain
(loss) on investment
securities available for sale,
net of tax effects
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (181
    )
    
    
    (181
    )Total Comprehensive Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    616Capitalization of offering costs
    
    
    
    
    
    
    
    
    
    
    (109
    )
    
    
    
    
    
    
    
    
    
    
    (109
    )Cash
dividend declared, $.05 per share
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (293
    )
    
    
    
    
    
    
    (293
    )Balance at March 31, 2005
    
    
    5.856.265
    
    
    $
    5,856
    
    
    $
    31,751
    
    
    $
    5,070
    
    
    $
    (310
    )
    
    $
    42,367
 See Notes to Condensed Consolidated Financial Statements 3




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FIRST STATE FINANCIAL CORPORATION 
 CONSOLIDATED STATEMENTS OF CASH FLOW
Three Months Ended March 31, 2005 and 2004
 2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    797
    
    
    $
    420Adjustments to reconcile net income to net cash from operating activitiesProvision for loan losses
    
    
    
    
    
    
    144Depreciation
    
    
    88
    
    
    
    72Net amortization of securities
    
    
    22
    
    
    
    (48
    )Net change in:Other assets
    
    
    (240
    )
    
    
    (713
    )Accrued expenses and other liabilities
    
    
    (67
    )
    
    
    (58
    )Net cash from operating activities
    
    
    600
    
    
    
    (183
    )Cash flows from investing activities:Available-for-sale securities:Maturities, prepayments and calls
    
    
    1,415
    
    
    
    3,297Purchases
    
    
    (2,201
    )
    
    
    (495
    )Loan originations and payments, net
    
    
    (24,095
    )
    
    
    (5,064
    )Net (purchase) sale of FHLB stock
    
    
    326
    
    
    
    Net change in premise and equipment
    
    
    (117
    )
    
    
    (76
    )Net cash from investing activities
    
    
    (24,672
    )
    
    
    (2,338
    )Cash flows from financing activities:Net change in deposits
    
    
    32,713
    
    
    
    17,254Repayment of short-term borrowing
    
    
    
    
    
    
    (8,456
    )Repayment of long-term borrowing
    
    
    (10,000
    )
    
    
    Proceeds from issuance of common stock, net of capitalized costs
    
    
    (109
    )
    
    
    1,860Cash dividend paid
    
    
    (293
    )
    
    
    Net cash from financing activities
    
    
    22,311
    
    
    
    10,658Net change in cash and cash equivalents
    
    
    (1,761
    )
    
    
    8,137Beginning cash and cash equivalents
    
    
    24,852
    
    
    
    4,798Ending cash and cash equivalents
    
    $
    23,091
    
    
    $
    12,935Supplemental cash flow informationInterest paid
    
    $
    1,361
    
    
    $
    1,181Income taxes paid
    
    
    496
    
    
    
    274
 See Notes to Condensed Consolidated Financial Statements 4




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FIRST STATE FINANCIAL CORPORATION 
 CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
 NOTE 1  BASIS OF PRESENTATION First State Financial Corporation is a bank holding company headquartered in Sarasota, Florida.
First State Financial Corporation owns all of the voting shares of First State Bank. First State
Bank is a state banking association with six branches located in Sarasota and Pinellas counties. The accompanying unaudited consolidated financial statements for First State Financial Corporation
(the Company) have been prepared in accordance with accounting principles generally accepted in
the United State of America for interim financial information and Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by accounting principles
generally accepted in the United State of America for complete financial statement presentation.
For further information and additional description of the Companys accounting policies, refer to
the Companys Annual Report on Form 10-K for the year ended December 31, 2004. The consolidated statements include the accounts of First State Financial Corporation and its
subsidiary, First State Bank (the Bank). All significant intercompany accounts and transactions
have been eliminated in consolidation. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included. CRITICAL ACCOUNTING POLICIES The accounting and reporting policies of the Company are in accordance with accounting principles
generally accepted within the United States of America and conform to general practices within the
banking industry. Accounting and reporting policies for the allowance for loan losses are deemed
critical since they involve the use of estimates and require significant management judgments. Our
allowance for loan loss methodology incorporates a variety of risk considerations, both
quantitative and qualitative, that management believes are appropriate at each reporting date.
Management may report a materially different amount for the provision for loan loss in the
statement of operations to change the allowance for loan losses if its assessment of these factors
changes. NOTE 2  STOCK-BASED COMPENSATION There were no stock options granted, exercised, or expired/forfeited during the three months ended
March 31, 2005. As of March 31, 2005, 54,700 options for shares were outstanding. Employee compensation expense under stock options is reported using the intrinsic value method. No
stock-based compensation cost is reflected in net income, as all options granted had an exercise
price equal to or greater than the market price of the underlying common stock at date of grant.
The following table illustrates the effect on net income and earnings per share if expense was
measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation. 2005
    
    
    2004Net income, as reported
    
    $
    797
    
    
    $
    420Stock-based compensation expense determined under fair value based method,
net of tax
    
    
    1
    
    
    
    1Pro forma net income
    
    $
    796
    
    
    $
    419Basic earnings per share as reported
    
    $
    0.14
    
    
    $
    0.13Pro forma basic earnings per share
    
    
    0.14
    
    
    
    0.13Diluted earnings per share as reported
    
    
    0.14
    
    
    
    0.13Pro forma diluted earnings per share
    
    
    0.14
    
    
    
    0.13
 5




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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Certain of the matters discussed under the caption Managements Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in the Form 10-Q may constitute
forward-looking statements within the meaning of the Private Securities Litigation Reform Act and
as such may involve known and unknown risk, uncertainties and other factors which may cause the
actual results, performance or achievements of First State Financial Corporation to be materially
different from future results described in such forward-looking statements. Actual results may
differ materially from the results anticipated in these forward-looking statements due to a variety
of factors, including, without limitation: the effect of future economic conditions; governmental
monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes
in interest rates on the level and composition of deposits, loan demand, and the values of loan
collateral, and interest rate risks; the effects of competition from other commercial banks,
thrifts, consumer financial companies, and other financial institutions operating in the Companys
market area and elsewhere. All forward-looking statements attributable to the Company are
expressly qualified in their entirety by these cautionary statements. The Company disclaims any
intent or obligation to update these forward-looking statements, whether as a result of new
information, future events or otherwise. The following discussion addresses the factors that have affected the financial condition and
results of operations of First State Financial Corporation (the Company) as reflected in the
unaudited consolidated statement of condition as of March 31, 2005, and statement of income for the
three months ended March 31, 2005. Operating results for the three months ended March 31, 2005 are
not necessarily indicative of trends or results to be expected for the year ended December 31,
2005. THREE MONTHS ENDED MARCH 31, 2005 AND 2004 RESULTS OF OPERATIONS Our net income of $797,000 for the first quarter of 2005 was a $377,000 or 89.8% increase compared
to $420,000 for the same period last year. Basic and diluted earnings per share for the first
quarter of 2005 were 14 cents and 14 cents respectively as compared to 13 cents and 13 cents per
share in the previous years quarter. Basic weighted average common equivalent shares outstanding
for the three months ended March 31, 2005 were 5,856,265 compared to 3,175,733 for the three months
ended March 31, 2004. This 84.4% increase in shares outstanding resulted from the exercise of
stock options and the issuance of 2,446,625 shares in December 2004 in connection with the
Companys initial public offering that raised $26.9 million in new capital. Annualized return on average assets was 1.16% and .78% for the first quarter of 2005 and 2004,
while return on average shareholders equity was 8.49% and 14.92% for the same periods. NET INTEREST INCOME Net interest income represents the amount by which interest income on interest earning assets
exceeds interest expense incurred on interest bearing liabilities. Net interest income is the
largest component of our income, and is affected by the interest rate environment, and the volume
and the composition of interest earning assets and interest bearing liabilities. Our interest
earning assets include loans, federal funds sold, interest bearing deposits in other banks, and
investment securities. Our interest bearing liabilities include deposits, Federal Home Loan Bank
advances, and other short term borrowings. Net interest income increased $799,000 or 39.6% to $2.8 million in the three months ended March 31,
2005 as compared to the same period last year. The primary drivers of this increase were interest
on loans and interest on federal funds sold. The capital raised by the Companys initial public
offering in December is beginning to be incorporated into the asset mix through loan production and
investment purchases. Until it is fully invested, we are maintaining the excess in overnight
funds. Federal funds sold averaged $19.7 million for the first quarter of 2005 compared to $3.0
million for the first quarter of 2004. 6




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During the fourth quarter of 2004 the Bank introduced a new money market product with various tiers
paying competitive market rates. As a result, money market balances increased to $38.8 million at
March 31, 2005, increasing $18.7 million from March 31, 2004. The average yield on the money
market products increased 100 basis points. The average yield on interest earnings assets for the first three months of 2005 was 6.40%,
annualized, which was an increase of 19 basis points compared to the 6.21% yield earned during the
first three months of 2004. The average cost of interest bearing deposits increased 19 basis
points from 2.50% during the first three months of 2004 to 2.69% for the comparable period in 2005.
The rate of all interest bearing liabilities increased 22 basis points, from 2.56% in 2004 to
2.78% in 2005. The Companys net interest margin increased to 4.27% in the first three months of
2005 compared to 3.94% in the first three months of 2004. However, due to the cash generated from
our recent initial public offering in December 2004, the Company has experienced some near term
compression in net interest margin. Our margin is derived from the rate difference between our
average yields on our current mix of assets in excess of our average cost of liabilities. It will
take a little time to invest all of the funds raised in our recent stock offering in a similar mix
of assets as currently exists on our balance sheet. 7




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The following table presents certain information related to our average balance sheet and our
average yields on assets and average cost of liabilities. Such yields have been derived by
dividing income or expenses by the average balance or the corresponding assets or liabilities. For the three months ended March 31,2005
    
    
    2004Average
    
    
    Income/
    
    
    Yields/
    
    
    Average
    
    
    Income/
    
    
    Yields/(Dollars in thousands)
    
    Balances
    
    
    Expense
    
    
    Rates
    
    
    Balances
    
    
    Expense
    
    
    RatesAssets:Earnings assets:Loans (a)
    
    $
    229,427

    
    
    $
    3,935
    
    
    
    6.96
    %
    
    $
    183,092
    
    
    $
    3,002
    
    
    
    6.59
    %Investment securities
    
    
    18,006
    
    
    
    156
    
    
    
    3.51
    %
    
    
    19,373
    
    
    
    161
    
    
    
    3.34
    %Other
    
    
    19,971
    
    
    
    130
    
    
    
    2.64
    %
    
    
    3,431
    
    
    
    14
    
    
    
    1.64
    %Total interest earning assets
    
    
    267,404
    
    
    
    4,221
    
    
    
    6.40
    %
    
    
    205,896
    
    
    
    3,177
    
    
    
    6.21
    %Non-interest earning assets
    
    
    12,118
    
    
    
    
    
    
    
    
    
    
    
    9,826Total assets
    
    $
    279,522
    
    
    
    
    
    
    
    
    
    
    $
    215,722Liabilities:Interest bearing liabilities:NOW accounts
    
    $
    14,017
    
    
    $
    9
    
    
    
    0.26
    %
    
    $
    14,899
    
    
    $
    9
    
    
    
    0.24
    %Money market
    
    
    37,034
    
    
    
    179
    
    
    
    1.96
    %
    
    
    20,010
    
    
    
    48
    
    
    
    0.96
    %Savings
    
    
    8,609
    
    
    
    10
    
    
    
    0.47
    %
    
    
    8,079
    
    
    
    6
    
    
    
    0.30
    %Time deposits
    
    
    131,426
    
    
    
    1,071
    
    
    
    3.30
    %
    
    
    129,113
    
    
    
    1,006
    
    
    
    3.13
    %Borrowings
    
    
    13,444
    
    
    
    134
    
    
    
    4.04
    %
    
    
    10,166
    
    
    
    89
    
    
    
    3.52
    %Total interest bearing liabilities
    
    
    204,530
    
    
    
    1,403
    
    
    
    2.78
    %
    
    
    182,267
    
    
    
    1,158
    
    
    
    2.56
    %Demand deposits
    
    
    30,981
    
    
    
    
    
    
    
    
    
    
    
    21,024Other non-interest bearing liabilities
    
    
    5,920
    
    
    
    
    
    
    
    
    
    
    
    1,111Total non-interest bearing liabilities
    
    
    36,901
    
    
    
    
    
    
    
    
    
    
    
    22,135Stockholders equity
    
    
    38,091
    
    
    
    
    
    
    
    
    
    
    
    11,320Total liabilities & stockholders equity
    
    $
    279,522
    
    
    
    
    
    
    
    
    
    
    $
    215,722Net Interest Income
    
    
    
    
    
    $
    2,818
    
    
    
    
    
    
    
    
    
    
    $
    2,019Interest rate spread
    
    
    
    
    
    
    
    
    
    
    3.62
    %
    
    
    
    
    
    
    
    
    
    
    3.65
    %Net interest margin (b)
    
    
    
    
    
    
    
    
    
    
    4.27
    %
    
    
    
    
    
    
    
    
    
    
    3.94
    %
   (a)
    
    average loans include nonperforming loans(b)
    
    net interest margin is net interest income divided by average total interest earning
assets 8




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The table below details the components of the changes in net interest income for the three
months ended March 31, 2005 and March 31, 2004. For each major category of interest earning assets
and interest bearing liabilities, information is provided with respect to changes due to average
volumes, changes due to rates, and with the changes in both volumes and rates allocated to these
two categories based on the proportionate absolute changes in each category. NetAverage
    
    
    Average
    
    
    Increase(Dollars in thousands)
    
    Volume
    
    
    Rate
    
    
    (Decrease)Increase (decrease) in interest income:Loans
    
    $
    789
    
    
    $
    144
    
    
    $
    933Investment securities
    
    
    (12
    )
    
    
    7
    
    
    
    (5
    )Other
    
    
    103
    
    
    
    13
    
    
    
    116Total interest income
    
    
    880
    
    
    
    164
    
    
    
    1,044Increase (decrease) in interest expense:NOW accounts
    
    
    (1
    )
    
    
    1
    
    
    
    Money market
    
    
    60
    
    
    
    71
    
    
    
    131Savings
    
    
    
    
    
    
    4
    
    
    
    4Time deposits
    
    
    18
    
    
    
    47
    
    
    
    65Borrowings
    
    
    31
    
    
    
    14
    
    
    
    45Total interest expense
    
    
    108
    
    
    
    137
    
    
    
    245Total change in net interest income
    
    $
    772
    
    
    $
    27
    
    
    $
    799
 Changes resulting from average balance/rate variances are allocated to the two categories based on
the proportionate absolute changes in each category. PROVISION FOR LOAN LOSSES The provision for loan losses represents the charge to income necessary to adjust the allowance for
loan losses to an amount that represents managements assessment of the estimated probable credit
losses inherent in our loan portfolio which have been incurred at each balance sheet date. A provision for loan losses was not charged in the first quarter of 2005 compared to a provision of
$144,000 in the comparable prior year quarter. The Company did not require a charge to the
provision in the first quarter of 2005 as a result of a reduction in allocations for impaired
loans, partially offset by concerns over rising energy costs on the transportation and tourism
segments of our loan portfolio. Total loans outstanding were $252.1 million at March 31, 2005,
compared to $187.6 million at March 31, 2004. Net recoveries were $12,000 during the first three
months of 2005 compared to net recoveries of $8,000 for the same period in 2004. Management
continues to monitor the credit quality of the portfolio and will recognize additional provisions
in the future as necessary. 9




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##### Table of Contents



NON-INTEREST INCOME Non-interest income for the first quarter of 2005 was $488,000. This represents a $138,000 or
39.4% increase over the prior year quarter which totaled $350,000. The increase in non-interest
income is attributable to an increase of $120,000 in mortgage banking fees. This increase was due
to higher volume in the month of March. NON-INTEREST EXPENSE Non-interest expense for the first quarter of 2005 was $2.0 million. This represents a $482,000 or
31.5% increase over the prior year quarter which totaled $1.5 million. The increase in
non-interest expense is mostly attributable to an increase of $345,000 in salaries and benefits.
The increase in mortgage banking fees resulted in higher commissions paid to our lenders. The
Company has also been expanding our staff to facilitate our growth. INCOME TAXES During the first three months of 2005 the income tax provision was $496,000 compared to $274,000
for the same period of 2004. The effective tax rate for 2005 is 38.4% and 39.5% for 2004. FINANCIAL CONDITION OVERVIEW Total assets were $296.9 million at March 31, 2005, compared to $274.0 million at December 31,
2004, an increase of $22.9 million or 8.3%. The increase in total assets was primarily
attributable to a 10.7% increase in loans, led by real estate construction. Total liabilities
increased 9.8% or $22.6 million to $254.5 million, as a result of a 15.4% growth in deposits.
Total stockholders equity increased 0.5% to $42.4 million, as compared to $42.2 million at
December 31, 2004. The book value per share of common stock issued and outstanding at March 31,
2005 was $7.23, compared to $7.20 at December 31, 2004. LOANS Net loans receivable at March 31, 2005 increased 10.7% or $24.1 million from December 31, 2004 to a
balance of $248.5 million. Construction loans led the way, in terms of percentage, with an
increase of 22.6% from the previous year-end, while commercial loan balances represented the
largest dollar increase, increasing $15.5 million. This activity is a reversal from first quarter
of 2004 which saw declines in both commercial and construction loans. INVESTMENT SECURITIES Investment securities available-for-sale are carried at estimated fair value and totaled $17.1
million at March 31, 2005, an increase of $490,000 or 3.0% from the balance at December 31, 2004.
All securities held are classified as available-for-sale. SHORT-TERM INVESTMENTS Short-term investments consisting of federal funds and interest bearing deposits in banks totaled
$15.1 million, a decrease of 24.7% as compared to December 31, 2004. As discussed, the Company
continues to invest these funds into higher yielding assets. DEPOSITS Deposits are the Companys primary source of funds. Total deposits increased in the first quarter
of 2005 by 15.4% or $32.7 million to $245.1 million. Non-interest bearing deposits totaled $39.5
million, an increase of $11.1 million or 39.0% from the previous year end. Interest bearing
deposits were $205.6 million, an increase of $21.6 million from December 31, 2004. Of this
increase, $5.8 million was attributable to money market accounts and $15.2 million in certificates
of deposit. At March 31, 2005 certificates of deposit represented 58.8% of total deposits compared
to 60.8% at the previous year end. 10




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##### Table of Contents



OTHER BORROWINGS Federal Home Loan Advances decreased $10 million or 55.6% to $8 million at March 31, 2005. The
Company chose to pay off, without penalty, its adjustable rate credits due August and December of
2006. STOCKHOLDERS EQUITY Stockholders equity at March 31, 2005 was $42.4 million, an increase of $214,000 or 0.5% from
December 31, 2004. The increase was due to earnings of $797,000, less the dividends paid on the
Companys common stock totaling $293,000, combined with the change in the unrealized loss on
available-for-sale investment securities of $181,000. The dividend was declared on February 16,
2005 for shareholders of record on March 10, 2005. The 5 cent per share dividend was paid on March
31, 2005. Stockholders equity was also affected by $109,000 in capitalized costs related to the
Companys initial public offering held in mid-December 2004. ASSET QUALITY LOAN PORTFOLIO AND ADEQUACY OF THE ALLOWANCE FOR LOAN LOSSES Management believes the allowance for loan losses accounting policy is critical to the portrayal
and understanding of our financial condition and results of operations. As such, selection and
application of this critical accounting policy involves judgments, estimates, and uncertainties
that are susceptible to change. In the event that different assumptions or conditions were to
prevail, and depending upon the severity of such changes, the possibility of materially different
financial conditions or results of operations is a reasonable likelihood. The Company manages the risk characteristics of its entire loan portfolio in an effort to maintain
an adequate allowance for loan losses and identify problem loans so that the risks in the portfolio
can be identified on a timely basis. Management performs a periodic analysis of risk factors that
includes the primary sources of repayment on individual loans, liquidity and financial condition of
borrowers and guarantors, and the adequacy of collateral. Loans subject to individual reviews are
analyzed and segregated by risk according to the Companys internal risk rating scale. Management
also considers the character of the loan portfolio, changes in nonperforming and past-due loans,
historical loss experience, concentrations of loans to specific borrowers and industries, and
general and regional economic conditions, as well as other factors existing at the determination
date. Although credit policies are designed to minimize risk, management recognizes that loan
losses will occur and that the amount of these losses will fluctuate depending on the risk
characteristics of the loan portfolio. NONPERFORMING ASSETS It is managements policy to discontinue the accrual of interest income and classify a loan as
nonaccrual when principal and interest is past due 90 days or more unless, in the determination of
management, the principal and interest on the loan are well collateralized and in the process of
collection. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if
collection of principal and interest is considered doubtful. Loans are not returned to accrual
status until principal and interest payments are brought current and future payments appear
reasonably certain. Interest accrued and unpaid at the time a loan is placed on nonaccrual status
is charged against interest income. As of March 31, 2005, total loans on nonaccrual status were $1 million compared to $803,000 at
December 31, 2004. The ratio of nonperforming loans to total loans as of these dates was 0.40% and
0.35%, respectively. 11




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##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY The goal of liquidity management is to ensure the availability of an adequate level of funds to
meet the loan demand and deposit withdrawal needs of the Companys customers. We manage the
levels, types and maturities of earning assets in relation to the sources available to fund current
and future needs to ensure that adequate funding will be available at all times. In addition to maintaining a stable core deposit base, we maintain adequate liquidity primarily
through the use of investment securities and unused borrowing capacity. The Bank has invested in
Federal Home Loan Bank stock for the purposes of establishing credit lines with the Federal Home
Loan Bank. The credit availability to the Bank is equal to 15 percent of the Banks total assets
as reported on the most recent quarterly financial information submitted to the regulators. The
credit availability approximated $44.5 million at March 31, 2005, under which $8 million was
outstanding. Borrowings against this line of credit are collateralized by investment securities
and the Banks residential loan portfolio. CAPITAL RESOURCES The Company and its subsidiary bank are subject to various regulatory capital requirements which
involve quantitative measures of the Companys assets, liabilities, and certain off-balance sheet
items. These capital requirements and classifications are ultimately subject to qualitative
judgments by the regulators about components, risk weightings, and other factors. The Company and
its subsidiary bank are subject to a minimum Tier 1 capital ratio (Tier 1 capital to risk-weighted
assets) of 4%, total capital ratio (Tier 1 plus Tier 2 to risk-weighted assets) of 8% and Tier 1
leverage ratio (Tier 1 to average quarterly assets) of 4%. To be considered a well capitalized
institution, the Tier 1 capital ratio, the total capital ratio, and the Tier 1 leverage ratio must
equal or exceed 6%, 10%, and 5%, respectively. March 31, 2005
    
    
    December 31, 2004(Dollars in thousands)
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    RatioFirst State Financial CorporationTier 1 capital
    
    $
    42,677
    
    
    
    16.59
    %
    
    $
    42,282
    
    
    
    18.22
    %Total capital
    
    
    45,415
    
    
    
    17.65
    %
    
    
    45,009
    
    
    
    19.40
    %Tier 1 leverage
    
    
    
    
    
    
    15.27
    %
    
    
    
    
    
    
    16.72
    %First State BankTier 1 capital
    
    
    42,265
    
    
    
    16.43
    %
    
    
    41,732
    
    
    
    17.99
    %Total capital
    
    
    45,004
    
    
    
    17.49
    %
    
    
    44,459
    
    
    
    19.16
    %Tier 1 leverage
    
    
    
    
    
    
    15.12
    %
    
    
    
    
    
    
    16.51
    %
 Management believes, as of March 31, 2005, that the Company and the Bank met all capital
requirements to which they are subject. 
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to various market risks in the normal course of conducting its business.
Market risk is the potential loss arising from adverse changes in interest rates, prices, and
liquidity. The Company has established the Asset/Liability Committee (ALCO) to monitor and manage
those risks. ALCO meets periodically and is responsible for approving asset/liability policies,
formulating and implementing strategies to improve balance sheet and income statement positioning,
and monitoring the interest rate sensitivity. The Company manages its interest rate risk
sensitivity through the use of a simulation model that projects the impact of rate shocks, rate
cycles, and rate forecast estimates on the net interest income and economic value of equity (the
net present value of expected cash flows from assets and liabilities). These simulations provide a
test for embedded interest rate risk and takes into consideration factors such as maturities,
reinvestment rates, prepayment speeds, repricing limits, decay rates and other factors. The
results are compared to risk tolerance limits set by ALCO policy. Based on the Companys most
recent interest rate sensitivity analysis, the impact to the net interest income and 12




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##### Table of Contents



economic value of equity are well within the tolerance limits for both a rising or declining
interest rate environment and sensitivity to market risk is moderate. Interest Rates Decrease
    
    
    Interest Rates
    
    
    Interest Rates Increase(Dollars in thousands)
    
    200 BP
    
    
    100 BP
    
    
    Remain Constant
    
    
    100 BP
    
    
    200 BPInterest Income
    
    $
    15,837
    
    
    $
    17,051
    
    
    $
    17,737
    
    
    $
    19,469
    
    
    $
    20,639Interest Expense
    
    
    4,767
    
    
    
    5,374
    
    
    
    5,981
    
    
    
    6,589
    
    
    
    7,196Net Interest Income
    
    $
    11,070
    
    
    $
    11,677
    
    
    $
    11,756
    
    
    $
    12,880
    
    
    $
    13,443Change in net income after
tax vs. constant rates
    
    $
    (428
    )
    
    $
    (49
    )
    
    
    
    
    
    $
    701
    
    
    $
    1,052
 
 Item 4. CONTROLS AND PROCEDURES The Company maintains controls and procedures designed to ensure that information required to be
disclosed in the reports that the Company files or submits under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported within the time periods specified in the rules
and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls
and procedures performed as of the end of the period covered by this report, the Chief Executive
Officer and Chief Financial Officer of the Company conclude that the Companys disclosure controls
and procedures were adequate. No significant deficiencies or material weaknesses in the design or
operation of internal controls which could adversely affect the Companys ability to record,
process, summarize, and report financial data have been identified. The Company made no
significant changes in its internal controls or in other factors that could significantly affect
these controls subsequent to the date of evaluation of those controls by the Chief Executive
Officer and Chief Financial Officer. 
 PART II 
 Item 1. LEGAL PROCEEDINGS None 
 Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None 
 Item 3. DEFAULTS UPON SENIOR SECURITIES None 
 Item 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS None 
 Item 5. OTHER INFORMATION   13




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##### Table of Contents



Item 6. EXHIBITS  Exhibit 31.1  Chief Executive Officers certification required under Section 302 of
Sarbanes-Oxley Act of 2002Exhibit 31.2  Chief Financial Officers certification required under Section 302 of
Sarbanes-Oxley Act of 2002Exhibit 32.1  Chief Executive Officers certification required under Section 906 of
Sarbanes-Oxley Act of 2002Exhibit 32.2  Chief Financial Officers certification required under Section 906 of
Sarbanes-Oxley Act of 2002 14




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: May 10, 2005 FIRST STATE FINANCIAL CORPORATION/s/ Corey J. CoughlinPresident and Chief Executive Officer/s/ Dennis GrinsteinerSenior Vice President and Chief Financial Officer
 15