Edgar Filing: 1ST STATE BANCORP INC

SCHEDULE 14A INFORMATION
(RULE 14a-101)
INFORMATION REQUIRED IN PROXY STATEMENT

SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. ___)

Filed by the Registrant /X/
Filed by a Party other than the Registrant /_/

Check the appropriate box:
/_/ Preliminary Proxy Statement /_/ Confidential, for Use of the
/X/ Definitive Proxy Statement Commission Only (as permitted
/_/ Definitive Additional Materials by Rule 14a-6(e)(2))
/_/ Soliciting Material Pursuant to ss.240.14a-12

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

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(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):
/X/ No fee required.
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pursuant to Exchange Act Rule 0-11 (set forth the amount on which
the filing fee is calculated and state how it was determined):

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/_/ Fee paid previously with preliminary materials:-------------------------

/_/ Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.

(1) Amount Previously Paid:

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[1st State Bancorp, Inc. Letterhead]

January 5, 2005

Dear Stockholder:

We invite you to attend the Annual Meeting of Stockholders (the "Annual
Meeting") of 1st State Bancorp, Inc. (the "Company") to be held at the main
office of 1st State Bank (the "Bank") located at 445 S. Main Street, Burlington,
North Carolina, on Tuesday, February 8, 2005, at 5:30 p.m., Eastern Standard
Time.

The attached Notice of Annual Meeting and Proxy Statement describe the
formal business to be transacted at the meeting. During the meeting, we will
also report on the operations of 1st State Bank, the Company's wholly owned
subsidiary. Directors and officers of the Company and the Bank will be present
to respond to any questions the stockholders may have.

ON BEHALF OF THE BOARD OF DIRECTORS, WE URGE YOU TO SIGN, DATE AND RETURN
THE ACCOMPANYING FORM OF PROXY AS SOON AS POSSIBLE EVEN IF YOU CURRENTLY PLAN TO
ATTEND THE ANNUAL MEETING. Your vote is important, regardless of the number of
shares you own. This will not prevent you from voting in person but will assure
that your vote is counted if you are unable to attend the meeting.

On behalf of the Board of Directors and all the employees of the Company
and the Bank, I wish to thank you for your continued support.

Sincerely,

/s/ James C. McGill

James C. McGill
President

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1st STATE BANCORP, INC.
445 S. MAIN STREET
BURLINGTON, NORTH CAROLINA 27215

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NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD ON FEBRUARY 8, 2005

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NOTICE IS HEREBY GIVEN that the Annual Meeting of Stockholders (the
"Annual Meeting") of 1st State Bancorp, Inc. (the "Company") will be held at the
main office of 1st State Bank (the "Bank"), located at 445 S. Main Street,
Burlington, North Carolina, on Tuesday, February 8, 2005, at 5:30 p.m., Eastern
Standard Time.

A Proxy Statement and Proxy Card for the Annual Meeting are enclosed.

The Annual Meeting is for the purpose of considering and acting upon the
following matters:

1. The election of three directors of the Company for three-year
terms; and

2. The transaction of such other business as may properly come
before the Annual Meeting or any adjournment thereof.

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

Any action may be taken on any one of the foregoing proposals at the
Annual Meeting on the date specified above or on any date or dates to which, by
original or later adjournment, the Annual Meeting may be adjourned. Stockholders
of record at the close of business on December 23, 2004, are the stockholders
entitled to notice of and to vote at the Annual Meeting and any adjournment
thereof.

You are requested to fill in and sign the enclosed proxy card which is
solicited by the Board of Directors and to mail it promptly in the enclosed
envelope. The proxy will not be used if you attend and vote at the Annual
Meeting in person.

BY ORDER OF THE BOARD OF DIRECTORS

/s/ A. Christine Baker

A. Christine Baker
Secretary
Burlington, North Carolina
January 5, 2005

IMPORTANT: THE PROMPT RETURN OF PROXIES WILL SAVE THE COMPANY THE EXPENSE
OF FURTHER REQUESTS FOR PROXIES IN ORDER TO INSURE A QUORUM. A SELF-ADDRESSED
ENVELOPE IS ENCLOSED FOR YOUR CONVENIENCE. NO POSTAGE IS REQUIRED IF MAILED IN
THE UNITED STATES.

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PROXY STATEMENT
OF
1st STATE BANCORP, INC.
445 S. MAIN STREET
BURLINGTON, NORTH CAROLINA 27215

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ANNUAL MEETING OF STOCKHOLDERS
FEBRUARY 8, 2005
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GENERAL
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This Proxy Statement is furnished to stockholders of 1st State Bancorp,
Inc. (the "Company") in connection with the solicitation by the Board of
Directors of the Company of proxies to be used at the Annual Meeting of
Stockholders (the "Annual Meeting") which will be held at the main office of 1st
State Bank (the "Bank"), located at 445 S. Main Street, Burlington, North
Carolina, on Tuesday, February 8, 2005, at 5:30 p.m., Eastern Standard Time, and
at any adjournment thereof. The accompanying Notice of Annual Meeting and proxy
card and this Proxy Statement are being first mailed to stockholders on or about
January 5, 2005.

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VOTING AND REVOCABILITY OF PROXIES
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Stockholders who execute proxies retain the right to revoke them at any
time. Unless so revoked, the shares represented by properly executed proxies
will be voted at the Annual Meeting and all adjournments thereof. Proxies may be
revoked by written notice to A. Christine Baker, Secretary of the Company, at
the address shown above, by filing a later-dated proxy prior to a vote being
taken on a particular proposal at the Annual Meeting or by attending the Annual
Meeting and voting in person. The presence of a stockholder at the Annual
Meeting will not in itself revoke such stockholder's proxy.

Proxies solicited by the Board of Directors of the Company will be voted
in accordance with the directions given therein. WHERE NO INSTRUCTIONS ARE
INDICATED, PROXIES WILL BE VOTED "FOR" THE NOMINEES FOR DIRECTOR SET FORTH
BELOW. The proxy confers discretionary authority on the persons named therein to
vote with respect to the election of any person as a director where the nominee
is unable to serve or for good cause will not serve, and matters incident to the
conduct of the Annual Meeting. If any other business is presented at the Annual
Meeting, proxies will be voted by those named therein in accordance with the
determination of a majority of the Board of Directors. Proxies marked as
abstentions will not be counted as votes cast. Shares held in "street name"
which have been designated by brokers on proxies as not voted will not be
counted as votes cast. Proxies marked as abstentions or as broker non-votes,
however, will be treated as shares present for purposes of determining whether a
quorum is present.

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VOTING SECURITIES AND SECURITY OWNERSHIP
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The securities entitled to vote at the Annual Meeting consist of the
Company's common stock, par value $.01 per share (the "Common Stock").
Stockholders of record as of the close of business on December 23, 2004 (the
"Record Date") are entitled to one vote for each share of Common Stock then
held. As of the Record Date, there were 2,956,373 shares of Common Stock issued
and outstanding. The presence, in person or by proxy, of at least one-third of
the total number of shares of Common Stock outstanding and entitled to vote will
be necessary to constitute a quorum at the Annual Meeting.

Persons and groups beneficially owning more than 5% of the Common Stock
are required to file certain reports with respect to such ownership pursuant to
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The
following table sets forth information regarding the shares of Common Stock
beneficially owned as of the Record Date by persons who beneficially own more
than 5% of the Common Stock, each of the Company's directors, the executive
officers of the Company named in the Summary Compensation Table set forth under
"Proposal I - Election of Directors - Executive Compensation - Summary
Compensation Table," and all of the Company's directors and executive officers
as a group.

SHARES OF COMMON STOCK
BENEFICIALLY OWNED PERCENT OF
5% STOCKHOLDER: AS OF THE RECORD DATE (1) CLASS (2)
-------------- ------------------------- ------------

1st State Bancorp, Inc. 305,259 (3) 10.33%
Employee Stock Ownership Plan ("ESOP")
445 S. Main Street
Burlington, North Carolina 27215

1st State Bank Deferred Compensation 349,072 (4) 11.81
Plan ("DCP")
445 S. Main Street
Burlington, North Carolina 27215

Maurice J. Koury 210,330 (5) 7.11
P.O. Drawer 850
Burlington, North Carolina 27216

DIRECTORS:
---------

Bernie C. Bean 31,675 (7) 1.07
James C. McGill 169,908 (6) 5.60
Virgil L. Stadler 71,315 (7) 2.40
James A. Barnwell, Jr. 61,675 (6) 2.08
James G. McClure 51,746 (7) 1.74
T. Scott Quakenbush 72,986 (7) 2.46
Richard C. Keziah 66,179 (6) 2.23
Richard H. Shirley 47,219 (7) 1.59
Ernest A. Koury, Jr. 1,000 (7) 0.03

EXECUTIVE OFFICERS:
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A. Christine Baker 99,618 3.32
Fairfax C. Reynolds 86,679 2.89
Frank Gavigan 34,087 1.15

All directors and executive
officers of the Company
as a group (13 persons) 808,469 24.85

(FOOTNOTES ON FOLLOWING PAGE)

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(FOOTNOTES FOR TABLE FROM PREVIOUS PAGE)

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(1) In accordance with Rule 13d-3 under the Exchange Act, a person is deemed
to be the beneficial owner, for purposes of this table, of any shares of
Common Stock if he or she has or shares voting or investment power with
respect to such Common Stock or has a right to acquire beneficial
ownership at any time within 60 days from the Record Date. As used herein,
"voting power" is the power to vote or direct the voting of shares and
"investment power" is the power to dispose or direct the disposition of
shares. The listed amounts include 15,816, 79,078, 15,816, 15,816, 15,816,
15,816, 15,816, 15,816, 0, 45,000, 45,000, 11,250 and 296,463 shares that
Directors Bean, McGill, Stadler, Barnwell, McClure, Quakenbush, Keziah,
Shirley and Koury, Executive Officers Baker, Reynolds and Gavigan, and all
directors and executive officers of the Company as a group, respectively,
have the right to acquire upon the exercise of options exercisable within
60 days of the Record Date.
(2) Based on a total of 2,956,373 shares of Common Stock outstanding as
of the Record Date.
(3) These shares are currently held in a suspense account for future
allocation and distribution among participants as the loan used to
purchase the shares is repaid. At the Record Date, 151,562 shares had been
allocated or committed to be allocated. See footnote 7 below for
information on how these shares are voted.
(4) The shares held by the DCP trust are held for the benefit of directors and
executive officers of the Company in the following amounts: Mr. Bean
13,322; Mr. McGill 118,816; Mr. Stadler 18,381; Mr. Barnwell 14,263; Mr.
McClure 13,464; Mr. Quakenbush 18,526; Mr. Keziah 19,543; Mr. Shirley
14,263; Ms. Baker 53,279; Mr. Reynolds 61,331; and Mr. Gavigan 3,884. Such
individuals do not have voting or investment power over such shares.
(5) Based on a Schedule 13G filed by Mr. Koury on January 30, 2004. This total
does not include 17,500 shares held by the Maurice J. Koury Foundation,
Inc. (the "Koury Foundation Carolina Hosiery Mills, Inc. Employee Profit
Sharing Trust ("Trust"). Mr. Koury is (a) one of four directors and
president of the Koury Foundation; (b) a director, president and 23.6%
shareholder of Carolina Hosiery; and (c) a trustee of the Trust. In all
such cases, Mr. Koury may have input into decisions concerning the voting
power over the shares held by the"), 53,500 shares held by Carolina
Hosiery Mills, Inc. ("Carolina Hosiery"); and 19,000 shares held by the
Koury Foundation, Carolina Hosiery and the Trust in certain limited
circumstances.
(6) The listed amounts do not include shares with respect to which Directors
Barnwell, Keziah and McGill share voting power by virtue of their
positions as directors of 1st State Bank Foundation, Inc. (the
"Foundation"), which holds 117,585 shares of Common Stock. The shares held
by the Foundation are voted in the same ratio as all other shares of
Common Stock are voted on any given proposal submitted to stockholders.
(7) The listed amounts do not include shares with respect to which Directors
Shirley, McClure and Stadler have voting power by virtue of their
positions as trustees of the trust holding 349,072 shares under the DCP
nor the shares with respect to which Directors Quakenbush, Bean and Koury
have voting power by virtue of their positions as trustees of the trust
holding 305,259 shares under the ESOP. Shares held by the ESOP trust and
allocated to the accounts of participants are voted in accordance with the
participants' instructions, and unallocated shares are voted in the same
ratio as ESOP participants direct the voting of allocated shares or, in
the absence of such direction, in the ESOP trustees' best judgment. The
shares held by the DCP trust are voted in the same proportion as the ESOP
trustees vote the shares held in the ESOP trust.

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PROPOSAL I -- ELECTION OF DIRECTORS
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GENERAL

The Company's Board of Directors consists of nine members. The Company's
Articles of Incorporation require that directors be divided into three classes,
as nearly equal in number as possible, with approximately one-third of the
directors elected each year. At the Annual Meeting, three directors will be
elected for a term expiring at the 2008 annual meeting of stockholders. The
Board of Directors has nominated Richard C. Keziah, Ernest A. Koury, Jr. and
Richard H. Shirley to serve as directors for a three-year period. All nominees
are currently members of the Board. Under Virginia law and the Company's Bylaws,
directors are elected by a plurality of the votes present in person or by proxy
at a meeting at which a quorum is present.

It is intended that the persons named in the proxies solicited by the
Board of Directors will vote for the election of the named nominees. If either
nominee is unable to serve, the shares represented by all valid proxies will be
voted for the election of such substitute as the Board of Directors may
recommend or the size of the Board may be reduced to eliminate the vacancy. At
this time, the Board knows of no reason why any nominee might be unavailable to
serve.
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The following table sets forth, for each nominee for director and
continuing director of the Company, his age, the year he first became a director
of the Bank, which is the Company's principal operating subsidiary, and the
expiration of his term as a director. All such persons except Mr. Koury were
appointed as directors of the Company in 1998 in connection with the
incorporation and organization of the Company. Each director of the Company also
is a member of the Board of Directors of the Bank. The following directors are
"independent directors" as defined under Nasdaq Rule 4200(a)(15): Richard C.
Keziah, Ernest A. Koury, Jr., Richard H. Shirley, Bernie C. Bean, Virgil L.
Stadler, James A. Barnwell, Jr., James G. McClure and T. Scott Quakenbush.

YEAR FIRST
AGE AT ELECTED AS CURRENT
SEPTEMBER 30, DIRECTOR OF TERM
NAME 2004 THE BANK TO EXPIRE
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BOARD NOMINEES FOR TERMS TO EXPIRE IN 2008

Richard C. Keziah 72 1983 2005
Ernest A. Koury, Jr. 50 2000 2005
Richard H. Shirley 57 1987 2005

DIRECTORS CONTINUING IN OFFICE

Bernie C. Bean 74 1978 2006
James C. McGill 63 1988 2006
Virgil L. Stadler 68 1982 2006
James A. Barnwell, Jr. 64 1988 2007
James G. McClure 59 1989 2007
T. Scott Quakenbush 73 1978 2007

Set forth below is information concerning the Company's directors. Unless
otherwise stated, all directors have held the positions indicated for at least
the past five years. The Board of Directors has determined that all directors
other than the Company's Chief Executive Officer, James C. McGill, are
independent directors under Nasdaq Rule 4200.

RICHARD C. KEZIAH is Chairman and Chief Executive Officer of Monarch
Hosiery Mills, Inc. in Burlington, North Carolina. He also serves on the Board
of Directors of Elon Homes for Children. He also serves as a director of 1st
State Bank Foundation, Inc. (the "Foundation"), a charitable foundation
dedicated to charitable and community service causes within the Bank's
community.

ERNEST A. KOURY, JR. is Vice President of Carolina Hosiery Mills, Inc., a
hosiery mill in Burlington, North Carolina. He serves as Vice Chairman of the
Alamance County Planning Board and a member of the Elon University Board of
Visitors.

RICHARD H. SHIRLEY is President of Dick Shirley Chevrolet, Inc., an
automobile dealership located in Burlington, North Carolina. He has served as
the President of the Alamance County YMCA and as a member and chairman of the
Economic Development Committee of the Burlington area Chamber of Commerce.

BERNIE C. BEAN is retired. From 1988 to 1995 he was the President and
General Manager of Craftique, Inc., a furniture manufacturer located in Mebane,
North Carolina.

JAMES C. McGILL is the President and Chief Executive Officer of the
Company and has been the President and Chief Executive Officer of the Bank since
December 1988. He has served on the Boards of Hospice of Alamance and Alamance
Community College and in 1997 served as the chairman of the North Carolina
Bankers Association. He also serves as a director of the Foundation.

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VIRGIL L. STADLER retired in October 2001 from his position as Chief
Executive Officer of Stadler's Country Hams, Inc. in Elon College, North
Carolina. He is active with the Front Street United Methodist Church and Elon
Homes for Children.

JAMES A. BARNWELL, JR. , the Chairman of the Board of Directors of the
Company, is President of Huffman Oil Co., Inc., a petroleum marketer in
Burlington, North Carolina. He has served on the advisory board of the Salvation
Army Boys & Girls Club and the Alamance County YMCA board. He serves as a
director of the Foundation. He also serves on the Board of Directors of the
Alamance Regional Medical Center.

JAMES G. McCLURE is President of Green & McClure, a retail furniture store
in Graham, North Carolina. He currently serves as Chairman of the Graham Area
Business Association and has served on the zoning board for the City of Graham.
He is active in the Graham Presbyterian Church.

T. SCOTT QUAKENBUSH retired in April 1997 from his position as Vice
President and sales manager with Carolina Paper Box Company in Burlington, North
Carolina.

EXECUTIVE OFFICERS WHO ARE NOT DIRECTORS

The following sets forth information with respect to executive officers
who do not serve on the Board of Directors.

AGE AT
SEPTEMBER 30,
NAME 2004 TITLE
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A. Christine Baker 51 Treasurer and Secretary of the
Company and the Bank and
Executive Vice President-Chief
Financial Officer of the Bank
Fairfax C. Reynolds 51 Vice President and Assistant
Secretary of the Company and
Executive Vice President-
Commercial and Retail Banking
of the Bank
Frank Gavigan 46 Senior Vice President - Senior
Credit Officer of the Bank
John D. Hansell 67 Manager - First Capital
Services, LLC

A. CHRISTINE BAKER is the Treasurer and Secretary of the Company and
served as the Executive Vice President, Secretary and Treasurer of the Bank
since April 1985. She currently serves on the Board of the Alamance County Meals
on Wheels and is active with First Presbyterian Church of Burlington. She is a
member of the Board of Trustees of Elon University.

FAIRFAX C. REYNOLDS is the Vice President and Assistant Secretary of the
Company and has served as the Bank's Executive Vice President in charge of
Commercial and Retail Banking since 1989. He serves on the Boards of Directors
of Alamance County YMCA, the Alamance County Arts Council and the United Way of
Alamance County.

FRANK GAVIGAN has served as the Bank's Senior Vice President - Senior
Credit Officer since 1990. He serves on the Boards of Directors of Hospice of
Alamance County and Alamance Eldercare.

JOHN D. HANSELL has served since May 1987 as Manager of First Capital
Services Company, LLC and its predecessor, First Capital Services, Inc.,
entities the Company owns that sell annuities, mutual funds and insurance
products on an agency basis. He has served on the small business council of the
Alamance Chamber of Commerce and on the Board of Directors of the Financial
Planning Association.

COMMITTEES OF THE BOARD OF DIRECTORS

The Board of Directors of the Company meets monthly and may have
additional special meetings. During the year ended September 30, 2004, the Board
of Directors of the Company met 12 times and the Board of Directors of the Bank
met 12 times. No director attended fewer than 75% in the aggregate of the total
number of Company Board of Directors meetings held during the year ended
September 30, 2004 and the total number of meetings held by committees on which
he served during such fiscal year.

The Company has a separately designated Audit Committee established in
accordance with Section 3(a)(58)(A) of the Exchange Act. During the fiscal year
ended September 30, 2004, the Board of Directors' Audit Committee consisted of
Directors McClure, Koury, and Shirley, who serves as Chairperson. Each of the
members of the Audit Committee are "independent," as "independent" is defined in
Rule 4200(a)(15) of the listing standards of the National Association of
Securities Dealers, Inc. ("NASD"). Additionally, Director Shirley has background
and experience that results in his having "financial sophistication" as defined
by Rule 4350(d) of the of the NASD's listing standards. However, the Board has
also determined that no member of the Audit Committee is an "audit committee
financial expert," as defined in Item 401(h) of Regulation S-K. Therefore, the
Company does not have an "audit committee financial expert" serving on its Audit
Committee. The Board of Directors has determined that by satisfying the
requirements of the NASD's listing standards with a member of the Audit
Committee that has the requisite "financial sophistication", the Company's Audit
Committee has the financial expertise necessary to fulfill its duties. The Board
of Directors has concluded that the appointment of an additional director to the
Company's Audit Committee is not necessary at this time.

The function of the Audit Committee is: to review and discuss the audited
financial statements with management, internal audit and the independent
auditors; to receive disclosures required by SAS No. 61 and the independence
letter from the independent auditors; to engage the independent auditors of the
Company; to review the internal audit function and internal accounting controls;
and to review and approve the internal audit plan. The Company's Board of
Directors adopted a written charter for the Audit Committee which is attached
hereto as Appendix A. The Audit Committee met two times during the year ended
September 30, 2004.

NOMINATING COMMITTEE. The Board of Directors' Nominating Committee
nominates directors to be voted on at the Annual Meeting and recommends nominees
to fill any vacancies on the Board of Directors. The Nominating Committee
consists of Directors Stadler, Koury, and Quakenbush. The members of the
Nominating Committee are "independent directors" as defined in Nasdaq listing
standards. The Board of Directors has adopted a Charter for the Nominating
Committee, a copy of which is attached hereto as Appendix B. The Nominating
Committee met once during the year ended September 30, 2004.

It is the policy of the Nominating Committee to consider director
candidates recommended by security holders who appear to be qualified to serve
on the Company's Board of Directors. Any stockholder wishing to recommend a
candidate for consideration by the Nominating Committee as a possible director
nominee for election at an upcoming annual meeting of stockholders must provide
written notice to the Nominating Committee of such stockholder's recommendation
of a director nominee no later than October 1 preceding the annual meeting of
stockholders. Notice should be provided to: A. Christine Baker, Secretary, 1st
State Bancorp, Inc., 445 S. Main Street, Burlington, North Carolina 27215. Such
notice must contain the following information:

o The name of the person recommended as a director candidate;

o All information relating to such person that is required to be
disclosed in solicitations of proxies for election of directors
pursuant to Regulation 14A under the Securities Exchange Act of
1934, as amended;

o The written consent of the person being recommended as a director
candidate to being named in the proxy statement as a nominee and
to serving as a director if elected;

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o As to the shareholder making the recommendation, the name and
address, as he or she appears on the Company's books, of such
shareholder; provided, however, that if the shareholder is not a
registered holder of the Company's common stock, the shareholder
should submit his or her name and address, along with a current
written statement from the record holder of the shares that
reflects ownership of the Company's common stock; and

o A statement disclosing whether such shareholder is acting with or
on behalf of any other person and, if applicable, the identity of
such person.

In its deliberations, the Nominating Committee considers a candidate's
personal and professional integrity, knowledge of the banking business and
involvement in community, business and civic affairs, and also considers whether
the candidate would provide for adequate representation of the Bank's market
area. Any nominee for director made by the Nominating Committee must be highly
qualified with regard to some or all the attributes listed in the preceding
sentence. In searching for qualified director candidates to fill vacancies in
the Board, the Nominating Committee solicits the Company's then current
directors for the names of potential qualified candidates. Moreover, the
Nominating Committee may ask its directors to pursue their own business contacts
for the names of potentially qualified candidates. The Nominating Committee
would then consider the potential pool of director candidates, select a
candidate based on the candidate's qualifications and the Board's needs, and
conduct a thorough investigation of the proposed candidate's background to
ensure there is no past history that would cause the candidate not to be
qualified to serve as a director of the Company. In the event a stockholder has
submitted a proposed nominee, the Nominating Committee would consider the
proposed nominee in the same manner in which the Nominating Committee would
evaluate nominees for director recommended by directors.

With respect to nominating an existing director for re-election to the
Board of Directors, the Nominating Committee will consider and review an
existing director's Board and committee attendance and performance, length of
Board service, experience, skills and contributions that the existing director
brings to the Board and independence.

COMPENSATION COMMITTEE. The Compensation Committee consists of directors
Barnwell, Shirley, and McClure. The Committee evaluates the compensation and
fringe benefits of the directors, officers and employees, recommends changes and
monitors and evaluates employee morale. The Compensation Committee met two times
during the year ended September 30, 2004.

BOARD POLICIES REGARDING COMMUNICATIONS WITH THE BOARD OF DIRECTORS AND
ATTENDANCE AT ANNUAL MEETINGS. The Board of Directors maintains a process for
stockholders to communicate with the Board of Directors. Stockholders wishing to
communicate with the Board of Directors should send any communication to A.
Christine Baker, Secretary, 1st State Bancorp, Inc., 445 S. Main Street,
Burlington, North Carolina 27215. All communications that relate to matters that
are within the scope of the responsibilities of the Board and its Committees are
to be presented to the Board no later than its next regularly scheduled meeting.
Communications that relate to matters that are within the responsibility of one
of the Board Committees are also to be forwarded to the Chair of the appropriate
Committee. Communications that relate to ordinary business matters that are not
within the scope of the Board's responsibilities, such as customer complaints,
are to be sent to the appropriate officer. Solicitations, junk mail and
obviously frivolous or inappropriate communications are not to be forwarded, but
will be made available to any director who wishes to review them.

Directors are expected to prepare themselves for and to attend all Board
meetings, the Annual Meeting of Stockholders and the meetings of the Committees
on which they serve, with the understanding that on occasion a director may be
unable to attend a meeting. All of the Company's directors attended the
Company's 2004 Annual Meeting of Stockholders.

COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

OVERVIEW AND PHILOSOPHY

The Company's executive compensation policies are established by the
Compensation Committee of the Board of Directors (the "Committee"). The
Committee is responsible for developing the Company's executive compensation
policies. The Committee's objectives in designing and administering the specific
elements of the Company's executive compensation program are as follows:

o To link executive compensation rewards to increases in shareholder
value, as measured by favorable long-term operating results and
continued strengthening of the Company's financial condition.

o To provide incentives for executive officers to work towards
achieving successful annual results as a step in achieving the
Company's long-term operating results and strategic objectives.

o To correlate, as closely as possible, executive officers' receipt of
compensation with the attainment of specified performance
objectives.

o To maintain a competitive mix of total executive compensation, with
particular emphasis on awards related to increases in long-term
shareholder value.

o To attract and retain top performing executive officers for the
long-term success of the Company.

In furtherance of these objectives, the Committee has determined that
there should be three specific components of executive compensation: base
salary, a cash bonus and stock benefit plans.

BASE SALARY. The Committee makes recommendations to the Board concerning
executive compensation on the basis of surveys of salaries paid to executive
officers of other bank holding companies, non-diversified banks and other
financial institutions similar in size, market capitalization and other
characteristics. The Committee's objective is to provide for base salaries that
are competitive with the average salary paid by the Company's peers.

BONUS. The Company pays a discretionary bonus on an annual basis based on
satisfaction of a combination of individual and Company performance objectives.
Whether bonuses are paid each year and the amount of such bonuses are determined
by the Committee, subject to ratification by the Board of Directors, at year end
based on the Company's ability to achieve performance goals established by the
Board in each year's Business Plan. Discretionary bonuses for achieving specific
performance goals during the year are paid during the next fiscal year.

STOCK BENEFIT PLANS. In addition, the Committee believes that
stock-related award plans are an important element of compensation since they
provide executives with incentives linked to the performance of the Common
Stock. Accordingly, the Board of Directors adopted a stock option plan and a
management recognition plan. Stockholders approved these plans at a special
meeting held on June 6, 2000.

Under the stock option plan, the Company reserved for issuance a number of
shares equal to 10% of the originally issued Common Stock. The Committee
believes that stock options are an important element of compensation because
they provide executives with incentives linked to the performance of the Common
Stock. The Company awards stock options as a means of providing employees the
opportunity to acquire a proprietary interest in the Company and to link their
interests with those of the Company's stockholders. Options are granted with an
exercise price equal to the market value of the Common Stock on the date of
grant, and thus acquire value only if the Company's stock price increases. There
are currently no options available for grant under the option plan.

8
10

Under the management recognition plan, officers and directors were granted
awards of restricted Common Stock, subject to vesting and forfeiture as
determined by the Committee. Under this plan, the Company reserved for issuance
a number of shares equal to 4% of the originally issued Common Stock. The
purpose of a management recognition plan is to reward and retain personnel of
experience and ability in key positions of responsibility by providing such
employees with a proprietary interest in the Company as compensation for their
past contributions to the Company and the Bank and as an incentive to make
further contributions in the future. There currently are no shares available for
award under this plan.

COMPENSATION OF THE PRESIDENT

Mr. McGill's base salary is established in accordance with the terms of
the employment agreement entered into between the Bank and Mr. McGill. See "--
Executive Compensation -- Employment Agreements." The Committee determines the
President's compensation on the basis of several factors. In determining Mr.
McGill's base salary, the Committee reviewed compensation paid to chief
executive officers of similarly situated banks and non-diversified banks and
other financial institutions of similar asset size. The Committee believes that
Mr. McGill's base salary is generally competitive with the average salary paid
to executives of similar rank and expertise at banking institutions which the
Committee considered to be comparable and taking into account the Bank's
superior performance and complex operations relative to comparable institutions.

Mr. McGill received bonus compensation for fiscal year 2004 pursuant to
the same basic factors as described above under "-- Bonus." In establishing Mr.
McGill's bonus, the Committee considered the Company's overall performance,
record of increase in shareholder value and success in meeting strategic
objectives and his personal leadership and accomplishments. These factors were
considered in conjunction with the Company's financial results for fiscal 2004
in relation to the established Business Plan and achieving certain annual
performance goals, including but not limited to return on assets and return on
equity and satisfactory results of regulatory examinations and independent
audits.

The Committee believes that the Company's executive compensation program
serves the Company and its shareholders by providing a direct link between the
interests of executive officers and those of shareholders generally and by
helping to attract and retain qualified executive officers who are dedicated to
the long-term success of the Company.

Members of the Compensation Committee

James A. Barnwell
James G. McClure
Richard H. Shirley

COMPARATIVE STOCK PERFORMANCE GRAPH

The graph and table which follow show the cumulative total return on the
Common Stock for the period from September 30, 1999 through the fiscal year
ended September 30, 2004 with (1) the total cumulative return of all companies
whose equity securities are traded on the Nasdaq Stock Market, and (2) the total
cumulative return of banks and bank holding companies traded on the Nasdaq Stock
Market. The comparison assumes $100 was invested on September 30, 1999 in the
Company's Common Stock and in each of the foregoing indices and assumes
reinvestment of dividends. The stockholder returns shown on the performance
graph are not necessarily indicative of the future performance of the Common
Stock or of any particular index.

CUMULATIVE TOTAL STOCKHOLDER RETURN
COMPARED WITH PERFORMANCE OF SELECTED INDEXES
SEPTEMBER 30, 1999 THROUGH SEPTEMBER 30, 2004

[Line graph appears here depicting the cumulative total shareholder return of
$100 invested in the Common Stock as compared to $100 invested in all companies
whose equity securities are traded on the Nasdaq Stock Market and $100 invested
in banks and bank holding companies whose equity securities are traded on the
Nasdaq Stock Market. Line graph plots the cumulative total return from September
30, 1999 to September 30, 2004. Plot points are provided below.]

-------------------------------------------------------------------------
9/30/99 9/30/00 9/30/01 9/30/02 9/30/03 9/30/04
-------------------------------------------------------------------------

COMPANY $100 $115.08 $139.19 $159.08 $190.30 $194.14
-------------------------------------------------------------------------

NASDAQ 100 133.99 54.85 43.05 65.95 70.38
-------------------------------------------------------------------------

NASDAQ BANKS 100 113.80 123.96 130.14 148.77 169.02
AND BANK HOLDING
COMPANIES
-------------------------------------------------------------------------

10
12

EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE. The following table sets forth the cash and
noncash compensation for the fiscal years ended September 30, 2004, 2003 and
2002 awarded to or earned by the President and the four other executive officers
who earned salary and bonus in fiscal 2004, 2003 and 2002 exceeding $100,000 for
services rendered in all capacities to the Company and the Bank.

LONG-TERM COMPENSATION
AWARDS
ANNUAL COMPENSATION ------------------------
--------------------------------------------- RESTRICTED SECURITIES
FISCAL OTHER ANNUAL STOCK UNDERLYING ALL OTHER
NAME YEAR SALARY BONUS COMPENSATION (1) AWARD(S) OPTIONS COMPENSATION
---- ------ ------ ----- ---------------- ---------- ------------ --------------

James C. McGill 2004 $175,000 $355,500 $ -- -- -- $184,118 (2)
President and Chief 2003 175,000 422,000 -- -- -- 186,378
Executive Officer of 2002 175,000 404,500 -- -- -- 208,332
the Company and the
Bank

A. Christine Baker 2004 $100,000 $175,500 $ -- -- -- 82,407 (2)
Treasurer and 2003 100,000 211,000 -- -- -- 84,666
Secretary of the 2002 100,000 202,250 -- -- -- 99,224
Company and the
Bank and Executive
Vice President-
Chief Financial Officer
of the Bank

Fairfax C. Reynolds 2004 $100,000 $175,500 $ -- -- -- $ 85,387 (2)
Vice President and 2003 100,000 211,000 -- -- -- 87,646
Assistant Secretary of 2002 100,000 202,250 -- -- -- 102,201
the Company and
Executive Vice
President of the
Bank

Frank Gavigan 2004 $ 85,000 $ 30,000 $ -- -- -- $ 25,036 (2)
Senior Vice 2003 85,000 30,000 -- -- -- 28,307
President-Senior 2002 80,000 35,000 -- -- -- 33,209
Credit Officer of
the Bank

---------------------
(1) Executive officers receive indirect compensation in the form of certain
perquisites and other personal benefits. The amount of such benefits
received by the named executive officer in fiscal 2004 did not exceed 10%
of the executive officer's salary and bonus.
(2) Includes $146,378, $44,666 and $47,646 accrued under the Company's
Deferred Compensation Plan for the benefit of executive officers McGill,
Baker and Reynolds, respectively, for service as an employee during the
year ended September 30, 2004. Also includes $37,741, $37,741, $37,741 and
$22,486 in shares of Common Stock committed to be allocated during the
year ended September 30, 2004 under the ESOP to the accounts of executive
officers McGill, Baker, Reynolds and Gavigan, respectively, and $2,550 in
matching contributions under the Bank's 401(k) Plan for executive officer
Gavigan.

FISCAL YEAR END OPTION VALUES. The following table sets forth information
concerning the value as of September 30, 2004 of options held by the executive
officers named in the Summary Compensation Table set forth above and the options
exercised during fiscal year 2004.

NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS
SHARES OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END (1)
AQUIRED ON VALUE ---------------------------- -----------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- -------- -------- ----------- ------------- ----------- -------------

James C. McGill -- $ -- 79,078 -- $971,869 $ --
A. Christine Baker -- -- 45,000 -- 553,050 --
Fairfax C. Reynolds -- -- 45,000 -- 553,050 --
Frank Gavigan -- -- 11,250 -- 138,263 --

----------------
(1) Based on the difference between the fair market value of the underlying
Common Stock as quoted on the Nasdaq National Market System on September
30, 2004 of $27.00 per share, and the exercise price of $14.71 per share,
which was adjusted to reflect the effect of the return of capital of $5.17
per share paid on October 2, 2000.

No options held by any executive officer of the Company repriced during
the past ten full fiscal years.

EMPLOYMENT AGREEMENTS AND GUARANTY AGREEMENTS. The Bank has entered into
employment agreements with James C. McGill, A. Christine Baker and Fairfax C.
Reynolds (each individual is referred to herein as an "Employee" and the three
individuals are referred to collectively as the "Employees"). The Board believes
that the employment agreements assure fair treatment of the Employees in their
careers with the Company by assuring them of some financial security.

The employment agreements provide for terms of three years each. On April
23 of each year, the anniversary date of the commencement of the employment
agreements, the term of the Employee's employment will be extended for an
additional one-year period beyond the then effective expiration date upon a
determination by the Bank's Board of Directors that the performance of the
Employee has met the required performance standards and that such employment
agreements should be extended. The employment agreements provide the Employee
with a salary review by the Board of Directors not less often than annually, as
well as with inclusion in any discretionary bonus plans, retirement and medical
plans, vacation and sick leave and any fringe benefits that become available to
senior management, including for example, any stock option or incentive
compensation plans and any other benefits commensurate with their
responsibilities. If the Board decides not to renew an employment agreement for
any reason, and if the Employee remains an employee of the Bank until the
Agreement expires, the Bank must pay the Employee an amount equal to two times
total compensation if the Employee is later terminated. The employment
agreements currently expire on April 23, 2007 and provide for base salaries of
$175,000, $100,000 and $100,000 for Mr. McGill, Ms. Baker and Mr. Reynolds,
respectively.

The employment agreements terminate upon the Employee's death, may
terminate upon the Employee's disability, are terminable for just cause, and no
severance benefits are available. If the Bank terminates the Employee without
just cause, the Employee is entitled to receive three times total compensation
as well as continued medical and dental insurance under any group plan chosen by
the Employee from the plans the Bank maintains, unless that coverage is not
permitted by the terms of such plan, in which case the Bank will remit to the
Employee, not less frequently than monthly, the actual cost to the Employee of
equivalent insurance. These provisions are in addition to, and not in lieu of,
any other rights that the Employee has under the employment agreement and will
continue until the Employee first becomes eligible for participation in
Medicare. If the employment agreements are terminated due to the Employee's
"disability" as defined in the employment agreements, the Employee will be
entitled to a continuation of his or her salary and benefits through the date of
termination, including any period prior to the establishment of the Employee's
disability. In the event of the Employee's death during the term of the
employment agreements, his or her estate will be entitled to receive three times
total compensation determined as of the date of death. Each Employee is able to
voluntarily terminate his or her employment agreement by providing 90 days'
written notice to the Board of Directors, in which case the Employee is entitled
to receive only his or her compensation, vested rights, and benefits up to the
date of termination.

The Bank will pay a severance benefit equal to the difference between the
product of 2.99 and the Employee's "base amount" as defined in the Internal
Revenue Code Section 280G(b)(3) and the sum of any other "parachute payments" as
defined under Code Section 280G(b)(2) that the Employee receives on account of
the

12
14

change in control, and (ii) provide long-term disability and medical
insurance for 18 months if any of the following occur:

o the Employee's involuntary termination of employment other than for
"just cause" during the period beginning six months before a change
in control and ending on the later of the first anniversary of the
change in control or the expiration date of the employment
agreements (the "Protected Period");

o the Employee's voluntary termination within 90 days of the
occurrence of certain specified events occurring during the
Protected Period which have not been consented to by the Employee;
or

o the Employee's voluntary termination of employment for any reason
within the 30-day period beginning on the date of the change in
control.

The Employee will be paid either in one lump sum within ten days of the
later of the date of the change in control and the Employee's last day of
employment or if prior to the date which is 90 days before the date on which a
change in control occurs, the Employee filed a duly executed irrevocable written
election, payment of such amount shall be made according to the elected
schedule. "Change in control" generally refers to the acquisition, by any person
or entity, of the ownership or power to vote more than 25% of the Company's or
the Bank's voting stock, the control of the election of a majority of the
Company's or the Bank's directors, or the exercise of a controlling influence
over the Company's or the Bank's management or policies. In addition, under the
employment agreements, a change in control occurs when, during any consecutive
two-year period, directors of the Company or the Bank at the beginning of such
period cease to constitute two-thirds of the Board of Directors of the Company
or the Bank, unless the election of replacement directors was approved by a
two-thirds vote of the initial directors then in office. The employment
agreements provide that within 10 business days of a change in control, the
Company must deposit in a trust an amount equal to the Internal Revenue Code
Section 280G maximum. The payments that would be made to Mr. McGill, Ms. Baker
and Mr. Reynolds assuming termination of employment under the foregoing
circumstances at September 30, 2004 would have been approximately $2.6 million,
$1.3 million and $1.3 million, respectively. These provisions may have an
anti-takeover effect by making it more expensive for a potential acquiror to
obtain control of the Company. In the event that the Employee prevails over the
Bank, or obtains a written settlement, in a legal dispute as to the employment
agreement, he or she will be reimbursed for legal and other expenses.

In addition to the employment agreements, the Company has entered into
guaranty agreements with each of the Employees. The guaranty agreements provide
that the Company will perform all covenants and honor all obligations required
to be performed or to which the Bank is subject pursuant to the employment
agreements in the event that such covenants are not performed or obligations are
not honored by the Bank, and that to the extent permitted by law, the Company
will be jointly and severally liable with the Bank for the payment of all
amounts due under the employment agreements. The guarantee agreements provide
the Employee with a salary review by the Board of Directors not less often than
annually, as well as with inclusion in any discretionary bonus plans, retirement
and medical plans, customary fringe benefits, vacation and sick leave.

DIRECTOR COMPENSATION

FEES. Each non-employee member of the Bank's Board of Directors receives a
monthly retainer fee based on the following schedule:

o the Chairman of the Board - $2,000;
o members of the Executive Committee - $1,750; and
o other directors - $1,500.

In addition, non-employee members of the Company's Board of Directors receive a
monthly retainer fee of $500 and members of the Audit Committee receive a fee of
$250 per meeting attended. Officers who are directors are not compensated for
their service as directors.

13
15

DEFERRED COMPENSATION PLAN. The Bank adopted the DCP for the Bank's
directors and select executive officers. Under the DCP, before each fiscal year
begins, each non-employee director may elect to defer receipt of all or part of
his future fees and any other participant may elect to defer receipt of up to
25% of his or her salary or 100% of his or her bonus compensation for the year.
Deferred amounts are credited at the end of the calendar year to bookkeeping
accounts in the name of each participant. No amounts were credited to the
accounts of nonemployee directors during the year ended September 30, 2004. Each
participant is fully vested in his or her account balance under the DCP.

Until distributed in accordance with the terms of the DCP, each
participant's account will be credited with a rate of return equal to the Bank's
highest rate of interest paid on the Bank's one-year certificates of deposit or
the total return on the Common Stock, as elected by each participant. Account
balances will normally be distributed in five substantially equal annual
installments beginning during the first quarter of the calendar year following
the calendar year in which the participant ceases to be a director or employee,
with any subsequent distributions being made by the last day of the first
quarter of each subsequent calendar year until the participant has received the
entire amount of his or her account. Participants may, however, elect to receive
their distributions in a lump sum or in installments paid over a period of up to
10 years. In the event of a participant's death, the balance of his or her plan
account will be paid in a lump sum (unless the participant elects to continue
the previously designated distribution method) to his or her designated
beneficiary, or if none, the participant's estate.

The Bank has established a trust in order to hold assets with which to pay
plan benefits to participants. Trust assets are subject to claims of general
creditors. In the event a participant prevails over the Bank in a legal dispute
as to the terms or interpretation of the DCP, he or she would be reimbursed for
his legal and other expenses.

TRANSACTIONS WITH MANAGEMENT

The Bank offers loans to its directors and executive officers. These loans
were made in the ordinary course of business on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with other persons and did not involve more than the
normal risk of collectibility or present other unfavorable features. Under
current law, the Bank's loans to directors and executive officers are required
to be made on substantially the same terms, including interest rates, as those
prevailing for comparable transactions with other persons and must not involve
more than the normal risk of repayment or present other unfavorable features.
Furthermore, all loans to such persons must be approved in advance by a
disinterested majority of the Company's Board of Directors. At September 30,
2004, loans to directors and executive officers and their affiliates totaled
$23.5 million, or 35.7% of the Company's stockholders' equity, at that date.

14
16

-------------------------------------------------------------------------------
REPORT OF THE AUDIT COMMITTEE
-------------------------------------------------------------------------------

The Audit Committee of the Board of Directors (the "Audit Committee") has:

1. Reviewed and discussed the audited financial statements for the
fiscal year ended September 30, 2004 with the management of the
Company.

2. Discussed with the Company's independent auditors the matters
required to be discussed by Statement of Accounting Standards No.
61, as the same was in effect on the date of the Company's financial
statements; and

3. Received the written disclosures and the letter from the Company's
independent auditors required by Independence Standards Board
Standard No. 1 (Independence Discussions with Audit Committees), as
the same was in effect on the date of the Company's financial
statements.

Based on the foregoing materials and discussions, the Audit Committee
recommended to the Board of Directors that the audited financial statements for
the fiscal year ended September 30, 2004 be included in the Company's Annual
Report on Form 10-K for the year ended September 30, 2004.

The Audit Committee has reviewed the non-audit services currently provided
by the Company's independent auditor and has considered whether the provision of
such services is compatible with maintaining the independence of the Company's
independent auditors.

Members of the Audit Committee

Richard H. Shirley, Chairman
Ernest A. Koury, Jr.
James G. McClure

-------------------------------------------------------------------------------
INDEPENDENT AUDITORS
-------------------------------------------------------------------------------

KPMG LLP was the Company's independent auditor for the 2004 fiscal year. A
representative of KPMG LLP is expected to be present at the Annual Meeting and
will have the opportunity to make a statement if he or she so desires. The
representative will also be available to answer appropriate questions.

-------------------------------------------------------------------------------
AUDIT FEES
-------------------------------------------------------------------------------

Fees of KPMG LLP for the years ended September 30, 2004 and 2003 were
$152,400 and $110,435, respectively. Such fees were comprised of the following:

AUDIT FEES

The aggregate fees for the audit of the Company's annual financial
statements and for the reviews of the financial statements included in the
Company's Quarterly Reports on Form 10-Q were $127,500 and $90,500 for the
fiscal years ended September 30, 2004 and 2003, respectively.

15
17

AUDIT-RELATED FEES

The aggregate fees for audit-related services were $7,500 and $3,000,
respectively, for the fiscal years ended September 30, 2004 and 2003. For both
fiscal years, these fees related to the FHLB agreed-upon procedures engagement.

TAX FEES

The aggregate fees for tax services for the fiscal years ended September
30, 2004 and 2003 were $17,400 and $16,935, respectively. For the fiscal year
ended September 30, 2004, these fees consisted of $17,400 for tax compliance
services. For the fiscal year ended September 30, 2003, these fees consisted of
$16,250 for tax compliance services and $685 for miscellaneous tax consulting
services.

ALL OTHER FEES

The aggregate fees for all other services, exclusive of the fees disclosed
above, rendered during each of the fiscal years ended September 30, 2004 and
2003, were $0.

-------------------------------------------------------------------------------
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
-------------------------------------------------------------------------------

Pursuant to regulations promulgated under the Exchange Act, the Company's
officers and directors and all persons who own more than 10% of the Common Stock
("Reporting Persons") are required to file reports detailing their ownership and
changes of ownership in the Common Stock and to furnish the Company with copies
of all such ownership reports that are filed. Based solely on the Company's
review of the copies of such ownership reports which it has received in the past
fiscal year or with respect to the past fiscal year, or written representations
that no annual report of changes in beneficial ownership were required, the
Company believes that during fiscal year 2004 all Reporting Persons have
complied with these reporting requirements.

-------------------------------------------------------------------------------
OTHER MATTERS
-------------------------------------------------------------------------------

The Board of Directors is not aware of any business to come before the
Annual Meeting other than those matters described above in this proxy statement
and matters incident to the conduct of the Annual Meeting. However, if any other
matters should properly come before the Annual Meeting, it is intended that
proxies in the accompanying form will be voted in respect thereof in accordance
with the determination of a majority of the Board of Directors.

-------------------------------------------------------------------------------
MISCELLANEOUS
-------------------------------------------------------------------------------

The cost of soliciting proxies will be borne by the Company. The Company
will reimburse brokerage firms and other custodians, nominees and fiduciaries
for reasonable expenses incurred by them in sending proxy materials to the
beneficial owners of Common Stock. In addition to solicitations by mail,
directors, officers and regular employees of the Company may solicit proxies
personally or by telegraph or telephone without additional compensation.

The Company's 2004 Annual Report to Stockholders, including financial
statements, is being mailed to all stockholders of record as of the close of
business on the Record Date. Any stockholder who has not received a copy of such
Annual Report may obtain a copy by writing to the Secretary of the Company. The
Annual Report is not to be treated as a part of the proxy solicitation material
or as having been incorporated herein by reference.

-------------------------------------------------------------------------------
STOCKHOLDER PROPOSALS
-------------------------------------------------------------------------------

For consideration at the Annual Meeting, a stockholder proposal must be
delivered or mailed to the Company's Secretary no later than January 5, 2004. In
order to be eligible for inclusion in the proxy materials of the Company for the
Annual Meeting of Stockholders for the fiscal year ending September 30, 2005,
any stockholder proposal to take action at such meeting must be received at the
Company's executive offices at 445 S. Main Street, Burlington, North Carolina
27215 by no later than August 28, 2004. Any such proposals shall be subject to
the requirements of the proxy rules adopted under the Exchange Act.

BY ORDER OF THE BOARD OF DIRECTORS

/s/ A. Christine Baker

A. Christine Baker
Secretary

January 5, 2005
Burlington, North Carolina

-------------------------------------------------------------------------------
ANNUAL REPORT ON FORM 10-K
-------------------------------------------------------------------------------

A COPY OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR
ENDED SEPTEMBER 30, 2004 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
WILL BE FURNISHED WITHOUT CHARGE TO EACH STOCKHOLDER AS OF THE RECORD DATE UPON
WRITTEN REQUEST TO THE CORPORATE SECRETARY, 1ST STATE BANCORP, INC., 445 S. MAIN
STREET, BURLINGTON, NORTH CAROLINA 27215.

APPENDIX A

AUDIT COMMITTEE

CHARTER

The Board of Directors of 1st State Bancorp, Inc. (the "Company") has
constituted and established an audit committee (the "Committee") with authority,
responsibility, and specific duties as described in this Audit Committee
Charter.

Committee Mission: The primary responsibility of the Committee is to
oversee the Company's financial reporting process on behalf of the Board of
Directors and report the results of these activities to the Board. Management of
the Company is responsible for preparing the Company's financial statements, and
the independent auditors retained by the Committee are responsible for auditing
those financial statements. The Committee in carrying out its responsibilities
believes its policies and procedures should remain flexible, in order to best
react to overall changing conditions and circumstances. The Committee should
take the appropriate actions to set the overall corporate policy for quality
financial reporting, sound business risk management policies and ethical
behavior.

A. COMPOSITION

The Committee shall consist of three or more directors, each of whom is
"independent" as such term is defined in Section 10A(m)(3) of the Securities
Exchange Act of 1934, as amended (the "Act") and regulations promulgated
thereunder by the Securities and Exchange Commission (the "SEC"), the ("SEC
Regulations "), or whose failure to be "independent" shall fall within one of
the exemptions set forth in the Act and SEC Regulations, and is independent
under the rules of The Nasdaq Stock Market ("Nasdaq") as set forth in the
National Association of Securities Dealers' Manual (the "Manual").

B. PRINCIPAL FUNCTIONS

The Committee shall have access to all records of the Company and shall
have and may exercise such powers as are appropriate to its purpose. The
Committee shall perform the following functions:

(1) Review the accounting policies used by the Company for financial
reporting and tax purposes and approve their application; it shall also
consider any significant changes in accounting policies that are proposed
by management or required by regulatory or professional authorities.

(2) Study the format and timeliness of financial reports presented to the
public or used internally and, when indicated, recommend changes.

(3) Meet and discuss with the Company's legal counsel, as appropriate, legal
matters that may have a significant impact on the Company or its
financial reports.

(4) Ensure that management has been diligent and prudent in establishing
accounting provisions for probable losses or doubtful values and in
making appropriate disclosures of significant financial conditions or
events.

(5) Review and reassess the adequacy of this Charter annually.

A-1

(6) Be directly responsible for the appointment, compensation, retention and
oversight of the work of the independent auditors employed for the
purpose of preparing or issuing an audit report with respect to the
Company or preparing other audit, review or attestation services for the
Company. Such independent auditors shall be duly registered with the
Public Accounting Oversight Board. Approve the fees and other significant
compensation to be paid to the independent auditors.

(7) Review, evaluate and approve any permissible non-audit services the
independent auditor may perform for the Company and disclose such
approved non-auditor services in periodic reports to stockholders.

(8) Review the Company's annual audited financial statements prior to filing
or distribution. Review should include discussion with management and
independent auditors of significant issues regarding accounting
principles, practices and judgments. Review and discuss with the
independent auditor all necessary accounting policies and
practices to be used, all alternative treatments of financial information
within generally accepted accounting principles that have been discussed
with management and the risks of using such alternative treatments, and
other material written communications between the independent auditor and
management.

(9) Meet with management and independent auditors to (a) discuss the scope of
the annual audit, (b) discuss the annual audited financial statements
including disclosures made in the Company's Annual Report on Form 10-K,
(c) discuss any significant matter arising from the audit or report as
disclosed to the Committee by management or the independent auditors, (d)
review the form of opinion the independent auditors propose to render
with respect to the audited annual financial statements, (e) discuss
significant changes to the Company's auditing and accounting principles,
policies, or procedures proposed by management or the independent
auditors, (f) inquire of the independent auditors of significant risks or
exposures, if any, that have come to the attention of the independent
auditors and any difficulties encountered in conducting the audit,
including any restrictions on the scope of activities or access to
requested information and any significant disagreement with management.

(10) Ensure that the independent auditors submit to the Committee written
disclosures and the letter from the independent auditors required by
Independence Standards Board Standard No. 1 Independence Discussions with
Audit Committees, and discuss with the independent auditors their
independence.

(11) Discuss with the independent auditors the matters required to be
discussed by SAS 61 Communication with Audit Committees and SAS 90 Audit
Committee Communications, which include:

(a) methods used to account for significant unusual transactions;
(b) the effect of significant accounting policies in controversial
or emerging areas for which there is a lack of authoritative
guidance or consensus;
(c) the process used by management in formulating particularly
sensitive accounting estimates and the basis for the auditor's
conclusions regarding the reasonableness of those estimates;
(d) disagreements with management over the application of accounting
principles, the basis for management's accounting estimates, and
the disclosures in the financial statements; and
(e) information regarding the auditor's judgment about quality, not
just acceptability, of the Company's auditing principles.

(12) Engage independent counsel and other advisers, as the Committee may
determine in its sole discretion to be necessary and appropriate, to
carry out the Committee's duties.

A-2
21

13) Be provided with appropriate funding by the Company, as determined by the
Committee, for payment of:

(a) compensation to any independent auditors engaged for the purpose of
preparing or issuing an audit report or performing other audit,
review or attest services for the Company;
(b) compensation to any advisers employed by the Committee; and
(c) ordinary administrative expenses of the Committee that are
necessary or appropriate in carrying out its duties.

(14) Obtain from the independent auditors, at least annually, a formal written
statement delineating all relationships between the independent auditors
and the Company, and at least annually discuss with the independent
auditors any relationship or services which may impact the independent
auditors' objectivity or independence, and take appropriate actions to
ensure such independence.

(15) Establish procedures for the receipt, retention and treatment of
complaints received by the Company regarding accounting, internal
accounting controls or auditing matters.

(16) Establish procedures for the confidential, anonymous submission by
employees of the Company of concerns regarding questionable accounting
matters.

(17) Review all related party transactions (i.e., transactions required to be
disclosed under SEC Regulation S-K, Item 404) for potential conflict
of interest situations on an ongoing basis and determine whether to
approve any such transaction.

(18) As required by law, the Audit Committee shall assure the regular rotation
of the lead and concurring audit partner, and consider whether there
should be a regular rotation of the auditor itself.

(19) Review and discuss the types of presentation and information to be
included in earnings press releases, and any additional financial
information and earnings guidance generally provided to analysts and
rating agencies.

(20) Review and discuss the form and content of the certification documents
for the quarterly reports on Form 10-Q and the annual report on Form 10-K
with the independent auditor, the chief financial officer and the chief
executive officer.

(21) Discuss any difficulties encountered by the independent auditor during
the course of the audit, any restrictions on their activities, any
restrictions on their access to information, and any significant
disagreements with management.

(22) Review the budget, plan, changes in plan, activities, organizational
structure, and qualifications of the internal audit function, as needed.
The internal audit function shall have a direct reporting responsibility
to the Board of Directors through the Audit Committee.

(23) Review the appointment, performance and replacement of the internal audit
function.

(24) Review significant reports prepared by the internal auditors together
with management's response and follow-up to these reports.

(25) Annually prepare a report to shareholders as required by the Securities
and Exchange Commission. The report may be included in the Company's
annual proxy statement.

A-3

(26) Perform any other activities consistent with this Charter, the Company's
Bylaws and governing law as the Committee or the Board deems necessary or
appropriate.

C. MEETINGS

Meetings of the Committee will be held at least quarterly and such other
times as shall be required by the Chairman of the Board, or by a majority of the
members of the Committee. Written minutes pertaining to each meeting shall be
filed with the Company's Secretary and an oral report shall be presented by the
Committee at the next Board meeting.

At the invitation of the Chairman of the Committee, the meetings shall be
attended by the President and Chief Executive Officer, the Chief Financial
Officer, the representatives of the independent auditors the Company's internal
auditor, and such other persons whose attendance is appropriate to the matters
under consideration.

Approved by the Board of the Company as of April 20, 2004.

A-4

APPENDIX B
CHARTER
OF THE
NOMINATING COMMITTEE
OF THE
BOARD OF DIRECTORS OF 1st STATE BANCORP, INC.

AS APPROVED BY THE BOARD OF DIRECTORS
ON APRIL 20, 2004

I. AUTHORITY AND COMPOSITION

The Committee is established pursuant to Article II Section 13 of the Bylaws of
1st State Bancorp, Inc. (the "Corporation"). Committee members should be
appointed annually by the Board and may be replaced by the Board. None of the
Committee members may be an officer of the Corporation. The Committee may
appoint a Secretary, who need not be a Director. The Committee Chairman shall be
appointed by the Board.

The Committee shall be comprised of at least three (3) members, each of whom
shall meet the independence requirements of the Nasdaq and shall meet any other
standards of independence as may be prescribed for purposes of any federal
securities laws relating to the Committee's duties and responsibilities.

II. PURPOSE OF THE COMMITTEE

The Committee's purpose is to assist the Board in identifying qualified
individuals to become Board members and in determining the composition of the
Board of Directors.

III. RESPONSIBILITIES OF THE COMMITTEE

IN FURTHERANCE OF THIS PURPOSE, THE COMMITTEE SHALL HAVE THE FOLLOWING AUTHORITY
AND RESPONSIBILITIES:

1. To lead the search for individuals qualified to become members of
the Board of Directors and to select director nominees to be
presented for stockholder approval at the annual meeting. The
Committee shall select individuals as director nominees who shall
have the highest personal and professional integrity, who shall
have demonstrated exceptional ability and judgment and who shall
be most effective, in conjunction with the other nominees to and
existing members of the Board, in collectively serving the
long-term interests of the stockholders.

2. Recommend to the Board persons to be appointed as Directors in the
interval between annual meetings of the Corporation's shareholders;

3. Review the qualifications and independence of the members of the
Board on a regular periodic basis and make any recommendations the
Committee members may deem appropriate from time to time concerning
any recommended changes in the composition of the Board; and

4. Establish a policy, if deemed appropriate by the Committee, with
regard to the consideration of director candidates recommended by
stockholders.

B-1

WITH RESPECT TO THE RESPONSIBILITIES LISTED ABOVE, THE COMMITTEE SHALL:

1. Report regularly to the Board on its activities;

2. Maintain minutes of its meetings and records relating to those
meetings and the Committee's activities;

3. Form and delegate authority to subcommittees of one or more
Committee members when appropriate;

4. Review and reassess the adequacy of this Charter annually and
recommend to the Board any proposed changes to this Charter; and

5. Annually review the Committee's own performance.

IV. GENERAL

IN PERFORMING THEIR RESPONSIBILITIES, COMMITTEE MEMBERS ARE ENTITLED TO RELY IN
GOOD FAITH ON INFORMATION, OPINIONS, REPORTS OR STATEMENTS PREPARED OR PRESENTED
BY:

1. One or more officers and employees of the Corporation whom the
Committee member reasonably believes to be reliable and competent in
the matters presented;

2. Counsel, independent auditors, or other persons as to matters which
the Committee member reasonably believes to be within the
professional or expert competence of such person; or

3. Another committee of the Board as to matters within its designated
authority which committee the Committee member reasonably believes
to merit confidence.

B-2

REVOCABLE PROXY

-------------------------------------------------------------------------------
1st STATE BANCORP, INC.
BURLINGTON, NORTH CAROLINA
-------------------------------------------------------------------------------

ANNUAL MEETING OF STOCKHOLDERS
FEBRUARY 8, 2005

The undersigned hereby appoints James G. McClure, T. Scott Quakenbush and
Virgil L. Stadler with full powers of substitution, to act as attorneys and
proxies for the undersigned, to vote all shares of the common stock of 1st State
Bancorp, Inc. which the undersigned is entitled to vote at the Annual Meeting of
Stockholders, to be held at the main office of 1st State Bank (the "Bank")
located at 445 S. Main Street, Burlington, North Carolina, on Tuesday, February
8, 2005, at 5:30 p.m. Eastern Standard Time (the "Annual Meeting"), and at any
and all adjournments thereof, as follows:

VOTE
FOR WITHHELD
--- ---------

1. The election as directors of all /_/ /_/
nominees listed below (except as
marked to the contrary below).

For a term expiring at the 2008 Annual Meeting:
----------------------------------------------

Richard C. Keziah
Ernest A. Koury, Jr.
Richard H. Shirley

INSTRUCTION: TO WITHHOLD YOUR VOTE
FOR ANY OF THE INDIVIDUALS NOMINATED, INSERT
THAT NOMINEE'S NAME ON THE LINE PROVIDED BELOW.

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

THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE NOMINEES LISTED ABOVE.

--------------------------------------------------------------------------------
THIS PROXY WILL BE VOTED AS DIRECTED, BUT IF NO INSTRUCTIONS ARE SPECIFIED, THIS
PROXY WILL BE VOTED FOR THE ELECTION OF DIRECTORS. IF ANY OTHER BUSINESS IS
PRESENTED AT THE ANNUAL MEETING, INCLUDING MATTERS RELATING TO THE CONDUCT OF
THE ANNUAL MEETING, THIS PROXY WILL BE VOTED BY THOSE NAMED IN THIS PROXY IN
ACCORDANCE WITH THE DETERMINATION OF A MAJORITY OF THE BOARD OF DIRECTORS. AT
THE PRESENT TIME, THE BOARD OF DIRECTORS KNOWS OF NO OTHER BUSINESS TO BE
PRESENTED AT THE ANNUAL MEETING.
--------------------------------------------------------------------------------

THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS

Should the undersigned be present and elect to vote at the Annual Meeting
or at any adjournment thereof, then the power of said attorneys and prior
proxies shall be deemed terminated and of no further force and effect. The
undersigned may also revoke his proxy by filing a subsequent proxy or notifying
the Secretary of his decision to terminate his proxy.

The undersigned acknowledges receipt from the Company prior to the
execution of this proxy of a Notice of Annual Meeting and a Proxy Statement
dated January 5, 2005.

Dated: , 2005
------------------------------

--------------------------------------- ------------------------------------
PRINT NAME OF STOCKHOLDER PRINT NAME OF STOCKHOLDER

--------------------------------------- ------------------------------------
SIGNATURE OF STOCKHOLDER SIGNATURE OF STOCKHOLDER

Please sign exactly as your name appears on the enclosed card. When
signing as attorney, executor, administrator, trustee or guardian, please give
your full title. Corporation proxies should be signed in corporate name by an
authorized officer. If shares are held jointly, each holder should sign.

PLEASE COMPLETE, DATE, SIGN AND MAIL THIS PROXY PROMPTLY IN THE ENCLOSED
POSTAGE-PAID ENVELOPE.