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Item 9A. Controls and Procedures

2023-03-16 compared with 2022-03-31 · 93 added, 51 removed, 78 unchanged (65% of the section changed)

1 unchanged sentence

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K.

Based on this evaluation, and the information described below in this Item 9A, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at December 31, 2021 due to the material weaknesses described below.

Material Weaknesses in Internal Control over Financial Reporting

We identified material weaknesses in our internal control over financial reporting at December 31, 2021 as set forth below.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

Notwithstanding the material weaknesses in our internal control over financial reporting, we have concluded that the consolidated financial statements included in this Annual Report on Form 10-K fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States of America.

The Company's management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of its disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K.

Based on this evaluation, and the information described below in this Item 9A, the Company's Chief Executive Officer and Chief Financial Officer concluded that its disclosure controls and procedures were not effective at December 31, 2022, due to the material weaknesses described below.

Management’s Annual Report on Internal Control Over Financial Reporting and Auditor Attestation

The Company's management, under the supervision and with the participation of its principal executive officer and principal financial officer and effected by its board of directors, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13(a)-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934, as amended.

The Company's internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.

Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of the Company's principal executive officer and principal financial officer, management conducted an evaluation of the effectiveness of the Company's internal control over financial reporting as of December 31, 2022 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control -- Integrated Framework (2013 framework).

Based on this assessment, management concluded that as of December 31, 2022, its internal control over financial reporting was not effective due to material weaknesses as described below.

A material weakness is a deficiency, or a combination of control deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

Material Weaknesses in Internal Control and Plan for Remediation

Management has determined that the Company has the following material weaknesses in its internal control over financial reporting at December 31, 2022:

• Control Environment, Risk Assessment

Management did not maintain appropriately designed entity-level controls impacting the control environment and risk assessment procedures to prevent or detect material misstatements to the consolidated financial statements.

• Control Environment, Risk Assessment, and Monitoring Activities

Management did not maintain appropriately designed entity-level controls impacting the control environment, risk assessment procedures and monitoring activities to prevent or detect material misstatements to the consolidated financial statements.

These deficiencies were attributed to:

(i) lack of structure and responsibility, insufficient number of qualified resources and inadequate oversight and accountability over the performance of controls, including retention of control evidence, and (ii) ineffective identification and assessment of risks impacting internal control over financial reporting, and (iii) insufficient evaluation and determination as to whether the components of internal controls were present and functioning based upon evidence maintained for certain management review controls and activity level controls across substantially all financial statement areas.

• Control Activities , and Information and Communication

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• Management did not design and maintain effective general controls over information systems that support the financial reporting process.

Specifically, management did not design and maintain effective logical user access controls, including user access reviews, to ensure appropriate segregation of duties and adequate restrictions of users, including those with privileged access.

◦ Management did not design and implement controls over the completeness and accuracy of underlying data used in the operation of certain controls within its financial reporting process.

◦ Management did not design and implement review controls at a sufficient precision level to detect a material misstatement in financial statement areas including income taxes, valuation of accounts receivable, and valuation of inventory.

Specifically, management did not design and maintain (i) effective logical user access controls, including user access reviews, to ensure appropriate segregation of duties and adequate restrictions of users, including those with privileged access, and (ii) appropriate review and authorization of change management in the systems.

• Management did not design and maintain effective controls over the completeness and accuracy of underlying data used in the operation of certain management review controls and activity level controls across substantially all financial statement areas.

• Management did not design and implement management review controls at a sufficient level of precision to detect a material misstatement across substantially all financial statement areas that include complex and judgmental areas of accounting and disclosure.

• Management did not design and maintain effective activity level controls over balances recorded within revenue and accounts receivable, including controls over (i) the approval of arrangements with customers and pricing changes, and (ii) the approval and matching of sales orders, shipping documents, and sales invoices in the revenue recognition process.

• Management did not design and maintain effective activity level controls over the balances recorded within inventory and cost of sales, including controls over (i) the year-end physical inventory counts and inventory count variances, and (ii) inventory costing and bill of material analysis.

• Management did not design and maintain effective activity level controls over the procurement process, including controls over (i) vendor master file changes, (ii) the approval and matching of purchase orders, invoices, and receiving documents, and (iii) authorization of vendor payments.

Plan of Remediation of Material Weakness in Internal Control Over Financial Reporting

Following the identification and communication of the material weaknesses, management commenced remediation actions relating to the material weaknesses beginning in the first quarter of fiscal year 2022.

These remediation actions include:

We performed a thorough review of users’ access rights to our significant information technology systems and implemented restrictions to user access to allow for appropriate segregation of duties.

We hired our new Chief Financial Officer in February 2022, who brings a strong background in accounting, financial reporting and business operations in the public company marketplace.

Additionally, we are in the process of implementing the below changes to our processes to improve our internal control over financial reporting and to remediate the control deficiencies that gave rise to the material weaknesses:

Under the supervision of our Audit Committee, Chief Executive Officer and Chief Financial Officer, we are initiating an internal project to implement a Sarbanes-Oxley compliance program under the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in its 2013 Internal Control – Integrated Framework.

We are in the process of conducting an enterprise risk assessment and establishing reporting objectives.

We are reviewing and assessing our entity-level controls and IT general controls, documenting and evaluating existing significant processes and internal controls, and identifying potential gaps in our existing control structure.

We are in the process of identifying third-party service providers to assist with the design and preparation of the implementation plan and perform testing of the effectiveness of internal controls.

We are in the process of recruiting a number of key positions with our finance, operations and other support functions that can further enhance financial reporting capabilities, allow for appropriate segregation of duties, and provide appropriate oversight and reviews.

Management is committed to remediating the material weaknesses in a timely fashion and to making continuous improvements of our internal control over financial reporting.

In response to the material weaknesses noted above, the Company's management began to take actions to remediate the identified material weaknesses in internal control over financial reporting.

As part of management's remediation plan, certain efforts were put into place and underway prior to December 31, 2022.

All new and revised controls that management started to implement towards the end of 2022 as part of the remediation plan require a period of seasoning to allow for a sufficient operating effectiveness testing sample.

Management plans to build on and continue such efforts going into the next fiscal year in order to successfully remediate the identified material weaknesses.

The following remedial actions were taken during 2022 to remediate the material weaknesses in internal control over financial reporting:

• Increased the number of personnel with the appropriate level of knowledge related to accounting transactions, accounting matters, and relevant systems, including the addition of a Chief Financial Officer and Controller.

• Engaged a third-party service provider to assist management with the design and implementation of internal controls.

• Started an initial risk assessment based on the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") to identify internal controls over financial reporting ("ICFR") risks and control objectives

• With the assistance from the third-party service provider, and under the supervision of the Company's Audit Committee, Chief Executive Officer and Chief Financial Officer, started the design and implementation of significant process transaction flows and key controls in the Company's business processes, including revenue, inventory, income taxes, and overall IT environment.

As discussed above, all new processes and controls were in the seasoning period as of December 31, 2022.

• Management started to adopt a process to identify and assess the Company's disclosure controls and procedures, including the preparation and review of presentation and disclosure requirement checklists.

Additionally, management is in the process of implementing the below changes to the Company's processes to improve its internal control over financial reporting:

• Evaluate the Company's needs for additional personnel and add, as needed, additional headcount primarily within the accounting and information technology departments.

Management will onboard individuals with the appropriate education, experience, certifications, and training.

The hiring of new employees is expected to create and ensure proper reporting lines and segregation of duties, while also providing additional oversight and structure to the organization.

• Continue to update the risk assessment, objectives, processes and control design and documentation, including such design and documentation as related to the completeness and accuracy of underlying data and a sufficient precision level in management review controls to detect material misstatement across all financial statement areas.

• Improve the process of retaining evidence of sales arrangements with customers including adopting a required retention period for applicable customer purchase orders.

Management is in the process of holding additional training for warehouse employees to appropriately perform and document the three-way match between sales orders, shipping documents, and sales invoices.

• Update and enhance the standard operating procedures of both periodic and year-end physical counts to ensure all inventory items are counted at all warehouses in a consistent manner.

Management is also in the process of continuing to enforce the newly-implemented controls requiring inventory adjustments to be reviewed and approved by the appropriate level of management and to be appropriately recorded and inventory costing analysis to be appropriately reviewed.

• Continue to enforce the newly adopted Company-wide approval matrix that establishes clear guidelines on authority levels for all types of cash disbursement transactions.

Management is in the process of reviewing user access and establishing appropriate reporting lines within the accounts payable department to ensure proper segregation of duties for and performance of controls and procedures including vendor master file changes and the three-way match between purchase orders, receiving documents, and vendor invoices.

• Enhance training programs for personnel that provide key information and perform key roles associated with ICFR.

Management plans to design such training programs in order to improve the level of understanding of the design and proper implementation of controls by the control owners and to instruct such individuals on appropriate level of documentation practices for evidencing review, especially over the completeness and accuracy of underlying data and the precision level used in the review.

• Continue to enhance policies and procedures to improve Information Technology General Controls and the Company's overall IT environment.

Examples of some of management's planned efforts include:

◦ Adopt the policy and procedure to regularly perform a thorough review of user's access rights relating to the Company's significant information technology systems.

◦ Maintain and monitor restrictions to user access where needed to allow for appropriate segregation of duties, and

◦ Maintain and enforce procedures and controls around system development and change management.

Management is committed to remediating the material weaknesses in a timely fashion and to making continuous improvements to the Company's internal control over financial reporting.

Management will continually assess the effectiveness of the remediation efforts and may determine to take additional measures to address control deficiencies or modify the remediation plan described above.

Management’s Annual Report on Internal Control Over Financial Reporting and Auditor Attestation

This annual report does not include a report of management's assessment regarding internal control over financial reporting or an attestation report of the company's registered public accounting firm due to a transition period established by rules of the Securities and Exchange Commission for newly public companies.

The material weaknesses identified did not result in the restatement of any previously reported financial statements or any related financial disclosure, nor does management believe that they had any effect on the accuracy of the Company’s financial statements for the current reporting period.

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except as described above.

Other than the matters set forth above, there have been no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, except as described above.

OTHER INFORMATION

On March 14, 2023, the Company amended the Line of Credit, which among other things, (1) extended the maturity date to March 14, 2025, and (2) revised the interest on any line of credit borrowings to an annual rate of one month term Secured Overnight Financing Rate ("SOFR") plus 2.50 %, with a SOFR floor of 1.0 %.

DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS

20 unchanged sentences

3.1 Certificate of Incorporation of Karat Packaging Inc.

(Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

3.2 Bylaws of Karat Packaging Inc.

4.1* Form of Common Stock Certificate

(Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

4.1 Form of Common Stock Certificate (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

4.2* Description of Registrant's Securities

10.1+ Karat Packaging Inc.

2019 Stock Incentive Plan

2019 Stock Incentive Plan (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.2+ Form of Restricted Stock Unit Award Agreement Pursuant to the Karat Packaging Inc.

2019 Stock Incentive Plan

10.3+ Form of Karat Packaging Inc.

2019 Stock Incentive Plan Stock Option Agreement

10.4* Amended and Restated Lease Agreement, by and between the Company and Global Wells Investment Group LLC for the Texas facility

2019 Stock Incentive Plan Stock Option Agreement (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.4 Amended and Restated Lease Agreement, by and between the Company and Global Wells Investment Group LLC for the Texas facility (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.5 Standard Industrial/Commercial Single-Tenant Lease-Gross, dated February 6, 2013, by and between First Industrial, LP, a Delaware limited partnership and Lollicup USA Inc.

(Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.6 First Amendment to Standard Industrial/Commercial Single-Tenant Lease-Gross, dated November 14, 2018, by and between First Industrial, LP, a Delaware limited partnership and Lollicup USA Inc.

(Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.7 Lease Agreement dated July 16, 2020, by and between Lollicup USA Inc.

and Global Wells Investment Group LLC for the New Jersey facility

and Global Wells Investment Group LLC for the New Jersey facility (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.8 Share Exchange Agreement and Plan of Reorganization, dated as of September 27, 2018, entered into by the Company, Lollicup USA Inc., and each of Alan Yu, Marvin Cheng, Karat Global Group, LTD.

(now known as Keary Global Group, LTD.) and Plutus Investment Holding Company

(now known as Keary Global Group, LTD.) and Plutus Investment Holding Company (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.9 Assignment and Assumption of Grants, by and between Lollicup USA Inc.

and Global Wells Investment Group LLC effective as of July 1, 2018

10.10* Form of Indemnification Agreement

and Global Wells Investment Group LLC effective as of July 1, 2018 (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.10 Form of Indemnification Agreement (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021.

10.11 Purchase and Sale Agreement dated April 9, 2019 by and between Global Wells Investment Group LLC and Atosa Catering Equipment, Inc.

(Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.12 Business Loan Agreement dated February 23, 2018 by and between Lollicup USA Inc.

and Hanmi Bank

and Hanmi Bank (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.13 Business Loan Agreement dated March 17, 2020 by and between Lollicup USA Inc.

and Hanmi Bank

10.14 Note dated April 16, 2020 by and between Lollicup USA Inc.

and Hanmi Bank

10.15* Commercial Security Agreement dated June 30, 2020 by and between Global Wells Investment Group LLC and Hanmi Bank

10.16*+ Form of Employment Agreement by and between the Company and Alan Yu

10.17*+ Form of Employment Agreement by and between the Company and Marvin Cheng

10.18*+ Form of Employment Agreement by and between the Company and Joanne Wang

10.19*+ Form of Amended and Restated Employment Agreement by and between the Company and Ann Sabahat

10.15 Commercial Security Agreement dated June 30, 2020 by and between Global Wells Investment Group LLC and Hanmi Bank (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.16+ Form of Employment Agreement by and between the Company and Alan Yu (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.17+ Form of Employment Agreement by and between the Company and Marvin Cheng (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.18+ Form of Employment Agreement by and between the Company and Joanne Wang (Incorporated by reference from the Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021).

10.20 Business Loan Agreement dated October 6, 2021 by and between Lollicup USA Inc.

and Hanmi Bank

10.21***+ Employment Agreement , dated February 1, 2022, by and between the Company and Jian Guo

21.1* List of Subsidiaries

23.1 Consent of BDO USA, LLP, independent registered public ac counting firm

and Hanmi Bank (Incorporated by reference to Exhibit 10.20 from the Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 31, 2022).

10.21+ Employment Agreement, dated February 1, 2022, by and between the Company and Jian Guo (Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 1, 2022).

10.22 Agreement, dated April 6, 2022, by and between Lollicup USA Inc.

and Happiness Moon Co., Ltd.

(English Translation) (Incorporated by reference to Exhibit 10.1 in the Company's Current Report on Form 8-K filed on April 7, 2022)

10.23 Business Loan Agreement between Global Wells Investment Group LLC and East West Bank, dated June 15, 2022 (Incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K, filed with the Securities and Exchange Commission on June 22, 2022).

10.24 Interest Rate Swap Termination Agreement, dated June 10, 2022, by and between Global Wells Investment Group LLC and East West Bank (Incorporated by reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on August 11, 2022).

10.25 Change In Terms Agreement, dated August 18, 2022, by and between Lollicup USA Inc and Hanmi Bank (Incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q, filed with the Securities and Exchange Commission on November 14, 2022).

10.26* Change In Terms Agreement, dated March 14, 2023, by and between Lollicup USA Inc and Hanmi Bank

21.1 List of Subsidiaries (Incorporated by reference to Exhibit 21.1 to the Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 31, 2022).

23.1* Consent of BDO USA, LLP, independent registered public accounting firm

31.1* Certification pursuant to Section 302 of the Sarbanes-Oxley Act

8 unchanged sentences

101.PRE* XBRL Taxonomy Extension Presentation Linkbase.

* Incorporated by reference from the registrant’s Registration Statement on Form S-1, filed with the Securities and Exchange Commission on February 18, 2021 and declared effective on April 14, 2021.

104* Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

* Filed herewith.

** Furnished herewith.

*** Incorporated by reference to Exhibit 10.1 to the registrant's Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 1, 2022

+ Indicates management compensatory agreement.

1 unchanged sentence

Pursuant to the requirements of Section 13 or 15(d) 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.

March 31, 2022 KARAT PACKAGING INC.

March 16, 2023

KARAT PACKAGING INC.

Chief Executive Officer

1 unchanged sentence

Chief Financial Officer

(Principal Financial Officer

(Principal Financial Officer and

Principal Accounting Officer)

2 unchanged sentences

March 16, 2023

(Principal Executive Officer)

Chief Financial Officer

March 16, 2023

(Principal Financial Officer and Principal Accounting Officer

/s/ Joanne Wang

7 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 9A. Controls and Procedures