What changed in this filing

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Item 9A. Controls and Procedures

2025-03-14 compared with 2024-03-15 · 46 added, 87 removed, 122 unchanged (52% of the section changed)

2 unchanged sentences

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 the Securities Exchange Act of 1934, as amended (“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, the Company's Chief Executive Officer and Chief Financial Officer concluded that its disclosure controls and procedures were not effective at December 31, 2023, due to the material weaknesses described below.

Management’s Annual Report on Internal Control Over Financial Reporting

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Under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of the Company's internal control over financial reporting as of December 31, 2024 using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in “Internal Control - Integrated Framework” (2013).

Based on this assessment, management concluded that as of December 31, 2023, its internal control over financial reporting was not effective due to the material weaknesses described below.

Based on this assessment, management concluded that as of December 31, 2024, its internal control over financial reporting was not effective due to the material weakness described 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 the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

Management has determined that the Company has the following material weakness in its internal control over financial reporting at December 31, 2023:

Management determined that the Company has the following material weakness in its internal control over financial reporting at December 31, 2024:

Management did not design and maintain effective controls to ensure appropriate segregation of duties related to the creation, approval and subsequent modification of journal entries.

This deficiency did not result in a material misstatement to the consolidated financial statements, however, it could result in a misstatement of substantially all account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.

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

During the year ended December 31, 2024, management has redesigned its control over the journal entry creation and approval process, remediated gaps in the design of such internal control and performed operating effectiveness testing.

However, additional time is required to demonstrate the control has operated effectively for a sufficient period of time.

Management will consider the material weakness to be fully remediated once all relevant controls operate effectively for a sufficient period of time and management confirms their effectiveness through testing.

Management is committed to remediating the material weakness 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 take additional measures to address control deficiencies or modify the remediation plan described above.

Remediation of Previously Identified Material Weaknesses

As reported in the 2023 Form 10-K, the Company previously identified and disclosed the following material weaknesses in its internal control over financial reporting for the year ended December 31, 2023:

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.

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(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.

This material weakness did not result in any material misstatements of the Company’s financial statements or disclosures for any prior or current reporting periods, but did result in immaterial misclassification adjustments to net sales, cost of goods sold, selling expenses and general and administrative expenses with no impact on net income for the quarter and year ended December 31, 2023 and an immaterial adjustment to deposits as of December 31, 2023.

This material weakness contributed to the following additional material weakness:

Management did not design and maintain effective controls over certain information technology ("IT") general controls for information systems that are relevant to the preparation of their financial statements.

Specifically, management did not design and maintain (i) program change management controls to ensure that program and data changes are

identified, tested, authorized and implemented appropriately, and (ii) user access controls to ensure appropriate segregation of duties and to adequately restrict user and privileged access to appropriate personnel.

These IT deficiencies did not result in a material misstatement to the financial statements.

Each of these material weaknesses could result in a misstatement of substantially all account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.

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

As reported in the 2022 Form 10-K, we have engaged in remedial actions in response to the deficiencies discussed above.

These efforts were on-going during 2022 and 2023 and will continue into 2024.

The following remedial actions were taken in the year ended December 31, 2022:

• 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.

• 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, initiated the design and implementation of significant process transaction flows and key controls in the Company's overall IT environment.

The following remedial actions were taken in the year ended December 31, 2023:

• As part of management's risk assessment and evaluation of the design of key controls, management updated control objectives and refined control design and documentation, including such design and documentations as related to the appropriate segregation of duties and monitoring activities.

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

Examples of some of management's efforts include:

◦ Adopted the policy and procedure to regularly review user's access rights relating to the Company's significant information technology systems;

◦ Designed and started to perform review of users’ access rights to our significant information technology systems;

◦ Maintained and enforced certain procedures, controls and developed IT policies around change management.

Additionally, the following remedial actions are currently in the process of being taken :

• Continue to evaluate the Company's needs for additional personnel and add, as needed, additional headcount primarily within the information technology department.

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

• Continue to enhance policies and procedures to improve Information Technology General Controls and the Company's overall IT environment, including continue to enforce newly or enhanced policies and controls around user provisioning, access reviews 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 believes the measures described above have strengthened 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.

Remediation of Previously Identified Material Weaknesses

We have previously identified and disclosed the following material weaknesses in our internal control over financial reporting for the year ended December 31, 2022:

• 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.

As of December 31, 2023, management sufficiently completed its remediation of these material weaknesses by taking the following measures:

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

• Completed a risk assessment based on the criteria established by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") to identify internal control 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, designed and implemented significant process transaction flows and key controls in the Company's business processes, including revenue, inventory, and procurement.

• Improved the process of retaining and reviewing evidence of sales arrangements with customers including adopting a required retention period for applicable customer purchase orders and internal review of sales order.

• Held additional training for warehouse employees to appropriately perform and document the three-way match between sales orders, shipping documents, and sales invoices.

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

Management designed 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.

• Enhanced 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.

• Adopted a Company-wide approval matrix that establishes clear guidelines on authority levels for all types of cash disbursement transactions.

• Established appropriate reporting lines within business processes, including 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.

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

• Updated 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.

Management has completed the documentation and review of the corrective actions described above, and concluded that the design and operation of our financial reporting processes and controls related to the corrective actions were effective and therefore that the related previously identified material weaknesses have been fully remediated as of December 31, 2023.

Specifically, management did not design and maintain (i) program change management controls to ensure that program and data changes are identified, tested, authorized and implemented appropriately, and (ii) user access controls to ensure appropriate segregation of duties and to adequately restrict user and privileged access to appropriate personnel.

As of December 31, 2024, management sufficiently completed its remediation of these material weaknesses with the exception of the segregation of duties, as discussed above, related to journal entry creation and approval process, by taking the following measures:

• Refined the design of entity-level controls impacting the control environment, risk assessment procedures and monitoring activities, including the implementation of controls and procedures to ensure adequate oversight and accountability over the performance of controls.

• Enhanced policies and procedures to improve Information Technology General Controls and the Company's overall IT environment, including enforcing newly or enhanced policies and controls around logical access and changes to significant IT systems.

• Updated and refined the COSO-based risk assessment to evaluate and identify risks impacting internal control over financial reporting.

• Implemented formal control activities to provide training and upskilling to key business process owners.

• Implemented and performed new control procedures to review all activities carried out and transactions completed by users with administrative rights (“privileged users”) within the Company’s ERP system.

• Enhanced control procedures around the monitoring and validating of information produced by the Company (“IPC”) supporting the performance of key controls including change management review procedures.

• Expanded user access review procedures to all key applications and relevant infrastructures that impact internal control over financial reporting.

• Enhanced user access control procedures by implementing additional review from the CFO for all new privileged users.

• Launched a new internally-developed management system which streamlined and centralized the workflow around user provisioning and deprovisioning and further expanded and enhanced deprovisioning review procedures.

• Enhanced control procedures around the completeness and accuracy of IPC used in supporting the performance of key controls.

Restricted access to making changes to the IPC to only IT administrators, and enhanced the IT change management process to include changes to IPC.

• Implemented and expanded periodic review procedures of user rights and permissions across all key applications to assess segregation of duties.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The implementation of the redesigned control over the journal entry creation and approval process as described above represents a change in our internal control over financial reporting that occurred during the quarter ended December 31, 2024 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.

OTHER INFORMATION

Amendments to Alan Yu's and Jian Guo's Employment Agreements

On March 12, 2024, the Company and Mr.

Yu entered into an amendment to his employment agreement (the “CEO Amendment”), effective as of March 12, 2024, which amends his employment agreement previously filed as Exhibit 10.16 to the Registration Statement on Form S-1, filed with the Securities and Exchange Commission (the "SEC") on February 18, 2021 and declared effective on April 14, 2021.

The CEO Amendment reflects that Mr.

Yu will continue in his role as Chief Executive Officer for an initial term expiring on March 12, 2026, subject to automatic extensions, unless either party provides the other with 60 days' prior written notice.

Pursuant to the CEO Amendment, Mr.

Yu's base salary will increase to of $300,000 per year.

The CEO Amendment also provides that Mr.

Yu will be granted 24,000 RSUs pursuant to the terms of the CEO Amendment and the Company's Stock Incentive Plan, in which 24,000 RSUs shall vest in three, equal installments on May 12, 2024, May 12, 2025 and May 12, 2026.

In the event the Mr.

Yu resigns or is terminated before the vesting of the last installment on May 12, 2026, Mr.

Yu is entitled to receive such RSUs subject to Section 5 of the his employment agreement.

Additionally, on March 12, 2024, the Company and Ms.

Guo entered into an amendment to her employment agreement (the “CFO Amendment”), effective as of March 12, 2024, which amends her employment agreement previously filed as Exhibit 10.1 to the Current Report on Form 8-K, filed with the SEC on February 1, 2022.

The CFO Amendment reflects that Ms.

Guo will continue in her role as Chief Financial Officer for an initial term expiring on March 12, 2026, subject to automatic extensions, unless either party provides the other with 60 days' prior written notice.

The CFO Amendment provides that Ms.

Guo will be granted 24,000 RSUs pursuant to the terms of the CFO Amendment and the Company's Stock Incentive Plan, in which 24,000 RSUs shall vest in three, equal installments on May 12, 2024, May 12, 2025 and May 12, 2026.

In the event the Ms.

Guo resigns or is terminated before the vesting of the last installment on May 12, 2026, Ms.

Guo is entitled to receive such RSUs subject to Section 5 of the employment agreement.

The foregoing descriptions of the CEO Amendment and the CFO Amendment do not purport to be complete and is qualified in its entirety by reference to the full texts of the CEO Amendment and the CFO Amendment, copies of which are included as Exhibits 10.32 and 10.33, respectively, to this Annual Report on Form 10-K and incorporated herein by reference.

Rule 10b5-1 Trading Arrangements

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Our Proxy Statement for the 2025 Annual Meeting of Stockholders is expected to be filed not later than 120 days after the end of our fiscal year ended December 31, 2024 and is incorporated into this report by this reference.

We have adopted a Code of Ethics that applies to our Chief Executive Officer, Chief Financial Officer, and to all of our other officers, directors, employees and agents.

The Code of Ethics is available on our website at www.karatpackaging.com.

We intend to disclose future amendments to, or waivers from, certain provisions of our Code of Ethics on the above website within five business days following the date of such amendment or waiver.

Code of Business Conduct and Ethics

We have adopted a Code of Business Conduct and Ethics that applies to our Chief Executive Officer, Chief Financial Officer, and to all of our other officers, directors, employees and agents.

The Code of Business Conduct and Ethics is available on our website at www.karatpackaging.com.

We intend to disclose future amendments to, or waivers from, certain provisions of our Code of Business Conduct and Ethics on the above website within five business days following the date of such amendment or waiver.

Policy on Insider Trading

Our Board of Directors has adopted a Policy on Insider Trading, which applies to all of our directors, officers, independent consultants, contractors, and employees.

A copy of our Policy on Insider Trading is included as Exhibit 19.1 to this Annual Report on Form 10-K and is also posted in the investor section of our website at www.karatpackaging.com.

EXECUTIVE AND DIRECTOR COMPENSATION

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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

4.2 Description of Registrant's Securities (Incorporated by reference to Exhibit 4.2 from the Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2024).

10.1+ Karat Packaging Inc.

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(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).

Lease Agreement, by and between the Company and G&O Chino Property, a California general partnership, as amended, for the Chino, California distribution center.

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

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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.

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

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).

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).

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).

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

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10.19 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).

10.20 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).

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10.24 Change In Terms Agreement, dated June 20, 2023, by and between Lollicup USA Inc and Hanmi Bank (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on June 22, 2023).

10.25 Change In Terms Agreement , dated February 24, 2025 by and between Lollicup USA Inc.

and Hanmi Bank (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on March 7, 2025).

10.26 Separation Agreement and General Release, dated August 30, 2023 (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the Securities and Exchange Commission on August 31, 2023).

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Amendment to Employment Agreement, dated March 12, 2024, between Karat Packaging Inc.

and Alan Yu, Chief Executive Officer.

and Alan Yu, Chief Executive Officer (Incorporated by reference to Exhibit 10.32 from the Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2024).

Amendment to Employment Agreement, dated March 12, 2024, between Karat Packaging Inc.

and Jian Guo, Chief Financial Officer.

Karat Packaging Inc.'s Amended Insider Trading Policy, effective as of March 12, 2024

and Jian Guo, Chief Financial Officer (Incorporated by reference to Exhibit 10.33 from the Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2024).

19.1 Karat Packaging Inc.'s Amended Insider Trading Policy, effective as of March 12, 2024 (Incorporated by reference to Exhibit 19.1 from the Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2024).

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 independent registered public accounting firm (PricewaterhouseCoopers LLP)

Consent of independent registered public accounting firm ( BDO USA, P.C.

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

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32.2** Certification pursuant to Section 906 of the Sarbanes-Oxley Act

97.1* Karat Packaging Inc.'s Clawback Policy, effective as of October 2, 2023.

97.1 Karat Packaging Inc.'s Clawback Policy, effective as of October 2, 2023 (Incorporated by reference to Exhibit 97.1 from the Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2024).

101.INS* XBRL Instance Document.

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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