Penguin Solutions, Inc. 10-Q

Item 4. Controls and Procedures Limitation on Effectiveness of Controls Any control system, no matter how well designed and operated, can provide only reasonable assurance as to the tested objectives. The design of any control system is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. The inherent limitations in any control system include the realities that judgments related to decision-making can be faulty, and that reduced effectiveness in controls can occur because of simple errors or mistakes. Due to the inherent limitations in a cost-effective control system, misstatements due to error may occur and may not be detected. 50 Evaluation of Disclosure Controls and Procedures Management is required to evaluate our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”). Disclosure controls and procedures are controls and other procedures designed to provide reasonable assurance that information required to be disclosed in our reports filed under the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include controls and procedures designed to provide reasonable assurance that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure. Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective as of February 26, 2021, the end of the period covered by this interim report, due to a material weakness in our internal control over financial reporting. As described in Item 9A “Controls and Procedures” in our Annual Report on Form 10-K/A for the year ended August 28, 2020, filed on April 6, 2021, management performed its assessment of the effectiveness of our internal control over financial reporting as of August 28, 2020 and concluded that our internal control over financial reporting as of that date was not effective because of the material weakness described below. Inadequate and ineffective controls over accounting for import taxes Our internal controls were not adequately designed to provide reasonable assurance that the timely accounting for import taxes, including the related financial statement disclosures, was recorded in accordance with generally accepted accounting principles in the United States of America. Specifically, upon the introduction of a new product or the commencement of importation of a new product in a particular country, we are required to assign a tax code that will determine, among other things, the tax rate on imports of these products. Beginning in 2015, we redesigned our internal controls surrounding the evaluation of new import tax codes to incorporate a review by an independent technical consultant, however, these redesigned controls were not applied to confirm the correctness of the codes on legacy products (being those products introduced or commencing importation prior to 2015) in a specific country, and, as a result, the incorrect import tax code on certain legacy products was not identified in a timely manner. This resulted in management not timely recording and paying for import taxes on certain legacy products. 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 annual or interim financial statements will not be prevented or detected on a timely basis. Management reevaluated the design and operating effectiveness of our internal control over financial reporting and concluded that our internal control over financial reporting as of August 28, 2020 was not effective due to the material weakness described above. Remediation plans and steps taken Following the identification of the foregoing material weakness, management commenced the development and execution of a remediation plan, which is ongoing. Management believes that the implementation of this plan will remediate the material weakness described above. The following steps of the remediation plan are currently in varying stages of completion, and management may determine to enhance controls and/or implement additional controls as the implementation procedures are performed and testing of the operating effectiveness of the controls is completed: • The Company engaged an independent technical consultant to review the import tax codes assigned to our legacy products (being those products introduced or commencing importation prior to the process change adopted in 2015). As a result of the independent and internal review of import tax codes for a specific country, an incorrect code was identified and corrected in the second quarter of fiscal 2021, and management believes that the impact of the material weakness was limited to this single code. • The Company will enhance training for responsible personnel involved in determining import tax codes. The Audit Committee of the Board of Directors of the Company has directed management to develop a plan and timetable for the implementation of the foregoing remedial measures (to the extent not already completed) and will monitor their implementation. Management expects these remedial actions and/or other actions related to this material weakness to be effectively implemented in fiscal 2021. In connection with management’s evaluation, the Company corrected the import tax code for certain legacy products prior to 2015, recorded an out-of-period adjustment in the second quarter of fiscal year 2021 to correct for underreported import tax costs, voluntarily disclosed to the taxing authority, and paid the underreported import tax and related interest. 51 As of the date of this Quarterly Report on Form 10-Q, we have not fully remediated such material weakness and as a result, our Chief Executive Officer and Chief Financial Officer have concluded that a material weakness continues to exist as of the end of the period covered by this Quarterly Report on Form 10-Q . Changes in Internal Control over Financial Reporting Other than the remediation actions described above, there were no changes in our internal control over financial reporting during the quarter ended May 28, 2021, which were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected or are reasonably likely to materially affect our internal control over financial reporting. 52 PART II. OTHER INFORMATION Item 1. Legal Proceedings Information with respect to this item may be found in Note 10, Commitments and Contingencies, in our Notes to Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1, of this Quarterly Report on Form 10-Q, which information is incorporated herein by reference.