Netflix ($NFLX) filed its latest quarterly report on Tuesday. Lots of numbers on the income statement looked solid — yet the streaming giant’s share price still tumbled 7.7 percent by the end of the day.

Why? Apparently because investors were surprised at a $619 million charge the company booked due to a long-running tax dispute in Brazil.

Unless, that is, you were a close reader of the disclosures Netflix made in its footnotes! Then you would’ve seen this “surprise” tax charge coming from miles away.

Let’s start with the disclosure Netflix made in this week’s filings, confirming the $619 million charge. That disclosure came in the Commitments and Contingencies footnote that all publicly traded companies are required to make every quarter. (Emphasis added by us.)

During the current period, developments in another taxpayer’s judicial proceedings have influenced our evaluation of the Company’s most significant non-income tax matter in Brazil and we now believe that it is probable that a loss will be incurred. The cumulative loss recognized as an operating expense in the current period related to non-income tax assessments with the Brazilian tax authorities was approximately $619 million.

Now look back at what Netflix had to say about this matter in its previous filing from July (again, emphasis added by us). 

The cumulative current potential exposure with respect to the various issues with Brazilian tax authorities regarding non-income tax assessments, for which the loss recognition criteria has not been met, is estimated to be approximately $600 million, and is expected to increase over time.

And now let’s look at what Netflix said its earnings report from one year ago, in Q3 2024:

There is inherent complexity and uncertainty with respect to these matters, and the final outcome may be materially different from our expectations. The current potential exposure with respect to the various issues with Brazilian tax authorities regarding non-income tax assessments is estimated to be approximately $400 million, which is expected to increase over time.

In fact, let’s go all the way back to the Q3 2023 earnings report Netflix filed two years ago:

The Company is involved in litigation matters not listed herein but does not consider the matters to be material either individually or in the aggregate at this time. The Company's view of the matters not listed may change in the future as the litigation and events related thereto unfold. 

As you can see, there’s no mention of any Brazil tax dispute at all. Either Brazilian authorities hadn’t launched their investigation yet or the dispute seemed so small that any settlement wouldn’t be material.

Indeed, the first mention of a tax dispute with Brazil seems to have appeared in Netflix’ 2023 annual report, filed on Jan. 26, 2024. That’s when the company added a “non-income taxes” subsection in its Contingencies disclosure, and said this:

Similar to other U.S. companies doing business in Brazil, the Company is involved in a number of matters with Brazilian tax authorities regarding non-income tax assessments. Although the Company believes it has meritorious defenses to these matters, there is inherent complexity and uncertainty with respect to these matters, and the final outcome may be materially different from our expectations. The current potential exposure with respect to the various issues with Brazilian tax authorities regarding non-income tax assessments is estimated to be approximately $300 million, which is expected to increase over time.

So over the course of two years, we went from no tax dispute at all, to a dispute that might cost $300 million, to $400 million, to $600 million, to a current total of $619 million.

Tracking Contingences

Contingencies — that is, potential costs, such as legal or regulatory settlements — are a tricky bit of financial analysis. Accounting rules require companies first to disclose when a dispute will probably lead to a loss, even if the company can’t estimate the likely number; and then to report the number once the size of the potential loss comes into better focus and is likely to be material.

So in theory, Netflix could even end up paying more than the $619 million disclosed this week; but probably not, and even if so, any final number isn’t likely to be materially higher than the $619 million the company has booked now.

Either way, readers of the footnotes would have seen for more than a year that this number was real, and it was growing. So you could have anticipated that possible outcome and adjusted your analysis and strategy accordingly.

One way to track contingencies in Calcbench is to read the exact disclosure in the Disclosures & Footnotes page, and then compare that period’s text to what the company said in the prior period. Figure 1, below, shows the comparison between Q3 (on the left) and Q2 (on the right) for Netflix:

Or you could track the disclosure on our Multi-Company page. Call up that specific line-item, then look at the time-series of disclosures to see how the number has changed over time. See Figure 2, below.

So if you know where to look, you can see these financial risks evolving over time. And like many dramas, this one was rather predictable.