Comstock Inc. 10-K

ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis provides information that management believes is relevant to an assessment and understanding of our consolidated financial condition and results of operations. This discussion should be read in conjunction with the Consolidated Financial Statements included herewith and the footnotes thereto and the risk factors contained herein. OVERVIEW Comstock innovates technologies that contribute to global decarbonization and circularity by efficiently converting massive supplies of under-utilized natural resources into renewable fuels and electrification products that contribute to balancing global uses and emissions of carbon . We intend to use our technologies to achieve exponential growth and extraordinary financial, natural and social returns by: - building, owning, and operating a fleet of advanced carbon neutral extraction and refining facilities; - selling an array of complimentary process solutions and related services, and - licensing selected technologies to qualified strategic partners. Our objective is to generate over $16 billion in revenue on an annualized basis by 2030, by responsibly producing and selling renewable energy products that enable us, our clients, and their downstream stakeholders to reduce greenhouse gas emissions by at least 100 million metric tons per year. Meeting that objective would offset the equivalent of more than 234 million barrels per year of fossil fuel, or about 6% of the U.S. transportation burn. Our technologies unlock vast quantities of historically wasted and unused feedstock supplies with enough short cycle carbon to offset many billions of metric tons of long cycle fossil fuel emissions worldwide. Most of that potential is provided by our Cellulosic Fuels technologies, which efficiently convert wasted, unused, widely-available and rapidly-replenishable woody biomass into intermediates and precursors for the production of carbon neutral oil, ethanol, gasoline, renewable diesel, jet fuel, marine fuel, and other renewable replacements for long cycle fossil derivatives. Our full portfolio of patented, patent-pending and proprietary technologies includes many additional processes that complement and add to that potential. We expect to use our technologies to meet our 2030 objectives with less than just 8% of the biomass residues produced annually in the U.S., however, we have structured our business to achieve and enable exponentially greater gains. We believe that the Earth’s natural carbon cycle provides the simplest, fastest, most scalable and most practical path for enabling systemic decarbonization and achieving a net zero carbon world. Our strategic plan is consequently based on innovating and using our technologies and renewable energy products to simultaneously: - reduce reliance on long cycle fossil fuels; - shift supply chains that terminate in combustion to short cycle renewable fuels; and - lead and support the adoption and growth of a highly profitable, balanced worldwide short cycle ecosystem that continuously offsets, recycles, and contributes to neutralizing global carbon emissions by rapidly growing and replenishing vast quantities of feedstock for renewable circular fuels In that fashion, we plan to empower our clients, the industries in which they operate, and the populations they serve to Burn Less fossil fuels, to Burn Smarter with renewable fuels, to Burn Cleaner by recycling emissions into additional renewable fuels, and to thereby make disruptive contributions to global decarbonization and helping to achieve a net zero carbon world. RECENT DEVELOPMENTS Comstock historically focused on natural resource exploration, development, and production, with an emphasis on mining gold and silver resources from its extensive contiguous property holdings in the historic Comstock and Silver City mining districts in Nevada (collectively, the “Comstock Mineral Estate”). Between 2012 and 2016, we mined and processed about 2.6 million tons of mineralized material from the Comstock Mineral Estate, producing 59,515 ounces of gold and 735,252 ounces of silver. We subsequently focused on mineral exploration and development activities in anticipation of continued production, while 47 evaluating and exploiting opportunities for the monetization of selected assets, debt elimination, new investments, and diversification. During 2020 and 2021, we completed a series of transactions that were designed to build on our competencies and reposition us to capitalize on the global transition to clean energy. Those transactions primarily included (i) our sale of Comstock Mining LLC, the owner of our Lucerne resource area in Storey County, Nevada, and related permits, (ii) our acquisitions of 100% of Comstock Innovations Corporation (F/K/A Plain Sight Innovations Corporation), 100% of Comstock Engineering Corporation (F/K/A Renewable Process Solutions, Inc.), 100% of MANA Corporation, and 90% of LINICO Corporation, (iii) our acquisition of the intellectual property portfolio from FLUX Photon Corporation, and (iv) our investments of 48.19% of Quantum Generative Materials LLC, 25.0% of Mercury Clean Up LLC, and 50.0% of MCU Philippines, Inc. These transactions added the management, employees, facilities, intellectual properties, and other assets needed to transform our company and business into an emerging leader in the innovation and sustainable production of renewable energy products, primarily by commercializing two new lines of business, cellulosic fuels and electrification metals. Additional information on these transactions is provided in Note 2 to our Consolidated Financial Statements, Acquisitions and Investments . SUMMARY RESULTS OF OPERATIONS We earned $862,165 and $201,700 in revenue for each of the years ended December 31, 2021 and 2020, respectively, 26.5% of which was attributable to mining and property development activities in our all other segment in 2021. We had loss from operations of $6,405,921 and $5,474,261 for the years ended December 31, 2021 and 2020, respectively. We had total assets of $43,001,837 and $83,952,795 in our renewable energy products and all other segments at December 31, 2021, respectively. We had total assets of $43,123,562 in our all other segment at December 31, 2020 and no assets in our renewable energy products segment in 2020. In 2021, the Company reestablished itself and its primary reporting segment as a renewable energy company (see Note 20, Segment Reporting , to the Consolidated Financial Statements). 48 Below we set forth a summary of comparative financial information for the years ended December 31, 2021 and 2020: 12/31/2021 12/30/2020 Change Revenue $ 862,165 $ 201,700 $ 660,465 Cost of goods sold 272,082 51,890 220,192 Gross profit 590,083 149,810 440,273 Selling, general and administrative expenses 5,546,767 4,401,633 1,145,134 Research and development 414,751 — 414,751 Depreciation and amortization 1,034,486 1,222,438 (187,952) Total operating expenses 6,996,004 5,624,071 1,371,933 Loss from operations (6,405,921) (5,474,261) (931,660) Other Income (Expense) Gain (loss) on investments (2,244,951) 3,152,702 (5,397,653) Gain on sale of membership interests in Comstock Mining, LLC — 18,275,846 (18,275,846) Change in estimated fair value of contingent forward asset — 765,880 (765,880) Interest expense (168,881) (421,887) 253,006 Interest income 1,017,947 473,681 544,266 Change in fair value of derivative instruments (13,155,946) 427,838 (13,583,784) Impairment of goodwill and intangible assets (6,394,610) — (6,394,610) Other income (expense) (2,979,363) (2,267,829) (711,534) Total other income (expense), net (23,925,804) 20,406,231 (44,332,035) Net income (loss) before deferred income tax benefit $ (30,331,725) $ 14,931,970 $ (45,263,695) Deferred income tax benefit 5,748,105 — 5,748,105 Net income (loss) $ (24,583,620) $ 14,931,970 $ (39,515,590) COMPONENTS OF REVENUES AND EXPENSES Our revenues are primarily derived from the sale of supporting engineering and related services and other returns generated by our investments. Our costs of sales primarily include allocable labor, materials and incidental expenses incurred in connection with our provision of services. Selling, general and administrative expenses consist of payroll, office expenses, insurance and professional fees for marketing, selling, legal, consulting, accounting and investor relations activities. Payroll, including employee compensation, and benefits, are the largest single category of expenditures in selling, general and administrative expenses. Other income (expense) includes interest income, interest expenses, income or expenses relating equity gains or losses in affiliates, impairment losses of goodwill and intangible assets, change in fair value of derivative assets and notes receivable, gain (loss) on investments and other non-operating items. RESULTS OF OPERATIONS Year Ended December 31, 2021 Compared to Year Ended December 31, 2020 Revenues for the year ended December 31, 2021, increased to $862,165 from $201,700 for 2020, as a result of higher engineering services revenue, attributable to our 2021 acquisition of Comstock Engineering. 49 Costs of sales for the year ended December 31, 2021, increased to $272,082 as compared to $51,890 for 2020, primarily resulting from costs associated with engineering sales that were not incurred in 2020. Gross profit correspondingly increased to $590,083 for the year ended December 31, 2021, as compared to $149,810 for 2020, with substantially all of the increase attributable to higher engineering service sales. Selling, general and administrative expense for the year ended December 31, 2021 increased to $5,546,767 from $4,401,633 for 2020, as a result of higher employee costs related to new employees from acquisitions, stock-based compensation related to 2021 grants and higher professional fees related to our recent acquisitions. Revenue, costs of sales, gross profit, and selling, general and administrative expenses in future periods will vary significantly depending on a number of factor, including the amount of renewable energy products that we produce an sell, the market prices for those products, the extent to which we secure and collect reasonable royalties, the degree to which we can provide event=driven engineering services, and the costs associated with each component of the aforementioned revenues. During 2021, the Company recorded a loss on investments of $2,244,951, as compared to a gain on investments in 2020 of $3,152,702. The 2021 loss was primarily due to an increase of $2,286,867 in the fair value of Tonogold common shares and a realized gain of $66,821 in Tonogold common shares sold, offset in part by a decrease in the market value of other securities. During 2020, the Company recorded a gain of $18,275,846 from the sale of membership interest in Comstock Mining, LLC, the entity that owns the Lucerne mine, the related reclamation liability, and permits. There was no comparable transaction in 2021. The change in fair value of our derivative instruments increased by $13,583,784, consisting primarily of $13,155,946 in 2021 losses from changes in the fair value of derivative assets and liabilities related to new investments and acquisitions, primarily those associated with potential make whole obligations for minimum value commitments on the Company’s common shares, including $6,660,000 for Quantum Generative Materials LLC ("GenMat"), $6,300,000 for LP Biosciences LLC ("LPB"), $2,743,162 from the LINICO purchase from the former founder, somewhat offset by $2,049,966 in gains from changes in fair value associated with similar make whole obligation from the original LINICO purchase. The increase from 2020, was also attributable to $427,838 in 2020 gains, primarily from $403,179 in fair value changes in the MCU derivatives. For the year ended December 31, 2021, the Company recorded $6,394,610 for the impairment of goodwill and other intangibles associated with the full impairment the MANA intangible asset related to the termination of the LP Biosciences contract during the first quarter 2022, consisting of $6,163,846 associated with the goodwill impairment and $230,764 associated with other intangibles impairment. There were no comparable impairments during 2020. Other expenses, net, for the year ended December 31, 2021, were $2,979,363, primarily consisting of $1,076,258 in expenses associated with our withdrawal from the LP Biosciences transaction, $2,049,070 of losses from equity method investments including $1,282,336 from LINICO, $675,713 from GenMat, $718,500 of other losses from valuation and impairment losses on notes receivable, and, $168,881in interest expense, which amounts were partially offset by $437,699 of other income, primarily consisting of amendment fees from Tonogold. Other expenses, net for the year ended December 31, 2020 were $2,267,829, primarily consisted of a $2,544,000 loss related to fair value adjustments to the Tonogold preferred shares and losses from the change in fair value of the Tonogold note receivable of $642,997, which amounts were partially offset by other gains of $261,170 for PPP loan forgiveness, $234,944 in reimbursements of acquisition costs and $425,185 of other income, net, from sales of mining claims, settlement of amounts due to vendors, and other expenses. Interest income increased by $544,266 for the year ended December 31, 2021, as compared to 2020, primarily due to an increase in the average Tonogold outstanding note receivable principal balance from 2021, and an increase in the average interest rate, due to an increase from the stated 12% rate to the 18% default rate since September 2021. Interest expense decreased by $253,006 for the year ended December 31, 2021, as compared to 2020, primarily due to lower average debt outstanding, including the early retirement of prior debt obligations in March 2021, which amounts were partially offset by a higher interest rate and discounts on the Promissory Notes. Deferred income tax benefit for the year ended December 31, 2021, was $5,748,105, resulting from temporary differences between our accounting and tax treatment associated with our recent acquisitions. There were no comparable deferred income tax benefits in 2020. 50 Net loss for the year ended December 31, 2021, was $24,583,620 as compared to net income of $14,931,970 for the year ended December 31, 2020. The decrease of $39,515,590 was primarily the result of the gain of $18,275,846 on the sale of Comstock Mining LLC, and other gains on investments of $3,152,702 during 2020, that did not recur in 2021, coupled with the 2021 other expenses of $2,979,363, changes in fair value of derivative instruments of $13,155,946, and losses on investments of $2,244,951, which amounts were partially offset deferred tax benefits of $5,748,105, and to a lesser extent, higher interest income. LIQUIDITY AND CAPITAL RESOURCES Our financial position and liquidity is based on our ability to generate cash flows from our operations, as well as our net sources of capital from financing as generally compared to our net uses of capital from investing activities. Our cash balances at December 31, 2021 and December 31, 2020 were $5,912,188 and $2,431,944, respectively. The Company had current assets of $13,828,989 and current liabilities of $23,909,510, representing working capital deficit of $10,080,521 at December 31, 2021. Our primary source of liquidity during 2021 was cash from financing activities. During the year ended December 31, 2021, we used $7,492,402 in cash in our operating activities and $16,097,485 in our investing activities, and we generated $27,070,131 in cash from our financing activities. During the year ended December 31, 2020, we used $3,764,575 in cash in our operating activities, and we sourced $3,207,696 from our investing activities and $1,972,966 from our financing activities. During 2021, 9,220,123 common shares were issued through equity issuance and private placement agreements, at an average price per share of $2.97 corresponding to net proceeds of $26,335,500, net of cash issuance fees of $1,064,498. During 2020, 5,747,608 common shares were issued through equity issuance and private placement agreements at an average price per share of $0.73 and net proceeds of $4,067,552, net of cash issuance fees of $130,186. We intend to fund our operations over the next twelve months from existing cash and cash equivalents, planned sales and profits from our cellulosic technology and related engineering services, planned sales of strategic and other investments, including our existing non-mining assets and investments in Tonogold and previously funded capital into our LINICO subsidiary. Based on these expected funding sources, management believes we will have sufficient funds to sustain our operations and meet our commitments under our investment agreements during the 12 months following the date of issuance of the condensed consolidated financial statements included herein. While we have been successful in the past in obtaining the necessary capital to support our operations, including registered equity financings from our existing shelf registration statement, borrowings and various other means, there is no assurance we will be able to obtain additional equity capital or other financing, if needed. Net cash used in operating activities for the year ended December 31, 2021 increased by $3,727,827 from 2020 primarily from increases in operating costs, decreased cash reimbursements, partially offset by increased revenue, and net uses of cash for working capital. Net cash used in investing activities for the year ended December 31, 2021 increased by $19,305,181 from the comparable year ended 2020 primarily due to $13,320,537 for cash payments incurred in connection with our acquisitions and investments as well as $3,285,000 in advances to SSOF during 2021, as compared to $6,700,929 of proceeds from investing activities in 2020, primarily from the sales and collections on Tonogold securities as well as $1,650,000 in advances to SSOF. Net cash provided by financing activities for the year ended December 31, 2021 increased by $25,097,165 from 2020, primarily from a net increase in proceeds from the issuance of common stock of $22,267,949 during 2021 as compared to 2020, plus a change of $3,076,354 resulting from increased debt in 2021, as compared to a net use of cash from debt reductions in 2021. Risks to our liquidity could result from future operating expenditures above management’s expectations, including but not limited to exploration, pre-development, research and development, selling, general and administrative, and investment related expenditures in excess of planned proceeds from the sale of Tonogold securities, repayment of the Note and advances to SSOF and sale of the Silver Springs Properties, amounts to be raised from the issuance of equity under our existing shelf registration statement, declines in the market value of properties held for sale, or declines in the share price of our common stock would adversely affect our results of operations, financial condition and cash flows. If we were unable to obtain any necessary additional funds, this could have an immediate material adverse effect on liquidity and raise substantial doubt about our ability to continue as a going concern. In such case, we could be required to limit or discontinue certain business plans, activities or operations, reduce or delay certain capital expenditures or investments, or sell certain assets or businesses. There can be no assurance that we would be able to take any such actions on favorable terms, in a timely manner, or at all. 51 OUTLOOK The acquisitions and business integrations during 2021 established our new renewable energy platform for growth. We will innovate and commercialize technologies that contribute to global decarbonization by efficiently converting under-utilized natural resources into renewable fuels and electrification products that shift supply chains away from fossil fuels. We will also lead and support the adoption and growth of a balanced net zero ecosystem based on the feedstocks unlocked by our technologies, with powerful embedded economic incentives for our clients, their industries, and the populations they serve to decarbonize. We will rapidly achieve exponential growth and extraordinary financial, natural, and social gains by building, owning, and operating a fleet of advanced carbon neutral extraction and refining facilities, by selling an array of complimentary process solutions and related services, and by licensing selected technologies to qualified strategic partners Our goal is to generate over $16 billion in revenue on an annualized basis by 2030, by producing and selling renewable energy products that enable us, our clients, and their downstream stakeholders to reduce greenhouse gas emissions by at least 100 million metric tons per year. Meeting that objective would offset more than 234 million barrels per year of fossil fuel, or about 6% of the U.S. transportation burn, and require an estimated 8% of the existing biomass residues produced annually in the U.S. Such scales are achievable by leveraging existing external fuel infrastructure. Our expanded team has extensive experience in the renewable fuels industry, having designed and built several dozen renewable fuel production facilities in the U.S. We have already made remarkable progress. We are currently building commercial pilot scale cellulosic fuels and LIB facilities, and we are preparing to commence operations at our full-scale LIB recycling facility later this year. We have also made significant strides in developing and establishing our new facilities and forging new revenue and licensing streams that we will soon share. We have also made meaningful progress and will complete the monetization of our non-strategic assets, as quickly as possible, while funding our new businesses and limiting our outlook and focus to the objectives outlined above. The Company’s Annual General Meeting is scheduled for May 26, 2022, where we plan presenting a more detailed outlook of our business plans, schedules, and near-term revenues and showcasing our renewable energy businesses. CRITICAL ACCOUNTING ESTIMATES The SEC has requested that all registrants address their most critical accounting policies. The SEC has indicated that a “critical accounting policy” is one which is both important to the representation of the registrant’s financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We base our estimates on past experience and on various other assumptions our management believes to be reasonable under the circumstances, the results of which form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results will differ, and may differ materially from these estimates under different assumptions or conditions. Additionally, changes in accounting estimates could occur in the future from period to period. Our management has discussed the development and selection of our most critical financial estimates with the Audit and Finance Committee of our Board of Directors. The following paragraphs identify our most critical accounting policies: Derivatives We accounted for our convertible debt in accordance with ASC 815, Derivatives and Hedging as the conversion feature embedded in the convertible debentures could result in the note principal and related accrued interest being converted to a variable number of our common shares. The conversion feature on these debentures is variable and based on trailing market prices. It therefore contains an embedded derivative. The fair value of the conversion feature was calculated when the debentures were issued, and we recorded a note discount and derivative liability for the calculated value. We recognize interest expense for accretion of the note discount over the term of the note. The conversion liability is valued at the end of each reporting period and results in a gain or loss for the change in fair value. Due to the volatile nature of our stock, the change in the derivative liability and the resulting gain or loss will usually be material to our results. Determination of Fair Values Management determines the fair value of a financial instrument based on the amount that could be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value 52 is calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity. In addition, the fair value of liabilities includes consideration of non-performance risk, including the party’s own credit risk. The Company applies the acquisition method of accounting for business combinations to all acquisitions where the Company gains a controlling interest, regardless of whether consideration was exchanged. With respect to business combinations, the Company (a) recognizes and measures the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree; (b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and, (c) discloses the nature and financial effects of the business combination. Accounting for acquisitions requires us to recognize, separately from goodwill, the assets acquired and the liabilities assumed at their acquisition-date fair values. Goodwill as of the acquisition date is measured as the excess of the fair value of consideration transferred and the net acquisition-date fair values of the assets acquired and liabilities assumed. While the Company uses our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, the estimates inherently are uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, the Company may record adjustments to the assets, including intangible assets acquired and liabilities assumed with corresponding offsets to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired and liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations. Deferred tax liabilities (“DTLs”) created in business combinations for the difference between the historical carryover basis of assets for tax purposes and the stepped-up fair value basis for book purposes are recognized as an increase to goodwill. All transactions in which goods or services are received for the issuance of shares of our common stock or options to purchase shares of our common stock are accounted for based on the fair value of the equity interest issued. The fair value of shares of common stock is determined based upon the closing price per share of our common stock on the date of issuance and other applicable inputs. The Company recognizes stock-based compensation for common stock grants evenly over the related vesting period. The fair value of market condition performance share awards is determined based on path-dependent valuation techniques and inputs including the closing price per share of our common stock at date of grant, volatility and the risk-free interest rate. The Company recognizes stock-based compensation for market condition performance share awards evenly over the derived service period resulting from the path-dependent valuation. The fair value of performance condition share awards is determined based on the closing price per share of our common stock at date of grant and the probability of achieving the performance condition during the term of the award agreement. The Company recognizes stock-based compensation for performance condition share awards evenly over the term of the award agreement. The Company recognizes forfeitures of unvested common stock, performance shares and stock option grants as they occur. Impairment of Mineral Rights and Properties, Plant and Equipment The Company assesses its mineral rights and properties, plant and equipment for possible impairment whenever events or changes in circumstances indicate the carrying value of the assets may not be recoverable. Such indicators include changes in the Company’s business plans, changes in precious metal prices and significant downward revisions of estimated mineralization quantities. If the carrying value of an asset exceeds the future undiscounted cash flows expected from the asset, an impairment charge is recorded for the excess of carrying value of the asset over its estimated fair value. Determination as to whether and how much an asset is impaired involves management estimates on highly uncertain matters such as future commodity prices, the effects of inflation and technology improvements on operating expenses, and the outlook for global or regional demand conditions for gold and silver. However, the impairment reviews and calculations are based on assumptions that are consistent with the Company’s business plans and long-term investment decisions. Management does not believe there are impairments present in mineral rights and properties, plant, and equipment. At the end of each reporting period, management considers whether impairment indicators exist to evaluate if a debt investment security or loan is impaired and, if so, record an impairment loss . At the end of each reporting period, management reassesses whether an equity investment security without a readily determinable fair value qualifies to be measured at cost less impairment, consider whether impairment indicators exist to evaluate if an equity investment security is impaired and, if so, record an impairment loss. Management reviews purchased intangible assets for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. We review indefinite-lived intangibles for impairment annually and more frequently if events or changes in circumstances indicate that it is more likely than not that the asset is impaired. We measure recoverability of these assets by comparing the carrying amounts to the future undiscounted cash flows that the assets or asset group are 53 expected to generate. If the carrying value of the assets or asset group are not recoverable, impairment is measured and recorded as the amount by which the carrying value exceeds its fair value. Goodwill is tested for impairment at the reporting unit level on an annual basis, and on an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. Management performs its annual goodwill impairment tests at December 31. Reclamation and Remediation Obligations Reclamation costs are allocated to expense over the life of the related assets and are periodically adjusted to reflect changes in the estimated present value resulting from the passage of time and revisions to the estimates of either the timing or amount of the reclamation and remediation costs. Reclamation obligations are based on when the spending for an existing environmental disturbance will occur. We review, on at least an annual basis, the reclamation obligation at each mine site in accordance with guidance for accounting for asset retirement obligations. Reclamation obligations for inactive mines are accrued based on management’s best estimate of the costs expected to be incurred at a site. Such cost estimates include, where applicable, ongoing care, maintenance and monitoring costs. Changes in estimates at inactive mines are reflected in earnings in the period an estimate is revised. Accounting for reclamation and remediation obligations requires management to make estimates unique to each mining operation of the future costs we will incur to complete the reclamation and remediation work required to comply with existing laws and regulations. Actual costs incurred in future periods could differ from amounts estimated. Additionally, future changes to environmental laws and regulations could increase the extent of reclamation and remediation work required. Any such increases in future costs could materially impact the amounts charged to earnings for reclamation and remediation. Income Taxes Our income tax expense and deferred tax assets and liabilities reflect management’s best assessment of estimated future taxes to be paid. Deferred income taxes arise from temporary differences between the tax and financial statement recognition of revenue and expense. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, we develop assumptions including the amount of future state, federal and foreign pretax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates that we are using to manage the underlying businesses. Valuation allowances are recorded as reserves against net deferred tax assets by the Company when it is determined that net deferred tax assets are not likely to be realized in the foreseeable future. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized.