This tool examines the true geometric angles between the faces. If an angle between two adjacent faces is lower than a given threhold value, the respective normals are set so that shading appears smooth over the edge between the faces. Otherwise normals are set to match the true geometric normal, and the edge will appear sharp.
In object mode, all normals are processed. The tool also flips all normals to a consistent direction. In point/edge/face editing mode, the tool changes only selected areas of the surface, and keeps the normal direction at the same side of the face as it originally was.